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Inefficiencies in Globalized Economies with Labor Market Frictions
1 : University Paris-Dauphine, PSL Research University, LEDa
University of Dauphine
2 : Université du Mans (GAINS-TEPP) & PSE, Cepremap & IZA
Université du Maine : EA2167
3 : University of Cergy-Pontoise & Cepremap
* : Corresponding author
EA 4507 - EMA - Université de Cergy-Pontoise
We study an open-economy model with labor market search frictions that affect both the intensive and the extensive labor margins. We identify two intertwined inefficiencies in the decentralized allocation: The trade externality (TE) and labor market frictions (LMF). While LMF create inefficiently low output, TE generates inefficiently high output and terms of trade. As a result, protectionism succeeds in eliminating the TE, but lowers employment. In a Ramsey problem, the government faces a trade-off: While TE calls for a higher overall tax wedge, LMF at the extensive labor margin calls for a lower tax burden.
