Most of the public debate concerning the liberalization of international trade revolves around the effect of trade on the levels of employment.  Proponents of trade liberalization argue that higher demand for domestic products from abroad would increase employment.  Opponents worry that competition with imported products, in driving domestic producers out of business, would lead to job losses overall.  For scholars, however, the complexity of countries’ economies and the functioning of their labor markets suggest that both views are at least incomplete.In the academic literature on this issue, models of unemployment incorporate labor market frictions into the market clearing mechanism, so that unemployment arises endogenously as an equilibrium outcome.

In the early literature, labor market frictions were restricted to minimum wages, rigid wages or union activity.  The more recent literature incorporates search frictions, efficiency wages, fair wages, implicit contracts, insider/outsider models of labor markets, among others.  In these models, because the allocation of resources determines employment across sectors, policies that affect the allocation of resources can have an impact on the levels of employment.  If international trade affects the allocation of resources, then employment is also affected by trade.There is now a growing body of research that emphasizes the decisions of individual firms and workers in understanding the causes and consequences of aggregate trade on employment.  This emergent theoretical literature is a response to empirical studies using micro data, which reveal a number of features of worker and producer behaviors that were not well explained by pre-existing theories of international trade.  In particular, these models introduce search and matching frictions into a (Melitz type) model of firm heterogeneity to analyze employment as well as the income distribution.  With firm heterogeneity it can be shown that, for example, more productive firms pay higher wages while exporting increases the wage paid by a firm with a given productivity, so that the opening of trade enhances wage inequality but can either raise or reduce unemployment.

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