Labor Market Frictions and the Balassa-Samuelson Model

Mardi | 2011-04-12

Romain RESTOUT – Olivier CARDI

This paper addresses the role of labor market frictions in the transmission process of sectoral productivities shocks to the relative price of nontradables. The Balassa-Samuelson model based on frictionless labor markets predicts (i ) proportionality between relative prices and the cross-sectoralproductivity differential and (ii ) wage equalization across sectors. Using panel cointegration and unit root tests applied to a panel of fourteen OECD economies, our empirical evidence does not support these implications. This paper shows that these puzzles can be successfully explained by a two-sector model with labor market frictions. In particular, this paper considers two types of rigidities: labor reallocation costs across sectors and matching frictions similar to those found in the Mortensen-Pissarides model of unemployment.