IDEAS home Printed from https://ideas.repec.org/p/jmp/jm2016/psu467.html
   My bibliography  Save this paper

Optimal Trade Policy, Equilibrium Unemployment and Labor Market Inefficiency

Author

Listed:
  • Wisarut Suwanprasert

Abstract

Why do politicians advocate trade protections to save domestic jobs when neoclassical trade models suggest that small open economies should implement free trade? The novel insight of this paper is that trade protections can be rationalized as a second-best policy that improves the domestic welfare when the equilibrium unemployment is different from the constrain-efficient unemployment. To understand the puzzle, I incorporate a Diamond-Mortensen-Pissarides frictional labor market into the standard Heckscher-Ohlin model of international trade. The model offers four main findings. First, when the relative price of the labor (capital)-intensive good increases, equilibrium unemployment decreases (increases). Second, a labor market in a competitive equilibrium is constrained-efficient when the Hosios condition is satisfied. Third, a capital-abundant country with inefficiently high unemployment may experience welfare losses from trade. Conditional on having the same observed trade share, a labor-abundant country with inefficiently high unemployment have extra welfare gains from international trade. Finally and importantly, when the labor market in a small open economy generates inefficiently high equilibrium unemployment, the optimal trade policy is to raise the domestic price of its labor-intensive goods (an import tariff in a capital-abundant country and an export subsidy in a labor-abundant country). Free trade is optimal only when a labor market is initially efficient. The model predictions are supported by patterns of tariffs in WTO member countries.

Suggested Citation

  • Wisarut Suwanprasert, 2016. "Optimal Trade Policy, Equilibrium Unemployment and Labor Market Inefficiency," 2016 Papers psu467, Job Market Papers.
  • Handle: RePEc:jmp:jm2016:psu467
    as

    Download full text from publisher

    File URL: https://ideas.repec.org/jmp/2016/psu467.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Simeon Djankov & Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer, 2002. "The Regulation of Entry," The Quarterly Journal of Economics, Oxford University Press, vol. 117(1), pages 1-37.
    2. Felbermayr, Gabriel & Prat, Julien & Schmerer, Hans-Jörg, 2011. "Globalization and labor market outcomes: Wage bargaining, search frictions, and firm heterogeneity," Journal of Economic Theory, Elsevier, vol. 146(1), pages 39-73, January.
    3. Mortensen, Dale & Pissarides, Christopher, 2011. "Job Creation and Job Destruction in the Theory of Unemployment," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 1-19.
    4. Elhanan Helpman & Oleg Itskhoki, 2010. "Labour Market Rigidities, Trade and Unemployment," Review of Economic Studies, Oxford University Press, vol. 77(3), pages 1100-1137.
    5. Davidson, Carl & Martin, Lawrence & Matusz, Steven, 1999. "Trade and search generated unemployment," Journal of International Economics, Elsevier, vol. 48(2), pages 271-299, August.
    6. Dutt, Pushan & Mitra, Devashish & Ranjan, Priya, 2009. "International trade and unemployment: Theory and cross-national evidence," Journal of International Economics, Elsevier, vol. 78(1), pages 32-44, June.
    7. Wolfgang F. Stolper & Paul A. Samuelson, 1941. "Protection and Real Wages," Review of Economic Studies, Oxford University Press, vol. 9(1), pages 58-73.
    8. Bradford, Scott, 2006. "Protection and unemployment," Journal of International Economics, Elsevier, vol. 69(2), pages 257-271, July.
    9. Elhanan Helpman & Oleg Itskhoki & Stephen Redding, 2010. "Inequality and Unemployment in a Global Economy," Econometrica, Econometric Society, vol. 78(4), pages 1239-1283, July.
    10. Matschke Xenia, 2010. "Do Labor Market Imperfections Increase Trade Protection? A Theoretical Investigation," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 10(1), pages 1-36, June.
    11. Davis, Donald R, 1998. "Does European Unemployment Prop Up American Wages? National Labor Markets and Global Trade," American Economic Review, American Economic Association, vol. 88(3), pages 478-494, June.
    12. Suwanprasert, Wisarut, 2017. "A note on “Jobs, Jobs, Jobs: A “New” Perspective on Protectionism” of Costinot (2009)," Economics Letters, Elsevier, vol. 157(C), pages 163-166.
    13. repec:hrv:faseco:30747190 is not listed on IDEAS
    14. Davidson, Carl & Martin, Lawrence & Matusz, Steven, 1988. "The Structure of Simple General Equilibrium Models with Frictional Unemployment," Journal of Political Economy, University of Chicago Press, vol. 96(6), pages 1267-1293, December.
    15. Davis, Donald R. & Harrigan, James, 2011. "Good jobs, bad jobs, and trade liberalization," Journal of International Economics, Elsevier, vol. 84(1), pages 26-36, May.
    16. Richard A. Brecher, 1974. "Minimum Wage Rates and the Pure Theory of International Trade," The Quarterly Journal of Economics, Oxford University Press, vol. 88(1), pages 98-116.
    17. Brecher, Richard A., 1992. "An efficiency-wage model with explicit monitoring : Unemployment and welfare in an open economy," Journal of International Economics, Elsevier, vol. 32(1-2), pages 179-191, February.
    18. Arthur J. Hosios, 1990. "On The Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 279-298.
    19. Brecher, Richard A., 1974. "Optimal commercial policy for a minimum-wage economy," Journal of International Economics, Elsevier, vol. 4(2), pages 139-149, May.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Optimal Trade Policy, Equilibrium Unemployment and Labor Market Inefficiency
      by Christian Zimmermann in NEP-DGE blog on 2016-05-13 18:00:31

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Tanapong Potipiti & Wisarut Suwanprasert, 2019. "Why Does the WTO Prohibit Export Subsidies But Not Import Tariffs?," PIER Discussion Papers 119, Puey Ungphakorn Institute for Economic Research, revised Dec 2019.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Heid, Benedikt & Larch, Mario, 2016. "Gravity with unemployment," Journal of International Economics, Elsevier, vol. 101(C), pages 70-85.
    2. Gabriel J. Felbermayr & Mario Larch & Wolfgang Lechthaler, 2013. "Unemployment in an Interdependent World," American Economic Journal: Economic Policy, American Economic Association, vol. 5(1), pages 262-301, February.
    3. Elhanan Helpman & Oleg Itskhoki, 2010. "Labour Market Rigidities, Trade and Unemployment," Review of Economic Studies, Oxford University Press, vol. 77(3), pages 1100-1137.
    4. Schmerer, Hans-Jörg, 2014. "Foreign direct investment and search unemployment: Theory and evidence," International Review of Economics & Finance, Elsevier, vol. 30(C), pages 41-56.
    5. David Hummels & Jakob R. Munch & Chong Xiang, 2018. "Offshoring and Labor Markets," Journal of Economic Literature, American Economic Association, vol. 56(3), pages 981-1028, September.
    6. Céline Carrère & Anja Grujovic & Frédéric Robert-Nicoud, 2020. "Trade and Frictional Unemployment in the Global Economy," Journal of the European Economic Association, European Economic Association, vol. 18(6), pages 2869-2921.
    7. Dinopoulos, Elias & Unel, Bulent, 2015. "Entrepreneurs, jobs, and trade," European Economic Review, Elsevier, vol. 79(C), pages 93-112.
    8. Helpman, Elhanan & Itskhoki, Oleg & Redding, Stephen, 2010. "Trade and Labor Market Outcomes," Foerder Institute for Economic Research Working Papers 275737, Tel-Aviv University > Foerder Institute for Economic Research.
    9. Carl Davidson & Steven J. Matusz, 2010. "Our Motivation," Introductory Chapters, in: International Trade with Equilibrium Unemployment, Princeton University Press.
    10. Felbermayr, Gabriel & Prat, Julien & Schmerer, Hans-Jörg, 2011. "Trade and unemployment: What do the data say?," European Economic Review, Elsevier, vol. 55(6), pages 741-758, August.
    11. Ian King & Frank Stähler, 2014. "International trade and directed search unemployment in general equilibrium," Canadian Journal of Economics, Canadian Economics Association, vol. 47(2), pages 580-604, May.
    12. Felbermayr, Gabriel J. & Larch, Mario & Lechthaler, Wolfgang, 2012. "Endogenous labor market institutions in an open economy," International Review of Economics & Finance, Elsevier, vol. 23(C), pages 30-45.
    13. Elhanan Helpman & Oleg Itskhoki & Stephen Redding, 2010. "Inequality and Unemployment in a Global Economy," Econometrica, Econometric Society, vol. 78(4), pages 1239-1283, July.
    14. Tang, Heiwai, 2012. "Labor market institutions, firm-specific skills, and trade patterns," Journal of International Economics, Elsevier, vol. 87(2), pages 337-351.
    15. Lukas Mohler & Rolf Weder & Simone Wyss, 2018. "International trade and unemployment: towards an investigation of the Swiss case," Swiss Journal of Economics and Statistics, Springer;Swiss Society of Economics and Statistics, vol. 154(1), pages 1-12, December.
    16. Carrère, Céline & Fugazza, Marco & Olarreaga, Marcelo & Robert-Nicoud, Frédéric, 2020. "Comparative advantage and equilibrium unemployment," European Economic Review, Elsevier, vol. 127(C).
    17. Nunn, Nathan & Trefler, Daniel, 2014. "Domestic Institutions as a Source of Comparative Advantage," Handbook of International Economics, in: Gopinath, G. & Helpman, . & Rogoff, K. (ed.), Handbook of International Economics, edition 1, volume 4, chapter 0, pages 263-315, Elsevier.
    18. Davidson, Carl & Matusz, Steven J., 2012. "A model of globalization and firm-worker matching: How good is good enough?," International Review of Economics & Finance, Elsevier, vol. 23(C), pages 5-15.
    19. Shoya Ishimaru & Soo Hyun Oh & Seung-Gyu Sim, 2017. "Trade preferences and political equilibrium associated with trade liberalization," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 26(3), pages 361-384, April.
    20. Elhanan Helpman, 2014. "Foreign Trade and Investment: Firm-level Perspectives," Economica, London School of Economics and Political Science, vol. 81(321), pages 1-14, January.

    More about this item

    JEL classification:

    • F11 - International Economics - - Trade - - - Neoclassical Models of Trade
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • F66 - International Economics - - Economic Impacts of Globalization - - - Labor

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:jmp:jm2016:psu467. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann). General contact details of provider: https://ideas.repec.org/jmp.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.