Inefficiencies in globalized economies with labor market frictions

François Langot, Lise Patureau and Thepthida Sopraseuth
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François Langot: IUF - Institut universitaire de France - M.E.N.E.S.R. - Ministère de l'Education nationale, de l’Enseignement supérieur et de la Recherche, GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université, CEPREMAP - Centre pour la recherche économique et ses applications - ECO ENS-PSL - Département d'économie de l'ENS-PSL - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres
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
Thepthida Sopraseuth: GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université, CEPREMAP - Centre pour la recherche économique et ses applications - ECO ENS-PSL - Département d'économie de l'ENS-PSL - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres, THEMA - Théorie économique, modélisation et applications - CNRS - Centre National de la Recherche Scientifique - CY - CY Cergy Paris Université

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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; Employment Subsidy; Inefficiency Wedge; Trade Policy; Open Economy; Intensive Margin of Labor; Extensive Margin of Labor; Labor Market Search; Trade Externality (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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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-05482076

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