International Trade and Unemployment: Theory and Cross-National Evidence

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 first model is Ricardian in that the only factor of production is labor and trade is based on relative technological differences. 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 find strong evidence for the Ricardian prediction that unemployment and trade openness are negatively related (protection and unemployment are positively related). We do not find 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.