In chapter 1, I investigate how resource reallocation can affect the change of trade patterns and welfare effect of trade. Specifically, trade liberalization can lead to a surge in the trade of intermediate goods. Increased accessibility to the critical intermediate goods through international trade can create an opportunity to initiate the expansion of capital-intensive industries, which can be referred to as specialization dynamics for developing countries. For this to occur, domestic resources must be reallocated toward high productivity sectors. In this paper, I capture the reallocation frictions in the labor market with sectoral wage differentials. A general equilibrium analysis explains the relationship between specialization dynamics and resource reallocation. I find that higher distortions in the skilled labor market negatively affect the productivity gain in the capital-intensive sector. This effect lowers overall welfare gains from trade for the countries with higher labor market distortions. In chapter 2, I deepen the argument in chapter 1 by extending the model to dynamic structural model. Sluggish labor market response to trade liberalization can reduce the welfare gains from trade by impeding resource reallocation. I estimate sectoral labor switching costs for 30 countries in a dynamic discrete choice problem to derive welfare implications of labor market rigidity through comparative cross-country analysis. On average, workers have to give up approximately 4-years of income to switch to another sector. Compared with labor market flexibility measures, labor switching costs are low when the country has a flexible labor market and vice versa. In addition, I embed the switching cost estimates into a dynamic multi-country, multi-sector Eaton and Kortum model. In a counterfactual trade liberalization simulation with a 20% drop in trade costs, high switching costs lead to a slower response in the labor market, which in turn, negatively affect a country's ability to achieve welfare gains from trade.
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