Trade Shocks and Labor Adjustment: A Structural Empirical Approach

Abstract

The welfare effects of trade shocks depend crucially on the nature and magnitude of the costs workers face in moving between sectors. The existing trade literature does not directly address this, assuming perfect mobility or complete immobility, or adopting reduced-form approaches to estimation. We present a model of dynamic labor adjustment that does, and which is, moreover, consistent with a key empirical fact: that intersectoral gross flows greatly exceed net flows. Using an Euler-type equilibrium condition, we estimate the mean and the variance of workers' switching costs from the U.S. March Current Population Surveys. We estimate high values of both parameters, implying both slow adjustment of the economy, and sharp movements in wages, in response to a trade shock. Simulations of a trade liberalization indicate that despite the high estimated adjustment cost, in terms of lifetime welfare, the liberalization is Pareto-improving. The explanation for this surprising finding --which would be missed by a reduced-form approach --is that the high variance to costs ensures high rates of gross flow; this helps spread the liberalization's benefits around.

A mapping of labor mobility costs in the developing world

“…For the simulation of section 6, however, it will be necessary to specify the functional form of the production and demand functions. See also Artuc et al (2010) for a thorough discussion. 9 Note that this means that the calibration is done in each step of the minimization search.…”

“…For estimation purposes, because of the aggregate nature of our data, we will assume that workers have perfect foresight so that they can make perfect predictions of the evolution of s t (see Section 3). With more detailed data, as in Artuc et al (2010), the model can accommodate first order Markov processes for s t . For presentational purposes, we keep a general notation in this section, and simplify the formulas for the case of perfect foresight in the estimation section.…”

“…When the economy is hit by the trade shock, we solve for the transition path to the new steady state. Details on the structure of the simulations and the algorithms to find the solutions are in Artuc et al (2008Artuc et al ( , 2010.…”

“…Artuc et al (2010) derive the estimators of these mobility costs based on panel data. The panels are used to build measures of gross employment flows across sectors that, together with utility compensating differentials, identify C, ν, and η i .…”

“…We adopt the labor adjustment analytical framework of Artuc et al (2010), where workers can move across sectors (e.g., in response to wage differences) at a cost. This cost has a common and an idiosyncratic component.…”