Relative Productivity and Search Unemployment in an Open Economy

Using a panel of eighteen OECD countries, we find empirically that the long-run effects of higher productivity of tradables relative to non-tradables vary across time, space and stages of the business cycle. More specifically, our evidence reveals that elasticities of the relative wage and relative price of non-tradables with respect to relative productivity of tradables increase over time. Our estimates also show that the fall in the relative wage is more pronounced whilst the appreciation in the relative price is less in countries where labor markets are more regulated and during periods of recession. To rationalize the evidence, we differentiate between labor mobility costs caused by job search efforts and hiring costs resulting from search frictions in the labor market in a two-sector open economy model. While time-declining labor mobility costs can account for the time-increasing effects of a productivity differential, international differences in labor market regulation and variations of hiring costs across the business cycle, respectively, can rationalize the cross-country and state-dependent effects we estimate empirically. Finally, labor market frictions have important implications for sectoral unemployment since labor mobility and hiring costs bias labor demand toward the traded sector which results in a greater decline in unemployment in tradables relative to unemployment in non-tradables following higher relative productivity.