Trade and the (Dis) Incentive to Reform Labor Markets: The Case of Reform in the European Union

When economies trade, labor market policies in one country spill over to other countries through a change in the terms of trade. This reduces the incentive to reform labor markets. In a policy game over firing taxes between countries, they find that countries optimally choose positive levels of firing taxes. A coordinated elimination of firing taxes yields considerable benefits. This insight provides some explanation for recent efforts toward labor market reform in the European Union.