International competition and labor market adjustment

Abstract

How does welfare change in the short- and long-run when trade integration takes place under imperfect labor markets? Even if consumers benefit from lower prices, there can be significant welfare losses from increases in unemployment and lower wages. I construct a dynamic multi-sector-country Ricardian trade model that incorporates both search frictions and labor mobility frictions. I then structurally estimate this model and quantify both the potential losses to workers and benefits to consumers arising from China’s integration into the global economy. I find that overall welfare increases in all economies, both in the transition period and in the new steady state equilibrium. In import competing sectors, however, workers bear a costly transition, experiencing lower wages and a rise in unemployment. I also conduct an exercise with model-based simulated worker level panel data for the UK and the USA. I find that Chinese import competition reduces relative workers’ earnings, and the magnitudes of the effects are similar to the ones found in the trade-labor reduced form literature.