International Trade, Wages, and Unemployment

Traditional trade theory has focused on the allocation of resources between various sectors of the economy and how it changes in response to trade liberalization while maintaining the assumption of free mobility of resources across sectors within an economy. This simplifying assumption is at odds with empirical evidence which shows considerable frictions in the movement of resources between sectors, at least in the short to medium run. Workers who lose their jobs in the import competing sector may find it hard to find a job immediately in the export sector. This has given rise to a growing literature that incorporates frictions in the mobility of factors of production in general, and labor in particular, in trade models. This article surveys the literature on trade and unemployment where unemployment is caused by search frictions or wage rigidity of some kind such as minimum wage, efficiency wage, or implicit contracts. While the focus is on unemployment, any model studying the impact of trade on labor markets features wage effects, too, and a brief discussion of wage effects is also provided. Trade affects unemployment in these multi-sector models through two main channels: sectoral unemployment rates and intersectoral reallocation of resources. In newer trade models with heterogeneous firms, trade can change unemployment by affecting the allocation of resources within a sector. While the theoretical models in this literature identify various channels through which trade liberalization affects unemployment, many of these channels have opposing implications for unemployment, rendering the net effect of trade liberalization on unemployment ambiguous in many settings. This has also given rise to an empirical literature studying the implications of trade liberalization on unemployment.