Unemployment in an Interdependent World

We introduce search unemployment in a model of trade in dierentiated,goods and heterogeneous,rms. Countries dier with respect to size, geographical location, and labor market institutions such as hiring costs, unemployment benets, and the eciency,of the matching process. Contrary to the literature, we show that bad institutions in one country worsen labor market outcomes not only in that country but also in those that are related through trade in goods. This spill-over eect,is conditioned by trade costs and country sizes: smaller and/or more central nations suer,less from inecient,policies at home than large and/or peripheral ones, whereas the spill-over eects is stronger for smaller/more central nations. The reason is that bad labor market institutions in one place reduce the global market potential which harms other countries as well. Our econometric analysis suggests that, controlling for business cycle eects, the conditional spatial correlation of unemployment rates is positive. Moreover, we show that trade-weighted inecient foreign labor market institutions increase unemployment,domestically by a non- trivial amount. Finally, labor market outcomes of more open economies are more strongly aected,by foreign institutions. Keywords: Unemployment; international trade; search frictions; heterogeneous,rms;