Unemployment in Open Economies

Trade is by no means a phenomenon of the last 25 years as the revived discussion about the globalisation and its effects on the (industrial) countries suggests. Therefore, it is not surprising that economic theory was concerned with the reasons of foreign trade from a very early stage.

Most countries in the European Union have experienced a steady increase of unemployment over the past decades. Figure 2.1 illustrates this fact by showing the average unemployment rate for the 15 countries of the European Union (EU 15) together with the unemployment rate of West Germany and the United States. In most years, West Germany’s unemployment rate was lower than the one of the EU 15 countries. The development however was analogous to that of the EU 15 countries. The experience of the European Union is contrasted by the development in the United States. The unemployment rate of the United States grew to almost 10% in 1980, but declined from then onwards with the exception of the short period between the late 80’s to the early 90’s.

It has long been known that search processes on the labour market are only another form of incompleteness on this factor market. Earlier works studied search processes and the behaviour of individuals, but seldom addressed the consequences for the whole economy.¹ In recent works, the search activities were simplified so that general equilibrium models can now easily be analysed.2 However, most of the papers base on models of a closed economy. On the contrary, almost all countries take the advantages trade offers so that it is desirable to have a search and matching model of an open economy.3

In the preceding chapter, a model of a two-sector economy was presented in which the search for a new job and worker caused nonnegligible costs. It was presumed that individuals behave risk-neutral. Normally, the assumption of risk neutrality is employed for simplicity, as in the preceding chapter. To posit a certain degree of risk aversion seems to be more appropriate. More important however, it can be expected that the individuals’ attitude towards risk differs across countries. Differences across countries in the private households’ saving rates or in the share of highly risky assets on total private asset holdings may indicate crosscountry disparities in the individuals’ risk behaviour.1 The OECD (1999) e. g. records a households’ saving rate of 0.5 percent of the disposable income for the United States, 13.6 percent for Japan and 11.0 percent for Germany in 1998. The saving rates suggest that the Japanese are more risk-averse than the U.S. Americans and the Germans.1 Since future employment positions are unknown, it can be expected that the individual’s risk behaviour influences the wage setting rule. As it was shown in the previous chapter, the properties of the wage agreement are important for the economy’s response to changes in the environment, as e.g. the appreciation of the domestic currency or the decline in a world market price.

Chapter 3 and 4 have shown that the response of wages to exogenous changes in the environment is crucial for the economy’s reaction. One of the most striking differences of the labour markets in various countries are the wage setting procedures. The preceding chapters presumed that wages are determined by negotiations between workers and firms. This assumption may be plausible for the United States. In most European countries, this assumption may be justified for the upper income classes. However, the influence of collective bargaining in most European countries is remarkable for middle and lower income classes.1 Consequently, the model presented in chapter 3 can only serve as a reference point for these countries.

The models presented in the last chapters described economies, in which firms could only choose the number of vacancies in order to adjust the desired stock of labour used in production. Although additional factors of production were used, they could not be adjusted within the considered time horizon. Following this line of argumentation the preceding chapters described economies and their behaviour in the short and medium run rather than in the long run. Therefore, the models had some resemblance to the standard specific factors model. However, a direct comparison to the standard Heckscher-Ohlin-Samuelson models is not possible. As only one factor could be adjusted in the models presented in the preceding chapters, well-known results of the international trade theory, as e. g. the Stolper-Samuelson Theorem or the Rybczinsky Theorem, cannot be verified for these models.

The present work intended to analyse the effects of an intensified international trade on small open economies with search frictions in a purely theoretical framework.1 The analysis solely focused on inter-industry trade and therefore described trade between industrialised countries and developing or newly industrialised ones. This has been justified with the example of Germany whose trade pattern with developing countries has changed between 1970 and 1993. Whereas Germany mainly imported raw material from developing countries in 1970, the share of manufactured goods on all imports increased to more than 67% in 1993 (cf. figure 2.4). Accordingly, it can be concluded that the developing countries have participated more intensively in international trade over the last twenty years.