Does globalization lead to unemployment? While of enormous interest to policy makers, the academic economist’s answer to this question is bound to be ambiguous. The theory of the second best teaches that dismantling barriers to trade in an environment featuring additional pre-existing distortions in the labor market that give rise to unemployment can either exacerbate or attenuate the welfare damage of those distortions (Lipsey and Lancaster, 1956). Hence, the answer to the above question will almost necessarily depend on modeling details. It therefore comes with some relief that merging the leading macroeconomic explanation of unemployment the Pissarides (2000) search and matching model–with the most recent version of the Krugman (1980) trade model–the Melitz (2003) model with heterogeneous firms–yields an unambiguous conclusion: globalization modeled as various types of trade liberalization lowers the equilibrium long-run rate of unemployment.
The Melitz (2003) trade model is a natural starting point to study unemployment in an open economy. It combines increasing returns to scale in production and product differentiation with heterogeneous firms. It has been successfully applied to a number of questions and has done very well in empirical studies (see the survey of Helpman, 2006). In that model, trade liberalization puts inefficient firms out of business while offering new opportunities to efficient ones. That selection effect leads to an aggregate productivity gain. There is ample evidence for this effect, both from microeconometric and from aggregate data (Bernard et al., 2003).