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Volatility, labor market flexibility, and the pattern of comparative advantage

  • Alejandro Cunat
  • Marc J. Melitz

This paper studies the link between volatility, labor market flexibility, and international trade. International differences in labor market regulations affect how firms can adjust to idiosyncratic shocks. These institutional differences interact with sector specific differences in volatility (the variance of the firm-specific shocks in a sector) to generate a new source of comparative advantage. Other things equal, countries with more flexible labor markets specialize in sectors with higher volatility. Empirical evidence for a large sample of countries strongly supports this theory: the exports of countries with more flexible labor markets are biased towards high-volatility sectors. We show how differences in labor market institutions can be parsimoniously integrated into the workhorse model of Ricardian comparative advantage of Dornbush, Fisher and Samuelson (1977). We also show how our model can be extended to multiple factors of production.

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File URL: http://eprints.lse.ac.uk/19714/
File Function: Open access version.
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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 19714.

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Length: 41 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:ehl:lserod:19714
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