GEP Research Paper 01/24
On Adjustment Costs
C. Davidson and S. Matusz
Abstract
In this paper we present and analyze a general equilibrium model of trade with labor market turnover in order to estimate the size and scope of adjustment costs that are associated with trade reform. The novel feature of our approach is that the training and job acquisition processes are modeled and the costs associated with them are taken into account. One of the advantages of the model is that it is simple enough to allow us to solve analytically for the adjustment path between steady states. Another advantage is that many of the model's key parameters, the labor market turnover rates, are observable, so that we can rely on existing data to determine their likely values. Surprisingly, even with our most modest assumption concerning training costs, we find that their inclusion in the model significantly increases our estimates of aggregate adjustment costs. For example, we find that when we take the time cost of retraining into account our estimate is that the short run adjustment costs amount to (at least) 10 to 15 percent of the long run benefits from liberalization. When the resource costs of retraining are taken into account as well, our estimates of these costs jump to 30 to 90 percent of the long run gains from freer trade. These results sharply contrast with earlier estimates of adjustment costs (which ignored the costs of job search and training) that indicated that they were likely to be small relative to the gains from trade.
Issued in October 2001.
This paper is available in PDF format .