Firm dynamics, job turnover, and wage distributions in an open economy

"This paper explores the effects of tariffs, trade costs, and firing costs on firm dynamics and labor markets outcomes. The analysis is based on a general equilibrium model with labor market search frictions, wage bargaining, firing costs, firm-specific productivity shocks, and endogenous entry/exit decisions.Firing costs reduce firms' profits and discourage them from quickly adjusting their employment levels in response to idiosyncratic shocks. Tariffs and other trade costs reduce rents for efficient firms and increase rents for inefficient firms, as in Melitz (2003). These well-known effects interact with idiosyncratic productivity shocks and with scale economies in hiring costs to determine the equilibrium size distribution of firms, entry/exit rates, job turnover rates, rate of informality, and cross-firm wage distributions. After fitting this model to Colombian micro data on establishments and households, we use counter- factual simulations to isolate the effects of that country's trade liberalization and labor market reforms circa 1990. We find that Colombia's tariff cuts, in isolation, would have shifted jobs toward large, stable firms, reducing job turnover and informality in the long run. Further, since firms pay higher wages when they wish to rapidly expand, the shift of jobs toward such firms would have compressed the top end of the wage distribution. On the other hand, Colombia's firing costs reductions, in isolation, would have led some large inefficient producers to contract, driving up job turnover rates and informality. Finally, however, the combination of tariff cuts and reduced firing costs that was implemented led to larger increases in turnover and informality than would have occurred if tariffs had been held fixed. The reason is that reduced firing costs made firms adjust their sales more dramatically in response to productivity shocks, while openness amplified this effect by making adjustments on the export margin more important"--National Bureau of Economic Research web site