![Page 1: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/1.jpg)
Trade with Unemployment
Part 2: New Insights from Old Trade Theory
Carl Davidson
Michigan State University
![Page 2: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/2.jpg)
“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
![Page 3: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/3.jpg)
“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?
![Page 4: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/4.jpg)
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
![Page 5: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/5.jpg)
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)
![Page 6: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/6.jpg)
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)
![Page 7: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/7.jpg)
HO Theorem
• Countries will have a comparative advantage in the good that makes relatively intensive use of its relatively abundant factor
![Page 8: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/8.jpg)
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
![Page 9: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/9.jpg)
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?
![Page 10: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/10.jpg)
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
![Page 11: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/11.jpg)
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
![Page 12: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/12.jpg)
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
![Page 13: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/13.jpg)
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)
![Page 14: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/14.jpg)
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)
![Page 15: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/15.jpg)
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?
![Page 16: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/16.jpg)
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
![Page 17: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/17.jpg)
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
![Page 18: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/18.jpg)
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
![Page 19: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/19.jpg)
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
![Page 20: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/20.jpg)
Unit input requirements
Lj
Kj
akj
aLj
X(L,K)=1
![Page 21: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/21.jpg)
Trade and Wages
• Totally diff. one product market clearing expression to get
KXLXKXLXX arawrawaP ˆˆˆˆˆ
But, since unit input requirements are optimal, the last two terms sum to zero
![Page 22: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/22.jpg)
Trade and Wages
• Subtract the two expressions yields
)ˆˆ(ˆˆ * rwPP YX
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
![Page 23: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/23.jpg)
Trade and Wages
• Suppose that the world price of a labor-intensive 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
![Page 24: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/24.jpg)
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
![Page 25: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/25.jpg)
Trade and Wages
• Note also: The price increase is a convex comb. of factor changes
rawaP KXLXX ˆˆˆ
Thus, labor gains in real terms
![Page 26: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/26.jpg)
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
![Page 27: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/27.jpg)
More Details on HOS
• Totally diff. the factor market clearing expressions yields
)ˆˆ(ˆˆ * rwYX
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).
![Page 28: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/28.jpg)
X/Y
Px/Py
w/r
w/r
FM clearing
45o line
PM clearing
RS
RD
![Page 29: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/29.jpg)
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
![Page 30: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/30.jpg)
Adding Unemployment
KXLXKXLXX rwrwP ˆˆˆˆˆ
• Key question: Are the unit input requirements optimal? If so, last two terms sum to zero again.
• If so we get an extension of Stolper-Samuelson…
![Page 31: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/31.jpg)
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
![Page 32: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/32.jpg)
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
![Page 33: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/33.jpg)
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
![Page 34: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/34.jpg)
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)
![Page 35: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/35.jpg)
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
![Page 36: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/36.jpg)
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
![Page 37: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/37.jpg)
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
![Page 38: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/38.jpg)
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
![Page 39: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/39.jpg)
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
![Page 40: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/40.jpg)
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
![Page 41: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/41.jpg)
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)
![Page 42: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/42.jpg)
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
![Page 43: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/43.jpg)
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
![Page 44: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/44.jpg)
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
![Page 45: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/45.jpg)
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 import-competing or exporting industry based on net trade position from NBER trade data
![Page 46: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/46.jpg)
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
![Page 47: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/47.jpg)
Fraction of 1991-92 PAC contributions
given to free trade proponents Capital Labor T-stat
Low Turn.
NAFTA .609 .531 1.188
GATT .728 .672 1.021
Both .515 .456 .929
High Turn.
NAFTA .628 .307 5.644*
GATT .746 .635 2.294*
Both .534 .265 4.955*
![Page 48: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/48.jpg)
Fraction of 1991-92 PAC contributions
given to free trade proponents Export Import T-stat
Low Turn.
NAFTA .624 .577 1.286*
GATT .748 .692 1.867**
Both .531 .484 1.339*
High Turn.
NAFTA .586 .602 -0.381
GATT .759 .718 1.248
Both .516 .506 0.259
![Page 49: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/49.jpg)
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
![Page 50: Trade with Unemployment Part 2: New Insights from Old Trade Theory](https://reader035.vdocuments.mx/reader035/viewer/2022062422/56813678550346895d9e0649/html5/thumbnails/50.jpg)
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