Labor Market Rigidities, Trade and Unemployment

Abstract

We study a two-country two-sector model of international trade in which one sector produces homogeneous products while the other produces differentiated products. The differentiated-product industry has firm heterogeneity, monopolistic competition, search and matching in its labor market, and wage bargaining. Some of the workers searching for jobs end up being unemployed. Countries are similar except for frictions in their labor markets. We study the interaction of labor market rigidities and trade impediments in shaping welfare, trade flows, productivity, price levels and unemployment rates. We show that both countries gain from trade but that the flexible country --which has lower labor market frictions --gains proportionately more. A flexible labor market confers comparative advantage; the flexible country exports differentiated products on net. A country benefits by lowering frictions in its labor market, but this harms the country's trade partner. And the simultaneous proportional lowering of labor market frictions in both countries benefits both of them. The model generates rich patterns of unemployment. Specifically, trade integration --which benefits both countries --may raise their rates of unemployment. Moreover, differences in rates of unemployment do not necessarily reflect differences in labor market rigidities; the rate of unemployment can be higher or lower in the flexible country. Finally, we show that the flexible country has both higher total factor productivity and a lower price level, which operates against the standard Balassa-Samuelson effect. Elhanan IntroductionInternational trade and international capital ‡ows link national economies. Although such links are considered to be bene…cial for the most part, they produce an interdependence that occasionally has harmful e¤ects. In particular, shocks that emanate in one country may negatively impact trade partners. On the trade side, links through terms-of-trade movements have been widely studied, and it is now well understood that, say, capital accumulation or technological change can worsen a trade partner's terms of trade and reduce its welfare. On the macro side, the transmission of real business cycles has been widely studied, such as the impact of technology shocks in one country on income ‡uctuations in its trade partners.Although a large literature addresses the relationship between trade and unemployment, we fall short of understanding how these links depend on labor market institutions. There is growing awareness that institutions a¤ect comparative advantage and trade ‡ows. Levchenko (2007) Our two-sector model incorporates Mortensen-Pissarides-type frictions into a sector that produces di¤erentiated products; another sector manufactures homogeneous goods under constant returns to scale. In the di¤erentiated-product sector heterogeneous …rms compete monopolistically, as in Melitz (2003). These …rms exercise market power in the product market on the one hand, and bargain with workers over wages on the other. 7 As in models wit...

Rigidities In Employment Protection And Exporting

“…In this paper, I present empirical evidence that supports the theoretical results of Helpman and Itskhoki (2010) 4 .…”

“…The analysis is based on two studies by Melitz (2003) and Helpman and Itskhoki (2010 an economy with heterogeneous producers as in Melitz (2003). With this setup, they allow firms to exercise market power in the product market on one hand and bargain with workers over wages on the other.…”

“…These regulations can also have detrimental effects on exporting. In a recent study, Helpman and Itskhoki (2010) construct a theoretical model that explains how rigidities in labor markets impact trade. In a general equilibrium model of trade with two countries, they show that labor market flexibility is a source of comparative advantage for firms.…”

“…Both Melitz (2003) and Helpman and Itskhoki (2010) present models that are constructed for manufacturing firms.…”

Competitiveness, labor market institutions, and monetary policy

“…They show that different labor market rigidities provide a form of Ricardian competitive advantage, meaning that firms are more competitive, hence more resilient to external shocks, in the presence of lower [7]. As a result, in countries with weaker labor market institutions, increasing openness to trade might increase unemployment.…”