International Trade and Labor Markets: Theory, Evidence, and Policy Implications by Carl Davidson and Steven J. Matusz, Kalamazoo, Michigan: W.E. Upjohn Institute for Employment Research, 2004, 145 pp., ISBN 0-88099-274-3.

Why is the debate about globalization so rancorous and unproductive? To anti-globalists, it seems obvious that import competition from low-wage countries such as China and India is forcing down wages and living standards in the developed countries of Europe and North America. Economists can’t see what’s in front of their faces due to their fixation on outmoded mathematical models. To economists and other promoters of free-trade, the anti-globalists are simply ignorant; they fail to understand the most basic of economic principles, i.e., wages reflect productivity, so that having low wages in no way confers an “unfair” competitive advantage to developing countries. Moreover, even when trade does create losers, it is possible to mathematically prove that the gainers gain more than the losers lose. Hence, it makes no more sense to protect textile workers from low cost imports than it does to protect typewriter manufacturers from low cost PCs. Why can’t the two sides of this debate agree? In International Trade and Labor Markets, two leading trade theorists, Carl Davidson and Steven Matusz, propose a simple and persuasive answer. They argue that the two sides are speaking different languages. Their basic premise is that anti-globalists are right to point out that economists often defend free trade with outmoded models that are incapable of addressing their concerns. At the same time, however, the authors argue that it is possible to incorporate the concerns of the anti-globalists in fully articulated general equilibrium models that respect basic economic principles. The authors contend that the key to bridging the gap is to enrich the labour market specification in traditional models of international trade. Traditional models abstract from search and other frictions, and assume all prices are fully flexible. As a result, resources (in particular labour) are always fully employed. Trade does influence labour market outcomes and the distribution of income, but only by influencing market clearing prices. It does not influence employment prospects. This is unfortunate, since the public debate is more about jobs than about wages. Summarizing their recent research on labour markets and international trade, Davidson and Matusz show how realistic frictions can be incorporated into standard trade models in a way that preserves analytical tractability yet at the same time generates an equilibrium unemployment rate that is responsive in predictable and empirically testable ways to the forces of globalization. They do this by wedding the well known Mortensen-Pissarides search model to a standard international trade model. In this model, it takes time and effort for workers to find new jobs and for firms to hire and train new workers. Most of the analysis centres on a simple two-sector example in which one sector (Sector 1) features low wage jobs that are easy to find, and another sector (Sector 2) features high wage jobs that are more difficult to find. Both jobs are assumed to disappear at their own exogenously specified “job destruction rates”. Once a worker loses his job, he must decide where to start looking for a new job. He knows that Sector 2 has higher wages, but he also knows that it is harder to find a job there. In equilibrium, Sector 2 wages are just high enough to offset the higher search costs. One of the major conclusions from the analysis is that labour market institutions, to the extent that they influence relative search costs, can become a source of comparative advantage, and thereby influence the pattern of international trade. For example, if an industry’s job destruction rate is relatively high in a particular country, then that country is likely to be an importer of that good. The reason …