Labor Market Rigidities, Trade, and Unemployment

63 Pages Posted: 17 Nov 2009

See all articles by Elhanan Helpman

Elhanan Helpman

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Oleg Itskhoki

Princeton University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: October 2009

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, which include efficiency of matching, cost of vacancies, firing costs, and unemployment benefits. We study the interaction of labor market rigidities and trade impediments in shaping welfare, trade flows, productivity, and unemployment. 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 from 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. In particular, better labor market institutions do not ensure lower unemployment, and unemployment and welfare can both rise in response to a policy change or falling trade costs.

Keywords: labor market frictions, productivity, trade, unemployment

JEL Classification: F12, F16, J64

Suggested Citation

Helpman, Elhanan and Itskhoki, Oleg, Labor Market Rigidities, Trade, and Unemployment (October 2009). CEPR Discussion Paper No. DP7502. Available at SSRN: https://ssrn.com/abstract=1507499

Elhanan Helpman (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
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National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
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Centre for Economic Policy Research (CEPR)

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United Kingdom

Oleg Itskhoki

Princeton University - Department of Economics ( email )

Fisher 306
Princeton, NJ 08544-1021
United States
+1 (609) 258-5493 (Phone)

HOME PAGE: http://www.princeton.edu/~itskhoki

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