Article ID: | iaor201111961 |
Volume: | 44 |
Issue: | 2 |
Start Page Number: | 509 |
End Page Number: | 540 |
Publication Date: | May 2011 |
Journal: | Canadian Journal of Economics/Revue canadienne d'conomique |
Authors: | Egger Peter, Greenaway David, Seidel Tobias |
Keywords: | simulation |
We develop a multi‐country model with imperfect labour markets to study the effect of labour market frictions on bilateral trade flows. We use a framework that allows for goods trade and capital mobility and show that labour market imperfections exert opposite effects in the absence of capital mobility (the short run) and its presence (the long run), respectively. In the short run, a higher degree of labour market rigidity decreases the value of total trade, but increases the share of intra‐industry trade for a country that is larger than its trading partner. The reverse effects are observed when capital is allowed to cross country borders. Using data on unemployment and income distribution for 23 OECD countries, we compute the central parameter in our theoretical model that describes the degree of labour market rigidity. We use this new empirical concept to provide evidence for our theoretical findings by means of reduced‐form regressions as well as simulation results of a calibrated general equilibrium model.