Unemployment in an Interdependent World

Country 1, ∆ Unemployment

Country 2, ∆ Unemployment

Figure 10: Change in unemployment [on the vertical axis] as a function of centrality and
size of the “bad” country 1 for a given increase of country 1’s search costs from 1 to 1.3
when wages are perfectly flexible.

in results indeed stems from wage rigidity.

Result 7 summarizes these findings.

Result 7 [The role of real wage rigidity]

The size of international spill-over effects depends on the degree of wage rigidity. When
wages are perfectly flexible, an increase in country 1’s search costs has small effects on
country 2 and 3’s unemployment rates. When real wages are perfectly rigid, the same
scenario leads to an increase in unemployment in countries 2 and 3 of up to 45% of the
effect in country 1.

4 Empirical evidence

In this section, we use panel data on labor market institutions and unemployment rates
for 20 rich OECD countries for 1982-2003. Our aim is not to provide a formal test of
our theoretical model, but rather to check whether the empirical evidence is in line with
three key predictions of our model, namely: (i) controlling for business cycle comovement,
unemployment rates are positively correlated across countries; (ii) the unemployment rate
of a country is not only determined by its own labor market institutions but also by those
of other countries; (iii) the relative importance of foreign countries’ institutional features
depends crucially on openness and relative size; (iv) the size of the spill-over effects
depends on the degree of real wage rigidity.

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