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Labor market frictions and the Balassa Samuelson model

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Niveau: Supérieur, Doctorat, Bac+8
Labor market frictions and the Balassa-Samuelson model? Olivier CARDI† and Romain RESTOUT‡ Abstract This paper addresses the role of labor market frictions in the transmission process of sectoral productivities shocks to the relative price of nontradables. The Balassa-Samuelson model based on frictionless labor markets predicts (i) proportionality between relative prices and the cross-sectoral productivity differential and (ii) wage equalization across sectors. Using panel cointegration and unit root tests applied to a panel of fourteen OECD economies, our empirical evidence does not support these implications. This paper shows that these puzzles can be successfully explained by a two-sector model with labor market frictions. In particular, this paper considers two types of rigidities: labor reallocation costs across sectors and matching frictions similar to those found in the Mortensen-Pissarides model of unemployment. Keywords: Balassa-Samuelson model, labor market frictions, productivity JEL Classification: F31, F41, J64 ?Constructive comments by David de la Croix, Frederic Jouneau-Sion, Frac¸ois Langot, Celine Poilly and Bruno Van der Linden are acknowledged. We are also grateful to seminar participants at ADRES 2011, Universite Catholique de Louvain and universities of Lille, Le Mans and Paris X. The responsibility for any errors is entirely ours. Romain Restout acknowledges financial support from the Belgian Federal Government (Grant PAI P6/07 ”Economic Policy and Finance in the Global Equilibrium Analysis and Social Evaluation”).

  • labor market

  • sectors

  • traded sector

  • friction

  • sector

  • across sectors

  • sectors occur without

  • relative wage

  • shocks


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LabormarketfrictionsandtheBalassa-SamuelsonmodelOlivierCARDIandRomainRESTOUTAbstractThispaperaddressestheroleoflabormarketfrictionsinthetransmissionprocessofsectoralproductivitiesshockstotherelativepriceofnontradables.TheBalassa-Samuelsonmodelbasedonfrictionlesslabormarketspredicts(i)proportionalitybetweenrelativepricesandthecross-sectoralproductivitydifferentialand(ii)wageequalizationacrosssectors.UsingpanelcointegrationandunitroottestsappliedtoapaneloffourteenOECDeconomies,ourempiricalevidencedoesnotsupporttheseimplications.Thispapershowsthatthesepuzzlescanbesuccessfullyexplainedbyatwo-sectormodelwithlabormarketfrictions.Inparticular,thispaperconsiderstwotypesofrigidities:laborreallocationcostsacrosssectorsandmatchingfrictionssimilartothosefoundintheMortensen-Pissaridesmodelofunemployment.Keywords:Balassa-Samuelsonmodel,labormarketfrictions,productivityJELClassification:F31,F41,J64ConstructivecommentsbyDaviddelaCroix,Fre´de´ricJouneau-Sion,Frac¸oisLangot,Ce´linePoillyandBrunoVanderLindenareacknowledged.WearealsogratefultoseminarparticipantsatADRES2011,Universite´CatholiquedeLouvainanduniversitiesofLille,LeMansandParisX.Theresponsibilityforanyerrorsisentirelyours.RomainRestoutacknowledgesfinancialsupportfromtheBelgianFederalGovernment(GrantPAIP6/07”EconomicPolicyandFinanceintheGlobalEquilibriumAnalysisandSocialEvaluation”).EcolePolytechniqueandUniversite´Panthe´on-AssasParis2,ERMES,12PlaceduPanthe´on,75230ParisCedex05.France.Phone:+33(0)144418973.Fax:+33(0)140518130.E-mail:olivier.cardi@u-paris2.fr.Universite´catholiquedeLouvain(UCL),IRES,3placeMontesquieu,B-1348Louvain-la-Neuve,Belgium.Phone:+32(0)10473989.Fax:+32(0)10473945.E-mailaddress:romain.restout@uclouvain.be.1
1IntroductionTheBalassa-Samuelsonmodel(BShereafter)hasachievedworkhorsestatusfortheanalysisofpro-ductivityshocksinthetradedandnontradedgoodssectors(Balassa[1964]andSamuelson[1964]).Itskeyinsightistoshowthat,iflabormarketisfrictionless,realwagesareequalizedacrosssectorsandtherelativepriceofnontradablesisstrictlyproportionaltothecross-sectoralproductivitydifferential.1ThevoluminousliteratureexploringtheinternalworkingsoftheBSmodelisaclearreflectionofitssuccess(seeFrootandRogoff[1995]forasurvey).Thisissomewhatsurprisinggiventhattheempiri-calvalidityofthestandardmodel’spredictionsarefarfromclear:thewageequalizationassumptiondoesnothold,bothintheshortandmediumrun,and,therelativepriceresponsivenesstosectoralproductivityshocksisgenerallyfoundtobesmallerthantheunit-elasticitypredictedbythetheory.2OurownempiricalevidencereportedinSection2confirmsthesefindingsandshowsthatthetrans-missionofproductivityshocksislikelytodifferfromthatoftheBSmodel.Theseapparentpuzzlesmayreflectarestrictivewayofmodellingthelabormarket.Inthispaper,wearguethatincorporatinglabormarketfrictionsintheBSmodelcanpotentiallyaccountfortheaboveevidence.InthestandardBSmodel,thelabormarketisperfectlycompetitiveandreallocationsofwork-ersacrosssectorsoccurwithoutfrictions.Insuchenvironment,wagesactasthemaintransmissionmechanismandconvertprimitiveshockstotechnologyintomovementsintherelativeprice.Inpar-ticular,biasedtechnologicalshocksfavoringthetradedsectorbidupwagesinthatsector.Laborbeingperfectlymobileacrosssectors,wagesinnontradablesincreasetoo.Becauseproductivitygainsinnontradablesaresmallerthanthoseintradables,nontradedproducersareonlyabletomeetthehigherwagesbyincreasingtheirprices.WhiletheassumptionofWalrasianlabormarketsisconvenientbecauseofitssimplicity,however,theBSmodelisunabletoexplainsectoralwagedifferentialsandthetendencyforrelativeproductivitiestogrowbymorethantherelativeprice.Incontrast,atwo-sectorgeneralequilibriummodelwithlabormarketfrictionshasthepotentialtoexplainthesefindingsinanotherwisestandardsetup.Inthispaper,weextendtheBSmodelwithamorerealisticlabormarket.Inparticular,weconsider,separately,twoalternativefrictionsintheformof(i)laborreallocationcostsacrosssectorsand(ii)matchingfrictionssimilartothosefoundintheMortensen-Pissaridesmodelofunemployment.Thetwotypesoflabormarketfrictionsconsideredherepossesstwoparticularyattractiveattributesfortheanalysisofproductivityshocksonpricesandwages.First,thetwoformulationsarequiteexplicitandhavestrongtheoreticalmicro-foundations.Asaresult,theframeworkspresentedinthispaperarehighlytractable,allowingforatransparentanalysisofproductivityshocksandaclearidentificationoftheunderlyingpropagationmechanisms.Second,thetwoinefficienciessubsistbothintheshortandthelongrun,whereasnominalwagerigidities(Calvo-stylewagesettingorquadraticcostsofadjustingnominalwages)onlyexistsintheshortrun.SincemostoftheBStheoreticalpriorsarebasedonlong-runeffectsofproductivity,thesefrictionsprovidewell-suitedextensionstoillustratetheroleoflabormarketrigidities.1Withcompetitivelabormarkets,wagerateequalsthemarginalproductoflabor,andwithstandardtechnologies,averageandmarginalproductsareproportional.Undertheseconditions,theslopeoftheproductionpossibilitycurve,givenbytherelativepriceofnontradables,isequaltotheratiooftheaverageproductsoflaborinthetwosectors.2Forthewageequalizationassumption,seeLee[1995],StraussandFerris[1996]andStrauss([1997],[1998]).SkepticalevidenceontheproportionalityhypothesisisproducedbyDeGregorioetal.[1994]andLeeandTang[2007],whileCanzonerietal.[1999]andKakkar[2003]findsomesupporttothishypothesis2