International Trade and Macroeconomic Dynamics with Labor Market Frictions (Job Market Paper)

Do country-speci\u85c labor market frictions hiring and \u85ring restrictions and protection of unemployed workers a¤ect the consequences of trade integration? I address this question in a two-country model of trade and macroeconomic dynamics with heterogeneous \u85rms, endogenous producer entry, and search and matching frictions in the labor market. I study the dynamic e¤ects of trade integration on unemployment and economic activity and the business cycle implications of stronger trade linkages. The model introduces a novel source of ampli\u85cation and propagation of domestic and international shocks, as cyclical uctuations in job creation and destruction a¤ect the pro\u85tability of producer entry into domestic and export markets. I show that domestic labor market frictions are an important determinant of short- to medium-term e¤ects of trade integration. As trade barriers are reduced, unemployment initially rises (falls) in countries with more rigid (exible) labor markets. In the long run, average productivity gains ensure positive employment e¤ects in both countries. Trade is always bene\u85cial for welfare, but the economy with a rigid labor market gains less. Also, a exible country bene\u85ts from the rigidity of its partner. In contrast to benchmark international real business cycle models, but consistent with the data, the model predicts that trade integration leads to increased business cycle synchronization. Volatility increases in the country with a rigid labor market, but it falls for the exible partner. JEL classi\u85cation: E32, F16, F41, J60