In this paper I highlight the importance of incorporating the institutional features of local labour markets into the analysis of trade reforms. A trade reform is often deemed beneficial because the elimination of trade barriers allows labour to reallocate towards those sectors in the economy in which the country has a comparative advantage. The amount and speed of the reallocation, however, and the post-reform behaviour of output, productivity and welfare, will depend on how regulated the labour market is. First, I document that high firing costs slow down the intersectoral reallocation of labour after a trade reform. Second, in order to isolate the effect of firing costs on labour reallocation, output and welfare after a trade reform, I build a dynamic general equilibrium model. I find that if a country does not liberalize its labour market at the outset of its trade reform, the intersectoral reallocation of workers will be 30% slower, and as much as 30% of the gains in real output and labour productivity in the years following the trade reform will be lost. From a policy standpoint, the message is that while trade reforms are desirable, they need to be complemented by labour market reforms in order to be fully successful.

In this article we argue that wage inequality and occupational mobility are intimately related. We are motivated by our empirical findings that human capital is occupation specific and that the fraction of workers switching occupations in the U.S. was as high as 16% a year in the early 1970's and had increased to 21% by the mid-1990's. We develop a general equilibrium model with occupation-specific human capital and heterogeneous experience levels within occupations. We find that the model, calibrated to match the level of occupational mobility in the 1970's, accounts quite well for the level of (within-group) wage inequality in that period. Next, we find that the model, calibrated to match the increase in occupational mobility, accounts for over 90% of the increase in wage inequality between the 1970's and the 1990's. The theory is also quantitatively consistent with the level and increase in the short-term variability of earnings.

Labour productivity in manufacturing differs starkly across regions in China. We document that productivity, wages, and start-up rates of non-state firms have nevertheless experienced rapid unconditional regional convergence after 1995. To analyse these patterns, we construct a Hopenhayn model that incorporates location-specific capital wedges, output wedges, and entry barriers. Using Chinese Industry Census data, we estimate these wedges and examine their role in explaining differences in performance and growth across prefectures. Entry barriers explain most of the differences. We investigate the empirical covariates of these entry barriers and find that changes in barriers are causally related to changes in the size of the state sector: a smaller state sector leads to lower entry barriers.

We build a heterogeneous agents life cycle model that captures a large number of salient features of individual male labour supply over the life cycle, by education, both along the intensive and extensive margins. The model provides an aggregation theory of individual labour supply, firmly grounded on individual-level micro-evidence, and is used to study the aggregate labour supply responses to changes in the economic environment. We find that the aggregate labour supply elasticity to a transitory wage shock is 1.75, with the extensive margin accounting for 62% of the response. Furthermore, we find that the aggregate labour supply elasticity to a permanent-compensated wage change is 0.44.

How does wealth taxation differ from capital income taxation? When the return on investment is equal across individuals, a well-known result is that the two tax systems are equivalent. Motivated by recent empirical evidence documenting persistent return heterogeneity, we revisit this question. With heterogeneity, the two tax systems typically have opposite implications for efficiency and inequality. Under capital income taxation, entrepreneurs who are more productive and therefore generate more income pay higher taxes. Under wealth taxation, entrepreneurs who have similar wealth levels pay similar taxes regardless of their productivity, which expands the tax base, shifts the tax burden toward unproductive entrepreneurs, and raises the savings rate of productive ones. This reallocation increases aggregate productivity and output. In the simulated model parameterized to match the U.S. data, replacing the capital income tax with a wealth tax in a revenue-neutral way delivers a significantly higher average welfare. Turning to optimal taxation, the optimal wealth tax (OWT) is positive and yields large welfare gains by raising efficiency and lowering inequality. In contrast, the optimal capital income tax (OKIT) is negative—a subsidy—and delivers lower welfare gains than OWT, owing to the welfare losses from higher inequality. Furthermore, when the transition path is considered, the gains from OKIT turn into significant welfare losses for existing cohorts, whereas OWT continues to deliver robust welfare gains. These results suggest that moderate wealth taxation may be a more appealing alternative than capital income taxation, which can be significantly more distorting under return heterogeneity than under the equal-returns assumption.