Search Frictions, Financial Frictions and Labour Market Fluctuations in Emerging Markets

This paper examines the role of the extensive and intensive margins of labour input in the context of a business cycle model with a financial friction. We document significant variation in the hours worked per worker for many emerging-market economies. Both employment and hours worked per worker are positively correlated with each other and with output. We show that a search-theoretic context in a small open-economy model requires a small income effect to explain these regularities at the expense of a smaller wage response. On the other hand, introducing a financial friction in the form of a working capital requirement can explain the observed movements of labour market variables such as employment and hours worked per worker, as well as other distinguishable business cycle characteristics of emerging economies. These include highly volatile and cyclical real wages, labour share, and consumption.