The Balassa-Samuelson Model with Job Separations

We incorporate sectoral job separation rates in a small open economy model to examine the Balassa-Samuelson (B-S) effect. Labour is mobile, but unemployment occurs due to search frictions. Moreover, unequal separation rates give rise to compensating wage differentials. We use Japanese data to simulate the model. With productivity growth in the tradeables sector, labour moves from the tradeables sector to the nontradeables sector if tradeables and nontradeables are complements in consumption, then the B-S effect is muted. When the separation rate is higher in the nontradeables sector, higher growth of the wage in the nontradeables sector amplifies this labour movement. Nevertheless, unemployment always falls due to a positive income effect. In contrast, the effect of productivity growth in the nontradeables sector is to lower the real exchange rate and raise unemployment