Working Paper: CEPR ID: DP7387
Authors: Hartmut Egger; Peter Egger; James R. Markusen
Abstract: We formulate a two-country model with monopolistic competition and heterogeneous firms to reconsider labor market linkages in open economies. Labor-market imperfections arise by virtue of country-specific real minimum wages. Two principal experiments are considered. First, we show that trade liberalization under minimum wages differs significantly from trade liberalization under standard assumptions. In the former case, there is effectively a perfectly elastic supply of labor to production whereas in the conventional case it is assumed that aggregate labor supply is perfectly inelastic. Standard effects on marginal and average firm productivity are reversed in our model, yet there are significant gains from trade arising from employment expansion, an effect quite different from the source of gains from trade in the conventional approach. Second, we show that with firm heterogeneity an increase in one country's minimum wage triggers firm exit in both countries and thus harms workers at home and abroad. In an extension to our baseline model, we illustrate that offshoring production from the high-wage to the low-wage country within multinational firms lowers the scope for exporting the costs of a higher minimum wage to the trading partner.
Keywords: heterogeneous firms; international trade; labour market linkages; minimum wages; offshoring; unemployment
JEL Codes: F12; F15; F16; F23; J30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| minimum wage increase in one country (J38) | firm exit in both countries (F23) |
| firm exit in both countries (F23) | harm to workers in both economies (F66) |
| minimum wage increase in one country (J38) | higher unemployment rates in both countries (F66) |
| offshoring production from high-wage to low-wage country (F16) | reduced ability to export costs of higher minimum wages (F66) |
| minimum wage changes in one country (J38) | employment dynamics in another country (J61) |
| minimum wage changes (J38) | firm behavior (D21) |