Trade with Unemployment
Part 2: New Insights from Old
Trade Theory
Carl Davidson
Michigan State University
“Old” Trade Theory
• For simplicity, I will focus on the 2
sector HOS and Ricardian GE models
• Here the industry is the appropriate
unit of measure (firms within an
industry are all the same)
• All markets are perfectly competitive,
there is full employment
“Old” Trade Theory
• Focus on the two biggest questions:
• What causes trade?
• Who gains and who loses from trade?
That is, what is the link between trade
and factor rewards?
• How does adding unemployment
change the answers?
What Causes Trade (Ricardo)?
• Interaction of cross-sector differences
and cross-country differences
• In Ricardian model, labor productivity
varies across countries and, for at least
one country, across sectors
What Causes Trade (HOS)?
• Sectors differ in their use of factors
(factor intensities, measured by aij)
• Countries differ in endowments of
resources
• Differences in factor use across
sectors coupled with differences in
endowments across countries leads to
trade between countries (HO Theorem)
HO Theorem
• If a country has a relatively large
endowment of labor, labor will be
relatively cheap in that country
• In that country, it will therefore be
relatively cheap to produce good that
are labor intensive in production (i.e.,
the autarkic price of that good will be
low relative to ROW)
HO Theorem
• Countries will have a comparative
advantage in the good that makes
relatively intensive use of its relatively
abundant factor
Adding Unemployment
• Basic point: The structure of the labor
market can influence trade patterns
• In our search framework, workers cycle
between periods of employment and
unemployment – the employment
process is risky
• Workers take this risk into account
when choosing an occupation
Adding Unemployment
• Suppose that two countries are
identical in all aspects except for the
structure of their labor markets
• In the labor markets, matching
technologies and job security may
differ for a variety of reasons (info
flows, policies related to hiring and
firing,…)
• What are the implications?
Adding Unemployment
• Suppose that in one country the matching
technology is relatively less efficient in a
sector than it is in the same sector in other
countries
• Then, workers face more risk looking for a
job in that sector than they do in other
countries – they must be paid a
compensating differential to seek such a job
• The compensating differential pushes up
autarkic prices and makes it less likely the
country can export that good
Adding Unemployment
• Suppose that in one country jobs are less
secure in a sector than they are in the same
sector in other countries
• Then, workers face more risk looking for a
job in that sector than they do in other
countries – they must be paid a
compensating differential to seek such a job
• The compensating differential pushes up
autarkic prices and makes it less likely the
country can export that good
Bottom Line
• Employment risk affects wages
• Wages affect autarkic prices and trade
patterns
• A country is more likely to have a
comparative advantage in a good that
is produced in a sector with a relatively
low duration of unemployment and a
relatively high job duration
Empirical Evidence?
• Substantial evidence that job
creation/job destruction rates vary
across sectors and countries (DHS
1996 and the work that followed)
• Evidence that employment risk affects
compensating differentials (Abowd and
Ashenfelter 1981)
Empirical Evidence?
• Using two sources of data on turnover
(DHS for job turnover, BLS for worker
turnover) we found strong evidence
that industry trade position is strongly
and negatively tied to job destruction
rate – that is, the higher the job
destruction rate, the more you import
(Davidson & Matusz RIE 2004)
Empirical Evidence?
• Alternative story: a surge of imports
destroys jobs, increases job
destruction rate (workers in more open
sectors face less job security)
• What is the direction of causality?
Causality?
• One story (ours) is about LR behavior –
look at relationship between trade
position and average turnover rate
• Second is a SR story – look at trade
position and deviation of turnover rate
from the mean
• In all regressions, relationship much
stronger for mean turnover rate
Additional Evidence
• Janiak (Working Paper 2006): Looks at how
changes in trade patterns (caused by
liberalization) affects turnover rates –
findings similar to ours, but story of
causation reversed
• Cunat and Melitz (Working Paper 2006):
Argue that labor market flexibility shapes
comparative advantage; find that countries
with flexible labor markets specialize in “high
volatility” industries
Trade and Factor Rewards (R)
• In Ricardian model, some factors are
sector specific, some are mobile
• Free trade benefits factors specific to
the export sector and harms those
specific to the import sector
• Impact on mobile factors is ambiguous
• For specific factors, industry affiliation
is all that matters
Trade and Wages (HOS)
• Many results in HOS model based on
manipulation of market clearing
conditions
L0 = LX + LY = aLXX + aLYY
K0 = KX + KY = aKXX + aKYY
PX = aLXwx + aKXrx
PY = aLYwy + aKYry
Unit input requirements
Kj
akj
X(L,K)=1
Lj
aLj
Trade and Wages
• Totally diff. one product market clearing
expression to get
PˆX  aLX wˆ  aKX rˆ  waˆ LX  raˆ KX
But, since unit input requirements are optimal,
the last two terms sum to zero
Trade and Wages
• Subtract the two expressions yields
*
ˆ
ˆ
ˆ  rˆ)
PX  PY   ( w
where * measures the relative factor
intensities of the two sectors (in value terms);
* > 0 means that sector X is relatively more
labor intensive than sector Y
Trade and Wages
• Suppose that the world price of a laborintensive good rises (PX increases)
• Prod. of X rises. Factors released from
sector Y are less labor intensive than
those absorbed in sector X.
• Demand for L rises, demand for K falls.
• w rises (L gains), r falls (K loses),
regardless of where it is employed
Trade and Wages
• Is there another effect? After all, all
firms become more K intensive (the aij
terms change)
• But, changing the aij terms has no
impact on prices since the aij terms
were optimal (Envelope theorem)!
• This will be useful shortly
Trade and Wages
• Note also: The price increase is a
convex comb. of factor changes
PˆX  aLX wˆ  aKX rˆ
Thus, labor gains in real terms
Stolper-Samuelson
• Trade benefits a country’s abundant
factor and harms its scarce factor
(industry affiliation does not matter)
• Protection of an industry benefits the
factor used relatively intensively in that
sector
More Details on HOS
• Totally diff. the factor market clearing
expressions yields
Xˆ  Yˆ  * ( wˆ  rˆ)
where * measures the relative factor
intensities of the two sectors (in physical
terms); * > 0 means that sector X is relatively
more labor intensive than sector Y (with
perfect competition, ** > 0).
Px/Py
RS
PM clearing
RD
X/Y
w/r
FM clearing
45o line
w/r
Adding Unemployment
• Yesterday I noted that with unemployment
the product market clearing conditions can
be written as
Px = αLxwXu + αKxrXv
Py = αLywYu + αKyrYv
• Differentiate to get
Adding Unemployment
PˆX   LX wˆ   KX rˆ  wˆ LX  rˆ KX
• Key question: Are the unit input
requirements optimal? If so, last two terms
sum to zero again.
• If so we get an extension of StolperSamuelson…
Adding Unemployment
• It is now the unemployed factors that
move to clear factor markets
• An increase in a price attracts more
unemployed factors to that sector
• This changes the mix of unemp. factors
• Usual SS result, but the implication is
now for the return to unemployed
factors
Extended Stolper-Samuelson
• If a country protects a good produced
in a labor intensive sector, all
unemployed labor benefits and all idle
capital is harmed
An Important Exception
• But, this version only holds if unit input
requirements (which include
unemployed factors) are optimal
• Why?
• When you differentiate factor market
clearing conditions the envelope
theorem no longer applies – can get
feedback effects on prices – this is due
to externalities in the search process
Implications?
• The free trade equilibrium may not be
optimal – equilibrium unemployment
may be too high or too low
• The relative supply curve need not be
upward sloping – it can bend back,
leading to multiple free trade equilibria
• Expectations about economic activity
become quite important
• See DMM (1987, 1988, 1991)
Why not emphasize these
results?
• Based on controversial, hard to
measure search externalities – it is
unclear if such externalities are
important, hard to predict which way
they go – more research needed
• Other interesting insights are present
even when unit input requirements are
optimal
Back to Stolper-Samuelson
• Hard to test extended SS – cannot
observe return to unemployed or idle
factors
• What about the return to employed
factors?
• We get a convex combination of SS and
Specific Factors (SF, or Ricardian)
effects
Trade and Wages with
Unemployment
• When factors are employed, frictions
create an attachment to that sector –
this makes them quasi-fixed factors –
this generates SF effects
• All employed workers realize that they
will spend a fraction of life unemployed
this generates SS effects
Predictions
• Trade and factor rewards will be linked
by a convex comb. of SF and SS effects
• SS effects will be strong in high
turnover industries
• SF effects will be strong in low turnover
sectors
Empirical Evidence
• How to test this?
• Some have tried to test SS by looking
at political contributions
• SS predicts that factor abundance
determines views on trade policy
• SF predicts that industry affiliation
determines view on trade policy
Empirical Evidence
• In the past it has been difficult to find
much support for SS empirically
• Magee (1980) looked at lobbying
behavior, found support only for SF
• Dismissed as a misunderstanding of
SS, which is really about long run
behavior
Empirical Evidence
• More recent evidence suggests that
industry affiliation and factor
abundance play a role (Beaulieu and
Magee 2004)
• Also some evidence that voting
behavior in US and Canada consistent
with SS (Beaulieu 1998, 2000; Balistreri
1997; Slaughter 1998)
Prediction of our Model
• Relatively abundant factors employed
in import sectors should favor
protection if turnover is low, free trade
if turnover is high
• Relatively scarce factors employed in
export sectors should favor free trade if
turnover is low, protection if turnover is
high
Data
• Look at PAC contributions in US aimed
at influencing NAFTA and GATT
• These lobbies typically give to both
parties (for access), will give more to
one to influence outcome and policy
• Theory says: Base decision on factor
abundance (SS effect), industry
affiliation (SF effect) and turnover rates
Data
• DHS Turnover data (robust to other
measures) – use average turnover rate
for 1988-1992
• Get PAC contributions from Federal
Election Committee – look at share
going to supporters of NAFTA,
approval of GATT (Uruguay Round),
and both
Data
• PACs can be linked to an industry
based on data from the Center for
Responsible Politics and from info on
the web
• PACs classified as representing importcompeting or exporting industry based
on net trade position from NBER trade
data
Predictions
• High Turnover Industries
– Capital and labor should differ in
preferences toward trade policy
• Low Turnover Industries
– Capital and labor should have the same
preferences toward trade policy
Fraction of 1991-92 PAC contributions
given to free trade proponents
Capital
Labor
T-stat
NAFTA
.609
.531
1.188
GATT
.728
.672
1.021
Both
.515
.456
.929
NAFTA
.628
.307
5.644*
GATT
.746
.635
2.294*
Both
.534
.265
4.955*
Low Turn.
High Turn.
Fraction of 1991-92 PAC contributions
given to free trade proponents
Export
Import
T-stat
NAFTA
.624
.577
1.286*
GATT
.748
.692
1.867**
Both
.531
.484
1.339*
NAFTA
.586
.602
-0.381
GATT
.759
.718
1.248
Both
.516
.506
0.259
Low Turn.
High Turn.
Extensions
• Can add controls, look at differences in
differences, add fixed effects, results
do not go away, often get stronger
• Bottom Line: There is (strong?)
support for the theory that the structure
of the labor market effects the link
between trade and wages
Important Extensions
• With the model established, it can be
used to look at a whole host of
important issues that could not be
addressed in full employment models
• For example:
– Costs of adjustment (taking spells of
unemployment and retraining into
account)
– What is the best way to compensate those
harmed by trade liberalization