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This incorporates equilibrium unemployment caused by efficiency wages into a monopolistic competition model of trade. Worker effort is treated as an endogenous variable that depends on the optimizing behaviour of firms and workers.
Opening up trade induces firms to demand greater worker effort and to cut the size of their workforce. This counteracts the positive employment effect due to entry of firms. Circumstances are indicated in which the two effects just balance, leaving aggregate employment unchanged.
Trade unambiguously increases worker effort, thereby enhancing within-firm productivity. In developed countries there is an ongoing public debate about whether the increasing integration of product markets through trade might have adverse effects on labour markets. In particular, it is widely believed that globalization threatens.
When looking at the potential effects of a trade policy, trade economists tend to insist on the real income effects, often dismissing its unemployment effects as of second-order importance, whereas policymakers and the public at large tend to voice concerns about jobs gained or lost.
We address the concerns on both incomes and unemployment and propose a model in which trade reforms reallocate resources across sectors and, by the expansion effect, affect overall job creation and real incomes.
In equilibrium, trade reforms influence both real incomes and unemployment rates. Importantly, though both tend to be correlated in the expected fashion – what is good for wages is usually good for employment – the model is flexible enough to allow for income and employment effects to work in opposite directions.
Trade patterns influence the equilibrium unemployment of countries above and beyond standard allocative efficiency effects.Equipped with this, we compute the potential unemployment and real income effects of several trade partnerships and of trade imbalances.
The average real income and unemployment effects of trade agreements are relatively small. The effects associated with trade imbalances are much larger.