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Third, a capital-abundant country with inefficiently high unemployment may experience welfare losses from trade. Conditional on having the same observed trade share, a labor-abundant country with inefficiently high unemployment have extra welfare gains from international trade. Finally and importantly, when the labor market in a small open economy generates inefficiently high equilibrium unemployment, the optimal trade policy is to raise the domestic price of its labor-intensive goods an import tariff in a capital-abundant country and an export subsidy in a labor-abundant country.


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Free trade is optimal only when a labor market is initially efficient. The model predictions are supported by patterns of tariffs in WTO member countries. VERY timely paper on a topic that economists are thought to have wide agreement on, perhaps wrongly. I am looking forward to the literature this paper will spawn. This entry was posted on Friday, May 13th, at pm and is filed under Uncategorized.

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You are commenting using your Facebook account. Notify me of new comments via email. Notify me of new posts via email. Mapping this estimate into an effect on the unemployment rate, however, requires an estimate of the slope of the Beveridge curve. To derive an estimate, we regress log vacancies on log unemployment, allowing for a break in the intercept beginning in Our estimated coefficient suggests that a one percent increase in the V-U ratio along a BC will lead to about a one-half percent decrease in the unemployment rate. As with any research, there are caveats associated with this analysis.

We note two particularly important ones here. First, we do not attempt to directly identify a decline in bargaining power, but rather show a strong empirical relationship between the labor share and the V-U ratio which is theoretically consistent with such a shift. Second, we do not claim that the average worker's welfare is higher under a low labor share, low unemployment regime.

Further research is needed to identify the structural shocks driving our results and their welfare implications. What does this imply for the evolution of the natural rate of unemployment going forward? That depends crucially, of course, on the persistence of the structural forces shifting the JC and BC. Together they suggest a natural rate corresponding to point C, little different from levels of a decade ago, represented by point A.

However, some research has suggested that the outward shift in the Beveridge curve may be largely a cyclical phenomenon.

In particular, researchers have identified a large component of the shift that can be attributed to a very high share of long-duration unemployed, who have lower job finding rates on average. If the labor market continues to improve and the long-duration share continues to decline, the Beveridge curve may move back to its former position. At the same time, the downward movement in the labor share has been quite persistent. Although further work is needed to identify the structural forces that have caused its decline, if declining bargaining power is responsible and persists, then the JC may remain at a persistently higher level.

As a result, the economy may end up at point B with a natural rate at lower levels than prior to the recession. On the other hand, if further increases in labor demand eventually increase worker bargaining power and the labor share--bringing them back to historically normal levels--and the reduction in matching efficiency persists, the economy may end up at point D, with a natural rate above levels of a decade ago.

Krueger, Alan B. Notowidigdo, and Lawrence F.

International Trade with Equilibrium Unemployment – By Carl Davidson and Steven J. Matusz

Other factors, such as demographics, have important effects on the natural rate of unemployment as well. See Aaronson et al.


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In theory, a measure of the labor share for the private business sector might seem the most appropriate for our analysis. Moreover, the decline in the non-farm business sector labor share over the same period is roughly the same as shown in Figure 3. For a more detailed discussion of the Beveridge curve, see Blanchard and Diamond , Diamond , and Elsby, Michaels, and Ratner Return to text.

We should note that we do not find previous research on the fall in the labor share to be inconsistent with a reduction in worker bargaining power. Karabarbounis and Nieman argue that the substitution of capital for labor in the production process is behind a substantial fraction of the decline in the labor share. For simplicity, we ignore the shift in the Beveridge curve associated with a rise in layoffs.

Optimal Trade Policy, Equilibrium Unemployment and Labor Market Inefficiency

A rise in layoffs would also shift out the Beveridge curve since, for a given unemployment rate, more vacancies would be needed to offset the rise in inflows into unemployment. Note that we are not claiming to identify the causal effect of bargaining power on the V-U ratio. Instead, our estimates encompass many shocks that drive both variables. This may lead our estimated coefficient on the labor share to either understate or overstate the causal effect of bargaining power on the V-U ratio.

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34.5 The Tradeoffs of Trade Policy

It certainly may be the case that there are factors other than bargaining power that we have not controlled for and that exaggerate the negative relationship between the labor share and the V-U ratio beyond that implied by changes in bargaining power. On the other hand, to the extent that we are not fully controlling for cyclical shocks, these would likely impart a positive correlation between V-U ratios and the labor share, and so we would be underestimating the negative relationship due to a change in bargaining power.

The Gains from International Trade in the Demand and Supply model

We use annual frequency data as those are available from the BEA for the longest period of time. Since we are interested in longer-run secular movements in the labor share, higher frequency data would not necessarily be advantageous. The industries we can match as closely as possible across the three sources of data are: natural resources and mining, construction, durable goods manufacturing, nondurable goods manufacturing, wholesale trade, retail trade, transportation and utilities, information services, financial and real estate services, professional and business services, education and health services, leisure and hospitality services, and other services excluding government.

HWOL data begin in May, We use the seasonally-adjusted data provided by the Conference Board and average over the partial year of data for For onwards, we use the average of the seasonally-adjusted data over the full year. To be conservative, we don't use the estimated coefficient from the state-level regression in changes column 3 which may be driven by the choice of endpoints.

Whereas the industry-level estimates are robust to different choices of endpoints, the state-level data series are too short to check their robustness. We estimate the Beveridge curves by fitting a regression of log vacancies on log unemployment both as fractions of the labor force from q1 to q4.

We then allow the intercept to shift beginning in q1, but constrain the slope to be the same as in the first time period. JC corresponds to an earlys assumed equilibrium unemployment rate of 5 percent, with an associated V-U ratio of 0. JC' is the job creation ray with a 30 percent higher V-U ratio as estimated from our state and industry regressions.

Figura, Andrew, and David Ratner Disclaimer: FEDS Notes are articles in which Board economists offer their own views and present analysis on a range of topics in economics and finance.

The Economy: Glossary

About the Fed. June 8, The Labor Share of Income and Equilibrium Unemployment Andrew Figura and David Ratner After rising to 10 percent in the wake of the Great Recession, the unemployment rate is now approaching a level that many observers--including the Congressional Budget Office, as shown in Figure associate with the natural rate of unemployment. Figure 1. The Unemployment Rate Source. Figure 2. The Beveridge Curve Note. Bureau of Labor Statistics. Figure 3. The Labor Share Note. Bureau of Economic Analysis. Figure 4. Figure 5.

Figure 6. Figure 7.