Working Paper: CEPR ID: DP8191
Authors: Elhanan Helpman; Oleg Itskhoki; Stephen J. Redding
Abstract: This paper reviews a new framework for analyzing the interrelationship between inequality, unemployment, labor market frictions, and foreign trade. This framework emphasizes firm heterogeneity and search and matching frictions in labor markets. It implies that the opening of trade may raise inequality and unemployment, but always raises welfare. Unilateral reductions in labor market frictions increase a country's welfare, can raise or reduce its unemployment rate, yet always hurt the country's trade partner. Unemployment benefits can alleviate the distortions in a country's labor market in some cases but not in others, but they can never implement the constrained Pareto optimal allocation. We characterize the set of optimal policies, which require interventions in product and labor markets.
Keywords: inequality; labor market policy; trade; unemployment
JEL Codes: F12; F16; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Opening of trade (F19) | Increased inequality (F61) |
| Opening of trade (F19) | Increased unemployment (J64) |
| Opening of trade (F19) | Enhanced welfare (I38) |
| Unilateral reductions in labor market frictions (F16) | Increased welfare (I38) |
| Unilateral reductions in labor market frictions (F16) | Unemployment rate (J64) |
| Unemployment benefits (J65) | Alleviate labor market distortions (J48) |
| Labor market frictions in one country (F16) | Affect trade partners (F10) |
| Coordinated reductions in labor market frictions (J48) | Raise welfare across all countries (I30) |
| Unilateral reforms (E69) | Negative externalities (D62) |