Chaoqun Zhan, Ph.D. in Economics, is an Assistant Professor in the Department of Accounting, Economics and Finance at Hong Kong Baptist University. His research focuses on global value chains, multinational enterprises, and the Chinese economy. His work has been published in leading domestic and international academic journals such as the Journal of International Economics, Journal of Development Economics, and China Economic Quarterly. He has received the Ann Tse Kai International Trade Research Award and a nomination award at the 2nd Masahiko Aoki Economics Paper Prize. He has been principal investigator on one General Research Fund grant from the Hong Kong Research Grants Council, one Youth Project grant from the National Natural Science Foundation of China.

This paper proposes a new mechanism through which trade liberalization affects the labor share. We show theoretically that reductions in input tariffs induce substitution of primary inputs for intermediate inputs, changing the cost share of intermediate inputs and hence the labor share in the presence of markups. We empirically test this new mechanism by utilizing tariff reductions around China’s WTO accession. Reductions in input tariffs significantly increase firm labor share. Changes in the cost share of intermediate inputs account for around a half of this effect. Estimates of the elasticity of substitution between primary and intermediate inputs are consistent with changes in the cost share. Global country-industry evidence from 43 countries confirms the finding. These results suggest that the intermediate input substitution mechanism is present and quantitatively important. As intermediate trade accounts for the majority of global trade, our study points to a previously ignored but important aspect of the impact of international trade on the labor share.