International Trade and Unemployment Theory and Cross.pdf

International Trade and Unemployment: Theory and Cross-National Evidence Pushan Dutt Devashish Mitra Priya Ranjan INSEAD Syracuse University University of California - Irvine December, 2007 Abstract In this paper, we present two alternative models of trade and unemployment, in which unemployment is generated through a search mechanism. The basic framework of the Örst model is Ricardian in that the only factor of production is labor and trade is based on relative technological di§erences. The second model has a Heckscher-Ohlin (H-O) framework with two factors of production, namely labor and capital that are intersectorally mobile. Using cross-country data on various measures of trade policy, unemployment and a variety of controls, we Önd strong evidence for the Ricardian prediction that unemployment and trade openness are negatively related (protection and unemployment are positively related). We do not Önd any support for the H-O prediction that this relation between trade openness and unemployment changes from negative to positive as we move from labor-abundant to capital-abundant countries. Our results are robust to the inclusion of controls for labor market institutions and macroeconomic distortions. They hold for both ordinary least squares and instrumental-variables approaches, where the latter accounts for the endogeneity of trade policy to unemployment and possible measurement errors in trade policy variables. 1 Introduction While unemployment is one of the big economic problems, trade economists have generally tended to abstract away from it. Most trade models are full employment models with fully áexible wages. Implicitly, thi