Date Added: Jul 2009
The authors formulate a two-country model with monopolistic competition and heterogeneous firms to reconsider labor market linkages in open economies. Labor-market imperfections arise by virtue of country-specific real minimum wages. Two principal experiments are considered. First, they show that trade liberalization under minimum wages differs significantly from trade liberalization under standard assumptions. In the former case, there is effectively a perfectly elastic supply of labor to production whereas in the conventional case it is assumed that aggregate labor supply is perfectly inelastic. Second, they show that with firm heterogeneity an increase in one country's minimum wage triggers firm exit in both countries and thus harm workers at home and abroad.