Rationale: Congenital diaphragmatic hernia (CDH) is characterized by incomplete closure of the diaphragm and lung hypoplasia. The pathophysiology of lung defects in CDH is poorly understood. Objectives: To establish a translational model of human airway epithelium in CDH for pathogenic investigation and therapeutic testing. Methods: We developed a robust methodology of epithelial progenitor derivation from tracheal aspirates of newborns. Basal stem cells (BSCs) from CDH patients and preterm and term, non-CDH controls were derived and analyzed by bulk RNA-sequencing, ATAC-sequencing, and air-liquid-interface differentiation. Lung sections from fetal human CDH samples and the nitrofen rat model of CDH were subjected to histological assessment of epithelial defects. Therapeutics to restore epithelial differentiation were evaluated in human epithelial cell culture and the nitrofen rat model of CDH. Measurements and Main Results: Transcriptomic and epigenetic profiling of CDH and non-CDH basal stem cells reveals a disease-specific, proinflammatory signature independent of severity or hernia size. In addition, CDH basal stem cells exhibit defective epithelial differentiation in vitro that recapitulates epithelial phenotypes found in fetal human CDH lung samples and fetal tracheas of the nitrofen rat model of CDH. Furthermore, steroid treatment normalizes epithelial differentiation phenotypes of human CDH basal stem cells in vitro and in nitrofen rat tracheas in vivo. Conclusions: Our findings have identified an underlying proinflammatory signature and BSC differentiation defects as a potential therapeutic target for airway epithelial defects in CDH.