Abstract
AbstractThis paper proposes a multi-industry trade model with integrated capital and goods markets. Labor market imperfections in line with Mortensen and Pissarides (Job Creation and Job Destruction in the Theory of Unemployment, 1994) give rise to unemployment and a channel for the government to influence markets through institutional changes. Labor market interventions feedback into the product market through changes in a country’s competitiveness. Moreover, the distinction between high- and low-skill workers facilitates the analysis of skillbiased institutional changes that have stronger impact on certain skill groups. The comparative static exercise in this paper shows that high-skilled benefit from low-skill biased labor market reforms through higher wages. Lower labor costs reduce unemployment of the low-skilled and increases the reforming country’s competitiveness. One-sided labor market interventions have feedback effects through adjustments at the extensive margin, which affect all workers at home and abroad irrespective of their level of skill. Governments in the non-reforming countries may react to this loss in competitiveness by initiating cooperative labor market reforms instead.
Highlights
The establishment of a common currency union fueled a lively debate about labor market reforms and its effects on competitiveness and trade imbalances within the Euro area
This paper’s main contribution is to extend the Feenstra and Hanson (1996, 1997) international trade model by Pissarides (2000) search frictions in a way that enables the analysis of different types of labor market institutions on skill-specific wages, unemployment and the pattern of trade and foreign direct investment
This in turn implies that wages and capital flows can be affected by both, trade liberalization and changes in labor market institutions
Summary
The establishment of a common currency union fueled a lively debate about labor market reforms and its effects on competitiveness and trade imbalances within the Euro area. This pattern is consistent with labor market reforms that mainly affected low-skilled workers The analysis of those effects builds on a multi-industry North-South trade model that goes back to Feenstra and Hanson (1996, 1997), FH model . Larch and Lechthaler (2011) distinguish between high- and low-skill workers and analyze the effects of trade liberalization on skill-specific unemployment in a model with heterogeneous firms and search frictions. To summarize the stylized facts discussed in the motivation, standard labor market models predict that a higher capital to labor ratio rises labor productivity and wages in the South but decreases wages in capital outflow country This affects prices and competitiveness of the countries iff there are no other channels of price adjustments.
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