The Restricted Reallocation Effect of Export Under Frictional Labour Market

ABSTRACT Labour market frictions impede the resource reallocation process induced by trade liberalization, thereby affecting firms' performance in the labour market. Taking frictional labour market as an assumption, this paper investigates the impact of exogenous export shocks on firm‐level labour constraints. We show that the positive export shock tends to tighten labour constraints overall for exporting firms and this effect is more stringent for firms with higher initial productivity, whereas it is reversed for the least productive firms. To explain this skewed response of labour constraints to common export shocks, we extend a canonical model of heterogeneous firms by introducing the vacancy posting costs, which simultaneously account for market expansion effect and competition effect. Counterfactual experiments imply that the aggregate output of China's exporting firms would increase by 1.82% annually when eliminating the impact of export shock on labour market, while completely removing labour market distortions would lead to aggregate output increase by 10.02%.