1 CHAPTER 3:TRADE AND EMPLOYMENT 3A: Wage rigidities 3B: Imperfect labour mobility, labour turnover, efficiency wages 3C: Labour market institutions, comparative advantages and unemployment 3D: Empirical evidence Globalisation and labour markets, H. Boulhol 1

3A: Context Trade can affect: -average real wage -relative wages -total employment -relative employment However, trade theory traditionally assumes “fixed amount of labour endowments” (stable unemployment). Why? -dichotomy between macro and micro issues: idea is that trade is a micro issue, whereas as unemployment is determined by cycles, and macro and structural policies -unemployment micro-foundations are recent -few empirical evidence on employment effects of trade policies

3A: General idea Through specialisation, trade influences relative employment It takes time for labour to relocate from contracting to expanding sectors Due to imperfect labour mobility across sectors in the short term, unemployment might rise In the medium / long term, resources are re-allocated, and unemployment returns to its “natural” level BUT TRADE CAN AFFECT STRUCTURAL UNEMPLOYMENT

3A: Endogenous comparative advantage Countries differ a lot in terms of: -Employment protection -Union coverage -Minimum wage -Labour turnover -Wage rigidities -Social insurance Labour market institutions may shape the pattern of trade, have an impact on the effect of trade itself on wages and employment

3A: The big question Do the classical results of trade theory (overall gains from trade, distributional effects: SS) extend to models with unemployment?

3A: Sources / formalisation of unemployment Matching frictions (search-based models emphasise transactions costs encountered by unemployed workers and firms with vacancies that seek each other out) Monitoring or motivational concerns (efficiency-wage models emphasise informational asymmetries ) Sticky wages (minimum wage models emphasise wage rigidities that prevent the labour market from clearing)

3A: Stylised framework with minimum wage Original work by Brecher (1974) Double magnification: -labour market distortion introduced by wage rigidities amplify the specialisation of rich countries -trade amplifies the effects of LM imperfections Induced over-specialisation is symptomatic, increases unemployment and depresses demand Krugman (1995) offers a simplified presentation of the mechanisms at work

3A: Krugman (1995) Purpose: Effects of trade with developing countries on developed (OECD) countries Effects depend on the structure of the OECD country’s labour market: -flexible wage country: wage distribution effect (Stolper-Samuelson) -rigid wage country: variable of adjustment is employment (of less skilled workers)

3A: Structure of the model U = U (C1, C2) Q1 = F (Ls1, Lu1) skill intensive good Q2 = F (Ls2, Lu2) less-skill intensive good Perfect competition, c.r.s. X1 = Q1 –C1 M2 = C2 – Q2

3A: “European” approach Rigid wages: Ws / Wu is fixed Implications -Ls / Lu is fixed in each sector -p1 / p2 is fixed (as long as both goods are still produced with trade)

3A: “European” approach Rigid wages: Ws / Wu is fixed Implications -Ls / Lu is fixed in each sector -p1 / p2 is fixed (as long as both goods are still produced with trade) Effects of trade with developing countries fall in relative demand for less-skill intensive good fixed Ws / Wu implies decrease in less-skill employment (weight of sector 1 increases, weight of sector 2 decreases at constant Ls / Lu within each sector)

3A: Aggregate gains from trade ? Two opposite effects: -usual gains from comparative advantage (at full / unchanged unemployment) -increase in low-skill unemployment Do these employment effects become much larger as industrialisation spreads in developing countries? -skill upgrading with development -limits to Factor Price Equalisation: full FPE applies only when there is no full specialisation When the change in relative prices is so large that the OECD no longer produce the import competing good, any further reduction in the relative price of low-skill intensive good has no effect on income distribution

3A: Davis (1998) North / North trade “flex-wage” USA vs “rigid-wage” Europe Wage rigidities affect comparative advantages (see paper’s presentation)

16 Davis (1998), Figure1