Adjustment costs in labour markets and the distributional effects of trade liberalization: Analytics and calculations for Vietnam

Abstract This paper explores the implications of different labour market adjustment formulations for the analysis of trade liberalization across different sectors and households in the Vietnamese economy using computable general equilibrium (CGE) models. The model is calibrated to a model admissible Vietnamese data set for 1997. We use five different adjustment cost treatments in analyzing the effects of trade liberalization in Vietnam. We compare simulation results from each and show how different treatments can significantly affect the distributional impacts of policy reforms, such as the trade liberalization. First, labour is treated as fully mobile across all sectors in the economy. Second, the sectors of economy are broken down into the two blocks of agricultural and industrial-service sectors and labour markets are treated as segmented by sector block. No mobility of labour between blocks is allowed while labour within each sector block remains fully mobile. The third is the same as the second, but movement within each agricultural and industrial-service sector block involves transactions costs. In the fourth, mobility of workers from the agricultural to industrial-service sectors and vice versa is possible with transactions costs. Finally, we calibrate the model with unemployment but no adjustment costs for labour reallocation to explore how model results differ in terms of adjustments in the labour market and welfare effects. Our results indicate significant differences in the impacts from trade liberalization across these cases. The redistributional impact of trade liberalization is sharper against poor rural households with segmented labour markets and with transactions costs, while aggregate efficiency gains are similar to no adjustment cost analyses. The conclusion is the choice of model structure for labour markets is crucially important for the perceived distributional impacts of trade liberalization.