Unemployment in an Interdependent World



Similarly, we consider trade costs in [1, 1.6] , i.e., ad valorem tariff equivalents from 0 to
60%. Remember that the benchmark value of τ is 1.3 for all country-pairs ij (or: 30%).
For our first investigation we assume L
i = L, hence countries are symmetric with respect
to all things except the unemployment benefits. The main insights from these experiments
are summarized in Results 1a to 1c and visualized in Figure 2. The left-hand diagram in
Figure 2 shows the unemployment rate in country 1 for various values of trade costs on
the x-axis (equal between all countries) and unemployment benefits in country 1 on the
y-axis. Trade costs are in percent, i.e., τ(%) = (τ
- 1) × 100. The right-hand diagram
shows the unemployment rate in country 2 for various values of trade costs on the x-axis
and unemployment benefits in country 1 on the y-axis (country three is not shown, as the
effects there are equal to the ones in country two).

Result 1a [Globalization and labor markets]

Trade liberalization leads to lower unemployment in all countries.

Result 1a extends the theoretical findings in Felbermayr, Prat, and Schmerer (2008)
to asymmetric countries. As shown in Figure 2, in all countries, unemployment is lowest
for minimum values of trade costs and unemployment benefits of country 1. If trade costs
decrease from 60% to 0%, unemployment in all countries falls from about 8% to 6.5%.
So, trade liberalization can have a very substantial impact on the long-run structural rate
of unemployment.

The intuition for Result 1a is as follows. Trade liberalization affects the equilibrium
productivity distribution through the selection effect introduced in Melitz (2003): on the
one hand, inefficient firms in all countries suffer from increased import competition by
more efficient foreign firms, their residual demands and revenue levels fall, and they are no
longer able to cover operating fixed costs; on the other hand, the most efficient domestic
firms can expand due to increased foreign sales. Hence, there is a
cleansing effect of trade,
and the average domestic firm
φii is now more efficient than before trade liberalization. It
has larger sales and a lower price, p
ii [pii] , but - due to the standard assumption σ > 1,
the price falls by less than productivity increases. It follows that
piipii [pii], the flow
value of an additional filled vacancy, increases due to trade liberalization. On top of this,
the aggregate price level goes down as prices of available varieties are on average lower.
Hence, the term Φ
i piipii [pii] goes up in all countries. To sum up, trade liberalization
strengthens the average firm’s incentives to post vacancies in all countries, leading to
lower unemployment in all countries.

This result is in line with aggregate empirical evidence presented by Dutt, Mitra, and
Ranjan (2009), or Felbermayr, Prat, and Schmerer (2009). However, it is in contrast to
a number of other theoretical contributions, such as Egger and Kreickemeier (2009) or
an array of recent contributions by Helpman, Itskhoki, and Redding. The first authors
focus on a different labor market paradigm - fair wages. Trade liberalization would lead to
trade dispersion, which is deemed unfair and needs to be compensated by a higher average
wage level. This mechanism drives up the unemployment rate. The latter papers use the
search-matching model as we do. However, in addition they make various other structural
assumptions that condition the effect of trade liberalization on unemployment. Helpman
and Itskhoki (2008), and Helpman, Itskhoki, and Redding (2008a, 2008b), assume the
existence of a num´eraire sector with costless international trade, perfect competition,

19



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