Trade and the (Dis)Incentive to Reform Labor Markets: The Case of Reform in the European Union

FRB of Philadelphia Working Paper No. 04-18

CIRPEE Working Paper No. 07-38

46 Pages Posted: 28 Oct 2004

See all articles by George Alessandria

George Alessandria

Federal Reserve Bank of Philadelphia

Alain G. Delacroix

Purdue University - Krannert School of Management

Date Written: November 2007

Abstract

In a closed economy general equilibrium model, Hopenhayn and Rogerson (1993) find large welfare gains to removing firing restrictions. We explore the extent to which international trade alters this result. When economies trade, labor market policies in one country spill over to other countries through their effect on the terms of trade. A key finding in the open economy is that the share of the welfare gains from domestic labor market reform exported substantially exceeds the share of the goods exported. In our baseline case, 105 percent of the welfare gains are exported even though the domestic economy only exports 30 percent of its goods. Thus, with international trade a country receives little to no benefit, and possibly even loses, from unilaterally reforming its labor market. A coordinated elimination of firing taxes yields considerable benefits. We find the welfare gains to the U.K. from labor market reform by its continental trading partners of 0.21 percent of steady state consumption. This insight provides some explanation for recent efforts toward labor market reform in the European Union.

Keywords: Firing costs, international trade, labor market reform

JEL Classification: D78, E24, E61, F16, F42, J65

Suggested Citation

Alessandria, George A. and Delacroix, Alain G., Trade and the (Dis)Incentive to Reform Labor Markets: The Case of Reform in the European Union (November 2007). FRB of Philadelphia Working Paper No. 04-18; CIRPEE Working Paper No. 07-38. Available at SSRN: https://ssrn.com/abstract=606644 or http://dx.doi.org/10.2139/ssrn.606644

George A. Alessandria (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States
(215) 574-6402 (Phone)
(215) 574-4364 (Fax)

Alain G. Delacroix

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

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