Abstract
This paper constructs a dynamic model of trade between two countries, one with flexible wages (America) and another with a rigid wage for less-skilled workers (Europe). The model incorporates global R&D races that generate random switches in trade patterns. Furthermore, rigid wages in Europe give rise to unemployment in that region. Using the model, I study the role of international trade and labor market institutions in mediating local and global shocks. I also investigate the factors behind the stylized trends in Europe and the US: rising European unemployment, rising wage inequality (especially for the US), skill upgrading, and rising R&D intensities. I find that technology shocks coupled with institutional response from the European labor markets can generate results consistent with the trends.
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