Does Trade Liberalization Lead to Unemployment? Theory and Evidence

Abstract

Exporting firms are larger and more productive than non-exporting firms. Trade openness leads to an increase in intra-industry firm turnover. As trade is liberalized, large firms need more labor to produce and small firms exit, leading to a reallocation of labor from the former to the latter. This mechanism leads to welfare gains as aggregate productivity is increased. This paper identifies another consequence of this transmission channel when labor market search frictions are introduced. I merge the Melitz (2003) model of intra-industry reallocations with the large firm model from Pissarides (2000) and find that an increase in trade exposure generates more job destruction than creation. Finally I test the model predictions by applying GMM panel data methods to US sectoral job flows. The empirical findings confirm the theoretical results.