TY - JOUR AU - Helpman,Elhanan AU - Itskhoki,Oleg TI - Labor Market Rigidities, Trade and Unemployment JF - National Bureau of Economic Research Working Paper Series VL - No. 13365 PY - 2007 Y2 - September 2007 UR - http://www.nber.org/papers/w13365 L1 - http://www.nber.org/papers/w13365.pdf N1 - Author contact info: Elhanan Helpman Department of Economics Harvard University 1875 Cambridge Street Cambridge, MA 02138 Tel: 617-495-4690 Fax: 617-495-7730 E-Mail: ehelpman@harvard.edu Oleg Itskhoki Department of Economics Princeton University Fisher Hall 306 Princeton, NJ 08544-1021 Tel: 609/258-5493 Fax: 609/258-6419 E-Mail: itskhoki@princeton.edu AB - We study a two-country two-sector model of international trade in which one sector produces homogeneous products while the other produces differentiated products. The differentiated-product industry has firm heterogeneity, monopolistic competition, search and matching in its labor market, and wage bargaining. Some of the workers searching for jobs end up being unemployed. Countries are similar except for frictions in their labor markets. We study the interaction of labor market rigidities and trade impediments in shaping welfare, trade flows, productivity, price levels and unemployment rates. We show that both countries gain from trade but that the flexible country -- which has lower labor market frictions -- gains proportionately more. A flexible labor market confers comparative advantage; the flexible country exports differentiated products on net. A country benefits by lowering frictions in its labor market, but this harms the country's trade partner. And the simultaneous proportional lowering of labor market frictions in both countries benefits both of them. The model generates rich patterns of unemployment. Specifically, trade integration -- which benefits both countries -- may raise their rates of unemployment. Moreover, differences in rates of unemployment do not necessarily reflect differences in labor market rigidities; the rate of unemployment can be higher or lower in the flexible country. Finally, we show that the flexible country has both higher total factor productivity and a lower price level, which operates against the standard Balassa-Samuelson effect. ER -