Relational Contracts, Unemployment Insurance, and Trade
Abstract: Labor-market institutions determine how firms and workers match to one another. In this paper, I argue that generous unemployment insurance protects workers against liquidity shocks and so induces superior matching with firms. Better matching has limited returns if firms can offer effective formal bonus contracts to their workers. In contrast, better matching leads to large returns if firms cannot use formal contracts and so must motivate their workers using long-term relational contracts. As a consequence, a country may implement generous unemployment insurance policies in order to cultivate firms that rely on relational contracts. If contracting technologies vary across industries, then ex ante homogeneous countries may optimally choose different levels of unemployment insurance to acquire absolute and comparative advantage in different sectors of the economy.
