Inefficiencies in globalized economies with labor market frictions

Francois Langot, Lise Patureau and Thepthida Sopraseuth
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Lise Patureau: LEDa - Laboratoire d'Economie de Dauphine - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique

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Abstract: In an open-economy model with labor market search frictions and both the intensive and extensive margins, we identify two interrelated inefficiencies in the decentralized allocation. First, a trade externality arises because domestic agents do not internalize their market power on external demand, leading to excessively high import prices. Second, labor market matching frictions create suboptimal employment levels. These inefficiencies create a policy dilemma. While protectionism can address the trade externality, it comes at the cost of lower employment. Conversely, hiring subsidies can boost employment, but at the expense of higher import prices. Interestingly, and unlike the conventional view, our analysis suggests that increasing the labor tax wedge can be optimal, even in the presence of labor market frictions. This is the case in economies with large trade externality.

Keywords: Tax Wedge; Labor Market Search; Extensive Margin of Labor; Intensive Margin of Labor; Open Economy; Inefficiency Wedge; Trade Externality; Trade Policy; Employment Subsidy (search for similar items in EconPapers)
Date: 2025-03
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Published in Annales d'Economie et de Statistique, 2025, March 2025 (157)

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Journal Article: Inefficiencies in Globalized Economies with Labor Market Frictions (2025)
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