key: cord-0068939-jpc6wxpu authors: Molana, Hassan; Montagna, Catia; Onwordi, George E. title: De-Globalization, Welfare State Reforms and Labor Market Outcomes date: 2021-10-25 journal: IMF Econ Rev DOI: 10.1057/s41308-021-00150-8 sha: 424b06e5a39db8558f569dbe2c65e25dc7291e83 doc_id: 68939 cord_uid: jpc6wxpu Within an open economy framework characterized by vertical linkages in production, and search frictions with two-sided heterogeneity in the labor market, raising trade barriers is shown to increase unemployment across skill levels and to reduce labor market participation and aggregate income. These effects are not necessarily moderated by maintaining frictionless mobility of capital across borders. We find that a flexicurity reform of a liberal welfare state can dampen the adverse effects of de-globalization. The perception that international trade has been a source of economic dislocations with adverse effects on labor market outcomes, above all in industrial economies, is arguably one of the causes of the backlash against globalization and the emergence of protectionist stances in recent years. However, particularly in the light of the growing complexity of global production chains, raising trade barriers can have multifaceted effects on labor markets-not least via their impact on aggregate productivity, a theme that has been central to debates about the potential implications of Brexit for the UK. In this paper our goal is to first examine the labor market effects of raising trade barriers, considering not only its impact on unemployment but also on labor market participation and job-skill mismatch, in an environment characterized by intersectoral linkages and the tradability of intermediate inputs. The analysis will be cast in terms of raising trade costs and throughout we shall note its relevance to the protectionist tendencies that have recently been observed. However, in so doing, the paper also clearly sheds light on the opposite case of trade liberalization. We shall then ask how welfare state and labor market reforms can influence the effects of raising trade frictions. Here, our focus will be on flexicurity policies which are central to the European 2020 employment strategy and have, more broadly, been supported by international institutions such as the IMF (see, e.g., Blanchard et al., 2014) . Given that our aim is to examine the implications of trade shocks and policy reforms on key aggregate and labor market outcomes, we shall not be concerned about the welfare implications of the reforms. Consequently, our policy analysis will consist of selected experiments informed by real world tendencies, such as the EU2020 employment strategy recommendations, and will not consider optimal policies. To examine these issues, we construct a general equilibrium model of an open economy that is characterized by vertical linkages in production and search frictions with two-sided heterogeneity in the labor market. Firms exhibit different productivity levels and use skilled and unskilled labor and capital to produce varieties of an intermediate input sold both domestically and internationally. We assume that workers are endowed with different skill levels and can be employed in high-and lowtech jobs as in, e.g., Albrecht and Vroman (2002) ; whilst high-tech jobs can only be performed by high-skill workers, low-tech jobs can be performed by both highskill and low-skill workers. Consequently, skill mismatch arises in the model (as in the notable contribution of Davidson et al., 2008) , reflecting the trade-off that highskill individuals face between not working and being employed in low-tech jobs and receiving a lower wage. Clearly, high-skill workers can then generate an externality for low-skill workers by increasing the competition for low-tech jobs. Two key features of this model distinguish it from those used in the existing studies that focus on the labor market effects of economic integration-and result in a richer characterization of labor market dynamics. First, it introduces endogenous participation and thus captures the transition in and out of the labor force, reflecting the trade-off the household faces between leisure and consumption. This aspect, to our knowledge, has been ignored in this strand of the literature. There are reasons why addressing this omission is important: as documented by, e.g., Elsby et al. (2015 Elsby et al. ( , 2019 , movements in and out of the labor force contribute significantly to the variations in unemployment over the long-run and play a key role in driving aggregate labor market outcomes. In addition, recent empirical evidence-e.g., Gaddis and Pieters (2012) , Autor et al. (2013) and Cooray et al. (2017) -shows that economic integration has had a significant effect on labor force participation decisions. Furthermore, as we demonstrate in this paper, these adjustments prove to be crucial when assessing the impact of both shocks (such as raising trade costs) and policies on equilibrium solutions. 1 The second key feature of the model is to allow for a relatively broad menu of active and passive labor market policy instruments so as to characterize the main dimensions of flexicurity and to capture the complex interaction between them in affecting labor market outcomes. We start by calibrating the benchmark solution of the model to reflect the main characteristics of the UK economy, which can be thought of as a liberal welfare state regime. The UK offers an interesting benchmark, considering the potential increase in trade costs with its main and geographically closer trading partners that might result from Brexit. 2 Moreover, its labor market policies and institutions are among the most deregulated in mature industrial economies and ought to offer, according to received wisdom, the best supporting framework to the economy's ability to adjust to and withstand the effects of adverse shocks. Our baseline analysis considers the impact of a permanent increase in trade cost and examines the transitional dynamics of the economy from the initial to the new equilibrium. We find that higher trade frictions can have adverse consequences for the level of economic activity and labor market outcomes due to their negative effects on firms' profitability and labor demand in the long-run. We then show that reforms of the labor market in the direction of flexicurity can mitigate these effects. Our aim is to assess the labor market implications for a country such as the UK of adopting a reform package that reflects some of the recommendations central to the EU employment strategy-which include improvements in the design of active labor market policies (ALMPs) such as the provision of public employment services and adequate income support to all jobseekers (European Commission, 2014) . To this end, we implement a labor market reform package in the direction of flexicurity that captures the key pillars of the latter and hence targets unemployment benefit, firing and vacancy creation costs, and investment in employment services. As a reference welfare system, we use Denmark (a pioneer of the flexicurity concept). We wish to stress that our objective is not to obtain an intercountry comparison between welfare state regimes, but to study the effects of reforms within a country. Clearly, from a methodological standpoint, since changes in individual policy instruments may have opposite effects on the equilibrium values of the variables, the extent to which they are altered relative to each other is an important determinant of the net impact of a given reform package. We therefore change the values used for UK individual policy instruments in the direction of and by a proportion consistent with their corresponding Danish counterparts. Notably, applying such a reform package to the UK's liberal regime would entail increasing employment protection, expenditure on unemployment insurance as well as that on ALMPs such as employment services-a policy that has received growing attention as a cost-effective means to reduce labor market frictions 3 but which has arguably become less prominent in the UK in recent years (Davies, 2018) . As conjectured above, the endogeneity of labor market participation turns out to be a crucial factor in determining the effects of both the trade shock and the policy reform. By reducing the demand facing firms, higher trade costs reduce vacancy creation, which implies greater unemployment and skill mismatch due to an intensification of workers' competition for jobs. With endogenous participation, in the short-run these effects are dampened by an outflow from the labor force into inactivity as a result of worsening job prospects. As the economy transitions to a new long-run equilibrium, however, the pool of unemployed increases and so does aggregate mismatch as high-skill workers seek low-tech employment as a means to escape unemployment. In the presence of mark-up pricing, the resulting downward pressure on wages provides the only recovery channel for firms' sales and employment. However, this channel is not sufficiently strong to overcome the negative impact of the rise in trade costs: domestic and foreign absorption both fall, reducing GDP, labor force and employment both shrink while the incidence of skill mismatch increases. The endogeneity of participation also shapes the effects of policy. For instance, increases in unemployment benefits (a typical passive labor market policy) can perform as an activation measure and have expansionary effects, contrary to conventional views that portray it as a distortionary policy that harms employment via higher labor costs. More generally, our model suggests that, despite involving higher unemployment benefits, a reform package that increases expenditure on active labor market policies can raise the level of economic activity via aggregate supply and demand effects that stimulate both labor market participation and job creation, with the new steady state being characterized by lower unemployment rates across the skill spectrum. We carry out two experiments to examine the robustness of the results. The first considers changes to the degree of capital mobility frictions. In so doing, we demonstrate the importance of the interaction between the latter and the degree of trade openness. In particular, we find that higher capital mobility frictions, by increasing the cost of capital, trigger a substitution in factors of production away from capital and towards labor-and hence lead to higher wages and employment. Thus, maintaining frictionless mobility of capital across borders does not necessarily moderate the negative impact of higher trade costs. The second experiment concerns the nature of taxation. Our main results are obtained using a neutral taxation where a lump-sum tax imposed on households adjusts to cancel the difference between government's revenue and expenditure resulting from shocks. On the one hand, this simplification facilitates the isolation and hence understanding of the effects of labor market policies. On the other hand, it prevents us from capturing the effects of distortionary income taxation on labor market decisions. We therefore later introduce direct taxation of labor and non-labor income, at different rates. We find that the presence of distortionary taxation enhances the impact of a trade shock. Albeit to a lesser extent, however, reforms continue to remain effective in countering the negative impacts of the shock. The extant literature on the effects of international economic integration on the labor market is vast and varied. A strand of this literature, to which this study is closely related, focuses on the productivity and unemployment effects of economic integration but does not reach a clear consensus. For instance, Felbermayr et al. (2011a) and Cacciatore (2014) , amongst others, show that higher trade integration reduces unemployment by inducing a reallocation of resources towards more productive firms. By contrast, and find that trade openness can potentially result in higher unemployment despite leading to higher firms' profitability. Moore and Ranjan (2005) argue that trade liberalization can lead to a higher unemployment rate of the unskilled, whereas its effect on aggregate unemployment is ambiguous. A major advancement of our paper in relation to these studies is to allow for the emergence of labor market mismatch with endogenous participation. The effects of openness on mismatch has received relatively little attention in the literature. At an empirical level, Davidson et al. (2014) and Krishna et al. (2014) find evidence of improved match quality as a result of globalization. At a theoretical level, building on the partial equilibrium framework with two-sided heterogeneity developed by Albrecht and Vroman (2002) , Davidson et al. (2008) study the effects of trade liberalization but focus on firms' export decisions. A similar approach is found in Arseneau and Epstein (2017) who study the effects of openness on labor market outcomes and argue that mismatched employment helps moderate the higher aggregate unemployment consequences of offshoring. A key difference is that our paper allows for the job-search decisions of the unemployed to reside with the household. Moore and Ranjan (2005) also study the impact of globalization on the unemployment outcomes of workers with different skills but focus on a labor market in which only perfect job matches exist in equilibrium. Finally, by considering the interaction between labor market policies and institutions and the degree of international trade openness, our work is also closely related to, e.g., and Coşar et al. (2016) but is distinguished from them by its use of an explicit definition of workers' heterogeneity and by focusing on how (de-)globalization interacts with a multiplicity of labor market policies to drive unemployment of different categories of workers and mismatch. The rest of the paper is organized as follows. Section 2 sets up the model and Section 3 describes its calibration. The effects of de-globalization and reforms are discussed in Sections 4 and 5 respectively. Section 6 considers the effects of capital mobility frictions and the nature of taxation. Section 7 concludes the paper. We construct a dynamic model of a small open economy in which a representative household's members are endowed with and supply high-skill and low-skill labor. Capital serves the dual purpose of wealth accumulation and factor of production and is allowed to be internationally mobile. In an upstream sector, monopolistically competitive firms with firm-specific productivities use capital and high-and low-skill labor to produce varieties of an intermediate input which they export as well as sell domestically to a downstream sector. The latter combines domestic and imported varieties to produce a homogenous final good under perfectly competitive conditions. The labor market is subject to search and matching frictions. The government implements labor market policies and uses a lump-sum tax levied on the household to balance its budget. There is a representative household with a continuum of infinitely-lived members whose measure is normalized to unity. Household members are either skilled or unskilled with their respective mass treated as exogenous and denoted by Z and 1 − Z. At any point in time t, each type is assumed to be active (participating in the labor force) or inactive. Denoting the proportion of those in latter states by X and L respectively, X + L = 1, and using the superscripts s and u to refer to high-and low-skill workers, it follows that X s t + L s t = Z and X u t + L u t = 1 − Z. Those participating in the labor force are either unemployed and searching for a job or employed, denoted by S and N, respectively. On the demand side, there are two types of tasks, low-tech and high-tech. The low-skill individuals can only search for and be employed in lowtech task jobs, hence X u t = S ul t + N ul t , where the superscripts ul refers to low-skill in low-tech task jobs. The high-skill individuals can search for and be employed in either task. Hence, respectively denoting by superscripts sl and sh those who go for the low-and high-tech task jobs, X s t = X sl t + X sh t . X sl t are assumed to opt for lowtech task jobs in order to exit from the unemployment pool. Therefore, we also use X sh t = N sh t + S sh t and X sl t = N sl t + S sl t to partition participation of high-skill workers into an employed and a searching status. All newly-formed job matches at any time t are assumed to become effective at the beginning of the following period. Thus, as far as the household is concerned, the three employment types evolve as follows 4 where i and q i are, respectively, the exogenous job destruction (or match separation) rate and the endogenous probability of a job match (job-finding rate), with the superscript i = h, l referring to low-and high-tech task jobs. Denoting the high-tech and low-tech matched jobs by M h t and M l t respectively, it follows that q h t = M h t S sh t and q l t = M l t S ul t + S sl t . Equations (1) to (3) show that the mass of workers who are employed at the beginning of t +1 consists of those who survived their 'match separation', i.e. 1 − i N j t , j = ul, sl, sh, and the new matches q i t S j t . (1) The household pools income from all sources and faces the budget constraint, 5 where: C is consumption; I is gross investment; T is the lump-sum tax paid to the government; w j , j = ul,sl,sh, is the negotiated wage rate received respectively by unskilled workers in low-tech job, skilled workers in mismatched low-tech jobs, and skilled workers in high-tech jobs; b is the unemployment benefit received by those who are actively searching for jobs, S = S ul + S sl + S sh ; Π is the profits from firms' which is distributed to households (to be clarified later); K is the capital stock held by the household sector; K D is firms' demand for capital stock; and r and r * are the domestic and foreign rate of return on capital, respectively. The budget constraint above reflects the economy's international borrowing/lending of capital with an inflow (outflow) of K t − K D t < 0 (> 0). The stock of capital depreciates at a constant rate δ leading to the capital accumulation process The instantaneous utility function of the household is assumed to be where U C t is the utility from consumption and A j X j t represents the disutility of participation (not enjoying leisure) of the relevant worker type. Treating the paths for T t |t ≥ 0 and the initial condition K 0 , N ul 0 , N sl 0 , N sh 0 as given, the household chooses the optimal paths for C t , K t+1 , X j t |t ≥ 0 to maximize the expected value of ∞ ∑ t=0 −t U t subject to (1)-(6), where ∈ (0, 1) is the subjective time preference discount factor. The first order conditions for the intertemporal maximization problem can be shown to imply the standard Euler equation governing the path of consumption and the following relationships govern the household's labor market participation decisions where we have used (7) to define Λ t+1 = U � C t+1 U � C t as the stochastic discount factor. Each equation equates the net marginal cost of the relevant members' participation with their expected net marginal benefit of securing a lasting job match and thus regulates the transition of individuals from outside the labor force into the pool of those searching for jobs. We assume that two types of 'specialized' hiring agencies, labelled low-and hightech, act as intermediaries between workers and firms operating in the intermediate good sector to meet their respective labor demand. The high-tech agency only considers high-skill workers. The low-tech agency, instead, posts vacancies that can be filled by either type of worker. In both segments of the labor market, random matching governs the pairing of workers to vacancies. The absence of differentiation in job postings between low-skill and mismatched workers in the low-tech segment of the labor market and the fact that a low-tech vacancy can be filled by either a high-or a low-skilled worker then give rise to direct competition for jobs between low-and high-skill workers, reflecting an additional externality that arises from mismatch (see, e.g., Shimer and Smith, 2001; Arseneau and Epstein, 2018) . Vacancies are denoted by V j , j = h, l. They are created and posted at a unit cost of c j -which is measured in terms of output and treated as a constant exogenous parameter 6 -and are filled following the process governing the search and matching frictions. As previously noted, the existing low-tech and high-tech job matches are subject to exogenously determined separation (or job destruction) rates, j , and a fixed firing cost of f per worker is incurred by the agencies. 7 Below we describe the job-matching process between each type of agency and worker that determines the respective wages. At any time t, the aggregate number of matches in the low-tech segment of the labor market is determined by the matching function assumed to satisfy the standard properties described by Pissarides (2000) . We define market tightness by l t ≡ V l t S ul t + S sl which state that the marginal gain (or the surplus) of a job match to the agency is given by the marginal revenue of a worker net of the wage rate it receives from the agency plus the expected discounted continuation value of the job. From the agency's perspective, its employment of high-skill workers evolves according to The degree of market tightness is given by h t ≡ V h t S sh t . Similar to the low-tech agency case, the temporal profit of the agency is where H h = h h N sh is the effective man-hour supplied by N sh t workers and w h is the wage rate the agency receives for a worker from firms that employ their services. The maximized job value F N sh t should then solve the Bellman equation and the marginal condition that eliminates profits from vacancy creation is where J sh t ≡ F N sh t N sh t , whose evolution is given by the derivative of Eq. (20) with respect to N sh . Hence, We use the conventional instantaneous Nash bargaining approach to model wage negotiations where the objective function to be maximized is the weighted product of the two parties' match surpluses. Given that profits from vacancy creation are eliminated, the match surpluses for the agencies are J j t , j = ul, sl, sh, as derived above. The corresponding surpluses for each type of worker, denoted by W j t , j = ul, sl, sh, can be shown to satisfy the recursive equations below, where workers' threat point is the value of unemployment: Assuming that the bargaining power of workers is job-type specific, and denoting it by j , j = h, l, the corresponding Nash bargaining functions are W ul which imply the following surplus sharing rules: Together with Eqs. (16), (17), (22)-(25), these yield the following solutions for w ul t , w sl t and w sh t which have the standard interpretation: The final good sector produces a homogenous good competitively combining domestically produced and imported varieties of the intermediate good according to a CES technology where Y is the quantity of the final good, y d it and y * it and M and M * are, respectively, the quantities and the masses of domestically produced and imported intermediate input varieties. Denoting the output and input prices respectively by P t , p d it and p * it , the sector's profit is berg trade cost incurred when importing varieties from abroad. Profit maximization yields the demand functions The price index dual to (29), then ensures that Π Yt = 0. The mass M of intermediate varieties is assumed to be time-invariant and each variety is produced by a firm whose total factor productivity is denoted by φ. We assume that firms differ in their productivity and that φ is distributed over the [1, ∞) support with a time-invariant density function. We therefore use the productivity parameter to distinguish between firms and firm-level variables and simplify notation by dropping the variety index, i ∈ M. Denoting export-related variables by the superscript x, a typical firm's input requirement for its domestic and export production satisfies where a t ( ) ≡ a d t ( ) + a x t ( ) is a composite input consisting of capital, k, and labor man-hours employed in high-tech and low-tech jobs, l h and l l (respectively supplied by high-skill workers only and by both low-skill and mismatched high-skill workers). We assume that these primary factors are combined according to the Cobb-Douglas technology, A firm's cost of production therefore is where p a is the unit price of a. Efficiency requires where h j and j , j = ul, sl, sh, are constant positive coefficients and the latter captures the required decreasing returns to scale. The respective man-hour wage rates paid by the firm, w l t and w h t are then determined by the labor market clearing condition that equates demand and supply for man-hours, The government operates a balanced budget and finances its expendituresunemployment benefit and public investment I g -with revenues generated through lump-sum tax from households and firing fees from employment agencies as well as the profit of the latter which we assume to be owned publicly. Thus, Note that the government budget constraint takes account of vacancy creation costs which are included in the employment agencies' profits-see (13) and (19). In our baseline analysis we avoid the use of proportional taxation in order to circumvent their distortionary effects but will later examine whether the results change if labor and non-labor income were taxed proportionally. Given the above, the demand for the final good, i.e. domestic absorption denoted by Y is given by which encompasses spending on consumption, private and public investments, and vacancy creation costs. GDP is then the sum of domestic absorption and its foreign equivalent (net exports): where we have assumed p * jt = p * t and y * it = y * t . We assume that capital mobility is governed by the (exogenously determined) rule where the excess demand for capital raises r above r * by an amount determined by the given value of ≥ 0 which is an inverse measure of capital mobility: = 0 corresponds to perfect mobility and the country can, in principle, sustain any excess demand for capital at the rate r = r * ; → ∞ instead frees any ties between r and r * and requires it to be determined by the capital market clearing condition K D = K which ought to hold in this case. The balance of payments, which requires the value of net exports to match the interest payments on net capital flow, can be shown to hold as long as all markets are cleared. In order to obtain closed form solutions, we assume that firms' productivity parameter has a time-invariant Pareto distribution, Thus, Eq. (42) implies We also assume that the household utility function has the following functional form where 1 c is the intertemporal elasticity of substitution and A j and j , j = u, sl, sh , are constant positive parameters-respectively capturing the weight and elasticity attached to the disutility of participation in the labor force. The matching functions are assumed to have the standard Cobb-Douglas constant returns to scale form where, for j = h, l, j ∈ (0, 1) determines match elasticities and m j t is a job-specific measure of the effectiveness of matching process. We assume that the latter is influenced by ALMPs such as investment in employment services. This form of public investment is seen as a cost-effective way of reducing the frictions that characterize the labor market (Gama et al., 2015) and has featured in labor market policies in many countries in recent years. In particular, job search assistance (which might include the adoption of information technology that influences the way jobs are advertised by firms and/or sought and applied for by workers, thus reducing search times and information asymmetry, or a form of investment in upgrading public job centers) has been found to be the most cost effective ALMP-with its short-run effectiveness exceeding that of training- Card et al. (2010) and Hotz et al. (2006) . Consistently, evidence from a number of OECD countries points to positive outcomes from investment towards public employment services which are shown to strengthen the effects of other ALMPs (ILO, 2015 and Gama et al., 2015) . 8 Despite its importance in policy discourse, the effect of investment in public employment services has however scarcely been studied as an instrument of labor market reform enabling policy interventions to target the efficiency of job search and matching. We capture its role here by letting m where m j > 0 , and is the stock of public capital used in employment services that enhance the effectiveness of matching and whose effect is captured by j > 0 . In essence, m j can be thought of as the underlying quality of matching of the corresponding segment of the labor market. For given values of m j and j , the effective quality of matching is driven by the level of investment in employment services, I g t . Finally, in order to examine how mismatch is affected by exogenous shocks, we construct the following index which is a modified version of the aggregate skill dispersion indicator recommended by Kiss and Vandeplas (2015) , and which accounts for the actual size of employment in the low-tech task jobs, We calibrate the model's steady state to reflect the stylized characteristics of the UK economy, with emphasis on the labor market features. We assume a quarterly timefrequency and base the calibration of all parameters on empirical evidence and data averages. When these are lacking, we choose the values commonly used in the relevant literature. In particular, following the common practice in the literature, we use the standard values for the subjective discount factor and capital depreciation rate, β=0.99 and δ = 0.025, and normalize the elasticity parameters in the utility function 8 In Germany, the restructuring of the federal employment agency, as part of the Hartz reform between 2003 and 2005, was aimed at improving job matching efficiency (Krebs and Scheffel, 2013) and was found to explain about 23% of the decrease in unemployment in the following years (Launov and Wälde, 2016) . In the UK, the complete overhaul of the Jobcentre Plus resulted in the introduction of Jobseeker Direct (a telephone job matching service) (Riley et al., 2011) and the Universal Job Match Service (offering a comprehensive 'one-stop-shop' for the unemployed allowing them to upload CVs and apply online within the same platform (European Commission, 2017). Mosseri-Marlio (2016) argues that digital tools, relying on data driven intervention, can drastically improve job centers' effectiveness. As pointed out by a referee, introducing this element to the matching function makes it akin to production functions used in the growth literature where total factor productivity is assumed to evolve, e.g. the Hicks-neutral process, or the more recent endogenous growth models with investment in human capital. by setting j = 1, j = c, ul, sl, sh. We also normalize GDP to unity and assume that trade is balanced in the initial steady state equilibrium. OECD (2016 OECD ( , 2018 data show that 56% of the work force in the UK consists of unskilled workers, identified as those with at most an upper secondary education. The average share of employed and unemployed in the UK labor force between 2008 and 2014 are respectively 73% and 6%, based on ONS statistics. These imply an aggregate inactivity level of 21%, given the normalization of the household population to unity. Based on the empirical evidence provided by Gomes (2012) , we target inactivity rates of the high-and low-skill at L s Z = 0.12 and L u ∕(1 − Z) = 0.28 , respectively. Using these values and allowing for the scale parameters for the disutility of labor market participation A j , j = u, sl, sh, to be freely determined by the model, we target the aggregate unemployment rate u = S ul + S s (X u + X s ) within the 5%-8.4% range, so as to match the figures reported by the OECD statistics for the UK over the 2008-2015 period, and mismatched employment ratio N sl N within the 0.13-0.15 interval as observed in the UK (ONS, 2016). Job destruction rates, h and l , are respectively set to 0.009 and 0.02 based on the empirical estimates reported in Gomes (2012) . The initial steady state unemployment benefit payment, b, is set based on evidence provided by van Vliet and Caminada (2012) so that the corresponding benefit replacement rate, b N ul + N sl + N sh N ul w ul + w sl N sl + w sh N sh , is 0.23. We assume symmetric bargaining across the job spectrum and set j = 0.5, j = l, h , and follow common practice in using the Hosios parameterization by setting j = j . As is well known, in the absence of distortions other than those arising from search externalities, the latter ensures that the market equilibrium solution delivers the socially optimal level of unemployment relative to vacancies (Hosios, 1990) . However, this condition is not sufficient to yield constrained efficiency in a model, such as ours, which is characterized by several other distortions arising from workers heterogeneity and skill mismatch, on-the-job-search, endogenous labor supply and international openness. 9 Assuming that trade and capital mobility are both frictionless and free to start with, we set = 1 and = 0 in the benchmark calibration. The latter implies r * = r . Using the foreign final good as the numeraire, we normalize its price to unity setting P * = 1 . Utilizing the relevant trade-related series over the 2008-2014 period from the World Bank Development Indicators dataset (WDI, 2016b), we calculate the scale factor in foreign demand and the relative price of exported to foreign varieties respectively as F * = 0.415 and p x p * = 0.785 and, to ensure that our calibration reflects the actual UK to world GDP ratio, we set M∕M * = 0.0465. 9 Shimer and Smith (2001) provide a comprehensive account of the externalities that arise in the presence of workers heterogeneity. Arseneau and Chugh (2012) identify the efficiency conditions in general equilibrium models. In a number of papers, Arseneau and Epstein identify and outline the distortions and derive the corresponding efficiency conditions in analytically tractable general equilibrium models with heterogeneous jobs and workers: Arseneau and Epstein (2018) show that the Hosios condition does not generate an efficient surplus split in the presence of mismatch, and Arseneau and Epstein (2014) demonstrate that OTJS amplifies the mismatch distortion. Given that we start with a balanced trade, K D = K holds initially and is sustained by private investment, which is set consistently with the UK investment/GDP ratio of 16.61% over the period 2008-2014. Using the data from EU-KLEMS (2016), we set the labor input elasticities as h = 0.44 and l = 0.26 , respectively, corresponding to the average values over the 2008-2015 period, and let k = 1 − h − l for consistency with the constant returns to scale assumption. 10 The values of the elasticity of substitution and the shape parameter of the Pareto distribution of firms' productivity, σ and γ, are set to yield a profit/output ratio of roughly 20%, corresponding to the average UK business profit share over the 2008-2014 period. 11 The chosen values, σ = 4.5 and γ = 3.8, are within the range used in similar studies and satisfy > − 1. The existing evidence suggests that, on average, overeducated mismatched workers receive a wage premium over non-overeducated workers in the same job (despite suffering a wage penalty relative to their counterparts in correctly matched jobs)see, e.g., ONS (2019) for the UK, Büchel (2000) for Germany, and CEDEFOP (2010) for EU countries. There is also evidence that over-education has positive direct effects on firm-level productivity-see, e.g. Kampelmann and Rycx (2012) and Benoît et al. (2015) for Belgium. We therefore assume that the high-skill workers are more productive when properly matched, and that they are mildly more productive than their low-skill peers in performing low-tech tasks, and set the labor input conversion technology parameters as h ul = 0.06, h sl = 0.065 and h sh = 0.111. These values are such that the steady state wage ratio is w l w h = 0.62 which is consistent with the average wage ratio of non-graduates to graduates reported over the 2008-2016 period (Department for Education, 2017). 12 In order to allow for sufficient concavity in converting labor to man-hours in Eqs. (43) and (44), we follow Christoffel et al. (2009) and set ul = sl = sh = 0.995. To explore the quantitative effects of allowing government investment in matching efficiency, we set I g GDP = 0.003 which reflects the UK's GDP share of public expenditure on Employment Services (Gama et al., 2015) and let g = 0.009 , which corresponds to the ratio of private to public capital depreciation rate of 0.36 as reported in Angelopoulos et al. (2012) . Empirical evidence for the values of the effectiveness of public sector investment on matching efficiency is rather limited. Riley et al (2011) find that increase in employment services coverage leads to between 2.4 and 4.2% increase in the exit rate from unemployment to employment. Choosing the midpoint between these estimates, we set l = h = 0.033 . The values of m l and m h are then allowed to be freely determined by the model, resulting in implied values of 10 Source: http:// www. eukle ms. net. 11 Sources: http:// ec. europa. eu/ euros tat/ web/ sector-accou nts/ data/ annual-data. 12 Our assumptions have clear implications for the nature of the low-skill/mismatched wage differential. However, since the low-and high-tech hiring agencies make separate, independent, decisions about vacancy posting, there are no implications for the willingness to post high-tech relative to low-tech jobs for given factor input demands expressed by firms. An alternative, as in Arseneau and Epstein (2014) , would have been to target the high-tech to low-tech ratio of take home (negotiated) wages. We chose to base our calibration on the firm-level hourly wages, w l and w h , since they are more readily observable. We have, however, verified that small deviations in the productivity differential from the initial calibration values for h j do not alter the qualitative nature of the results. m l = 0.2 and m h = 0.25 . Consistent with Thomas and Zanetti (2009) , we define the firing cost to average wage ratio as f N ul + N sl + N sh w ul N ul + w sl N sl + w sh N sh , which we set at 0.06-an approximate value based on the normalised average 1985-2014 OECD data on measures of the strictness of regulation of individual dismissal of employees on regular contracts. The unit costs of vacancy creation is then left to emerge endogenously, implying initial values of c l = 0.21 and c h = 2.5 , respectively. Our benchmark solution for the immediately relevant variables, corresponding to the calibration described above, is given in column 2 of Table 1 in the Appendix and was found to be robust to sensitivity analysis in which we perturbed the values of parameters of interest and relevant exogenous variables. Trade flows have slowed down worldwide since the 2007-2008 financial crisis, with further disruptions resulting from the Covid-19 pandemics. At the same time, revival of protectionist stances and backlashes against globalization have resulted in political developments that might further raise trade barriers-e.g., Brexit in the UK, the rise of anti-EU sentiments in other EU nations, and the trade policies of the Trump administration in the US (which the Biden administration had not fully reversed at the time of writing). To examine the impact of raising trade frictions, we consider an increase in trade costs-specifically, in the form of a perfect foresight permanent increase in τ by 20%. We then examine the transitional dynamics which shows the paths that endogenous variables take to reach their new equilibrium values. Figure 1 displays the results for selected variables where solid-lines illustrate the adjustment paths in the absence of labor market reforms. The immediate effect of a higher τ is to increase the effective prices of both exported and imported intermediate varieties. The higher price of the intermediate input raises production costs in the final good sector. Together with the higher export prices, this reduces demand in both downstream and upstream sectors. Despite a substitution of demand away from foreign towards domestic varieties, and some shifting of resources from exports to domestic production, firms' demand for primary factors falls, leading to lower wages and vacancy creation especially in the short-run and, consequently, to a contraction in job finding probabilities and employment across all worker types. The worsening of job prospects lowers the opportunity cost of leisure, initially reducing participation, and results in lower short-run unemployment and mismatch rates (reflecting a lower crowding out of low-skill workers by highskill workers in low-tech occupations). As a result of the income effect of the drop in wages and employment, however, participation rises as the economy transitions to a new equilibrium characterized by higher unemployment and mismatch rates. Thus, despite the fact that with mark-up pricing in the intermediate sector the lower wages ultimately translate into a reduction in the price of domestic varieties which partially offsets the drop in demand, the rise in trade cost implies that domestic and foreign absorption both fall and so do GDP, labor force and employment, whilst skill mismatch increases. Overall, the volume of trade falls with as both foreign demand Graphs show deviaƟons in percentage points from the respecƟve iniƟal soluƟons Trade shock without reform Trade shock with reform Fig. 1 The effect of raising trade cost with and without labour market reform. Graphs show deviations in percentage points from the respective initial solutions. Blue solid line trade shock without reform. Black dotted line trade shock with reform for domestically produced varieties and domestic demand for foreign varieties remaining permanently below their initial steady-state levels. Broadly, these results match observed empirical regularities. For instance: Barattieri et al. (2018) find that protectionist shocks are recessionary; Cooray et al. (2017) document empirically the adverse effect of trade frictions on the size of labor force; Felbermayr et al. (2011b) discuss the greater unemployment consequences of trade restrictions; and Davidson et al. (2014) and Krishna et al. (2014) also offer evidence of improved firm-worker sorting as a result of trade integration. In this section we ask how labor market reforms would affect the impact of raising trade barriers. To do so, we start from our benchmark calibration, which portrays a liberal welfare state system, and examine how implementing a flexicurity reform package (FRP) affects the economy's response to increasing trade frictions. As previously noted, since changes in individual policy instruments may have opposite effects on the equilibrium, the extent to which they are altered relative to each other is an important determinant of the net impact of a given reform package. To this end, we use Denmark, one of the flexicurity pioneers, as our example of the flexicurity system and change the relevant UK policy parameters in the direction of and by a proportion consistent with taking them to their corresponding Danish counterparts. This implies: (i) increasing the unemployment benefit rate b by 60% (based on the estimates provided by Nickell et al., 2005; Vliet and Caminada, 2012) ; (ii) raising the firing cost f by 43% (OECD, 2013, p. 86); (iii) increasing public expenditure on labor market services I g by 40% (Gama et al, 2015, p. 52) ; and (iv) reducing the unit vacancy creation costs c j , j = l, h. Quantifying the reduction in c j to mimic the Danish situation is not straightforward since there is no clearly defined measure of these parameters in the available data. One way to circumvent this problem is to utilize the World Bank's ease of doing business indicator which shows that it is relatively easier to establish a business (and presumably hire workers) in Denmark than in the UK, and which suggests a required reduction of around 50%. We therefore opted for a 45% reduction in costs c l and c h in the first instance but, given its large size, we shall reconsider this value later in the paper. Figure 1 juxtaposes the transitional dynamics of the impact of an increase in trade cost in the baseline case (solid lines) and in the case in which the rise in trade cost goes hand in hand with the implementation of the FRP (broken lines). As the graphs show, reforming the benchmark liberal labor market in the direction of flexicurity can moderate both the short-and long-run effects of a rise in trade cost. Specifically, in our numerical example, the reform attenuates the negative impact of a higher τ on GDP, domestic, and foreign absorptions. It also mitigates the impact of the trade shock on key labor market variables, resulting in a new steady-state that is characterized by higher labor force participation and market tightness. Interestingly, our model predicts that in the short-run the economy may experience greater aggregate as well as skill-specific unemployment and mismatch rates, due to an increase in participation and the presence of matching frictions. However, successful matching implies that the reform softens the negative long-run effects of the trade shock on unemployment and skill mismatch rates. Given the multifaceted nature of the reform, to appreciate the driving mechanisms behind these results it is worth examining the effects of changes in the individual policy instruments. These are reported in Table 1 in the Appendix; as one would expect, the various instruments have different quantitative and, in some cases, qualitative effects. By exerting a downward pressure on the value of employment and profits from job matches, an increase in firing cost f, which can be interpreted as lowering the degree of labor market flexibility, reduces vacancy creation and works towards an increase in unemployment. This is countered, however, by a worsening of job prospects which reduce incentives to labor market participation. We find the first impact to dominate since the net effect of a higher f is an increase in both unemployment levels and rates. 13 Overall, the increase in f has a contractionary impact on both domestic and foreign absorption and hence on GDP. This is however quantitatively mild, which is consistent with the ambiguous effects of employment protection found in the empirical literature. Changes to all other policy instruments have expansionary effects on the level of economic activity, albeit to different extents. This is very intuitive for an ALMP measure such as an increase in investment in employment services ( I g ) which, by simultaneously raising job finding and vacancy filling probabilities, facilitates job matching and results in a lower level of unemployment across worker types and in a shorter duration spell of both unemployment and vacancies. Consistent with the evaluation of the impact of job-brokering on labor market outcomes in the UK offered by Riley et al. (2011) , a higher investment in employment services leads in our model to a lower aggregate level of inactivity. Unsurprisingly, and consistent with the implications of the standard search and matching model, lowering vacancy creation costs is also expansionary. By incentivizing vacancy creation, a reduction in c l and c h increases market tightness and bargained wages for all searchers, stimulating participation and reducing the incidence of mismatch due to greater job-finding probabilities. These effects result in lower unemployment rates, a higher aggregate demand and an increase in GDP and in both domestic and foreign absorption. Interestingly, and somewhat counter to conventional wisdom, an increase in unemployment benefit b-a typical passive labor market policy-is also found to be expansionary. The key mechanism underpinning this results hinges on the indirect effect of this policy instrument on the matching function-which is increasing in both vacancies and searchers. By raising the value of a worker's outside option in wage negotiations, a higher b results in a higher bargained wage. This works towards reducing vacancy creation. At the same time, it also raises the opportunity cost of leisure-and, through this channel, stimulates search activity. Clearly, in models characterized by exogenous participation (e.g., as in Cacciatore et al., 2016) , this second effect would not arise and the number of job matches would unambiguously fall. With endogenous participation, however, the net impact of a higher b on aggregate job matches depends on which of these two effects dominates. In our policy experiments, the effect on participation is sufficiently large to slightly dominate the negative effect on vacancy creation and lead to a small increase in the number of job matches. 14 The intuition for this is that the increase in household income resulting from the higher take home wage and unemployment benefit raises aggregate demand, thus triggering an increase in demand for both labor and capital by firms. This stimulates a capital inflow: the required increase in net exports to satisfy the balance of payments further enhances the overall demand for labor, N, necessitating a rise in the number of successful matches, since M = N should hold in equilibrium. In other words, the final adjustments in unemployment (job searchers) and vacancies ought to deliver the necessary rise in the number of matches-i.e. the effect of the increase in the former needs to dominate that of the reduction in the latter. This, combined with higher wages, explains the increase in GDP, with domestic and foreign absorption both rising. In this case, however, skill mismatch increases since the greater participation across the skill spectrum combines with lower vacancy creation to increase competition for jobs-with a larger number of high-skill workers willing to accept low-tech jobs. Thus, an important implication of our analysis is that the endogeneity of workers' participation in the labor market is a key channel in the transmission mechanism of the policy and implies that a passive labor market policy instrument such as the unemployment benefit rate can be used as an activation measure. Two caveats are in order in interpreting the above results. First, they are clearly sensitive to the size of the changes in individual instruments. As can be seen from the column of Table 1 in the Appendix labelled FRP, the reduction in vacancy creation costs plays the dominant role amongst the four policy instruments included in the FRP we have analyzed. This is hardly surprising given the relatively large reduction we have implemented and the fact that it has a direct first order effect on vacancies-which in turn raise matches directly. As mentioned above, our decision to reduce c j by 45% was guided by empirical stylized facts. Our sensitivity analysisbased on varying the reduction in c j within the reform package, including the case reported in the last column of Table 1 in the Appendix in which the reform does not encompass any reduction in c j -confirms that the smaller is the reduction in this parameter the more limited is the impact of the reform. In addition, whilst the qualitative effects of reform on GDP, domestic and foreign absorption and aggregate participation remain unchanged even when c j is not altered within the reform package, the effects on labor market variables can change qualitatively when the reductions in c j is sufficiently small. For instance, market tightness falls and the aggregate unemployment rate increases following the implementation of a reform which involves a sufficiently small reduction in c j . Second, and more generally, these results should not be interpreted as normative prescriptions but merely as suggesting that it is possible to formulate reforms of a liberal welfare state system in the direction of flexicurity which can improve labor market outcomes and moderate the adverse impact of increases in trade barriers. A key implication of our analysis is that the effects of the reform depend on how the different instruments are combined. ALMPs that affect the degree of frictions in the labor market (such as investment in employment services or vacancy creation costs) are important drivers in expanding employment and the level of economic activity. Perhaps more surprisingly, however, even a passive labor market policy such as unemployment benefit can be expansionary-and crucial to this result is the fact that this instrument can be used to stimulate labor market participation. The relevance of our analysis is supported by the fact that, qualitatively, our results are broadly consistent with observed empirical regularities. For instance, a major review of the effects of flexicurity on the performance of different economies in the aftermath of the Great Recession of 2007 carried out by the European Commission (Smith et al., 2013) finds that the Nordic countries were better able to withstand the impact of the recession compared to the Anglo-Saxon countries. Consistent with our findings, in terms of specific policy instruments, the review also found that countries with low expenditures on ALMPs experienced greater skill mismatch. In an earlier study, Lehmann and Kluve (2010) had already come to a similar conclusion, arguing that job creation subsidies can result in a higher job matching efficiency, implying a lower mismatch rate. However, it is important to stress that, as noted, our theoretical analysis is not an 'inter-country' comparison between different welfare state regimes-which would entail contrasting models with different initial calibrations so as to reflect the structural characteristics of the two economies. Rather, we seek to understand how an economy-given its initial structural characteristics-would perform were it to introduce reforms in a certain direction. In this section we carry out two experiments to examine the robustness of the results. These concern the effects of a change in (i) the degree of capital mobility, which is the other aspect of international openness, and (ii) the nature of taxation, by allowing for proportional income taxation of different types of income. Whilst the rise of financial globalization had been a defining feature of the world economy since the 1980s, it slowed down considerably since the financial crisis against a shifting consensus towards the desirability of regulating international financial flows. Here we consider the effect of introducing some friction in the cross border mobility of capital by letting > 0 in Eq. (49). In a theoretical model such the one used in this paper, the extent of capital mobility, characterized by the response of capital flows to interest rate differential, enables the economy to accommodate an excess demand or supply of capital that is consistent with the trade balance. Specifically, with some capital mobility friction, the interest parity can no longer be attained and an interest rate differential persists that is consistent with the excess demand for capital-i.e. the discrepancy between domestic firms' demand for and households' accumulated capital stock. Consequently, the balance of payment will only hold if the resulting interest payments on capital inflow (outflow) is matched by a trade deficit (surplus). Put differently, the economy can sustain a trade deficit or surplus as long as it is offset by the return on capital flows; the higher is the barriers to capital flows, the smaller is the sustainable magnitude of the trade deficit/surplus. Thus, the impact of raising capital mobility frictions is likely to be contingent on whether the economy is initially in a position of trade surplus or deficit. Starting from a trade surplus position where the economy is a net exporter, the overall effect of an increase in such frictions will be contractionary. The opposite would hold if the economy were initially a net importer. To illustrate this, we set = 0.25. In Figure 2 the solid and dashed lines depict, respectively, the effects of changes in the trade cost without and with restrictions to capital mobility. We find that, by limiting capital flows and thus the size of the trade balance, a higher κ leads to a temporary moderation of the adverse effects of rising trade barriers. As can be seen from the graphs, the short-run negative effects of raising trade costs on GDP, aggregate employment and participation are dampened. The underlying intuition is straightforward and relies on the substitutability between capital and labor in production. When capital mobility is frictionless, firms enjoy almost an infinitely elastic supply of capital at a constant rate r = r * . Imposing capital mobility frictions changes this, such that any excess demand for capital raises r above r * and induces factor substitution away from capital. In the long run, however, due to the fall in firms' profits, aggregate outcomes remain adversely affected by the increase in trade barriers. Our analysis so far has been carried out by assuming away distortionary taxation and using a lump-sum tax to balance the government budget. This enabled us to isolate the effects of labor market polices. However, the fact that governments tax labor and non-labor income proportionally is relevant to our inquiry. We therefore examine here whether our results would hold if we allowed for proportional taxation within the model. Using w t and t to respectively denote the average proportional labor and non-labor income tax rates, we rewrite the household and government budget constraints respectively as follows Graphs show devia ons in percentage points from the respec ve ini al solu ons Trade shock without capital mobility fric ons Trade shock with capital mobility fric ons reason for this lies in the adjustment of the participation margin: as market tightness falls, so do searchers' job finding rates, resulting in higher unemployment duration and in an outflow from the labor force which mitigates the higher competition for jobs and hence lowers mismatch. Nevertheless, unemployment rises because distortionary taxation drives a wedge between the bargained and firm level wage rates, thus lowering the surplus from job matches and the degree of market tightness relative to what would be obtained with lump-sum taxation only. This paper has examined the labor market consequences of reducing the level of trade integration of an open economy characterized by vertical linkages in production and by labor markets exhibiting search frictions and two-sided heterogeneity. Raising trade barriers are found to lead to under-utilization and misallocation of resources, resulting in higher unemployment rates across skill levels and in lower The model predicts that implementing a reform package which moves an economy with a liberal welfare state system in the direction of flexicurity, despite involving greater unemployment benefit and firing restrictions, can enable it to better withstand the adverse effects of increasing trade costs. A broad implication of the paper is that labor markets do not need to be thin on worker security to ensure high levels of employment. Importantly, unemployment insurance can in fact act as an activation policy by fostering labor market participation-an effect that is reinforced if coordinated with other 'activation policies' (such as a reduction in vacancy creation costs and investment in employment services) that support job creation and reduce frictions in search activities. Our results are broadly consistent with empirical stylized facts concerning the role of welfare state institutions and reforms in affecting countries' ability to withstand the effects of negative exogenous shocks. In providing theoretical underpinning for some of these documented facts, our analysis offers valuable insights into the role of labor market policy. According to received wisdom, the labor market institutions of a country such as the UK-which are among the most deregulated in mature industrial economies-ought to offer the best supporting framework to an economy's ability to adjust to and withstand the effects of adverse shocks. Our analysis clearly casts doubt on this view and is also relevant to current debates in the UK surrounding the potential increase in trade costs with the country's main, and geographically closer, trading partners resulting from Brexit. Given the focus on the implications of policies that resonate with current debates on labor market reforms, in carrying out our policy experiments we have not addressed efficiency considerations-as is done, for instance, by Arseneau and Chugh (2012) who identify conditions of efficiency for general equilibrium welfare models and by Epstein (2014, 2018) who provide an analytical characterization of the distortions resulting from mismatch and show that there is an optimal level of mismatch. This remains an interesting area for future research. Long-run effects of individual labour market policies and of a reform package which combines them * The unemployment rate figures are reported in percentage points, e.g. the initial rate is 7.6% and the 60% increase in b increases this by 1.45 percentage point to 9.05%. A Matching Model with Endogenous Skill Requirements Business Cycles and Labor-Market Search Tax Structure, Growth, and Welfare in the UK The Welfare Costs of Skill-Mismatch Employment Efficient Mismatch. Discussion Paper 2018-037, Finance and Economics Discussion Series, Division of Research and Statistics and Moneary Affairs Tax Smoothing and Frictional Labor Markets Offshoring, Mismatch, and Labor Market Outcomes The China Syndrome: Local Labor Market Effects of Import Competition in the United States Protectionism and the Business Cycle. NBER Working Educational Mismatch and Firm Productivity: Do Skills, Technology and Uncertainty Matter? Working Papers CEB 15-007 Labor market policies and IMF advice in advanced economies during the Great Recession Fiscal Expansions, Unemployment, and Labor Force Participation: Theory and Evidence The Effects of Overeducation on Productivity in Germany: The Firms' Viewpoint International Trade and Macroeconomic Dynamics with Labor Market Frictions Market Deregulation and Optimal Monetary Policy in a Monetary Union Active Labor Market Policy Evaluations: A Metaanalysis Gravity without Apology: The Science of Elasticities The Skill Matching Challenge: Analysing Skill Mismatch and Policy Implications The Role of Labor Markets for EURO Area Monetary Policy Trade Openness and Labor Force Participation in Africa: The Role of Political Institutions Firm Dynamics, Job Turnover, and Wage Distributions in an Open Economy Globalization and Firm Level Adjustment with Imperfect Labor Markets Globalization and Imperfect Labor Market Sorting Help not Hassle: A Case for Better Employment Support. Forthcoming, IPPR Progressive Review. Department for Education On-the-Job Search in a Matching Model with Heterogeneous Jobs and Workers Employment and Social Developments in Europe 2012. Directorate-General for Employment, Social Affairs and Inclusion Directorate A An Investment Plan for Europe. Communication form the Commission to the European Pariament Unemployment Cycles On the importance of the participation margin for labor market fluctuations Flow Origins of Labor Force Participation Fluctuations Labor Input Data: United Kingdom Universal Jobmatch: Online Vacancy Platform for Employers and Jobseekers Globalization and Labor Market outcomes: Wage Bargaining, Search Frictions, and Firm Heterogeneity Trade and Unemployment: What do the Data Say? Trade Liberalization and Female Labor Force Participation: Evidence from Brazil The Role of Employment Service Providers Labor market flows: Facts from the United Kingdom Should Governments of OECD Countries Worry about Graduate Underemploymnet? Labor Market Rigidities, Trade and Unemployment Inequality and Unemployment in A Global Economy On the Efficiency of Matching and Related Models of Search and Unemployment Evaluating the Differential Effects of Alternative Welfare-to-Work Training Components: A Reanalysis of the California GAIN Program An Employment-Oriented Investment Strategy for Europe The Impact of Educational Mismatch on Firm Productivity: Evidence from Linked Panel Data Employment, Social Affairs and Inclusion: Measuring Skills Mismatch. The European Commission Analytical Web Note Macroeconomic Evaluation of Labor Market Reform in Germany Wage Effects of Trade Reform with Endogenous Worker Mobility The Employment Effect of Reforming a Public Employment Agency The Labor Market Impact of the EU Enlargement. A New Regional Geography of Europe? edition 1 The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity Search in the Labor Market and the Real Business Cycle Globalization vs Skill-Biased Technological Change: Implications for Unemployment and Wage Inequality Unemployment in the OECD since the 1960s. What Do We Know? Education at a Glance Enhancing Flexibility: A New Look at Employment Protection Legislation Strengthening Public Employment Services. Paper prepared for the G20 Employment Working Group Analysis of the UK Labor Market: Estimates of Skills Mismatch Using Measures of Over and Under Education Overeducation and Hourly Wages in the UK Labor Market Equilibrium Unemployment Theory The Introduction of Jobcentre Plus: An Evaluation of Labor Market Impacts. Department for Work and Pensions On-the-Job Search and Strategic Bargaining Matching, Search, and Heterogeneity Evaluation of Flexicurity 2007-2010: Final Report. Directorate-General for Employment, Social Affairs and Inclusion Doing Business: Measuring Business Regulations. The World Bank Labor market reform and price stability: An application to the Euro Area Unemployment Replacement Rates Dataset Among 34 Welfare States 1971-2009: An Update, Extension and Modification of Scruggs. Welfare State Entitlements Data Set We are grateful to two anonymous referees and to the Editor of the Journal for very constructive suggestions. We would also like to thank Stephen Boyd, Nils Braakmann, Holger Görg, Sebastian Könings, Steve Matsus, Fredrik Sjöholm, John Skåtun, Allan Sørensen and participants at the NORFACE Welfare State Futures Programme Final Conference at the EUI in Fiesole and at the Glo-bLabWS final workshop in Aberdeen for useful comments. This work was supported by the NORFACE ERA-NET (New Opportunities for Research Funding Agency Co-operation in Europe Network) Welfare State Futures Programme, Grant Number 462-14-120. The usual disclaimer applies. We also modify all other equations involving labor and non-labor income as necessary so as to reflect the difference between gross and net income from each source. According to OECD data, the labor and corporate income tax rates in the UK are, on average, 23.4% and 19% respectively. We therefore re-calibrate the benchmark model setting ζ w = 0.234 and ζ π = 0.19 while ensuring that all key measures-such as labor force participation rate, mismatch, GDP, employment and unemployment levels, etc.-remain consistent with the original values.For selected variables, Figure 3 gives the transitional dynamics following the trade shock with (dotted line) and without (solid line) the labor market reform. In both cases, labor and non-labor income taxes adjust proportionally to balance the government budget. Clearly, the nature of taxation matters for the effectiveness of reforms; whilst continuing to mitigate the impact of the trade shock on GDP, domestic and foreign absorption and aggregate participation, the reforms do not offset its effect on the unemployment rates but reduce mismatch. The main Table 1 .Publisher's Note Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Catia Montagna (PhD) is the Jaffrey Chair of Political Economy at the University of Aberdeen. She is a fellow of the Academy of Social Sciences.George E. Onwordi (PhD) is a Lecturer (Assistant Professor) of Economics at the University of Aberdeen.