Can Countries with Severe Labor Market Frictions Gain from Globalization?

Abstract

The interaction between increased Southern trade integration (globalization) and labor market frictions is analyzed in a dynamic general-equilibrium North–South nonscale growth model with endogenous Northern innovation and endogenous Southern imitation. The qualitative employment, growth, and relative-wage effects of globalization are shown to depend crucially on the degree of Northern labor market frictions. I demonstrate that only Northern countries with particularly large labor market adjustment costs for both firms and workers benefit from globalization in terms of permanently lower unemployment, temporarily faster growth, and permanently higher wages. This is because of the resulting general-equilibrium feedback effects of Northern labor market frictions that deter Southern imitation incentives. The result does not imply the recommendation to increase Northern labor market rigidities, but it challenges the common belief that labor market flexibility helps Northern countries to better adjust to the “globalization threat” coming from the South.