Trade-Induced Job Turnover and Unemployment: The Role of Variable Demand Elasticity

Abstract

This paper develops and estimates an open economy dynamic general equilibrium model to introduce and quantify a new mechanism through which openness influences productivity. The model features matching frictions in the labor market and endogenous demand elasticities in product markets. Because openness affects demand elasticities, it influences productivity through several channels. First, higher demand elasticities make firms’ employment decisions more responsive to their idiosyncratic productivity shocks. This causes aggregate job turnover to rise, and thereby tends to raise unemployment. Second, this same increase in job turnover means that workers are moved more frequently from less to more efficient firms. Finally, to the extent that openness reduces the cross-firm dispersion in markups, it likewise tends to reduce the distortionary wedges between firms’ marginal revenue products. Counterfactual analysis quantifies these trade-induced impacts on job turnover, unemployment, and welfare. I show that a 10 percentage point reduction in import tariffs combined with a 12 percent reduction in the iceberg trade cost raises job turnover and unemployment (in steady state) by roughly 8 and 17 percent, respectively. These effects would be almost four times smaller if demand elasticities were not allowed to respond to openness. Moreover, gains from trade are almost 20 percent larger if one allows demand elasticities to respond to openness.