Journal Article

Labour Market Rigidities, Trade and Unemployment

Elhanan Helpman and Oleg Itskhoki

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 77, issue 3, pages 1100-1137
Published in print July 2010 | ISSN: 0034-6527
Published online July 2010 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2010.00600.x
Labour Market Rigidities, Trade and Unemployment

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We study a two-country, two-sector model of international trade in which one sector produces homogeneous products and the other produces differentiated products. Both sectors are subjected to search and matching frictions in the labour market and wage bargaining. As a result, some of the workers searching for jobs end up being unemployed. Countries are similar except for frictions in their labour markets, such as efficiency of matching and costs of posting vacancies, which can vary across the sectors. The differentiated-product industry has firm heterogeneity and monopolistic competition. We study the interaction of labour market rigidities and trade impediments in shaping welfare, trade flows, productivity, and unemployment. We show that both countries gain from trade. A country with relatively lower frictions in the differentiated-product industry exports differentiated products on net. A country benefits from lowering frictions in its differentiated sector's labour market, but this harms the country's trade partner. Alternatively, a simultaneous, proportional lowering of labour market frictions in the differentiated sectors of both countries benefits both of them. The opening to trade raises a country's rate of unemployment if its relative labour market frictions in the differentiated sector are low, and it reduces the rate of unemployment if its relative labour market frictions in the differentiated sector are high. Cross-country differences in rates of unemployment exhibit rich patterns. In particular, lower labour market frictions do not ensure lower unemployment, and unemployment and welfare can both rise in response to falling labour market frictions and falling trade costs.

Journal Article.  17861 words.  Illustrated.

Subjects: Economics

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