Unemployment in an Interdependent World

27  January 2011    4:00 pm

Mario Larch, University of Bayreuth

In cooperation with:
Research Centre International Economics (FIW) 


wiiw, Rahlgasse 3, 1060 Vienna, lecture hall (entrance from the ground floor)


We introduce search and matching unemployment into a model of trade with differentiated goods and heterogeneous firms. Countries may differ with respect to size, geographical location, and labor market institutions. Contrary to the literature, our single-sector perspective pays special attention to the role of income effects and shows that bad institutions in one country worsen labor market outcomes not only in that country but also in its trading partners. This spill-over effect is conditioned by trade costs and country size: smaller and/or more centrally located nations suffer less from inefficient policies at home and are more heavily affected from spill-overs abroad than larger and/or peripheral ones. We offer empirical evidence for a panel of 20 rich OECD countries. Carefully controlling for institutional features and for business cycle comovements between countries, we confirm our qualitative theoretical predictions. However, the magnitude of spill-over effects is larger in the data than in the theoretical model. We show that introducing real wage rigidity can remedy this problem.

Keywords: spill-over effects of labour market, institutions, unemployment, international trade, search frictions, heterogeneous firms

JEL classification: F11, F12, F16, J64, L11