Davide Romelli

Oana Peia

Nima Fazeli

Jérémie Juste

Tista Kundu

Joonsuk Kwon

Hyunwoo Shim

Yong June Yoon

Heesang Ryu

Xiao Jia

Francesco Carbonero

Muhammad Waleed

Daniel Samaan

Frictions in a Small Open Economy Faced with Uncertainty Shocks: The Case of Korea

This dissertation concludes four years of hard work, dozens of pages of code, but above all a fantastic opportunity to meet and interact with bright and generous people at ESSEC, Université de Cergy-Pontoise, and more recently at ILO.

Introduction

The labor market is a central institution in any modern economy. This market allocates workers to jobs. If the labor market operates properly, workers will nd employment at the right speed, and these jobs will be appropriate to their experience and skill. If the market does not function satisfactorily, willing workers will remain unemployed for too long, vacancies will stay unlled, and many workers will occupy positions that are unsuited for them. Moreover, rms will not appear, grow, or close at the optimal rate. At the same time, the labor market is characterized by pervasive regulation. Across nations, the labor market is subject to minimum wages, hiring and ring restrictions, compulsory collective bargaining and arbitrage, limitations on the number of hours, antidiscrimination clauses, curtailments on work by age and by gender, etc. Moreover, substantial dierences in labor market exibility persist even within groups of countries with similar income levels.

A recent and growing literature investigates the consequences of such heterogeneity in labor market institutions, studying how labor market rigidities aect the causes and consequences of policy changes, such as trade liberalization and market reforms. An important conclusion of these research is that the institutional features of local labor markets shape the pattern of comparative advantage across countries, contributing to the determination of long-run outcomes of regime changes. Thus far, however, few works have addressed the implications of labor market rigidities for trade-induced labor dynamics focusing on the informal sector, or the second moment shocks in an open economy setting. Important questions remain open for researchers and policymakers: How does labor market frictions interact with uncertainty in a small open economy? How do labor market frictions in formal and informal sectors aect the transition dynamics generated by trade integration? Are labor market frictions important for understanding the propagation of uncertainty shocks across countries? The purpose of this thesis is to address these questions, studying the role of labor market frictions and its interaction with international trade and uncertainty.

Chapter One The rst chapter investigates the impact of uncertainty shocks in a small open economy with search and matching frictions and rm entry. Other existing works analyze the macroeconomic eect of uncertainty shocks using either search and matching models, or in an open economy setting. To the best of our knowledge, none has used rm entry model. In our paper, we combine all elements and show how they interact and magnify 1 recessionary eects of uncertainty shocks.

We rst develop our empirical analysis in the context of the Korean economy, as all dimensions of the model are relevant in this country. An increase in uncertainty lowers output, consumption, investment and job nding rate, while raising unemployment and job separations. We also supplement the existing empirical evidence by looking at rm dynamics, real exchange rate and current account behavior. Increased uncertainty generates current account surplus, real exchange rate depreciation and reduces the number of rms in the economy. In our theoretical framework, we illustrate new transmissions mechanism that are ignored in the literature. Economic mechanisms go beyond the simple addition of each feature. Search frictions, rm entry and the open economy dimension actually strongly interact to amplify the eects of uncertainty shocks and make the model consistent with the empirical evidence.

This paper is co-authored with Thepthida Sopreseuth (Université de Cergy-Pontoise (THEMA)). We thank Olivier Charlot, Lise Patureau, Lee Sang Seok and Cristina Terra for their comments as well as participants to T2M conference (Lisbon, 2017), Asian Meeting of the Econometric Society (Hong Kong, 2017), Society for Computational Economics (New York, 2017), KEA-APEA conference (Seoul, 2017).

Chapter Two The second chapter studies how tax reforms help ensure a fair globalization. Over the past decades, trade liberalization has led to signicant trade expansion, with positive eects on the economic activity. However, trade liberalization has not always been associated with better working conditions and more equal income distribution. In this paper we develop a two-area model: a developed and an emerging country. The two areas dier according to the size of the informal sector, which is characterized by a more exible labor market (i.e. rapid entry and exit and more exible adjustment to change in demand) and lower productivity. Our analysis suggests that trade liberalization boosts economic activity and employment in both the formal and informal sector. However, this employment expansion is biased toward the informal sector, which is not subject to labor regulation and hence more exible. Hence, trade liberalization leads to lower employment quality, as informal workers are not covered by the labor legislation (e.g. minimum wages) and social security, and receive lower wage.

In order to reduce the increasing incidence of informality by trade liberalization, both countries should introduce incentives to develop businesses in the formal economy. A budgetneutral tax reform switching the tax burden from payroll taxes paid by rms operating in the formal sector to a consumption tax may represent a strategy to support the formal sector.

Moreover, these tax reforms succeed in mitigating the adverse eects of trade liberalization on employment quality. However, formalization comes at the cost of widening income inequality between formal and informal workers. This paper is co-authored with François Langot (Le Mans University (Gains-TEPP & IRA), Paris School of Economics & Cepremap) and Rossana Merola (ILO). The work greatly beneted from guidance, encouragement and helpful comments by Stéphane Adjemian, Thomas Brand, Matteo Cacciatore, Ekkehard Ernst, Fabio Ghironi, Stefan Kühn, Pierella Paci, Christian Viegelahn and members of the DYNARE team. It has been presented at the World Bank (2018) and Asian Meeting of the Econometric Society (Seoul, 2018).

Chapter Three The third chapter assesses the importance of labor market institutions in the transmission of uncertainty shocks to labor markets. Since the work by [START_REF] Bloom | The impact of uncertainty shocks[END_REF], uncertainty about the future course of the economy has been identied as a possible driving force behind business cycle uctuations. A number of recent papers have shown that an increase in uncertainty leads to a drop in economic activity: output, investment, consumption, and employment. However, most of the analysis studies the impact of uncertainty shocks in single-country analysis and cross-country evidence focusing on the labor market is still scarce.

Using country-specic VARs across OECD countries, I nd that there is substantial cross-country heterogeneity in the responses of unemployment rates to uncertainty shocks.

I also provide evidence that this heterogeneity can be attributed to dierential employment protection legislation (EPL). Low EPL countries suer more severe rises in unemployment compared to high EPL countries following uncertainty shocks. Stricter EPL mutes the reaction of unemployment, making it more costly to lay workers o. Moreover, the second moment shock reinforces this mechanism through the real options channel. Under irreversibility and uncertainty, ring costs come with a bigger cost. On the other hand, the role of other labor market characteristics is ambiguous.

Introduction

This paper investigates the impact of uncertainty shocks in a small open economy with search and matching frictions, endogenous job separation and rm entry. We combine these elements to highlight important transmission mechanisms that have not been analyzed in the existing work. We develop our analysis in the context of the Korean economy, as all dimensions of the model are relevant in this country: Korea is a globalized economy with heavily regulated labor and product markets, in which the job separation margin explains a large share of unemployment uctuations.

We rst provide original empirical evidence on the eects of uctuating uncertainty on macroeconomic aggregates, labor market adjustments, rm dynamics, real exchange rate and current account. Using survey data, we compute the job nding and job separation rates.

Following Shimer (2012)'s variance decomposition, unemployment inows appears to be the main driver of unemployment cyclical behavior, which stresses the need for endogenous separation in the model. We then investigate the macroeconomic impact of time-varying volatility in a structural VAR. In doing so, we extend the literature along several dimensions.

First, to our knowledge, we are the rst to provide empirical evidence on labor market ows, rm dynamics and open-economy variables. Previous studies either investigate labor market ows or open-economy dimension. None look at rm dynamics. We look at all dimensions in Korean data. Secondly, the papers that analyze the eect of uncertainty shocks on the labor market [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF], [START_REF] Guglielminetti | The labor market channel of macroeconomic uncertainty[END_REF], [START_REF] Riegler | The Impact of Uncertainty Shocks on the Job-Finding Rate and Separation Rate[END_REF]) focus on US data. However, gross labor market ows are large in the US, suggesting that search and matching frictions may be too low to create large irreversibility. The macroeconomic eects of uncertainty may be larger in more regulated labor and product markets, such as in Korea.

With the exception of [START_REF] Miyamoto | Uncertainty shocks and labor market dynamics in Japan[END_REF] on Japanese data, to our knowledge, there is no empirical study on labor market ows in other countries in uncertain times. We ll this gap.

We nd that an increase in uncertainty lowers output, consumption, investment and job nding rates, while raising job separations and unemployment. We also nd that increased uncertainty generates current account surplus, real exchange rate depreciation and reduces the number of rms in the economy.

We next develop a small open economy with search and matching frictions, endogenous job separation and rm entry. Uncertainty shocks are dened as unexpected exogenous variations in the volatility of the technological process. We consider only this uncertainty shock in order to compare our results to the literature (that mainly focuses on the macroeconomic impact of this shock). The model predicts that an increase in uncertainty raises unemployment, job separation rates, and lowers output, consumption, investment, the number of rms and job nding rates. The economy is also characterized by a current account surplus and real exchange rate depreciation. These eects are consistent with the VAR evidence.

The economic mechanisms are the following. In the standard real business cycle (RBC) model, uncertainty creates a precautionary saving motive: Domestic households cut consumption spending to invest in physical capital, job creation, rm entry or Foreign bonds.

In a search and matching model, a job match is an irreversible long-term employment relation, which creates an option-value channel. When uncertainty increases, the value of a job match declines as the option value of waiting increases. Under the benchmark calibration, the option-value channel dominates the precautionary motive eects such that the increase in uncertainty reduces vacancies. Firms also use the separation margin to lay o the least productive workers. Unemployment goes up, making it harder for unemployed workers to nd jobs. The decline in employment drives the marginal product of capital downward, which triggers fall in capital investment. The real option channel also applies to rm entry.

As rm entry is costly, the option value of waiting increases. The expected value of a rm falls, which drives rm entry down. The number of producers declines. At the aggregate level, the reduction in the number of rms is equivalent to a drop in the capital stock. This amplies the initial fall in output. The recessionary eects of increased uncertainty make investment in capital, job creation and rms unattractive. Households are then attracted by foreign bonds, which creates a current account surplus. Real exchange rate depreciates in response to increased uncertainty because of the fall in domestic relative prices, induced by the reduction in the number of producers. Real exchange rate depreciation makes Foreign bonds attractive as an hedging device against domestic shocks. Economic mechanisms go beyond the simple addition of each feature. Search frictions, rm entry and the open economy dimension actually strongly interact to amplify the eects of uncertainty shocks and make the model consistent with the empirical evidence. Several elements illustrate these interactions. First, in a search and matching model with rm entry, rm entry interacts with labor frictions as the number of competitors aect the rm's relative price, hence the marginal value of a match. In turn, as rm entry involves vacancy opening, labor market tightness aects rm entry costs (Cacciatore & Fiori (2016)). Secondly, rm entry aects relative prices, hence consumer price index. The real exchange rate is therefore responsive to changes in the competitive environment. Furthermore, real exchange rate depreciation makes Foreign bonds attractive as an insurance device against domestic shocks.

Households then strongly reduce consumption and investment in domestic smoothing tools (jobs, rms or capital), thereby amplifying the recession in uncertain times.

Our work relates to the literature that documents the relationship between uncertainty and the business cycle. [START_REF] Basu | Uncertainty shocks in a model of eective demand[END_REF] argue that the fall in output, consumption, investment, and employment can be obtained after an uncertainty shock in a demand-driven economy, with price rigidity. In [START_REF] Basu | Uncertainty shocks in a model of eective demand[END_REF]'s model, increased uncertainty leads to an endogenous rise in markups, which is crucial in driving down employment in uncertain times. In this paper, as heightened uncertainty lowers rm entry, markups also endogenously increase. With respect to [START_REF] Basu | Uncertainty shocks in a model of eective demand[END_REF], we investigate the macroeconomic eects of uncertainty shocks on labor market ows in an open economy setting. Other existing works analyze the macroeconomic eect of uncertainty shocks using either search and matching models, or in an open economy setting. To the best of our knowledge, none has used rm entry model. In our paper, we combine all elements and show how they interact and magnify recessionary eects of uncertainty shocks.

With respect to the literature on uncertainty shock in an open economy setting [START_REF] Fernandez-Villaverde | Risk matters: The real eects of volatility shocks[END_REF], [START_REF] Fogli | Macroeconomic volatility and external imbalances[END_REF], [START_REF] Kollmann | International business cycles and risk sharing with uncertainty shocks and recursive preferences[END_REF]), our originality lies in investigating the consequences of time-varying volatility on labor market adjustments and rm entry. All models, including our own, correctly predict that heightened uncertainty is associated with a current account surplus. However, Kollmann (2016)'s model predicts that heightened uncertainty leads to higher domestic consumption and real exchange rate appreciation, which is not consistent with Korean data. [START_REF] Fernandez-Villaverde | Risk matters: The real eects of volatility shocks[END_REF] and [START_REF] Fogli | Macroeconomic volatility and external imbalances[END_REF]'s models generate a large precautionary savings that entices domestic households to work more, which is also inconsistent with Korean data. With respect to the literature in a search and matching environment [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF][START_REF] Guglielminetti | The labor market channel of macroeconomic uncertainty[END_REF][START_REF] Miyamoto | Uncertainty shocks and labor market dynamics in Japan[END_REF]), we lay stress on the endogenous separation and study the interaction between search and matching frictions and rm entry in an open economy setting. In particular, with endogenous separation, job nding rate increases in uncertain times, which is not consistent with the data [START_REF] Miyamoto | Uncertainty shocks and labor market dynamics in Japan[END_REF]). Schaal (2017)'s search model also predicts an increase in the job nding rate during the Great recession 1 . [START_REF] Riegler | The Impact of Uncertainty Shocks on the Job-Finding Rate and Separation Rate[END_REF]'s search and matching model correctly predicts a fall in the job nding rate in response to increased uncertainty. With respect to his paper, we investigate the impact of uncertainty in aggregate shocks, rather than idiosyncratic volatility shock. Furthermore, Riegler (2015) introduces 1 Schaal (2017) also get sizable eects from idiosyncratic volatility shocks partly by assuming a negative correlation between the volatility shocks and the level of aggregate productivity. We do not follow this route. costly job creation (in addition to the usual hiring cost) to obtain the desired fall in job nding rate after an increase in uncertainty. We do not follow this route. Finally, we take into account the feedback eect of rm dynamics on relative prices, hence real exchange rate, which in turn aects precautionary motives and investment. [START_REF] Schaal | Uncertainty and unemployment[END_REF] andRiegler (2015) propose interesting insight in labor market dynamics. However, they say nothing about consumption and investment dynamics. As pointed out by [START_REF] Basu | Uncertainty shocks in a model of eective demand[END_REF], papers experience diculty in generating business-cycle comovements among output, consumption, investment, and employment from changes in uncertainty. Our paper succeeds in doing so, in addition to generating data-consistent a fall in the number of rms, current account surplus and real exchange rate depreciation. Finally, we relate to the literature using search and matching models with rm dynamics. Cacciatore & Fiori (2016) and Cacciatore et al. (2016) focus on structural reforms. We extend this work by investigating the macroeconomic eects of uncertainty shocks.

The paper is organized as follows. We investigate the macroeconomic eects of uncertainty shocks in Korean data in Section 2. We develop a small open economy model with search and matching, endogenous separation and rm entry in Section 3. We explore the macroeconomic eects of uncertainty shocks in Section 4. Section 5 concludes.

Eects of uncertainty shocks: empirical evidence 1.2.1 Measuring uncertainty

Our measure of uncertainty is forecast dispersion computed from the Korean economy forecasts. Periods when forecasters hold more diverse opinions are likely to reect greater uncertainty. Survey-based measures of uncertainty have been commonly used in the empirical literature [START_REF] Bachmann | Uncertainty and economic activity: evidence from business survey data[END_REF], [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF], [START_REF] Guglielminetti | The labor market channel of macroeconomic uncertainty[END_REF] among others). Since January 1995, Consensus Economics has surveyed over prominent nancial and economic forecasters for their estimates of a range of Korean macroeconomic variables, including GDP, ination, unemployment and interest rates over a 2 year forecast horizon.

Among them, we use the cross-sectional standard deviation of GDP forecasts.

2 The monthly 2 To construct the series, we compute the average of cross-sectional standard deviations of GDP forecasts over a 2 year horizon. [START_REF] Bloom | Fluctuations in uncertainty[END_REF] also checks that forecast dispersion provides a good proxy for perceived uncertainty. In the US Survey of Professional Forecasters, in 1992, forecasters provide probabilities for GDP growth (in percent) falling into ten dierent bins. Using the subjective uncertainty calculated using these probabilities, Bloom shows that disagreement across forecasters indeed captures changes in subjective time series are seasonally adjusted using X-13-ARIMA-SEATS method and we quarterly average the series from 1995Q1 to 2015Q4.

Since we study the eects of a domestic uncertainty shock, however, our measure needs to be orthogonal to foreign uncertainty shocks. Therefore, we regress our forecast dispersion on US uncertainty measure 3 and use the residual from this regression as our uncertainty measure. Figure 1.1 displays our measure of uncertainty. In particular, our measure is positively associated with the unemployment rate. This counter-cyclical behavior is consistent with empirical ndings on US data.

Measuring worker ows

As in [START_REF] Shimer | Reassessing the ins and outs of unemployment[END_REF], we measure the probability that an employed worker becomes unemployed and the probability that an unemployed worker nds a job, using EAPS survey data, between 1995Q1 and 2015Q4 4 . Job nding and employment exit probabilities are uncertainty.

3 As US uncertainty indicator, we use a measure of disagreement drawn by the Survey of Professional Forecasters (SPF) administered by the Philadelphia FED. Professional forecasters are asked to disclose their best predictions about several macroeconomics indicators at dierent horizons. The Philadelphia FED itself computes a measure of forecast dispersion, which consists of the dierence between the 75th and the 25th percentiles of the forecasts. We use this measure computed for the forecast on nominal GDP.

4 See Appendix 1.5 for a full description of the microdata and the methodology.

reported in Figure 1.6 in Appendix 1.5. The job nding probability falls in recession, while employment exit probability rises in economic slumps. These cyclical features are also found in other OECD countries [START_REF] Elsby | Unemployment Dynamics in the OECD[END_REF][START_REF] Shimer | Reassessing the ins and outs of unemployment[END_REF]). The salient stylized fact in Korean data lies in the leading role of job separations in unemployment uctuations. Based on Shimer (2012)'s variance decomposition, exit from employment accounts for nearly 80% of unemployment uctuations (versus an upper bound of 50%-60% on US and French data [START_REF] Fujita | The cyclicality of separation and job nding rates[END_REF], [START_REF] Hairault | The cyclicality of the separation and job nding rates in france[END_REF]).

5 As a result, the model developed in this paper includes endogenous separation.

VAR evidence

The structural VAR consists of six time-series; in the following order, a measure of uncer- As in [START_REF] Basu | Uncertainty shocks in a model of eective demand[END_REF] and [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF], we assume that uncertainty does not respond to the state of the economy on impact, but labor variables, real domestic GDP, and current account are allowed to react instantaneously to uncertainty. As in [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF], our identication strategy exploits the fact that, when answering questions at time t about their expectations, survey participants do not have complete information about the time t realizations of variables in our VAR model because the macroeconomic data have not yet been made public. Thus, the measure of uncertainty comes rst in the Cholesky ordering.

Figure 1.2 plots the eects of the relevant variables to one-standard deviation shock to 5 See Appendix 1.5 for details on the computation of Shimer (2012)'s variance decomposition.

6 Korean rm data are available on a semi-annual basis. Thus, semi-annual stock of rms is turned into quarterly data using spline. Furthermore, for want of data, we could not include vacancies in the VAR.

uncertainty with the 68% condence bands. The responses of all macroeconomic variables appear statistically signicant. First of all, a surge in uncertainty reduces output, consumption, and investment. Specically, an increase in uncertainty produces a peak decline in output of about 0.6 percent, which falls within the range found in the literature (0.2 percent in [START_REF] Basu | Uncertainty shocks in a model of eective demand[END_REF], 2.5 percent in [START_REF] Bloom | Really Uncertain Business Cycles[END_REF]). The peak decline in investment is twice larger as the decline in output, as in US data [START_REF] Basu | Uncertainty shocks in a model of eective demand[END_REF]). Heightened uncertainty lowers GDP, consumption and investment, as well as the job nding rate while job separation increases. Both eects on the job nding and separation rates contribute to an increase in unemployment. In particular, a one-standard-deviation increase in uncertainty leads to a peak increase of unemployment rate of about 5.1 percent relative to the sample average. The negative eects of higher uncertainty on labor variables are in line with the recent empirical studies on US ows [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF], [START_REF] Riegler | The Impact of Uncertainty Shocks on the Job-Finding Rate and Separation Rate[END_REF] and [START_REF] Guglielminetti | The labor market channel of macroeconomic uncertainty[END_REF]). The number of rms signicantly drops following an uncertainty shock. Increased uncertainty is also associated with current account surplus. This is consistent with the empirical result that heightened uncertainty reduces domestic absorption (consumption and investment fall, [START_REF] Fogli | Macroeconomic volatility and external imbalances[END_REF], [START_REF] Fernandez-Villaverde | Risk matters: The real eects of volatility shocks[END_REF].

Korean real exchange depreciates on impact. This is also consistent with current account surplus as real depreciation makes imports more expensive and sustains exports. In Appendix 1.5, we also show that the results are robust to alternative identication, volatility measure, and specication.

Small open economy with labor market frictions, endogenous job separation and rm entry

In this section, we develop a small open economy with labor market frictions, endogenous job separation and rm entry as in Cacciatore & Fiori (2016) and Cacciatore et al. (2016).

Foreign variables are denoted with a superscript star. The subscript d refers to quantities and prices of a country's own goods consumed domestically. x refers to quantities and prices of exports.

Household's preference

The economy is populated by a unit mass of households, where each household is an extended family. In each family, some members are employed, others are employed. This assumption is made to avoid heterogeneity across households, as in [START_REF] Andolfatto | Business cycles and labor-market search[END_REF]. The representative household maximizes the expected intertemporal utility function

E 0 ∞ t=0 β t C 1-σc t 1 -σ c
where β ∈ (0, 1) is the discount factor, and σ c > 0 risk aversion. C t represents consumption of market and home-produced goods:

C t = C M t + (1 -L t )h p , where C M t is consumption
of market goods, h p is home production, and L t is the number of employed workers. The aggregate market-consumption basket C M t is a CES aggregate of domestic (C d,t ) and foreign (C *

x,t ) goods with elasticity of substitution φ > 0:

C M t = (1 -γ) 1 φ C φ-1 φ d,t + γ 1 φ (C * x,t ) φ-1 φ φ φ-1
with 0 < γ < 1 the share of foreign goods in the consumption basket and φ the elasticity of substitution between Home and Foreign goods. The corresponding composite price index is:

P t = (1 -γ)P 1-φ d,t + γ(ε t P * x,t ) 1-φ 1 φ-1
with ε t the nominal exchange rate. The domestic consumption basket C d,t is dened over a set Ω t of available consumption goods. As in [START_REF] Bilbiie | Endogenous entry, product variety, and business cycles[END_REF], we assume that C d,t and C * x,t take a translog form as in Feenstra (2003) such that the elasticity of substitution across varieties ω in the subset C d,t increases with the number of available goods in the economy.

The price index associated with translog preferences is

ln P d,t = 1 2σ 1 N t - 1 Ñt + 1 N t ω⊂Ω d,t ln p d,t (ω)dω + σ 2N t ω⊂Ω d,t ω ⊂Ω d,t ln p d,t (ω) (ln p d,t (ω) -ln p d,t (ω )) dωdω
with σ > 0 the price elasticity of demand on an individual good, p d,t (ω) the price of a variety ω produced and sold at Home, N t the total number of Home producers (the mass of Ω t ),

and Ñt the maximum number of varieties (the mass of Ω). (2000) and Cacciatore & Fiori (2016).

A lled job i at rm ω produces Z t z it k α iωt with Z t aggregate productivity, z it match-specic productivity, k iωt stock of capital allocated to the job. Within each rm, jobs with identical productivity z it produce the same amount of output. As a result, i be can ignored. Each job is characterized by its match-specic productivity z t . z t is a per-period i.i.d. draw from a time-invariant distribution with c.d.f. G(z), positive support, and density g(z). When solving the model, we assume that G(z) is lognormal with log-scale µ z and shape σ z . Total output for producer ω is

y ωt = Z t l ωt 1 [1 -G (z c ωt )] ∞ z c ωt k α ωt (z)zg(z)dz z c
ωt endogenous threshold below which jobs that draw z t < z c ωt are not protable. As in [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF], the aggregate TFP shock Z t follows the stochastic process

ln Z t = ρ z ln Z t-1 + σ zt z t (1.1) with 0 < ρ Z < 1. z t is an i.i.d.
ln σ zt = (1 -ρ σz ) ln σ z + ρ σz ln σ z,t-1 + σ σz σz t (1.2) with 0 < ρ σz < 1.
M t = χU ε t V 1-ε t with χ > 0, 0 < ε < 1, U t
k ωt = l ωt kωt where kωt = 1 [1 -G (z c ωt )] ∞ z c ωt k α ωt (z)g(z)dz
The inow of new workers and the outow of workers due to separations jointly determine the evolution of rm level employment.

l ωt = (1 -λ ωt ) (l ωt-1 + q t-1 v ωt-1 )
where λ ωt = λ x t + (1 -λ x t ) G (z c ωt ) denotes total separations within the rm ω. λ x t is the fraction of jobs that are exogenously separated in each rm.

Prot maximization Producer ω's production function can be written as

y ωt = Z t zωt k α ωt l 1-α ωt with k ωt = l ωt kωt , zωt = 1 [1-G(z c ωt )] ∞ z c ωt z 1 1-α g(z)dz 1-α and kωt = 1 [1-G(z c ωt )] ∞ z c ωt k α ωt (z)g(z)dz. Let ρ ωt = p ωt Pt
denote the relative price of good ω with respect to the consumer price index. ρ xωt = pxt Pt as p xt is the export price, expressed in Home consumption units. The rm per-period prot (in units of consumption) is

d ωt = ρ dωt y d,t (ω) + ρ xωt y x,t (ω) -wωt l ωt -r t k ωt -(1 -λ x t ) G (z c ωt ) (l ωt-1 + q t-1 v ωt-1 ) F -κv ωt where wωt = 1 [1-G(z c ωt )] ∞ z c ωt w ωt (z)g(z)
M ax Π t = E t ∞ s=t β t (1 -δ) s-t λ t+s λ t d ωs subject to l ωt = (1 -λ ωt ) (l ωt-1 + q t-1 v ωt-1 ) (ψ ωt ) y ωt = y x,t (ω) + y d,t (ω) = Z t l ωt 1 [1 -G (z c ωt )] ∞ z c ωt k α ωt (z)zg(z)dz (ϕ ωt ) y ωt = y x,t (ω) + y d,t (ω) = σ ln pd,t p d,t (ω) P d,t p d,t (ω) P d,t P t -φ (1 -γ)Y C t + Q φ t γY C * t (µ ωt ) y x,t (ω) = γσ ln px,t p x,t (ω) P x p x,t (ω) P x,t ε t P * t -φ Y C * t (µ xωt ) y d,t (ω) = (1 -γ)σ
κ q t = β (1 -δ) (1 -λ x )E t λ t+1 λ t 1 -G z c ωt+1 y ωt+1 l ωt+1 ϕ ωt+1 (1 -α) -wωt+1 + κ q t+1 -G z c ωt+1 F (1.3)
The rm determines the optimal number of vacancies such that the cost of vacancy posting (κ incurred during an average number of periods of 1 qt ) equal the expected return of a lled vacancy (which includes, if the job is not destroyed, future labor productivity and vacancy costs saved on next period's job, net of wage cost, and, for lost jobs, ring costs).

Job destruction The job destruction equation denes a productivity threshold z c ωt below which a job is destroyed

(1 -α) ϕ ωt y ωt l ωt z c ωt zt 1 1-α -w ωt (z c ωt ) + κ q t = -F (1.4)
The job destruction equation states that, at productivity level z c ωt , the rm's outside option (ring the worker, thereby incurring the ring cost F ) equals its prot (marginal product, net of labor costs) in addition to the recruitment costs the rm saves by keeping the worker.

Price setting

ρ dωt = ρ xωt = µ ωt ϕ ωt (1.5)
Let θ ωt = -∂lnyωt ∂lnpωt denote the price elasticity of total demand for variety ω. Then the rm's mark up over marginal cost µ ωt = θωt θωt-1 .

Wage setting

The wage is the solution of the Nash bargaining process that splits the surplus of the match between the rm and the worker as in most of the labor search literature. At the symmetric equilibrium, all rms ω behave similarly. The average wage is then

wt = (b + h p ) (1 -η) + η (1 -α) ϕ t yt lt + κθ t + 1 -(1 -δ) (1 -λ x ) (1 -s t ) βE t λ t+1 λt F with s t = Mt
Ut the job nding rate and η the worker's bargaining power. The wage is a weighted sum of the worker's outside option and the value of the match for the rm, which includes the expected marginal product of labor, the search costs saved by the rms because she kept the worker within the rm. Firing costs have two opposing eects on the current wage. On the one hand, the rm saves today the ring costs, which increases the current wage. On the other hand, the rm will pay future ring costs, in case of job separation in the next period, which lowers the current wage.

Firm entry

As in Cacciatore & Fiori (2016), prior to entry, rms pay a sunk entry cost

f Et = f Rt + f T t + κv e t (1.6)
The rst two terms represent, respectively, the costs in terms of goods and services imposed by regulatory and administrative barriers to market entry (f Rt ) and technological require- ments for business creation (f T t ) such as research and development (R&D), nonresidential structures, etc. f Rt + f T t are paid in terms of the nal good Y t . Upon entry, new entrants choose the same amount of labor as incumbent. They then post v e t vacancies such that v e t = lt+qtvt qt . Prospective entrants compute their expected post-entry value, such that is the present discounted value of their expected prot stream

e t = E t ∞ s=t β t (1 -δ) s-t λ t+s λ t d s (1.7)
The free entry condition is e t = f Et . As in [START_REF] Bilbiie | Endogenous entry, product variety, and business cycles[END_REF], we introduce a one-period time-to-build lag. New and incumbent rms can be hit by a death shock with probability δ ∈ (0, 1) at the end of the period. The law of motion is given by

N t = (1 -δ) (N t-1 + N Et-1 )
Upon exit, the rm's workers join the unemployment pool.

Household budget constraint

Household accumulates physical capital and rent it to rms. Investment consists of domestic and foreign goods, in the same fashion as the consumption basket. Capital accumulation obeys a standard law of motion:

K t+1 = (1 -δ K )K t + I t 1 - ν 2
I t I t-1 -1 2 (1.8)
with scale parameter ν > 0 and 0 < δ K < 1 capital depreciation rate. On the international nancial market, households have access to foreign-currency risk-free bonds. Let us dene

b * t = B * t P * t
real holdings of Foreign-currency bonds (in units of Foreign consumption). We assume a quadratic cost of adjusting Foreign bond holding, as in [START_REF] Benigno | Price stability with imperfect nancial integration[END_REF]. In addition, households hold shares in a mutual fund of rms. As in [START_REF] Ghironi | International trade and macroeconomic dynamics with heterogeneous rms[END_REF], household savings are made available to prospective entrants to cover their entry costs through the mutual fund. x t denotes the share in the mutual fund held by the household at the beginning of period t. The representative household receives each period, N t d t , the total prot of all rms that produce in that period (in units of consumption). Each period t, the household buys x t+1 shares in a mutual fund of N t + N Et rms. Household's budget constraint (in units of consumption basket) is

C t + b t + Q t b * t + ξ 2 Q t (b * t ) 2 + (N t + N E,t ) e t x t+1 + I t = r t K t + W t + Q t b * t-1 (1 + i * ) + N t x t (d t + e t ) + (1 + i t-1 ) P t-1 P t b t-1 + (b + h p ) (1 -L t ) + Π t + T t (λ t )
where T t are lump-sum transfers, ξ > 0 the scale parameter on adjustment costs on Foreign bond holding. This is a small open economy. As a result, Foreign variables are considered as exogenous. In addition, as we focus on technological shocks, Foreign variables are assumed to be constant. λ t is the Lagrange multiplier associated with the budget constraint. The rst-order condition on Foreign holding is

1 + ξb * t = β(1 + i * )E t λ t+1 λ t Q t+1 Q t (1.9)
Choice of investment in rm entry is such that

e t = β(1 -δ)E t λ t+1 λ t (d t+1 + e t+1 )
(1.10) Household's choice on capital is such that

ζ K t = βE t λ t+1 λ t ϕ t+1 α Y t+1 K t+1 + ζ K t+1 (1 -δ) (1.11) ζ K t 1 - ν 2
I t I t-1 -1 2 -ν I t I t-1 I t I t-1 -1 + βE t λ t+1 λ t ζ K t+1 I t+1 I t 2 ν I t+1 I t -1 = 1
(1.12) with ζ K t is the multiplier associated with equation (1.8) and captures the shadow price of capital.

Equilibrium

In the symmetric equilibrium, the elasticity of substitution across varieties is θ t = 1 + σN t and the mark-up

µ t = 1 + 1 σN t = θ t θ t -1 (1.13)
As the number of producers N t increases, the mark up decreases. As a result, the relative price

ρ t = exp - 1 2 Ñt -N t σ Ñt N t (1.14) declines if N t falls. Total employment is L t = N t l t , the law of motion of employment is L t = (1 -λ t ) (1 -δ) [L t-1 + q t-1 V t-1 ] while the mass of unemployed workers is U t = 1 -L t . Total vacancies are V t = (N t + N E,t ) v t + N E,t lt qt while aggregate capital is K t = N t k t . Total output for all producing rms in terms of consumption units is Y t = ρ t Z t zt K α t L 1-α t .
8 As pointed out by [START_REF] Ghironi | International trade and macroeconomic dynamics with heterogeneous rms[END_REF], the number of rms behaves very much like a capital stock. Aggregate variables are directly aected by changes in the number of producers. Firm entry then potentially provides a potent magnication mechanism to uncertainty shocks.

Current account dynamics is given by

Q t b * t -Q t b * t-1 = Q t b * t-1 i * + ρ t N t y t -Y C t (1.15) with Y C = C M + N E,t (f Rt + f T t ) + κV t + I t + F L t G (z c t ) [1 -G (z c t )] + ξ 2 Q t (b * t ) 2
Notice, in equation (1.15), that Home resources are scaled by the number of producers N t and the relative price ρ t (that comoves with N t , equation (1.14)). A fall in the number of producers N t then reduces Home aggregate production through these two channels.

1.4 Eects of uncertainty shocks 1.4.1 Solution method and calibration Solution method Uncertainty shocks, which are the second-moment shocks in our model only enter the model's policy functions independently from the level shocks at third order.

Hence, the model is solved using a third-order approximation around the deterministic steady state. We then simulate the model and compute moments of endogenous variables using pruning 9 . The Dynare is used for that purpose [START_REF] Adjemian | Dynare. Reference manual, Cepremap[END_REF]).

As Calibration We calibrate the model at a quarterly frequency and choose parameter values from the literature to match features of the Korean economy. However, when data is not available for Korea, we use standard values in the literature. The benchmark calibration is summarized in Table 1.1 . We choose standard values for all the parameters that are conventional in the literature: the discount factor β, risk aversion σ C , the capital share in the Cobb-Douglas production function α, and the capital depreciation rate δ K (β = 0.99, σ C = 1, α = 0.33, and δ K = 0.025). Moreover, we set workers' bargaining power parameter η to 0.6 following [START_REF] Petrongolo | Looking into the black box : A survey of the matching function[END_REF]. Using [START_REF] Hosios | On the eciency of matching and and related models of search and unemployment[END_REF] condition, we set also the elasticity of matches to unemployment ε to 0.6. Adjustment costs on capital are set such that the model matches the relative volatility of investment (leading to ν = 0.5).

Concerning the parameters related to the product market, we set regulation entry cost f R following the procedure described in [START_REF] Ebell | Product market deregulation and the us employment miracle[END_REF]. [START_REF] Djankov | The regulation of entry[END_REF]'s assessment of entry costs in Korea amounts to 27% of annual GDP per capita. We then infer the entry costs in terms of months of lost output. We add this measure to Pissarides (2001)' index of entry costs (converted in the same unit of months of lost output).

11

We set the technological entry cost f T such that aggregate R&D expenditures are 1.7 percent of GDP as in Cacciatore & Fiori (2016). In order to get the calibrated value of f T , we convert the empirical target in terms of quarterly output per capita. The calibrated value is a lower bound for the Korean economy as Korea is characterized by the largest growth in R&D expenditures over the recent years (OECD (2015b)).

To pin down the rm exit rate δ, we target the portion of worker separation due to rm exit equal to 26 percent, within the range of estimates reported by [START_REF] Haltiwanger | Assessing job ows across conntries: The role of industry, rm size and regulations[END_REF].

We set the price elasticity of demand on an individual good, σ, such that the steady state markup is 10 percent, a benchmark value in the literature.

We now turn to the parameters that are specic to the search and matching framework.

Unemployment benet b, are equal to 61 percent of the steady state wage (OECD, Benets and Wages Database, Korea) 12 . We choose the exogenous separation rate, λ x , so that the percentage of jobs counted as destroyed in a given year that fail to reappear in the following year is 71 percent as in Cacciatore & Fiori (2016). We set home production, h p , the matching eciency parameter, χ, and ring costs, F , to match the total quarterly separation rate, λ, the unemployment rate, U , and the probability of lling a vacancy, q. We set U = 11.2, q = 0.6, and λ = 0.027, in line with the estimates in Appendix 1.5. The resulting ring costs and home production appear to be, respectively, 3 percent of average wage and 31 percent of average wage, at the steady state. For the lognormal scale and shape parameters, µ z and σ z , we normalize µ z to zero, and choose σ z such that the model reproduces the variability of the job separation rate. Hiring costs as a fraction of steady-state average wage is κ w = 0.10, close to the estimates by [START_REF] Abowd | The cost of hiring and separations[END_REF] on French data. We consider France as a heavily regulated labor market, as in Korea.

As for the open economy dimension, as in Cacciatore et al. (2016), elasticity of substitution between domestic and foreign goods φ is 3.8, and adjustment costs on Foreign bonds ξ = 0.0025. 12 We consider net replacement rates during the initial phase of unemployment

We calibrate the parameters in the rst-moment shock. We set the persistence parameter to ρ z = 0.9 and choose the average standard deviation, σ z , to match the absolute standard deviation of GDP in the data. When it comes to the parameters in the second-moment shock, we set the standard deviation of the uncertainty shock to σ σz = 0.17 and the persistence parameter to ρ σz = 0.70, based on our VAR estimation from section 1.2. We check in Appendix 1.5 that the moments predicted by the model provides a satisfactory match of the data.

Q. Job nding rate is s t = Mt Ut . Job separation is λ x t + G(z c t )(1 -λ x t ) + δ(1 -λ x t )(1 -G(z c t )) total
separation rate, including separations due to rm exit. Current account as % of GDP.

Mechanisms at work

Precautionary savings. As in the standard RBC model, uncertainty creates a precautionary saving motive: domestic households want to consume less and save more in order to insure themselves against future shocks. Since marginal utility is convex, the stochas- When uncertainty hits the economy, the option value of waiting rises, causing a drop in ϕ the marginal value of a match to the rm. The real-option eect dominates the precautionary savings eect. Hence, faced with a lower expected return on the match, rms post fewer vacancies.

Separations are also subject to an option value. As productivity can quickly revert, rms become more reluctant to separate from their workforce, all the more so as they pay ring costs. This could lead to less separations. However, conicting forces are at work. As rms post lower vacancies, q the probability of lling a vacancy increases, thereby lowering the average hiring costs κ qt . This creates incentives to destroy more matches as rehiring is less costly. The combined eect on separations is ambiguous. In the benchmark calibration, job destruction rises. As a result, the decline in vacancy posting and the increase in separations push unemployment upward, making it harder for unemployed workers to nd jobs. The decline in total employment drives the marginal product of capital downwards, which triggers a fall in capital investment. The interaction between capital and endogenous separation makes the propagation of the shock stronger, as in Den [START_REF] Den Haan | Job destruction and propagation of shocks[END_REF].

Let us have a look at rm dynamics. As rm entry entails sunk costs (equation (1.6)), real option channel also applies to rm entry. With higher uncertainty, e the expected value of a rm falls, which drives rm entry down. The number of producers eventually declines, raising mark-up (equation (1.13)).

Interaction between search frictions and rm entry Firm dynamics have an impact on job creation and separation decisions, and vice versa. First, rm entry condition (equation (1.6)) depends on labor market conditions. With lower vacancies and higher unemployment, labor market tightness declines, which drives rm entry cost down. Nonetheless, the number of rms still falls in response to higher uncertainty due to the option value channel. Secondly, rm entry also aects job creation and job destruction (in equations (1.3) and (1.4)) as ϕ,

the marginal cost of a job, depends on the number of competitors. The fall in the number of rms N drives the relative price ρ downward (equation (1.14)) and raises the mark-up.

The price-setting (equation (1.5)) implies that the real marginal benet of a match ϕ goes down. Hence, the fall in the stock of rms amplies the initial decline in vacancy posting, making expected future prots less. At the same time, it reinforces job destruction as existing matches become less valuable to the rm. Finally, with a reduced stock of rms, the total number of vacancy posting falls, making labor market tightness even lower. Overall, rm dynamics amplies the deterioration in labor market conditions.

Open economy dimension and interaction with rm dynamics. We lay stress, in the previous paragraphs, on the fall of the Home relative price ρ. This eect drives consumer price index down, thereby generating a real exchange rate depreciation (Q rises). This is consistent with the empirical ndings in section 1.2.

In addition, a rise in uncertainty induces households to save more and consume less. In the standard RBC closed economy model, this precautionary savings motive translates into higher investment, which is counterfactual. In our model, the domestic household has several investment opportunities to smooth consumption: jobs, capital, rms or foreign bonds. As pointed out in the previous paragraphs, the value of domestic physical capital, jobs, and rms fall. Households are then enticed to invest in Foreign bonds whose returns i * are not aected by the local uncertainty shock. The rise in uncertainty generates a current account surplus. To further understand the current account dynamics, let us rewrite equation (1.9)

as 1 + ξb * t = β(1 + i * ) E t λ t+1 λ t E t Q t+1 Q t + cov λ t+1 λ t , Q t+1 Q t (1.16)
It is clear from equation (1.16) that the rise in β λ t+1 λt entices households to buy more Foreign bonds. The real exchange rate depreciation (rise in Q driven by relative prices and rm dynamics) amplies this urge to invest in Foreign bonds. The covariance between changes in the discount rate and real exchange rate is also positive. In other words, consumers use foreign bonds to smooth consumption, all the more so as the Home currency depreciates (foreign currency appreciates in real terms). As the foreign bond is denominated in foreign currency, it provides an interesting hedging device against the fall in Home consumption purchasing power if Foreign currency appreciates when Home consumption falls.

In the description of the economic mechanisms we just provided, we lay stress on the link between the magnitude of real exchange rate depreciation and the current account surplus.

As changes in the real exchange rate stem from rm dynamics (through changes in relative price ρ), the model display a strong interaction between the open economy dimension and rm dynamics. 13 Search and matching with endogenous separation. With respect to [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF], our model includes endogenous separation and capital. Figure 1.4 shows that the addition of job separation and capital (SaM only) actually moves the model further away from the data. Indeed, the model predicts an counterfactual increase in investment and job nding rate (row 3. of Table 1.2). Due to real option value, job creation and destruction both decrease. The combined eect lowers unemployment, making it easier to nd jobs.

The increase in employment leads to a rise in investment. Endogenous separation seems to be the key to the counterfactual results. With exogenous separation, lower vacancy would increase unemployment, leading to lower investment. [START_REF] Guglielminetti | The labor market channel of macroeconomic uncertainty[END_REF] uses a search and matching model with exogenous separation and capital. Absent endogenous separation, she nds that the model is able to replicate the contemporaneous drop in output, consumption and investment and the negative impact on the labor market.

Firm entry. To illustrate the link between search frictions and rm dynamics, we add rm dynamics shutting o the open economy dimension (row 4. of Table 1.2). Adding the open economy dimension. In a closed economy, the precautionary savings motive entices households to invest more, which is counterfactual. In an open economy, foreign assets provide an more interesting investment opportunity to build up a buer stock against future shocks, as the return on Foreign assets i * is exogenous (row 5. of Table 1.2). Kollmann (2016) also nds that, following an unexpected rise in output volatility, Home net foreign assets increase, which is consistent with our IRFs. However, in Kollmann (2016)'s 2-country model, under complete nancial markets, the international risk sharing implies that the rise in Home output volatility triggers a wealth transfer from the rest of the world to the Home country, such that Home consumption rises, and the Home real exchange rate appreciates. These features are counterfactual on Korea data. [START_REF] Fogli | Macroeconomic volatility and external imbalances[END_REF] show that, in a standard one-good 2-country RBC model, faced with increased domestic uncertainty, hence increased risk on domestic investment opportunities, agents buy more foreign assets. Our results show that these mechanisms are also at work in our model. However, in [START_REF] Fogli | Macroeconomic volatility and external imbalances[END_REF]'s setting, as well as in Fernandez-Villaverde et al. ( 2011), the precautionary savings motive entices households to work more, which is counterfactual.

Our model correctly predicts a fall in employment.

14 The decline in output is persistent. It is also the case in [START_REF] Fernandez-Villaverde | Risk matters: The real eects of volatility shocks[END_REF][START_REF] Fogli | Macroeconomic volatility and external imbalances[END_REF] and [START_REF] Kollmann | International business cycles and risk sharing with uncertainty shocks and recursive preferences[END_REF] as households gradually build-up a buer stock of Foreign assets. Figure 1.4 suggest that rm dynamics also adds to the persistence of GDP response to increased uncertainty.

Conclusion

Using a VAR model, we show that an increase in uncertainty lowers output, consumption, investment and job nding rates, while raising job separations and unemployment. We also supplement the existing empirical evidence by looking at rm dynamics, real exchange rate and current account behavior. We nd that increased uncertainty generates real exchange rate depreciation, current account surplus and reduces the stock of rms in the economy.

We then investigate the impact of uncertainty shocks in a small open economy with search and matching frictions, endogenous job separation and rm entry to illustrate new transmission mechanism. [START_REF] Basu | Uncertainty shocks in a model of eective demand[END_REF] points out that papers experience diculty in generating business-cycle co-movements among output, consumption, investment, and employment from changes in uncertainty. Our paper succeeds in doing so, in addition to generating data-consistent a fall in the number of rms, current account surplus and real exchange rate depreciation. The key mechanisms are real options channel and precautionary saving motive. The real options channel aects labor adjustment as well as rm entry.

Precautionary saving motive gives rise to capital outow and real exchange rate depreciation.

The interaction of these channels in an open economy setting leads to sizable macroeconomic eects of heightened uncertainty, and helps reproduce data-consistent results. unemployment (U), and never consider transition from and to inactivity (I). To calculate the transition rates, we rst consider the gross ow n

U E t = N U E t N EE t + N EU t
Then, we seasonally adjust the series using X-13-ARIMA-SEATS method, and corrects the time aggregation bias. We then compute quarterly averages of the monthly transition rates, as in [START_REF] Shimer | Reassessing the ins and outs of unemployment[END_REF]. Figure 1.6 displays the job nding (f t ) and separation (s t ) rates in Korea. The correlation of the corresponding steady-state unemployment u = st st+ft with actual unemployment rate is very high (0.96), which tends to validate our method for measuring worker ows.

A.1.3 Contribution of the transition rates to unemployment

We next consider the cyclicality of the job nding and separation rates following Shimer (2012). If the economy were in steady state at some date t, the unemployment rate would be determined by the job nding and separation rates, st st+ft

. In quarterly-averaged data, the correlation between this steady state measure and actual unemployment is 0.96. We use this strong relationship to calculate the contribution of changes in each of the two transition rates to uctuations in unemployment rate.

Let f and s denote the average values of f t and s t during the sample period and compute the hypothetical unemployment rates s s+ft and st st+ f as measures of the contribution of uctuations in the job nding and separation rates to overall uctuation in the unemployment rate. Figure 1.7 shows the contribution of uctuations in the job nding and separation rates to the uctuations in the unemployment rate. This exercise nds that the separation rate contributes much more to accounting for the uctuation in the unemployment in Korea.

In order to quantify this, Shimer (2012) looks at the comovement of detrended data.

Therefore, we use the Hodrick-Prescott lter for detrending with a smoothing parameter of 1600. Over the sample periods, the correlation of the cyclical components of unemployment and s s+ft is 0.209, while the correlation of unemployment and st st+ f is 0.796. It shows that the job separation rate is the main driver of the uctuation in the unemployment rate. These ndings are consistent with [START_REF] Kim | Accounting for ins and outs of unemployment in korea[END_REF] who show that inows into unemployment contributes substantially to unemployment uctuations in Korea.

A.2 A rst look at the data with lower job nding rate, higher separation and increases in current account. The correlation of the uncertainty measure with unemployment outows, inows and current account as % of GDP are respectively -0.52, 0.72 and 0.49. In section 1.2, we go beyond the descriptive statistics using a structural VAR to identify the causal eect of uncertainty on macroeconomic dynamics. This section shows that the impulse response function in Figure 1.2 is robust to alternative identication, volatility measure, and specication. Our assumptions to identify uncertainty shocks imply that uncertainty does not respond to macroeconomic shocks in the impact period. To check the extent to which this assumption may aect our results, uncertainty is placed last in our vector. Uncertainty may reect the forecasters' perceptions of bad economic times rather than an uncertain future. To control for potential eects from changes in consumer sentiment, we estimate a ve-variable VAR that includes a consumer sentiment index as an additional variable. Our uncertainty measure is constructed to take a value 1 for each quarter that uncertainty exceeds the threshold and a 0 otherwise. This indicator function is used to ensure identication comes only from these large, and arguably exogenous, uncertainty shocks rather than the smaller ongoing uctuations. The outcome of all robustness checks are reported in Figure 1.9. In all cases, the responses are comparable to the baseline.

A.4 Macroeconomic data

The data coverage is 1986Q1-2015Q4.

• Output: real gross domestic product, seasonally adjusted, 2010 reference year, Statistics Korea.

• Consumption: private consumption expenditure, seasonally adjusted, 2010 reference year, Statistics Korea.

• Investment: the sum of gross capital formation and changes in inventories, seasonally adjusted, 2010 reference year, Statistics Korea.

• Unemployment rate: ocial unemployment rate, job-search for 4 weeks standard, seasonally adjusted, Statistics Korea.

• Number of rms: the number of corporations in operation as of end of the relevant period, semi-annual frequency from 1995H1 to 2014H2, National Tax Statistics. We use a spline to transform semi-annual data into quarterly data.

• Current account as a % of GDP: seasonally adjusted, OECD Dataset. With respect to labor market variables, the model is able to produce volatile job nding and separations rates. In particular, separation are more volatile than job ndings, which is Finally, the model predicts a negative correlation between unemployment and vacancies.

This is an interesting feature as a positive correlation between unemployment and vacancies is a well-known feature of [START_REF] Mortensen | Job creation and job destruction in the theory of unemployment[END_REF]'s model with endogenous destruction.

Indeed, with the separation margin, rms can quickly adjust the employment level, which is preferred by the rm as hiring is costly and takes time. Following a positive TFP shock, rm can increase employment by keeping more workers, even less productive ones, rather than waiting for new workers to arrive from the matching market. Vacancies can go down, so does unemployment, thereby generating a positive correlation between unemployment and vacancies. With rm entry, unemployment and vacancies can display a negative correlation in spite of endogenous separation. Indeed, as rm entry falls, with the decline in the number of rms actually result in a fall in aggregate vacancies.

Introduction

Over The empirical literature provides mixed evidence on the distributional eects of trade liberalization. On the one side, trade liberalization is deemed to have boosted the demand of skilled workers and hence triggered an increase in the relative wage of skilled to unskilled workers, the so-called skill premium. As a consequence, income inequality has widened (see [START_REF] Epifani | Increasing returns, imperfect competition, and factor prices[END_REF], [START_REF] Matsuyama | Beyond icebergs: Towards a theory of biased globalization[END_REF], [START_REF] Verhoogen | Trade, quality upgrading, and wage inequality in the mexican manufacturing sector*[END_REF], [START_REF] Goldberg | Distributional eects of globalization in developing countries[END_REF] and the literature mentioned herein). On the other side, other studies nd that trade liberalization reduces the skill premium and hence inequality especially in middle and lowincome countries (see [START_REF] Mccaig | Exporting out of poverty: Provincial poverty in vietnam and u.s. market access[END_REF] for Vietnam, [START_REF] Zhang | Globalization and the urban poor in china[END_REF] for China, Amiti & Cameron (2012) for Indonesia, [START_REF] Robertson | Relative prices and wage inequality: evidence from mexico[END_REF] for Mexico, [START_REF] Gonzaga | Trade liberalization and the evolution of skill earnings dierentials in brazil[END_REF] for Brazil, Kumar and Mishra (2008) for India).

To address raising inequality, tax policies can play a major role in redistributing income and making the post-tax income distribution less unequal. Ecient tax systems are important tools in addressing rising inequality and informality and restoring robust economic growth. Indeed, a targeted and well-balanced tax code is an essential element in making further progress in achieving the Sustainable Development Goals by providing a stable funding base for high-quality public services for all and eective transfers targeted to those most in need. However, using tax policies to address income inequality in an open economy faces particular challenges. In achieving a more equitable distribution of income, governments should prefer those tax instruments which, at the same time, reduce the incidence of informality.

The high incidence of informality is an issue of concern especially in developing countries, that already have high informality rates to begin with and are characterized by poor working conditions.

1 On average, more than 50 percent of the labor force in developing countries is informal. In many Latin American countries informal employment exceeds 50 percent of total urban labor force [START_REF] Gasparini | Labor Informality in Latin America and the Caribbean: Patterns and Trends from Household Survey Microdata[END_REF]). Estimates for Sub-Saharan Africa and Asia are even higher [START_REF] Jütting | Informal Employment Re-loaded[END_REF]). Nevertheless, informality is a matter of concern also in advanced economies, although to a lesser extent. During the late 20th century there was a general increase in the informal economy in many countries around the world, including OECD countries (see [START_REF] Schneider | Shadow economies: Size, causes, and consequences[END_REF]). [START_REF] Heintz | Informalization , economic growth and the challenge of creating viable labor standards in developing countries[END_REF], informality. If trade liberalization causes labor informality to increase, this could constitute a potentially large welfare loss from it. In this context, it would be crucial to identify policy strategies which may curb informality and reduce the incidence of low-quality jobs.

for
These structural changes, induced by a growing trade, as well as the need to ght rising inequalities through tax reforms ask for a structural approach. Thus, we develop a twocountry DSGE model with a developed and a developing country (asymmetric equilibrium). We model informality as in [START_REF] Charlot | Informality in developing economies: Regulation and scal policies[END_REF]. Our model closely follows [START_REF] Cacciatore | Trade, Unemployment, and Monetary Policy[END_REF]. However, [START_REF] Cacciatore | Trade, Unemployment, and Monetary Policy[END_REF] focus on developed economies where representative agent can be employed in only one sector, the presence of informality being not considered. In order to fully capture the impact of trade liberalization and tax reform in emerging economies, it seems to be crucial to model the interplay between the formal and informal sector. Therefore, our main contribution is that we embed the informal sector, as we do believe that the analysis of labor market dynamics can not be limited to the sole formal sector, given the high incidence of informality especially in developing and emerging countries. Furthermore, in order to assess whether a scal reform can enable transition to formalization, we add taxation as well as hand-to-mouth agents in the model, which is not embedded in [START_REF] Cacciatore | Trade, Unemployment, and Monetary Policy[END_REF].

Our work is related to the emerging literature analyzing the impact of taxation on informality. Empirical evidence points out that reducing taxation on formal businesses eases the migration of entrepreneurs from the informal to the formal sector, where productivity is higher, with positive eect on output and economic eciency (see [START_REF] Slonimczyk | The eect of taxation on informal employment: evidence from the Russian at tax reform[END_REF] for Russia and [START_REF] Araujo | Taxation, credit constraints and the informal economy[END_REF] for Brazil). Higher tax rates among rm-owners induce not only substantial movements to the informal sector, but also under-reporting of taxable earnings and income shifting to tax-favored business forms, which may ultimately lead to inecient allocation or resources (see [START_REF] Waseem | Taxes, informality and income shifting: Evidence from a recent pakistani tax reform[END_REF] for an analysis of the Pakistani tax reform introduced in 2009). If informality is voluntary, lower taxation rates should reduce rms' incentives to enter the informal sector. However, even if informality is involuntary, lower tax rates could reduce informality by encouraging formal sector rms to expand employment and create more formal jobs. This strand of the literature suggests that the best approach to reduce the size of the informal sector is using taxation to reduce the costs of being formal and create the right incentives for companies and workers intending to switch to the formal sector.

Our analysis highlights a number of interesting results. We show that trade expansion resulting from a permanent fall in export costs raises GDP growth rate in both developed and emerging countries. However, trade expansion and higher levels of economic activity do not necessarily imply higher employment quality and better working conditions. In fact, the adjustment on the labor market is crucial in the evaluation of the eects of trade liberalization. We show that trade liberalization boosts economic activity and employment in both the formal and informal sector. However, this employment expansion is biased toward the informal sector, which is not subject to labor regulation and hence is more exible.

We show that it is possible to correct this bias in favor of the informal sector by reducing payroll taxes paid in the formal sector. An increase of the consumption tax could be a relevant strategy to nance the payroll tax cuts. However, formalization comes at the cost of widening income inequality between formal and informal workers.

The rest of the paper is structured as follows. In Section 2 we describe the model while in Section 3 we discuss the calibration. We analyze the impact of trade liberalization in Section 4. The impact of a budget-neutral tax reform is discussed in Section 5. Finally, Section 6 concludes. Some technical aspects are reported in the Appendix.

Model

We develop a two-country model, calibrated on a developed and an emerging country. The two economies are modeled exactly symmetrically, so that the following description in this Section holds for both economies. Variables appearing with an asterisk refer to the modeled foreign economy.

There For the sake of simplicity, the model does not feature nominal price rigidities and goods are produced using only labor without capital.

Households

There are two types of households in the economy: Ricardian and non-Ricardian. Ricardian households (indexed by a) do not work, hold assets and have access to international nancial markets. Non-Ricardian households supply labor, but have no access to nancial markets.

Non-Ricardian households can work in the formal sector (indexed by F ), work in the informal sector (indexed by I) or being unemployed (indexed by u). For all agents, the consumption basket C t aggregates Home and Foreign consumption in a Dixit-Stiglitz form:

C t = 1 0 C t (i) φ-1 φ di φ φ-1 (2.1)
where φ > 1 is the symmetric elasticity of substitution across goods. The corresponding consumption-based price index, P t , is given by:

P t = 1 0 P t (i) 1-φ di 1 1-φ (2.2)
Ricardian agents smooth their consumption, C at , over time and thus maximize the lifetime utility function E 0 ∞ t=0 β t (Cat) 1-γc

1-γc

, where γ is the risk aversion parameter and β is the discount factor. Utility maximization is subject to the following budget constraint:

A t+1 + S t A * t+1 + P t ψ 2 A t+1 P t 2 + S t P * t ψ 2 A * t+1 P * t 2 + (1 + τ c t )P t C at = (1 + i N t )A t + (1 + i * N t )A * t S t + P t (T A t + T i t + T f t )
Ricardian agents hold domestic assets A t (denominated in domestic currency) on which they receive the nominal interest rate i N t and foreign assets A * t+1 (denominated in foreign currency) on which they receive the interest rate i * N t . Assets are subject to quadratic adjustment costs, measured by the parameter ψ . These costs are paid to nancial intermediaries whose only function is to collect these transaction fees and rebate the revenue to households in lump-sum fashion in equilibrium. Ricardian households pay a consumption tax τ c t on their consumption C a t . S t is the nominal exchange rate. Moreover, T A t is a lump-sum rebate of costs of adjusting asset holdings from the intermediaries to which it is paid and T i t and T f t are a lump-sum rebate of prots from intermediate and nal goods production.

If we denote A t+1

Pt = a t+1 and

A * t+1 P * t = a *
t+1 , we can re-write the budget constraint in real terms:

a t+1 + Q t a * t+1 + ψ 2 (a t+1 ) 2 + Q t ψ 2 a * t+1 2 + (1 + τ c t )C at = (1 + i N t ) 1 + π t a t + (1 + i * N t ) 1 + π * t Q t a * t + T A t + T i t + T f t
where π t is the ination rate and 1 + π t = Pt P t-1

. The term Q t = S t P * t /P t stands for the real exchange rate. If we dene the domestic and foreign gross real interest rates as 1+i t = (1+i N t ) 1+πt

2 We assume that Ricardian households are rms' owners.

3 The denition of this set of lump-sum rebate of costs and prots is the same as in Cacciatore and Ghironi (2015) and hence we refer to their paper for a complete derivation of these variables. The only dierence in our model concerns the lump-sum rebate of prots from intermediate goods, which is dened as:

T i t = P t φ t Z F t l F t -w F t Pt l F t -w It Pt l It -κ F V F t -κ I V It . and 1 + i * t = (1+i * N t ) 1+π * t
, we can re-write the budget constraint as:

a t+1 + Q t a * t+1 + ψ 2 (a t+1 ) 2 + ψ 2 Q t a * t+1 2 + (1 + τ c t )C at = (1 + i t )a t + (1 + i * t )a * t Q t + T A t + T i t + T f t (2.3)
where i t and i * t are respectively the real interest rates on domestic and foreign assets.

The Euler equations for domestic and foreign asset holding are respectively:

(1

+ ψa t+1 ) = (1 + i t+1 )βE t C -γc at+1 C -γc at 1 + τ c t 1 + τ c t+1 (2.4) (1 + ψa * t+1 ) = (1 + i * t+1 )βE t C -γc at+1 C -γc at Q t+1 Q t 1 + τ c t 1 + τ c t+1 (2.5)
On the other hand, non-Ricardian households do not have access to nancial markets and hence they can nance their consumption needs either though labor income (w F t if they supply labor to the formal sector and w It if they supply labor to the informal sector) or through unemployment benets (b t ) if they do not work.

The following equations dene non-Ricardian agents' consumption depending on whether they work in the formal sector, or they work in the informal sector, or they are unemployed:

C F t = (1 -τ w F t ) (1 + τ c t ) w F t l F t (2.6) C It = w It (1 + τ c t ) l It (2.7) C ut = b t (1 + τ c t ) (1 -l t ) (2.8)
The payroll tax on employees, τ w F t , is borne only by non-Ricardian agents employed in the formal sector. Total labor supply, l t , is the sum of labor supplied by non-Ricardian households in the formal and informal sector, i.e. l t = l F t + l It . In equilibrium, aggregate unemployment is given by:

U t = 1 -l F t -l It (2.9)
Total consumption C t is dened as the weighted sum of consumption of Ricardian households (C at ) and non-Ricardian households working in the formal sector (C F t ), in the informal sector (C It ) or unemployed (C ut ):

C t = ωC at + (1 -ω)(C F t + C It + C ut ) (2.10)
where ω is the share of Ricardian households.

Production

There are two vertically integrated production sectors. In the upstream, in both the formal and the informal sector, intermediate goods are produced in perfect competition using only labor. Intermediate goods are then sold to nal good producers. In the downstream, each sector i is populated by a representative monopolistically competitive multi-product rm, which uses intermediate goods as inputs to produce dierentiated varieties. In equilibrium, some of these varieties are exported while others are sold only on the domestic market.

Intermediate goods

We assume a unit mass of intermediate good producers, which operate both in the formal and informal sector. Both sectors are subject to search and matching frictions as in the Diamond-Mortensen-Pissarides framework. Unemployed agents search for a job in both sectors and search eorts are endogenous. Wages are set though an individual bargaining process.

We assume a constant-return-to-scale matching technology in each sector j, for j = F, I, where F and I refer respectively to the formal and the informal sector. The matching technology converts aggregate unemployed workers, U t , and aggregate vacancies, V t , into aggregate matches, M t . The matching rate in each j sector is:

M jt = χ j (e jt U t ) 1-ε V ε jt (2.11)
where U t is the total number of unemployed workers and V t is the number of vacancies. The parameters χ and measure respectively the matching eciency and the matching function elasticity, with χ > 0 and 0 < < 1. Let e jt denote search eorts for the job type j when agents are unemployed.

The job lling rate, q t , is:

q jt = M jt V jt = χ j e jt U t V jt 1- (2.
12)

The job nding rate, ι is:

ι jt = M jt U t = χ j V jt e jt U t e jt (2.13)
As in Krause and Lubik (2007), we assume that newly created matches become productive only in the next period. The law of motion of employment, l jt , is:

l jt = (1 -λ j )l jt-1 + q jt-1 v jt-1 (2.14)
where λ j ∈ (0, 1) is the exogenous separation rate and v jt is the number of vacancies posted by the rm in period t. In equilibrium v jt = V jt . Firms, both in the formal and informal sector, hire labor l t to produce an intermediate good y jt according to the following technology :

y Int jt = Z jt l jt ∀ j = F, I (2.15)
where Z jt is an exogenous technology term which follows an autoregressive process AR(1):

log Z jt = φ Z1 log Z jt-1 + φ Z2 log Z * jt-1 + Z jt .
(2.16)

In both sectors j = F, I, intermediate rms choose the number of vacancies, v jt , and employment, l jt , to maximize the discount value of their prots:

E 0 ∞ t=0 β t u C,t u C,0 ϕ t Z jt l jt -w jt l jt (1 + τ f jt ) -κ j v jt (2.17)
subject to the law of motion for labor: l jt = (1 -λ j )l jt-1 + q jt-1 v jt-1 . where ϕ t is the real price at which intermediate goods producers sell their goods to nal good producers and it is expressed in units of consumption 4 ; w F t is the wage paid to workers in the formal sector (l F t ), while w It is the wage paid to workers in the informal sector (l It ). In both sectors, intermediate good producers incur a cost of κ j units of consumption per vacancy posted v jt . The term τ f jt represents a payroll tax on employers. These taxes are paid only by rms operating in the formal sector. Hence τ f F t > 0, whereas τ f It = 0. The rst order conditions (hereafter, FOCs) on v jt and l jt in the formal and informal sector are respectively:

κ j q jt = E t [β t,t+1 µ jt+1 ]
(2.18)

µ jt = ϕ jt Z jt -w jt (1 + τ f jt ) + E t [β t,t+1 (1 -λ j )µ jt+1 ] (2.19)
where µ jt is the Lagrangian multiplier for labor adjustment and measures the current value of an additional worker. Combining both FOCs leads to the job creation conditions in both sectors:

κ F q F t = E t β t,t+1 (1 -λ F ) κ F q F t+1 + ϕ t+1 Z F t+1 -w F t+1 (1 + τ f F t+1 ) (2.20) κ I q It = E t β t,t+1 (1 -λ I ) κ I q It+1 + ϕ t+1 Z It+1 -w It+1 (2.21) where β t,t+1 ≡ β u C,t+1 u C,t
is the one period ahead stochastic discount factor.

For both the formal and the informal sector, the job creation conditions state that, in equilibrium, the vacancy creation cost incurred by the rm per current match is equal to the expected discounted value of the vacancy creation cost per future match, further discounted by the probability of current match survival 1 -λ, plus the prots from the match at time t. Prots from the match take into account the future marginal revenue product from the match and its wage cost.

Wages Nominal wages are set through an individual Nash bargaining process. In each t period and in both sectors J = F, I, the real value of an existing, productive match for a producer, J t , is the sum of the marginal product of the match (ϕ t Z jt ) and the expected discounted continuation value of the match (E t β t,t+1 (1 -λ j )J jt+1 ), net of the wage bill:

J jt = ϕ t Z jt -w jt (1 + τ f jt ) + E t β t,t+1 (1 -λ j )J jt+1 (2.22)
The worker's value of being matched, in both the formal and informal sector, is given by the sum of real wage received and the expected discounted future value of being matched by the rm:

W jt = (1 -τ w jt ) (1 + τ c t ) w jt + E t {β t,t+1 [(1 -λ j )W jt+1 + λ j U u,t+1 ]} (2.23)
The expected future value of being matched by the rm (the last term on the r.h.s) is a weighted average of probability 1 -λ that the match will survive or the probability λ that the worker will become unemployed.

The value of being unemployed is dened as:

U t = b t (1 + τ c t ) -ϑ e 1+ F t 1 + -ϑ e 1+ It 1 + +E t {β t,t+1 [ι F t W F t+1 +ι It W It+1 +(1-ι F t -ι It )U u,t+1 ]} (2.24)
where ϑ e 1+ jt 1+ is a convex search cost and is the elasticity of disutility of searching. Therefore, the value of being unemployed is the sum of unemployment benets 5 net of search costs and the expected discounted future value of future states, where ι F t and ι It are the probability of becoming employed respectively in the formal or informal sector.

We dene worker's surplus H jt ≡ W jt -U t . The worker surplus in the formal and informal sector is given by:

H F t = (1 -τ w jt ) (1 + τ c t ) w jt - b t (1 + τ c t ) -ϑ e 1+ F t 1 + -ϑ e 1+ It 1 + + (1 -λ F -ι F t -ι It )E t (β t,t+1 H F t+1 ) (2.25) H It = w It (1 + τ c t ) - b t (1 + τ c t ) -ϑ e 1+ F t 1 + -ϑ e 1+ It 1 + + (1 -λ I -ι F t -ι It )E t (β t,t+1 H It+1 ) (2.26)
Nash bargaining maximizes the joint surplus J η jt H 1-η jt with respect to w jt , where H jt and J jt stand for surpluses respectively for workers and rms and the parameter η measures the bargaining power of rms. The FOC implies:

ηH jt ∂J jt ∂w jt + (1 -η)J jt ∂H jt ∂w jt = 0 (2.27)
where ∂J jt

∂w jt = -(1 + τ f jt ) and ∂H jt ∂w jt = 1-τ w jt 1+τ c t .
Hence, the sharing rule can be rewritten in the following form:

(1 + τ f jt )ηH jt = 1 -τ w jt 1 + τ c t (1 -η)J jt (2.28)
The bargained wage satises the following condition, respectively in the formal and informal 5 We assume that the informal sector does not allow the worker to be eligible for the unemployment benets. Given that we have a representative unemployed worker, we set an average unemployment benets,

b t = l F t /(l F t + l It )bW F t ,
where the parameter b is the replacement rate and measures benet generosity by comparing unemployment benets received when not working to wages earned when employed.

sector:

w F t = η 1 -τ w F t b t (1 + τ c t ) -ϑ e 1+ F t 1 + -ϑ e 1+ It 1 + + 1 -η 1 + τ f F t ϕ t Z F t + E t β t,t+1 J F t+1 (1 -λ F ) -(1 -λ F -ι F t ) 1 + τ f F t 1 + τ f F t+1 1 -τ w F t+1 1 -τ w F t (2.29) w It = η b t (1 + τ c t ) -ϑ e 1+ F t 1 + -ϑ e 1+ It 1 + + (1 -η) [ϕ t Z It + ι It E t (β t,t+1 J It+1 )]
(2.30)

Wages are a linear combination determined by the bargaining power parameter η of worker's outside option and the marginal revenue product generated by the worker plus the expected discounted continuation value of the match to the rm. For high values of η, the bargaining power of rms is higher and the portion of the net marginal revenue product and continuation value to the rm appropriated by workers as wage payments is smaller, hence the outside option becomes more relevant.

Optimal search intensities are given by ∂U t /∂e jt = 0, which yields:

ϑe jt = ∂ι jt ∂e jt E t (β t,t+1 H jt+1 ) (2.31) ϑe F t = 1 -η η χ F V F t e F t U t 1 -τ w t+1 (1 + τ f t+1 )(1 + τ c t+1 ) κ F q F t (2.32) ϑe It = 1 -η η χ I V It e It U t 1 1 + τ c t+1 κ I q It (2.33)
This set of equations shows that search eorts are increasing in market tightness (V jt /U jt ) and decreasing in taxes. We dene the tax wedge as T W

F t = 1-τ w t+1 (1+τ f t+1 )(1+τ c t+1 )
in the formal sector and T W It = 1 1+τ c t+1 in the informal sector. Equations above show that the higher the tax wedge, the lower the search eort. However, the tax wedge is not symmetrical between sectors and hence the incentive to search for an informal job are reduced only by an increase in the consumption tax, τ c t , but they are not aected by changes in payroll taxes, τ f t and τ w t .

Final goods

In this subsection variables denoted by the letter d refer to a country's own goods consumed or produced domestically, whereas x refers to quantities and prices of exports. Producer i is a multi-product rm that produces a set of dierentiated product varieties, indexed by ω, y(ω, i), which is dened over a continuum Ω:

Y t (i) = ∞ ω∈Ω y t (ω, i) θ-1 θ dω θ θ-1 (2.34)
where θ > 1 is the symmetric elasticity of substitution across varieties. To save notation, from now on, we omit the index i, since consumption-producing sectors are symmetric in the economy.

We dene P y t , the cost of the product bundle Y t :

P y t = ∞ ω∈Ω p y t (ω) 1-θ dω 1 1-θ (2.35)
where p y t (ω) is the nominal marginal cost of producing variety ω. To create a new variety ω, each retailer needs to create a new plant, facing a sunk investment, f e,t , denominated in units of intermediate input. Each plant produces using dierent technologies indexed by relative productivity z(ω), which is drawn from a common distribution G(z) with support on [z min , ∞). For the sake of simplicity, from now on we omit ω. This relative productivity level remains xed thereafter. Productivity level of foreign plants are drawn from an identical distribution. Each plant uses intermediate inputs to produce its dierentiated product variety, facing the real marginal cost:

ϕ z,t ≡ p y t (z) P T = ϕ t z (2.36)
The number of products created and commercialized by each retailer is endogenous. At each point in time, only a subset of varieties Ω t ⊂ Ω is actually available to consumers. Therefore, at time t, each Home retailer commercializes N d,t varieties and creates N e,t new products that will be available for sale at time t + 1. New and incumbent plants can be hit by a "death" shock with probability δ ∈ (0, 1) at the end of each period. The law of motion for the stock of producing plants is:

N d,t+1 = (1 -δ)(N d,t + N e,t ) (2.37)
where δ is the rm's exit rate. When serving the foreign market, each retailer faces per-unit iceberg trade costs, τ t > 1, as well as xed export costs, f x,t paid for each exported product and denominated in units of intermediate input. We dene total xed costs fx,t = f x,t N x,t , where N x,t denotes the number of product varieties exported abroad. If xed export costs are absent ( fx,t = 0), each producer would nd it optimal to sell all its product varieties both domestically and abroad. Fixed export costs imply that only varieties produced by plants with suciently high productivity (above a cuto level z x,t , determined below) are exportable.

We dene two special average productivity levels (weighted by relative output shares):

an average z d for all producing plants and an average z x,t for all exporting plants:

z d = ∞ z min z θ-1 dG(z) 1 θ-1 z x,t = 1 1 -G(z x,t ) ∞ zx,t z θ-1 dG(z) 1 θ-1 We assume that G(•) is Pareto with shape parameter k p > θ -1. 6 As a result, z d = κ 1 θ-1 z min and z x,t = κ 1 θ-1 z x,t , where κ = k p /[k p -(θ -1)].
The share of exporting plants is given by:

N x,t = [1 -G(z x,t )]N d,t = z min z x,t -kp κ kp θ-1 N d,t
(2.38)

The real costs of producing the bundles Y d,t and Y x,t are respectively:

P y d,t P t = N 1 1-θ d,t ϕ t z d , P y x,t P t = N 1 1-θ x,t ϕ t z x,t (2.39)
The nal producer determines N d,t+1 and the productivity cuto z x,t to minimize the present discount value of costs:

∞ s=t β t,s P y d,s P s Y d,s + τ s P y x,s P s Y x,s + N s+1 1 -δ -N s f e,s ϕ s + N x,s f x,s ϕ s (2.40) 6 Hence, G(x) = z zmin -kp .
subject to (2.38), (2.39), and z x,t = κ 1 θ-1 z x,t .

The FOC with respect to z x,t yields:

τ t P y x,t P t Y x,t N x,t = (θ -1)k p k p -(θ -1) f x,t ϕ t (2.41)
In equilibrium, the marginal revenue from adding a variety with productivity z x,t to the export bundle has to be equal to the xed cost. Thus, varieties produced by plants with productivity below z x,t are distributed only in the domestic market. The composition of the traded bundle is endogenous and the set of exported products uctuates over time with changes in the protability of export.

The FOC with respect to N d,t+1 determines product creation:

ϕ t f e,t = (1 -δ)β t,t+1   ϕ t+1 f e,t+1 -N x,t+1 N d,t+1 f x,t+1 + 1 θ-1 P y d,t+1 P t+1 Y d,t+1 N d,t+1 + τ t+1 P y x,t+1 P t+1 Y x,t+1 N x,t+1 N x,t+1 N d,t+1   (2.42)
In equilibrium, the cost of producing an additional variety, ϕ t f e,t , must be equal to its expected benet, which includes expected savings on future sunk investment costs augmented by the marginal revenue from commercializing the variety, net of xed export costs, if it is exported. Domestic and export prices Let P d,t and P x,t be the price of the product bundle Y d,t and Y x,t . Each nal producer faces the following domestic and foreign demand for its product bundles:

Y d,t = P d,t P t -φ Y C t , Y x,t = P x,t P * t -φ Y C * t (2.43)
where Y C t and Y C * t stand for aggregate demands of the consumption basket in the domestic and foreign country. The elasticity of substitution across sectoral bundles for the aggregate demand, φ > 1, is equal to the elasticity of substitution for the consumption basket, although aggregate demand in each country includes sources other than consumption. This assumption ensures that the consumption price index for the the consumption aggregator is also the price index for aggregate demand of the basket.

We assume producer currency pricing (PCP): nal producers set the price of the product bundle, P d,t , and the the price of the export bundle, P h

x,t , in their own domestic currency, letting the price in the foreign market move with the nominal exchange rate, that is: P x,t = τ P h x,t /S t . Because of xed export costs, the composition of domestic and export bundles is dierent, and hence producers face dierent marginal costs of producing these bundles.

Therefore nal producers set two dierent prices for the Home and Foreign markets. The optimal price for domestic sales and exported sales satises respectively: (2.44), we obtain the average price of a domestic and an exported variety, respectively dened as:

P d
ρd,t = φ φ -1 ϕ t zd , ρx,t = φ φ -1 τ t Q t ϕ t zx,t (2.45)
Finally, the average output of, respectively, a domestic and exported variety are dened as:

ỹd,t = ρ-φ d,t N θ-φ 1-θ d,t Y C t , ỹx,t = ρ-φ x,t N θ-φ 1-θ x,t Y C * t (2.46)

Government

In each period, we assume that government spending and unemployment benets are funded by taxation on consumption and wage income:

G t = τ c t ωC a t + (1 -ω)(C F t + C I t + C u t ) + (τ w t + τ f t )w F t l F t -b t U t (2.47)

Closing conditions

Aggregate demand is the sum of private and public consumption and is dened as:

Y C t = ωC at + (1 -ω)(C F t + C Z It + C ut ) + κ F V F t + κ I V It + G t (2.48)
We assume that he cost of opening new vacancies are socially shared.

Assets are in zero net supply, which implies the equilibrium condition:

a t+1 + a * t+1 = 0 (2.49)
Net foreign assets are determined by:

(a t+1 -a t ) + Q t (a * t+1 -a * t ) = i t a t + Q t i * t a * t + Q t N x,t ρx,t ỹx,t -N * x,t ρ * x,t ỹ * x,t (2.50)
where the last term in brackets represents the trade balance:

T B t = Q t N x,t ρx,t ỹx,t - N * x,t ρ * x,t ỹ *
x,t .

Calibration

We calibrate the model using quarterly data from the U.S. and Brazilian economy. We believe that Brazil is an illustrative example of an emerging countries which, starting form high level of informality in the late 1990s, has adopted a set of policy initiative to facilitate the move to formality. A rst program, called SIMPLES, was launched in 1996 and was followed by a second one, the SUPERSIMPLES program, in 2006. Since, in Brazil there is a strong correlation between size of company and prevalence of informality, these programs aimed at reducing the costs of formalization through a reduction of tax rates and tax regulations for Brazilian micro rms with no more than ve paid employees. Since the SUPERSIMPLES came into force in July 2007, some 9 million businesses have joined this system of taxation.

7

In this section we discuss the calibration strategy. Broadly speaking, we choose some parameter values from the literature, while other parameters are set so to match macroeconomic series observed for the United States and Brazil. We assume that the two countries are asymmetric, hence some parameters describing labor and goods markets may dier across countries. Table 2.1 summarizes the asymmetric calibration.

We set the discount factor β to 0.99, implying that the annual real interest rate is 4 percent. The value of the risk aversion parameter, γ c , is equal to 2. Following [START_REF] Bernard | Plants and productivity in international trade[END_REF], we set the elasticity of substitution across product varieties, θ, equal to 3.8. Following [START_REF] Ghironi | International trade and macroeconomic dynamics with heterogeneous rms[END_REF], we set the elasticity of substitution across Home and Foreign goods, φ, equal to θ, and the dispersion of rm productivity k p equal to 3.4. We normalize z min to 1. We set iceberg trade costs τ equal to 1.7, following the estimates of trade costs reported by [START_REF] Anderson | Gravity with gravitas: A solution to the border puzzle[END_REF]. We calibrate the xed export costs f x so that the shares of exporting plants in the developed and emerging country are respectively equal to 21 percent and 18 percent, consistently with data reported in Bernard 7 See ILO (2015) for a discussion and an evaluation of some programs launched in emerging countries to move to formalization. et al. (2003) for the United States and in the World Bank Enterprise Survey for Brazil. 8 To ensure steady-state determinacy stationarity of net foreign assets, we set the parameter ψ measuring asset adjustment costs equal to 0.0025 as in [START_REF] Ghironi | International trade and macroeconomic dynamics with heterogeneous rms[END_REF]. Following [START_REF] Ebell | Product market deregulation and the us employment miracle[END_REF], we set entry costs, f e , so that regulation costs amount to 5.2 months of per capita output. To pin down the rm exit rate δ, we target the portion of worker separation due to rm exit equal to 30 percent in the United States and to 37 percent in Brazil: these values fall within the range of estimates reported by [START_REF] Haltiwanger | Assessing job ows across conntries: The role of industry, rm size and regulations[END_REF].

Empirical evidence indicates that informal rms are less productive than formal ones.

Regarding the parameters specic to the search and matching framework, the gross replacement rate for unemployment benets b in the formal sector is set to 13 percent for the United States and 15.2 percent for Brazil. The parameter measuring rms' bargaining power, η, is equal to 0.4, as estimated by [START_REF] Flinn | Minimum wage eects on labor market outcomes under search, matching, and endogenous contact rates[END_REF]. The elasticity of the matching function ε is equal to 0.4, so that it falls within the range of estimates reported by [START_REF] Petrongolo | The ins and outs of european unemployment[END_REF] and the Hosios condition holds. We set the costs of vacancy posting (κ F and κ I ), matching eciency (χ F and χ I ) and exogenous separation rate (λ F and λ I ) in the formal and informal sectors so to match the underlying structure of the two countries, with the values of steady-state ratios summarized in Table 2.1. We choose a calibration based on the long-run averages (1992-2017) from ILO data. Steady-state unemployment rates are respectively 6 percent and 8.7 percent in the United States and Brazil, while the ratio of informal employment to total employment is respectively 7 percent and 30 percent in the United States and Brazil. 9 This calibration yields an informal wage gap (i.e. dierence be- tween wages for formal and informal workers) equal to 66 percent in the United States and 11 percent in Brazil. This latter value is very close to estimates in [START_REF] Bargain | The informal sector wage gap: New evidence using quantile estimations on panel data[END_REF] and [START_REF] Bargain | Is Informality Bad? Evidence from Brazil, Mexico and South Africa[END_REF] who conclude that earning dierentials driven by the informal wage penalties are quite modest in Brazil and remain below 10 percent all along the distribution. Labor market regulations and high employer costs attached to formal employment in Brazil may simultaneously explain the large extent of informal work and the relatively modest informal wage gap. Firms tend to recoup high employers' payroll taxes paid to hire formal workers, which could partly explain low informal wage gaps. In Brazil informal wage penalties may only partly be related to the rm size eect, since many informal workers are to be found in large formal rms. 8 As a caveat, we point out that the World Bank Enterprise Survey covers only rms of the formal private sector with ve or more employees. Hence informal and micro rms are excluded from the sample. 9 We use vulnerable employment as a proxy for informal employment.

Finally, we set the initial value of tax rates at their respective steady-state levels. The United States employs a retail sales tax rather than a value added tax (VAT) as the principal consumption tax. The retail sales tax in the United States is not a federal, but it is a tax imposed at the state and local government levels. The total tax rate ranges between 0 percent (e.g. in Delaware, Oregon, New Hampshire, Montana) and 13.5 percent (in Alabama). We decide to set τ c for the United States at the average rate, 7.8 percent. Brazil operates a multiple rate system with ICMS (Imposto de Circulação de Mercadorias e Serviços) tax levied at a state level. The standard state rate of ICMS is 17 percent (18 percent in São Paulo, Minas Gerais and Paraná and 19 percent in Rio de Janeiro). Therefore, for Brazil we set τ c equal to 17 percent. The personal income tax rate ranges between 0 percent and 37 percent in the United States and between 0 percent and 27.5 percent in Brazil. We choose the average value of the personal income tax rate and we set τ w equal to 18 percent for the USA and 14 percent for Brazil. In the United States, the social security tax rate in 12.4 percent (6.2 percent on employees and 6.2 percent on employers). On top, there is a tax of 2.9 percent (half imposed on employer and half withheld from the employee's pay) of all wages for Medicare. In Brazil, the employer's contribution is determined at the rate of approximately 20 percent of salary to be paid to the National Institute of Social Security (Instituto Nacional do Seguro Nacional, INSS). On top, the FGTS is the Fundo de Garantia por Tempo de Serviço which is the Employee Indemnity Guarantee Fund and an employee compulsory fund. All Companies are obligated to deposit the FGTS contribution into their employers account. The tax corresponds to an 8 percent rate on top of the gross salary.

Since in our model we consider only the share of payroll taxes paid by employers, we set the steady-state payroll tax rate, τ f equal to 7.65 percent for the US and 28 percent for Brazil.

The impact of trade liberalization

We use the model to analyze the impact of trade liberalization on employment in both developed and emerging countries. World trade liberalization is captured by a reduction in xed export costs in both countries.

Trade liberalization is modeled in the following way: in a rst phase, the "Home" country, which is the developed country, cuts its per-unit iceberg trade costs (τ t ). This process starts at the beginning of the simulation period and ends 70 quarters later (17.5 years). The cut in iceberg trade costs gives a competitive advantage to the developed country. In a second phase, which starts 5 years later (i.e. 20 quarters), the emerging country experiments the same decline in its own iceberg costs. Hence, 22.5 years after the initial reduction of trade costs observed in the developed country, iceberg costs in the developing country will have converged to those observed in the developed country. At this third phase, the two countries benet from the same reduction in trade costs and trade liberalization becomes symmetrical.

For the sake of clarity, we rst analyze the dynamics in the developed country and then in the emerging country. We discuss the dynamics both in the short term, i.e. before than the emerging country benets from trade liberalization, and in the medium to long term, i.e.

when both countries can take advantage for the trade cost reductions.

The short-run adjustment on the goods markets. In the rst phase of trade liberalization, i.e. when the developed country cuts its trade costs but the emerging country still does not benet from new technologies allowing it to reduce its trade costs, lower trade costs allow exporters to have higher prots in the developed country. Trade translates into increased protable opportunities for exporting rms, which induces more rms to enter the export market. These rms face lower costs and hence increase their labor demand, which ultimately leads to higher real wage. This, in turn, brings down the prots of the least productive rms such that the rm entries are reduced. Notice that these low productive rms produce only for the domestic market. Hence as it is shown in the Figure 2.1, the number of rms in the developed country declines, but at the same time, the number of exporters in this country increase (the export-cuto decreases). Indeed, a higher proportion of exporting rms in the developed country leads to higher average quality of goods.

In the developed country, at each period, domestic market prices (ρ d,t in the model notation and "Price in H -H" in the gures) and export prices (ρ x,t in the model notation 66 The blue lines display the dynamics with only trade liberalization, and the red lines display the dynamics when the tax reform is implemented.

and "Price in F -H" in the gures) are given by the following equations:

ρ d,t = φ φ -1 ϕ t z d ρ x,t = τ t Q t φ φ -1 ϕ t z x,t
Hence, the increase in input prices, ϕ t , generated by the expansion in nal good producers' demand explains the rise in domestic market prices ρ d,t . On the other hand, export prices ρ x,t drops as trade liberalization, through the decline in trade costs τ t , compensates the increase in input prices as well as the decline in productivity ( z x,t ) of export rms. Finally, lower iceberg costs in the developed country leads to a decline in the real exchange rate (Q t ) underlining the gains in competitiveness of this country.

In the short run, the emerging economy does not observe a decline of trade costs. Instead, higher home prices in the developed country, combined with the decrease in the real exchange rate, lead consumers in the developed country to redirect their demand toward their trade partner. This increase in demand addressed to emerging economy motivates more exporting rms in this area. This, in turn, leads to a rise in input demand, and thus to a rise in the production costs (see Figure 2.1). As a consequence, input demand and production costs increase, which ultimately reduce the number of new rms entries: the number of rms (N f = "Domestic producers -F") declines in the emerging country (see Figure 2.1). Indeed, in the emerging country, at each period, the price of domestic goods (ρ * d,t and "Price in H -F" in the gures) and the price of exported goods (ρ * x,t and "Price in F -F" in the gures) are modeled as in the developed economy, in a symmetric way:

ρ * d,t = φ φ -1 ϕ * t z * d ρ * x,t = τ t Q t φ φ -1 ϕ * t z * x,t
It is clear that the rise of input price causes the rise in the domestic price (ρ * d ). The increase of the input price (ϕ * ) as well as the decline of productivity of exporters ( z *

x ) raises the export price, even though the real exchange rate (Q) declines.

The short-run adjustment on the labor markets. In the developed contry, higher input prices for nal producers translate into higher marginal revenues for the intermediate good producers, and ultimately into higher wages. Figure 2.2 shows that labor demand increase in both the formal and the informal sector, driven by the increase in the price of intermediate goods sold to nal producers. A part of this increase in the job surplus is redistributed to workers via wage increases. Figure 2.2 shows that wages increase in both the formal and the informal sector. Given that these wage increases are driven by the rise in the price of intermediate goods in both sectors (more demand must be satised by the nal goods producers, leading to an increase of intermediate goods demands), they are similar across the formal and the informal sector and thus wage inequalities remain stable.

Although employment increases in both sectors, in the informal sector the increase is relatively larger, due to lower labor costs, which ensures that more job vacancies are opened in the informal sector. Indeed, expanded job creation in the informal sector encourages unemployed agents to search for a job more intensively in this sector, thus reinforcing the sector's advantage in the hiring process (see Figure 2.3). On the one side, at the beginning of the process trade liberalization induces higher informality in the developed country. On the other side it also induces a reduction in unemployment (see Figure 2.3). Tightness on labor market increases in the emerging country, although for reasons dierent from those observed in the developed country, and consequently employment and wage rise. As in the developed country, lower labor costs in the informal sector favor this sector during the expansion (see Figure 2.2). Moreover, unemployment declines, while the share of informality goes up (see Figure 2.3). Note that the rise in informality is of small amplitude in the emerging economy. This is due to the initial share of informal employment. As the emerging economy has a larger share of informality, it causes a more negative congestion eect: the job lling rate falls more rapidly with vacancy postings. Hence, this curbs job openings in the informal sector.

The medium to long-run adjustments on the goods markets. In the medium run, trade liberalization also aects the emerging country, where iceberg costs also decline, although with a delay. Hence, higher rms' prots worldwide boost income and labor demand leading to higher wages. The increase in labor costs leads both economies to be more selective: the number of rms declines, but the share of exporting rms, which are more productive, increases (see Figure 2.1). The larger participation of the emerging country to the world trade stabilizes export prices in the developed country: the real exchange rate is more stable and the bias cost in favor of the developed country slows down (see Figure 2.1).

In the emerging economy, in the medium run, trade liberalization ultimately induces An easy way to promote formal employment is to reduce the payroll tax paid by rms.

Nevertheless, the cost of this policy is a reduction of government budget, and thus a cut in public expenditures on social security. An alternative solution might be implementing a budget-neutral tax reform, consisting in increasing the consumption tax to fund the cut in payroll taxes. An advantage of this strategy is that the consumption tax has a larger base, it is easier to collect and more dicult to evade. This policy mix, called "social VAT", has been implemented in many European countries in the recent years, for instance in Denmark in 1988, in Sweden in 1993, in Germany in 2006and in France in 2012. In the rest of the paper, the tax reform is implemented in both countries at the beginning of their respective trade liberalization process. The tax reform is country-specic. We calibrate the tax reform as follows: (i) the reform is budget-neutral and (ii) the initial and the nal levels of informality in both countries are the same. Given these constraints, the payroll tax is reduced from 8.0 percent to 5.8 percent with an increase in the consumption tax from 8 percent to 9.8 percent in the developed countries, whereas in the emerging country, the payroll tax is reduced from 28.0 percent to 24.0 percent with an increase in the consumption tax from 17.0 percent to 18.8 percent.

The impact on nal goods sector. Figure 2.1 depicts the eects of trade liberalization in the nal good sector when the government implements a budget-neutral tax reform. This scenario is represented by the red solid lines. Taxation has no direct impact on the behavior of nal goods producers. The comparison with the pre-reform scenario (represented by the blue dotted lines in Figure 2.1) points out that the dynamics of variables in the nal good sector remain unchanged because the main driver of both short-run and long-run changes in productivity and prices is trade liberalization. The tax reform only aects the distribution of jobs, across the formal and informal sector leaving the aggregate demand of intermediate goods unchanged. the following equations:

w F t = η 1 -τ w F 0 b (1 + τ c 1 ) -ϑ e 1+ F t 1 + -ϑ e 1+ It 1 + + 1 -η 1 + τ f F 1 ϕ t Z F t + κ F ι F q F t w It = η b (1 + τ c 1 ) -ϑ e 1+ F t 1 + -ϑ e 1+ It 1 + + (1 -η) ϕ t Z It + κ I ι It q It
where τ w F 0 is the tax paid by employees before the reform (indexed by 0). This tax rate remains unchanged, while the payroll tax paid by employers and the consumption tax jump instantaneously to their new post-reform values (respectively τ f F 1 and τ c 1 ):

As observed for the baseline simulation without the tax reform (Figure 2.2, blue dotted lines), wages increase in both sectors. However, when the tax reform is implemented, the increase in wages is more remarkable in the formal sector than in informal sector (Figure 2.2).

As a consequence, the wage gap between formal and informal workers is getting wider. Figure 2.4 shows that, before the tax reform, wages in the formal sector was 66.0 percent larger than in informal sector in the advanced economy and 11.0 percent in the emerging country (see blues dotted lines). After the reform, this gap rises to 69.0 percent in the advanced economy and to 14.5 percent in the emerging country (see solid red lines). Widening wage gaps across the two sectors stem from the reduction of tax wedges, leading to a larger job surplus and thus higher wages. The tax reform also changes the sharing rule between rms and workers, at the advantage of the workers. The underlying mechanism is due to two channels: on the one hand, the drop in the tax paid by employers increases the share of productivity paid to employees in the formal sector. On the other hand, the increase in the consumption tax reduces the disposable wage. However, this moderation is proportional to the weight of the unemployment benets in the wage: as it is weak for workers in the formal sector, this wage moderation induced by the increase of the consumption tax is of small amplitude for the formal sector. The rst channel clearly dominates and leads to wage increases in the formal sector after the tax reform.

Given that the search eort is endogenous, the tax reform also changes the reservation wage of the workers. Indeed, the cut in payroll taxes stimulates rms to open new vacancies, which increase the chance for unemployed workers to nd a job in the formal sector. The optimistic job prospects in the formal sector encourage the unemployed to focus their search eorts more on this sector. Search eorts increase in the formal sector and decline in the informal sector (see Figure 2.3, red solid lines). Hence, the tax reform ultimately redirects the labor force toward formal employment.

11 Figure 2.3 shows that the tax reform reduces the search eort relatively to the benchmark scenario (i.e. trade liberalization without the tax reform, represented by the blue dotted lines), explaining the increase in the reservation wage, and thus the rise in the wages.

Figure 2.3 shows that, following the tax reform, unemployment increases on impact and in the short-run. The underlying reason is that benets from trade liberalization are gradual, while the tax reform is immediate: given the lack of attractiveness of the informal sector, search eorts devoted to nd a job in the informal sector before the implementation of the tax reform now decrease, leading to an increase of unemployment in the short run (see Figure 2.3, red solid lines). At the beginning of the trade liberalization process, the marginal value of intermediate goods and workers' productivity, although higher, are not large enough to absorb the excess of unemployed workers who stop searching for an informal job. This explains why unemployment increases on impact and in the short-term especially in the emerging country, where the incidence of informality is higher than in the advanced economy.

Inequalities and welfare. He suggests that the reform would increase total employment by between 0.3 to 0.5 percent and formal employment by between 3.4 to 3.7 percent over the pre-reform scenario. In Brazil, tax cuts for small rms introduced by the reforms in 1996 and 2006 have led more than 9 millions of businesses into the formal sector. Note: H and F indicate respectively the Home country (i.e. the developed country) and the Foreign country (i.e. the emerging country). Wage inequality is dened by w F t /w It -1. Welfare is dened as consumption (purchasing power). For example, in the formal sector, it is (1

-τ w t )/(1 + τ c t ) * w F t .
reform). This comes as no surprise, since the reduction in the welfare of workers employed in the informal sector is the corollary to the decline of informal employment share: only reduction in the welfare of this workers type allows labor market to reallocate toward the formal sector. The most important point is certainly the fact that the tax reform allows the welfare of the unemployed workers to increase, despite the large initial loses induced by the jump in the consumption tax (see Figure 2.4). These welfare gains for the unemployed workers are larger in the emerging country because more unemployed workers are eligible for the unemployment benets following the tax reform.

Conclusion

In this paper, we show that trade liberalization boosts economic activity in both developed and emerging countries. However, we nd that trade liberalization is associated to higher informality, which ultimately implies less job security and lower employment quality.

Policy makers should consider placing a high priority on promoting job quality and income equality. Policy interventions to curb informality should follow a comprehensive approach that rests on three pillars: increasing the benets of formality, decreasing the costs of formalization and improving enforcement methods. In this respect, we investigate whether taxations may smooth the way for formalization of jobs. To this purpose, we extend the [START_REF] Melitz | The impact of trade on intra-industry reallocations and aggregate industry productivity[END_REF] model and develop a two-country DSGE model, featuring a developed and emerging (or developing) country as in [START_REF] Cacciatore | Trade, Unemployment, and Monetary Policy[END_REF]. In addition, we embed the tax system and the informal labor sector in the model with the aim to analyze whether taxation may correct the bias toward informality introduced by trade liberalization. We argue that a scal reform can mitigate these adverse eects of trade on labor market. A Social VAT, switching the tax burden from payroll taxes paid by rms in the formal sector to the consumption tax, can increase the incentives to operate in the formal sector. However, this comes at the cost of widening income disparities.

Of course, we acknowledge that a tax reform alone is not sucient to reduce the incidence of low-quality jobs. Tax policy interventions should go hand in hand with more eective social protection systems and labor laws. Extending unemployment benets to all workers in the formal sector including those working part-time and/or on temporary contracts, could prevent unemployed from looking for an informal job. Another step to enhance the quality of existing jobs is intensifying labor inspections in those sector where the incidence of informal work is higher.

• The equilibrium price index

1 = ρ1-θ d,t N 1-φ 1-θ d,t + ρ * 1-θ x,t N * 1-φ 1-θ x,t • Average export productivity ρ-θ x,t N θ-φ 1-θ x,t Y C * t = θ -1 k p -(θ -1) zx,t τ t f x,t • Labor market clearing Z F l F t + Z I l It = N d,t ỹd,t zd + N x,t ỹx,t zx,t τ t + N e,t f e,t + N x,t f x,t
• Law of motion of employment

l jt = (1 -λ j )l jt-1 + q jt-1 V jt-1 • New variety (product) creation 1 = (1 -δ)βE t   C -γc t+1 C -γc t 1 + τ c t 1 + τ c t+1 ρd,t+1 ρd,t   f e,t+1 fe,t -N x,t+1 N d,t+1 f x,t+1 fe,t + 1 (θ-1)fe,t ỹd,t+1 zd + N x,t+1 N d,t+1 τ t+1 zx,t+1 ỹx,t+1     • Job creation 1 = βE t C -γc t+1 C -γc t 1 + τ c t 1 + τ c t+1 (1 -λ j ) q jt q jt+1 + q jt κ j ϕ t+1 Z jt+1 -w jt+1 (1 + τ f jt+1 ) • Wage determination w F t = η 1 -τ w F t b (1 + τ c t ) -ϑ e 1+ F t 1 + -ϑ e 1+ It 1 + + 1 -η 1 + τ f F t ϕ t Z F t + + κ F q F t (1 -λ F ) -(1 -λ F -ι F t ) 1 + τ f F t 1 + τ f F t+1 1 -τ w F t+1 1 -τ w F t w It = η b (1 + τ c t ) -ϑ e 1+ F t 1 + -ϑ e 1+ It 1 + + (1 -η) ϕ t Z It + κ I ι It q It • Search intensity ϑe F t = 1 -η η χ F V F t e F t U t 1 -τ w t+1 (1 + τ f t+1 )(1 + τ c t+1 ) κ F q F t ϑe It = 1 -η η χ I V It e It U t 1 1 + τ c t+1 κ I q It • Euler equation for domestic bond holding (1 + ψa t+1 ) = (1 + i t+1 )βE t C -γc at+1 C -γc at 1 + τ c t 1 + τ c t+1
• Euler equation for foreign bond holding

(1 + ψa * t+1 ) = (1 + i * t+1 )βE t C -γc at+1 C -γc at Q t+1 Q t 1 + τ c t 1 + τ c t+1 • Bond market clearing a t+1 + a * t+1 = 0 • Net foreign assets (a t+1 -a t ) + Q t (a * t+1 -a * t ) = i t a t + Q t i * t a * t + Q t N x,t ρx,t ỹx,t -N * x,t ρ * x,t ỹ * x,t
• Law of motion for the stock of producing plants

N d,t+1 = (1 -δ)(N d,t + N e,t )
• Share of exporting plants

N x,t = z min zx,t kp α kp θ-1 N d,t • Export productivity cuto zx,t = α 1 θ-1 z x,t
• Average price of a domestic variety

ρd,t = φ φ -1 ϕ t zd • Average price of an exported variety ρx,t = φ φ -1 τ t Q t ϕ t zx,t • Average output of a domestic variety ỹd,t = ρ-φ d,t N θ-φ 1-θ d,t Y C t • Average output of an exported variety ỹx,t = ρ-φ x,t N θ-φ 1-θ x,t Y C * t • Aggregate demand Y C t = ωC at + (1 -ω)(C F t + C Z It + C ut ) + κ F V F t + κ I V It + G t • Formal workers' consumption C F t = w F t l F t 1 -τ w t 1 + τ c t • Unemployed agents' consumption C ut = b t (1 -l t ) 1 + τ c t • Informal workers' consumption C It = w It l It 1 + τ c t • Total consumption C t = ωC at + (1 -ω)(C F t + C It + C ut ) • Unemployment U t = 1 -l F t -l It • Job lling rate q jt = χ j e jt U t V jt 1-ε • Job nding rate ι jt = χ j V jt e jt U t ε e jt • Productivity shock log Z jt = φ Z1 log Z jt-1 + φ Z2 log Z * jt-1 + Z jt • Government spending G t = τ c t [ωC at + (1 -ω)(C F t + C It + C ut )] + (τ w t + τ f t ) w F t l F t -b t U t
B Initial and nal steady states

Introduction

Since the work by [START_REF] Bloom | The impact of uncertainty shocks[END_REF], uncertainty about the future course of the economy has been identied as a possible driving force behind business cycle uctuations. A number of recent papers have shown that an increase in uncertainty leads to a drop in economic activity: output, investment, consumption, and employment.

1 However, most of the analysis studies the impact of uncertainty shocks in single-country analysis and cross-country evidence focusing on the labor market is still scarce.

2

This paper investigates heterogeneity on the eects of uncertainty shocks to labor markets across 30 OECD countries. Using country-specic VARs, I nd that a sudden rise in uncertainty lowers output and increases unemployment. More importantly, however, there is substantial cross-country heterogeneity on the eects of uncertainty shocks. Why do some countries suer severe rises in unemployment following an uncertainty shock? What can account for the cross-country dierences in responses? There are a number of candidate channels that are available to account for the heterogeneity in responses: labor market institutions (LMIs), nancial frictions, regulatory framework, etc. In particular, this paper focuses on the role of LMIs and explores how it can aect the responses of labor market to an uncertainty shock.

The labor market is a central institution in any modern economy, and it is characterized by pervasive regulation. Across nations, the labor market is subject to minimum wages, hiring and ring restrictions, compulsory collective bargaining and arbitrage, limitations on the number of hours, etc. Moreover, these LMIs vary across countries. Exploring the cross-sectional dimension by comparing dierences across country groups, I provide evidence that heterogeneity in reactions of unemployment can be related to dierential employment protection legislation (EPL), among others. The impact of an uncertainty shock visibly diers between the two subgroups (low EPL vs. high EPL). Following an uncertainty shock, countries with low EPL suer higher rise in unemployment, take longer to recover to their pre-shock trend, and do not display a subsequent over-adjustment. On the other hand, high EPL countries present the modest and short-lived increase in unemployment, which is subsequently compensated for.

The economic mechanism I study is the following. When uncertainty hits the economy, the drops in real activity reduces labor demand. Firms should adjust their workforce by 1 Related contributions include [START_REF] Alexopoulos | Uncertain Times, Uncertain Measures[END_REF][START_REF] Bachmann | Uncertainty and economic activity: evidence from business survey data[END_REF][START_REF] Caggiano | Uncertainty shocks and unemployment dynamics in u.s. recessions[END_REF], [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF], [START_REF] Riegler | The Impact of Uncertainty Shocks on the Job-Finding Rate and Separation Rate[END_REF], [START_REF] Guglielminetti | The labor market channel of macroeconomic uncertainty[END_REF] and [START_REF] Oh | Frim entry, search and matching in a small open economy faced with uncertainty shocks: The case of korea[END_REF].

2 Carriére-Swallow & Cépedes (2013), [START_REF] Gourio | International risk cycles[END_REF][START_REF] Bhattarai | Global Spillover Eects of US Uncertainty[END_REF] hiring less and laying o more. In theory, when ring costs are higher, rms nd it easier and cheaper to absorb shocks by keeping workers. This mechanism is in line with the rst moment shock. However, the second moment shock reinforces this mechanism through the real options channel. In periods of high uncertainty, ring costs which have larger xed component come with a bigger cost, as it would be costly to hire new workers when productivity reverts quickly. Under irreversibility and uncertanty, rms become more cautious to lay workers o and separation margin is more important on business cycle uctuations.

Hence, EPL, which is closely related to xed costs of ring, might be a key parameter to explaining the heterogenous responses in unemployment rate. High EPL (thereby incurring high non-convex ring cost) increases the option value of waiting more, reduces separations, and mitigates the rise in unemployment. This paper is related to a number of recent studies that examine the impact of uncertainty shocks from a cross-country perspective. [START_REF] Bachmann | Uncertainty and economic activity: evidence from business survey data[END_REF] nd that surprise increase in uncertainty have more persistent negative eects on economic activity in the US than in Germany. In particular, Germany features "wait and see" dynamics, whereas the evidence for "wait and see" eects in the US is mixed. They argue that "wait and see' dynamics might be an important driving force in Germany because of frictions to adjusting labor. [START_REF] Gourio | International risk cycles[END_REF] show that a group of G7 countries presents a similar negative eect on unemployment, and there is some heterogeneity. However, they do not document what can cause heterogeneity. Carriére-Swallow & Cépedes (2013), which constitute key motivation for this paper, nd substantial heterogeneity in reactions of investment and consumption to uncertainty shocks across 40 countries. In comparison to developed countries, emerging market economies suer much more severe falls in investment and private consumption, and take longer to recover. They point to the importance of nancial frictions channel. Using fteen emerging market economies data, [START_REF] Bhattarai | Global Spillover Eects of US Uncertainty[END_REF] show that an unanticipated rise in US stock market uncertainty has negative eects on their stock prices and exchange rate, and leads to capital outows. Moreover, they nd clear heterogeneity between South American countries and the rest of emerging market economies. This heterogeneity can be related to dierential monetary policy reaction by these two groups of countries. However, little is known about the dierential impact of uncertainty shocks on unemployment. Our originality lies in investigating cross-country heterogeneity in terms of labor market responses. This work also contributes to a recent body of literature that investigates the role of LMIs for business cycle uctuations. Much of the existing analysis of LMIs have focused on the impact on the underlying structural features of the economy 3 , but only a few papers have studied their impact on business cycle uctuations. In theory, stricter EPL reduces unemployment volatility as suggested by the search and matching models of [START_REF] Thomas | Labor market reform and price stability: An application to the euro area[END_REF] and [START_REF] Zanetti | Labor market institutions and aggregate uctuations in a search and matching model[END_REF]. On the other hand, little consensus emerges from empirical studies. Some studies nd no eect on output volatility [START_REF] Rumler | Labor Market Institutions And Macroeconomic Volatility In A Panel Of Oecd Countries[END_REF]), while others nd a negative eect on unemployment or output volatility [START_REF] Merkl | Macroeconomic volatilities and the labor market: First results from the euro experiment[END_REF]) or an inverted U-shaped eect on the relative unemployment to output volatility [START_REF] Lochner | Employment protection in dual labor markets: Any amplication of macroeconomic shocks?[END_REF]).

The available evidence is also inconclusive in the case of unemployment benet or unions.

However, none has considered uncertainty shocks for the impact of LMIs on business cycle dynamics. This paper lls this gap.

The rest of the paper is organized as follows: Section 2 explains the data and the empirical strategy. Section 3 presents the main results and economic mechanisms. Section 4 conducts a number of robustness checks. Section 5 concludes.

Data and Empirical methodology

In this section, I explain the data for empirical analysis as well as the methodology I adopt.

Data

The economic literature oers various methods for proxying the unobservable level of uncertainty: nancial market indicators, news-based measure, survey-based measure, and forecast errors. There is no single general indicator of uncertainty, as such indicator has its advantages and pitfalls. The availability of indicators at country level represents an important constraints in the OECD context. Therefore, our baseline measure of uncertainty is stock market volatility, which is one of the most widely used measures in the literature (See Bloom (2014)). Implied volatility derived from equity options, however, are not available for many countries or over the long samples. I thus resort to realized volatility. Fortunately though, implied and realized equity volatilities are highly correlated 4 .

On the other hand, in measuring uncertainty for a panel of countries, it is debatable whether the relevant measure is a local indicator, or a common global measure. [START_REF] Gourio | International risk cycles[END_REF] show that country-level risk measures constructed using local realized equity 3 See the survey by [START_REF] Mortensen | Job Reallocation, Employment Fluctuations and Unemployment, chapter 18[END_REF] 4 For US, they are correlated at 0.874 (1996)(1997)(1998)(1999)(2000)(2001)(2002)(2003)(2004)(2005)(2006)(2007)(2008)(2009)(2010)(2011)(2012)(2013)(2014)(2015) volatilities contain a large common component across OECD countries: the rst principle component accounts for more than 40% of total variance in a large set of 27 OECD countries Unemployment rate and GDP data come from the OECD. Appendix 3.5 provides a detailed data description.

VAR specication

I analyze the eect of changes in uncertainty on unemployment rate and GDP. Specically, to identify the eects of uncertainty shocks, I estimate country-specic VARs linking stock prices, unemployment rates, and real GDP. To do this, the dynamics of the vector Y t = 5 Following [START_REF] Bloom | The impact of uncertainty shocks[END_REF], they are identied as periods in which the HP de-trended VXO index exceeds its mean by more than 1.65 standard deviations.

6 They include Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Israel, Italy, Japan, Korea, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, and United States. [sp t , vol t , u t , gdp t ] takes the following functional form:

      Equity return Uncertainty measure Unemployment rate real GDP       Y t = B 0 + B 1 Y t-1 + ...B p Y t-p + A 0 ε t (3.1)
The sp t variable is log of equity return, which is proxied by MSCI, vol t is uncertainty measure, u t is log of unemployment rate, and gdp t is log of real GDP. This Cholesky ordering assumes that shocks instantaneously inuence the stock market (levels and volatility), then real economic outcome (unemployment and output). For robustness, I also tested other orderings, which did not materially alter the impulse response functions. Including equity return as the rst variable in the VAR is a conservative choice to control for rst-moment shocks to returns as in [START_REF] Carriére-Swallow | The impact of uncertainty shock in emerging economies[END_REF] 7 . All variables are seasonally adjusted, and detrended using the HP lter with smoothing parameter 1600. Two lags of each variables are included according to Akaike's information criterion. The magnitude of the orthogonalized shock to uncertainty is one standard deviation. I estimate the model separately for each of the countries. I can then classify countries into groups based on their structural characteristics and explore the cross-sectional dimension by comparing dierences across country groups.

Estimation results

Main ndings

Our interest lies in the estimated responses of the domestic variables to the uncertainty shock. Figure 3.2 plots the median and the interquartile range of individual country impulse responses to a one-standard deviation shock to our measure of uncertainty for 30 OECD countries.

These results provide a rst glimpse of the heterogeneity of the responses. While there is meaningful heterogeneity of unemployment responses to uncertainty shocks, a rise in uncertainty has signicant eects on unemployment, averaging about 0.5 percent over the rst 2 quarters, and fading away. As expected, in most countries, GDP decreases in response to a uncertainty shock. These results are consistent with existing empirical literature, which shows that high uncertainty leads to a contractionary eects on the economy. In Appendix 3.5, I report the impulse response functions country by country.

Candidate explanatory channels

The signicant cross-section variation in unemployment responses potentially provides us with the evidence needed to look at the candidate explanatory channels. A number of potential channels are available to account for the heterogeneity in responses: labor market institutions, nancial frictions, and regulatory framework.

Labor market institutions The large body of theoretical discussion about the eects of uncertainty focuses on "real options eects" following [START_REF] Bernanke | Irreversibility, uncertainty, and cyclical investment[END_REF]. The option value of delay is high when uncertainty is high. Therefore, uncertainty makes rms cautions about decisions on investment and hiring, which adjustment costs can make expensive to reverse.

Labor adjustment entails non-convex costs 8 , which are determined in part by LMIs.

When we look at rm's decision in the labor market, hiring is likely to involve several sunk costs: job advertising, compensation of applicants, and training of newly hired employees. In addition, employment contracts are usually long-term relationships. With high uncertainty, the option value of waiting increases and rms should delay hirings. [START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF] shows that in a search and matching model, vacancy posting is subject to real option eects with heightened uncertainty. On the other hand, separations should be also subject to an option value because it entails several sunk costs: procedural inconvenience, notice and severance pay, and diculty of dismissal. Therefore, high uncertainty induces a drop in the number of layos. In a search and matching model with endogenous job separation, [START_REF] Schaal | Uncertainty and unemployment[END_REF] shows that separation is also subject to real option eects.

Empirical studies also show clearly that labor adjustments have xed costs, in particular, with regard to separation. [START_REF] Abowd | The costs of hiring and separations[END_REF] Hence, EPL, which is closely related to xed costs of ring, might be a key parameter to explaining the heterogenous responses in unemployment to an uncertainty shock. We expect that high EPL (high ring cost) might increase the option value of waiting, induce lower separations, and alleviate the rise in unemployment.

Financial frictions A plausible explanation that could account for the heterogeneity in responses across countries is the presence of nancial frictions. As the economy enters a period of high uncertainty, rms may nd it more dicult to obtain nancing for their projects if (i) banks nd it more dicult to gauge the degree of risk involved in the project, (ii) banks are unable to obtain external nancing themselves due to a shortage of liquidity or ight-to-quality episode, or (iii) rms suer a deterioration of their balance sheets (perhaps due to a currency mismatch and sudden depreciation) which reduces the collateral available to post against new loans. The fall in the collateral value and/or the deterioration in the rms' balance sheets increase the negative eect of the uncertainty shock in the economy both in terms of the initial fall but also in terms of the persistence of the drop in investment.

As a result, the decrease in investment might lead to the fall in labor demand and output.

Carriére-Swallow & Cépedes (2013) explore the link between the eects of uncertainty shocks and the functioning of nancial markets. They show that economies with less-developed nancial markets suer more in terms of investment. We expect that the depths of local nancial sector are inversely associated with the responses of unemployment.

Regulatory framework Product market exibility is determined by the quality of business regulation and the degree of competition, which are likely to vary across countries. This regulatory framework might help describe the heterogeneity in the unemployment responses.

Countries with regulatory frameworks that make investments or rm entry less irreversible should thus generate larger real-option values to waiting during the period of heightened uncertainty, and thus leads to a severe fall in real activity, then labor demand. We expect that there is a positive correlation between regulatory framework and the unemployment responses.

Which channel is more important?

In order to examine the dierences in reactions across countries, I compute for each country the amplitude of impulse response function for unemployment rate, dened as the biggest value in the country's IRF. Moreover, I compute the correlations between the amplitudes of impulse responses and relevant country characteristics across 30 OECD countries. As proxies for labor market institutions, I use EPL 9 , unemployment benet (net replacement rates), minimum wage (relative to average wages of full-time workers), bargaining coverage (the ratio of employees covered by collective agreements, divided by all wage earners with right to bargaining), and trade union density (the ratio of union members divided by the total number of employees) by OECD. Among them, I view EPL as a useful measure of the ring costs. I also consider GDP per capita and nancial depth, dened as private credit by deposit money banks to GDP (%), which are from World Bank. Financial depth is generally interpreted as a proxy for nancial constraints. Indicators of product market regulation comes from the OECD 10 . I view this index as product market constraint or the degree of irreversibility in an economy. Emerging countries with less-developed nancial markets suer more with heightened uncertainty than advanced countries do. However, the role of nancial depth is not signicant. Moreover, product market regulation is positively associated with unemployment responses.

With high uncertainty, regulation can come with a bigger cost and discourage entrepreneurs, leading to lower labor demand. Therefore, heavily regulated countries suer more with high uncertainty. However, the eect of product market regulation is also not signifcant.

Subgroup analysis

I can estimate average eects (Figure 3.2) using all the countries in the sample as well as those pertaining to the sub-groups of countries. This latter aspect of empirical exercises led us to explore the cross-sectional dimension and study the role of EPL in the transmission of uncertainty shocks. To do so, I split the OECD countries by EPL. and take longer to recover to their pre-shock trend. On the other hand, high EPL countries do not present a signicant eect.

These results generalize the ndings of [START_REF] Gourio | International risk cycles[END_REF] and [START_REF] Bachmann | Uncertainty and economic activity: evidence from business survey data[END_REF] with 30 OECD countries. [START_REF] Gourio | International risk cycles[END_REF] investigate a group of G7 countries: low EPL countries (Canada, Japan, UK, and US) suer higher rise in unemployment rate than high EPL countries (France, Germany, and Italy) do. [START_REF] Bachmann | Uncertainty and economic activity: evidence from business survey data[END_REF] nd that the response to a surprise increase in uncertainty in the US is quite dierent from the one in Germany: in the US, high uncertainty has larger and much more persistent eects on production and employment.

Robustness checks

In this section, I conduct a series of robustness exercises. are similar to those with local uncertainty measures. Importantly, there is no evidence of over-adjustment in low EPL countries when economies recover from the shocks, whereas the short-lived increase in unemployment in high EPL countries is subsequently compensated for. This similar evidence suggests that OECD countries suer from both idiosyncratic and common uncertainty shocks, reecting the high degree of interconnectedness of their economies.

In the baseline specication, I put equity return before uncertainty measures in the VARs.

In this exercise, I remove equity return, then uncertainty comes rst in the three variable VARs. Figure 3.7 presents the weighted average of impulse responses of three variable VARs.

The eects of an uncertainty shock are bigger than those in the benchmark, and the dierence between two groups is more signicant.

Moreover, I construct another two subgroups by EPL. In this exercise, each subpanel has ten sample countries as a conservative choice. impulse responses with new subgropus. While the error bands are rather wide as expected, the results between two groups are signicantly dierent.

In the baseline exercise, impulse responses of each group are the weighted average of the point estimates. I conduct an additional exercise with median impulse responses of each group. The median IRF in step i is dened as the median across all IRFs in step i as in Carriére-Swallow & Cépedes (2013). Figure 3.9 reports the median impulse response to a one standard deviation shock to a local uncertainty variable. Results remain roughly unchanged.

Conclusion

The eects of uncertainty shocks can vary across countries, depending on their structural characteristics, policy reactions, etc. This paper tries to focus on the role of LMIs in the

Figure

  Figure 1.1: Uncertainty measure

Figure 1 . 2 :

 12 Figure 1.2: Structual VAR : The eects of one-standard deviation increase in uncertainty

  Figure 1.3 displays the impulse responses of macroeconomic variables to a one-standard deviation increase in technology uncertainty shock.

Figure 1 . 3 :

 13 Figure 1.3: Impulse responses of macroeconomic variables to a one-standard deviation technology uncertainty shock

  tic discount rate (β λ t+1 λt ) goes up following an uncertainty shock as in Fernandez-Villaverde et al. (2011), which raises the value of investing in job creation (equation (1.3)), rms entry (equation (1.10)), foreign bonds (equation (1.9)) and physical capital (equation (1.11)). Real option value. Uncertainty also makes economic agents cautious about decisions like employment, which adjustment costs can make expensive to reverse. Thus, it gives rise to a contractionary real option-value eect. In our model, real options apply to key decisions: hirings, ring and rm entry. As for hirings, unlike in a standard RBC model, employment cannot adjust each period due to search and matching frictions. Vacancy posting decisions are based on the expected value of a lled vacancy (equation (1.3)), which is determined by the stochastic discount rate times the expected surplus of a match. On the one hand, the stochastic discount rate increases, which raises the expected value of a lled vacancy. The present value of a job match goes up. On the other hand, a job match is an irreversible long-term employment relation. Therefore, the expected volatility of the economy aects the expected value of a lled vacancy (right hand-side of equation (1.3)), thereby introducing a real option eect.

  Understanding the respective role of search and matching, open economy and rm entry In order to provide further understanding of the respective role of search and matching, open economy and rm entry in the model, we display the response of the economy to a technology uncertainty shock in 3 dierent models. We start with the simple model with search and matching frictions and endogenous separations (no rm entry, closed economy) and analyze the eects of endogenous separation. We extend then this simple model along one dimension: either rm entry (a model with search and matching frictions in an closed economy, with rm entry) or the open economy dimension (a model with search and matching frictions in an open economy, no rm entry).

  Figure 1.4 shows that the introduction of rm entry (SaM + Firm entry) generates a fall in job nding rate and investment, which is consistent with the data. As the option value channel also aects rm entry decision, the number of producers N t goes down in uncertain times, which increases mark up (µ equation (1.13)) and reduce relative prices (ρ equation (1.14)). This means that the marginal gain from a match ϕ falls (equation (1.5)). Therefore, rms post less vacancies and separate from more matches. Unemployed workers face a lower probability of nding a job. Investment falls as the decrease in employment reduce the marginal product of capital.

Figure 1 '

 1 Figure 1.4: Impulse responses to a one-standard deviation increase in technology uncertainty shock

  Figure 1.5, with open economy and rm entry (the full model), real exchange rate depreciates more, leading to larger foreign bond holding and current account surplus. This outcome is consistent with larger reduction in consumption and investment. Moreover, comparing Figures 1.4 and 1.5 shows that a larger fall in GDP is obtained under the full model because of the interaction with the open economy dimension.

  14

Figure 1 '

 1 Figure 1.5: Impulse responses to a one-standard deviation increase in uncertainty shock

Figure 1 .Figure

 1 Figure 1.8 displays our measure of uncertainty along with workers' ows and current account as % of GDP. Visual inspection suggests that increased uncertainty tends to be associated

Figure 1

 1 Figure 1.8: Job nding rate, separation rate, current account and uncertainty index

Figure 1 . 9 :

 19 Figure 1.9: The eects of one-standard deviation shock to uncertainty: robustness checks

  the past decades, trade liberalization has led to a signicant trade expansion. By 2007, global trade had reached more than 60 percent of world GDP, compared with less than 30 percent in the mid-1980s[START_REF] Bacchetta | Globalization and informal jobs in developing countries. A joint study of the International Labour Oce and the Secretariat of the World Trade Organization[END_REF]). Despite its uncontroversial expansionary eects on global growth, trade expansion has not always been translated into more equal incomes and better working conditions. Rising concerns on the distributional eects of trade emphasized the fall in wages for unskilled and low-income workers, as well as the rise in informal and less protected forms of employment.Our contribution to the literature is two-fold. First, we assess the impact of trade openness on informality and inequality. Second, we investigate whether taxation may correct any possible negative eect that trade liberalization may have on labor quality and income distribution. Our analysis is based on a Dynamic Stochastic General Equilibrium (DSGE) model with two asymmetric countries: a developed and a developing country. The originality of our approach is to extend the Melitz (2003)'s model by introducing search and matching frictions as in[START_REF] Helpman | Inequality and unemployment in a global economy[END_REF], but in a dynamic framework, following[START_REF] Cacciatore | Trade, Unemployment, and Monetary Policy[END_REF]. In order to provide a credible impact of tax reforms, we also depart from the representative agent model by introduce hand-to-mouth agents as in Gali,Lopez-Salido and Valles (2007). A calibrated version of this model is the parsimonious way to quantify the transitional dynamics of labor reallocation induced by the world trade liberalization, as well as the redistributive eect of tax reforms.

  example, show that within a data set of 23 countries, 19 showed increases in informality. Similarly, ILO data from 2002 show that self-employment increased in all developing regions, and world-wide increased from about one quarter to one third of non-agricultural employment during the period1980 -2000 (ILO, 2013)).Trade liberalization is deemed to have further increased the incidence of informality. In developing countries, job creation resulting from trade liberalization has mainly taken place in the informal economy. In some regions (e.g. Latin American countries), the increase in informality took place concomitantly, or in the aftermath of, major trade reforms in dierent countries of the region, which drastically cut tari and non-tari barriers, and opened markets to foreign competition. Indeed, there is a long standing concern about the labor market consequences of trade liberalization. One major concern in developing countries is that it could induce substantial reallocation of workers from the formal to the informal sector[START_REF] Goldberg | The response of the informal sector to trade liberalization[END_REF]). The empirical literature provides mixed evidence on the eects of trade liberalization on informality. Some papers nd little or no eect of trade liberalization on informality (e.g.[START_REF] Goldberg | The response of the informal sector to trade liberalization[END_REF],[START_REF] Menezes-Filho | Labor Reallocation in Response to Trade Reform[END_REF],[START_REF] Bosch | Trade liberalization, labor reforms and formal-informal employment dynamics[END_REF]), whereas some others (e.g.[START_REF] Kovak | Regional eects of trade reform: What is the correct measure of liberalization?[END_REF] , Dix-Carneiro & Kovak (2017)) nd signicant eects of trade liberalization on informality and wages. The lack of a clear consensus motivates the need to further investigate the eects of trade liberalization on 1 For an overview on job quality in emerging economies, see OECD (2015a).

  These two countries dier according to the size of the informal sector in the intermediategood sector. The informal sector is characterized by a more exible labor market (i.e. rapid entry and exit and more exible adjustment to change in demand) and lower productivity.In this respect our paper relates to the recent theoretical literature embedding the informal sector in DSGE models (e.g.[START_REF] Conesa | Explaining cross-country dierences in participation rates and aggregate uctuations[END_REF],[START_REF] Busato | Market and underground activities in a two-sector dynamic equilibrium model[END_REF],[START_REF] Orsi | Size, trend, and policy implications of the underground economy[END_REF],[START_REF] Pappa | Fiscal consolidation with tax evasion and corruption[END_REF],[START_REF] Dellas | Fiscal policy with an informal sector[END_REF]). Within this strand of literature, very few works enrich DSGE models with both informality and a fully-edged labor market with search and matching frictions. The few exceptions, to the best of our knowledge, are[START_REF] Cook | Dual labor markets and business cycles[END_REF],[START_REF] Zenou | Job search and mobility in developing countries. theory and policy implications[END_REF],[START_REF] Satchi | Labor markets and productivity in developing countries[END_REF],[START_REF] Batini | Informality, Frictions and Monetary Policy[END_REF][START_REF] Bosch | The labor market eects of introducing unemployment benets in an economy with high informality[END_REF] and[START_REF] Anand | Macroeconomic Impact of Product and Labor Market Reforms on Informality and Unemployment in India[END_REF]. However, most of the aforementioned theoretical works focus on the role of regulation and none of them analyzes the eect of taxation on informality from both a developed and a developing country perspective.The novelty of our paper is to focus on the interactions between the choices to participate at the international trade[START_REF] Melitz | The impact of trade on intra-industry reallocations and aggregate industry productivity[END_REF]) and the induced labor reallocations between formal and informal activities. Starting from the[START_REF] Melitz | The impact of trade on intra-industry reallocations and aggregate industry productivity[END_REF]'s model where search and matching frictions are introduced on the labor market as in[START_REF] Helpman | Inequality and unemployment in a global economy[END_REF], our original contribution is to propose a dynamic two-country model where asymmetric areas, a developed and an emerging country, are characterized by dierent incidence of informality.

Figure

  Figure 2.1: The nal good sector

Figure

  Figure 2.2: The labor market

Figure

  Figure 2.3: Unemployment

  Figure 2.4 shows that trade liberalization allows workers to reach higher welfare, regardless of the labor market status. Not surprisingly, welfare gains are higher for workers occupied in the informal sector. The underlying reason is that trade liberalization favors employment in the informal sector where rms open more jobs, wages increase leading to higher welfare gains for informal workers. This result has to be interpreted with some caveats. The initial welfare of the workers occupied in the informal sector is largely lower than the welfare of those occupied in the formal sector. Hence, following trade liberalization a larger share of workers suer from poor working conditions associated to informality, although trade liberalization slightly reduces the welfare gap between formal and informal workers. When the tax reform is introduced, in both countries welfare gains for workers employed in the formal sector increase signicantly (see Figure2.4). This is mainly due to the large initial jump in wages in the formal sectors. Conversely, welfare associated to the outside options (i.e. unemployment or a job in the informal sector) are lower than those observed in the baseline scenario (i.e. trade liberalization without tax 11 Similar conclusions are drawn in Antón who analyzes the eects of the 2012 tax reform in Colombia.

Figure

  Figure 2.4: Wage inequality and welfare

Figure

  Figure 2.5: Goods markets

  over 40 years. Moreover, they use the mean of country-level indices as a measure of global risk. Carriére-Swallow & Cépedes (2013) use the Chicago Board Options Exchange S&P 100 Volatility (VXO) index, to identify global shocks, given that it is debatable to what extent nancial market series are a proper measure of local business condition in an emerging economy. In this paper, I use both local and global measures. In a benchmark model, I choose to use a local stock market volatility to take into account country-specic variations in uncertainty. Moreover, I test whether the results are robust to using VXO index as a common measure of global uncertainty.

Figure 3 .

 3 Figure 3.1 shows the local uncertainty series for G5 countries (France, Germany, Japan, UK, and US) and identied global uncertainty shocks 5 . Realized equity volatility series contain a common component across countries: they tend to coincide around the most pronounced peaks (which are identied as global shocks), such as the period of Russian & LTCM default in 1998, WorldCom & Enron and Gulf War in 2002-2003, the global nancial crisis in 2008-2009, and the euro area debt crisis in 2012. On the other hand, there are other periods, where some local crises are not identied as a global shock, such as the Asian crisis in 1997 and the dot-com bubble burst in 2001. I use 30 OECD countries data 6 at the quarterly frequency for the period from 1996Q1 to 2015Q4. I import daily MSCI equity returns for the sample countries and build quarterly series of stock market volatility by computing standard deviations over calendar quarters.

I

  Figure 3.1: Uncertainty measures

Figure

  Figure 3.2: The impulse responses to an uncertainty shock

Figure

  Figure 3.3: Response function amplitudes of unemployment rates and country characteristics

  Figure 3.4 represents EPL measures of 30 OECD countries. I construct a subpanel of Member states having lower EPL (six countries with the lowest EPL 11 ) versus a subpanel of Member states with higher EPL (six countries with the highest EPL 12 ).

Figure 3 .

 3 Figure 3.5 reports the weighted average of impulse responses to a one standard deviation shock to uncertainty variable with 68 percent error bands for each of two groups (low EPL vs. high EPL). Weights are inversely proportional to the standard deviation of each impulse response. The impact of an uncertainty shock visibly diers between the two groups. Following an uncertainty shock, countries with low EPL suer more severe rise in unemployment 11 Portugal, Belgium, Italy, Netherland, Germany, and France (from lowest level) 12 New Zeland, United States, Canada, United Kingdom, Chile, and Australia (from highest level)

Figure 3 . 5 :

 35 Figure 3.5: The weighted average of impulse responses of unemployment rates to a local uncertainty shock

First

  of all, I replace local measures (individual country's equity return and realized equity volatility) with global measures (S&P 500 and VXO Index) in the VAR. I consider VXO as a common measure of global uncertainty. Figure 3.6 reports the weighted average of impulse responses to a one standard deviation shock to global uncertainty variable. The results

13

  Figure 3.6: The weighted average of impulse responses of unemployment rates to a global uncertainty shock

Figure 3 . 7 :

 37 Figure 3.7: The weighted average of impulse responses of unemployment rates to a local uncertainty shock (three variable VAR)

Figure 3 . 8 :

 38 Figure 3.8: The weighted average of impulse responses of unemployment rates to a local uncertainty shock (each panel has 10 sample countries)

Figure

  Figure 3.9: The median impulse response of unemployment rates to a local uncertainty shock

  the total number of unemployed workers in the economy and V t the aggregate number of vacancies. The probability of lling a vacancy is q t = Mt Let v ωt denote the vacancies posted by producer ω. Total capital stock for rm ω is

		Vt	and labor
	market tightness is θ t = Vt Ut	. Firms select capital after observing aggregate and idiosyncratic
	shocks.

  dz is the average wage paid by the rm. When terminating a job, each job incurs a real cost F . Firing costs are not a transfer to workers, they refer to pure administrative losses. The rm's program is

  The relative price of a variety ω is ρ dωt = p dωt

	Pt	and ρ xωt = pxωt Pt	. Price setting
	is such that

Table 1

 1

		.1: Calibration
	Parameter Description	Value
	β	Discount factor	0.99
	σ C	Risk aversion	1
	α	Capital share	0.33
	δ K	Capital depreciation rate	0.025
	σ	Variety elasticity	13.5
	δ	Plant exit	0.007
	f R	Regulation entry cost	7.9
	f T	Technology entry cost	7.8
	χ	Matching eciency	0.32
	κ	Vacancy cost	0.0966
	σ z	Lognormal shape	0.08
	ρ z	TFP, persistence	0.9
	σ z	TFP, standard deviation	0.0105
	ρ σz	TFP uncertainty, persistence	0.70
	σ σz	TFP uncertainty	0.17

v Investment adjustment costs 0.5 λ Total quarterly separation rate 0.027 b/w Unemployment benet replacement ratio 0.61 F Firing costs 0.0483 ε Matching function elasticity 0.6 η Worker's bargaining power 0.6

Table 1

 1 row 4. of Table1.2) helps the model predict a fall in investment and job nding rate, which is consistent with empirical evidence. The stock of rms also falls, as in the data. The addition of the open economy dimension (row 5.) does not solve the counterfactual rise in the job nding rate but helps the model predict a fall in investment. Moreover, the behavior of open-economy variables match the data. The following subsections describe the economic mechanisms and underline the interaction between search and matching, open economy and rm entry.

		Table 1.2: Responses of macroeconomic variables to increased uncertainty
			C	I	E	U	JFR	JSR	N	CA	RER
	1.	Korean Data	-	-			+	-	+	-	+	+
	Our paper
	2.	Benchmark	-	-	-	+	-	+	-	+	+
	3.	SaM only (endo. sep.)	-	+	*				+	*
	4.	SaM + Firm entry (closed economy)		-				-		-
	5.	SaM + open economy (no rm entry)		-				+ *		+	+
	Neo Keynesian model (sticky p.)
	6.	Basu & Bundick (2017)	-	-	-
	Search and matching (closed economy)
	7.	Leduc & Liu (2016) , sticky p., exo. sep.	-					+
	8.	Guglielminetti (2016), ex. p., exo. sep.	-	-			+	-
	9.	Miyamoto (2016), ex. p., endo. sep.	-					+	+ *	+
	Open economy (no search and matching)
	10.	Kollmann (2016)	+ *									+	- *
	11.	Fogli & Perri (2015)	-	+ *	+	*					+
	12.	Fernandez-Villaverde et al. (2011)	-	-	+	*

.2 summarizes our ndings and contribution to the literature. Results of existing works are either incomplete or inconsistent with respect to Korean data. With search and matching frictions and endogenous separations (row 3. of Table

1

.2), the model predicts an increase in investment and job nding rate. Firm entry 13 Each model is not an extreme calibration of the full model. We actually wrote separate models. In all models, all parameter values are kept at their benchmark values reported in Table

1

.1, except the parameters whose value is derived at the steady state (home production, matching eciency and ring costs) that are computed to match the same empirical targets: Unemployment, vacancy lling rate and total quarterly separation rate. (+ C consumption, I investment, E employment, U unemployment, JFR Job Finding Rate, JSR Job Separation Rate, N number of rms, CA Current Account, RER Real Exchange Rate (+ means depreciation of national currency) Following an increase in uncertainty, based on IRFs displayed in paper. "+": IRF displays an increase in the short-run. "-": based on IRFs displayed in paper, IRF displays a decrease in the short-run. * : counterfactual IRF. Example: displays a "+", should be "-" to be consistent with the data. Or vice versa. "sticky p.": sticky price; "ex. p": exible price. "exo. sep." / "endo. sep.": exogenous / endogenous job separation.

[START_REF] Leduc | Uncertainty shocks are aggregate demand shocks[END_REF]

develop a model without capital, hence without investment.

Table 1

 1

	.3: Business cycle statistics: Model versus data
		Volatility	Cyclicality
		(1)	(2)	(3)	(4)
		Data	Model	Data	Model
	Y(i)	2.07	2.07	1(iii)	1
	C(ii)	1.44	0.59	0.86	0.75
	I	2.42	2.20	0.83	0.90
	JSR	8.74	8.78	-0.73	-0.68
	JFR	4.13	3.77	0.48	0.76
	U	8.44	9.70	-0.81	-0.77
	V	8.54 (iv)	8.73	0.9(iv)	0.35
	corr(U,V)			-0.80 (iv)	-56.4
	(i). Output std. in %, in columns (1) and (2).

(ii). For all variables except output, std. relative to output, in columns (1) and (2) (iii). Correlation with output in columns (

3

) and (4) (iv). For want of Korean data, US value a specic feature of the Korean economy. The model's predicted volatility of unemployment and vacancies is consistent with the data. For vacancies, there is no available data on Korean vacancies, we then report the business cycle statistics on US data.

Consumption is more volatile than output in Korean data. It is a well-known feature in emerging economies

[START_REF] Aguiar | Emerging market business cycles: The cycle is the trend[END_REF]

among others). The model fails to capture this feature. Capturing the high consumption volatility is beyond the scope of the paper. Furthermore, the high consumption volatility is not a robust stylized fact in Korean data. From 1980Q1 to 1995Q4, the relative volatility of consumption was 0.67. The relative consumption volatility prevailing during this period is closer to the model's predicted consumption volatility.

  are four actors in each country: households, rms producing intermediate goods, rms producing nal goods and the government. The model features heterogeneous households: Ricardian and non-Ricardian. Ricardian households hold bonds but do not supply labor, whereas non-Ricardian households do not have access to nancial markets to nance their consumption needs. Therefore, they may decide to either supply labor in the formal sector, or supply labor in the informal sector or be unemployed. Labor is hence supplied only by non-Ricardian households to intermediate good producers. Intermediate good producers operate in a perfect competitive market and hire labor either on the formal or informal market to produce intermediate goods which are sold to nal good producers. Final good

producers combine intermediate goods into a nal good which is sold on a monopolisticallycompetitive market. Finally, to provide public goods and unemployment benets, the government collects taxes paid on consumption by all households as well as payroll taxes paid only by employees and employers (i.e. intermediate good producers) operating in the formal sector.

  Q t = S t P * t /P t is the real exchange rate. We dene the average price of a domestic variety, ρd,t ≡ N (P d,t /P t ) and the average price of an exported variety, ρx,t ≡ N

	,t P t	=	φ φ -1	P y d,t P t	,	P h x,t P t	=	τ t Q t	φ φ -1	P y x,t P t	(2.44)
										1
										θ-1
				d,t 1
				θ-1 x,t (P x,t /P * t ). Combining the equations (2.39) and

where

Table 2

 2

	.1: Calibration

  estimate hiring and ring costs, using 8 These are xed costs and partial irreversibility, then generate real options eects a cross-sectional matched employer-employee data for France. They nd that separation costs include a very large xed component whereas hiring costs are much lower.[START_REF] Kramarz | The shape of hiring and separation costs in france[END_REF] estimate the functional form of hiring and ring costs using French data.Let us look at the transmission of uncertainty shocks in the labor market. When uncertainty hits the economy, the drops in real activity reduce labor demand. Firms should adjust their workforce by hiring less and ring more. In theory, ring costs reduce job destruction during downturns. When ring costs are higher, rms nd it easier and cheaper to absorb shocks by keeping workers. Instead, rms might adjust prices and wages. This mechanism is also in line with the rst moment shock.[START_REF] Thomas | Labor market reform and price stability: An application to the euro area[END_REF] and[START_REF] Zanetti | Labor market institutions and aggregate uctuations in a search and matching model[END_REF] nd in a search and matching model that higher ring costs dampen the employment adjustment with the rst moment shock. However, the second moment shocks reinforces this mechanism through the real options channel: in periods of high uncertainty, ring costs which have larger xed component come with a bigger cost, as it would be costly to hire new work-

	They nd that collective terminations entail very large xed costs whereas hiring costs are
	small, with a negligible xed component.

ers when productivity reverts quickly. Under irreversibility and uncertainty, rms become more reluctant to lay workers o and separation margin is more important on business cycle uctuations.

  Amplitude is dened as the biggest value in the country's IRF for the rst 8 quarters. (ii) variables correspond to average value during 2008∼2013. (iii) *, **, *** indicate statistical signicance at 10%, 5%, 1%, respectively.

	Table 3.1: Correlations between response function amplitudes and country characteristics
														Correlation
						Labor market institutions
							Employment protection legislation	-0.43***
							Unemployment benet			-0.14
							Minimum wage				-0.08
							Bargaining coverage				-0.34*
							Trade union density				0.00
						Others
							GDP per capita				-0.34*
							Financial depth				-0.19
							Product market regulation		0.10
						Notes: (i)
	9 The	OECD	indicators	of	employment	protection	legislation	measure	the	procedures
	and	costs	involved	in	dismissing	individuals	or	groups	of	workers	and	the	procedures
	involved	in	hiring	workers	on		xed-term	or	temporary	work	agency	contracts.	See
	http://www.oecd.org/els/emp/oecdindicatorsofemploymentprotection.htm
	10 See http://www.oecd.org/eco/growth/indicatorsofproductmarketregulationhomepage.htm#Sources
											99

  Note: EPLs correspond to average value during 2008 2013. Blue and red bars indicate the lowest EPL and the highest EPL countries, respectively

	3.50
	3.00
	2.50
	2.00
	1.50
	1.00
	0.50
	NZL	USA	CAN	GBR	CHL	AUS	IRL	JPN	CHE	FIN	KOR	ISR	HUN	DNK	NOR	TUR	POL	AUT	SVK	SWE	ESP	GRC	MEX	CZE	FRA	DEU	NLD	ITA	BEL	PRT

In the model as in the data, real exchange rate is the US CPI expressed in South Korean wons relative to Korean CPI. An increase in the real exchange rate captures a depreciation of the Korean currency.

Because of the love for variety, measures in units of consumption are not data-consistent. The aggregate price index in the model takes into account changes in the number of available products, which is not the case in CPI data.[START_REF] Ghironi | International trade and macroeconomic dynamics with heterogeneous rms[END_REF] suggest to solve this problem by deating all variables using an average price index. When we assess the model's t with the data, we make sure to consider data-consistent variables.

To ensure stable sample paths, pruning discards higher order terms when iteratively computing simula- tions of the solution. At third order, Dynare 4.4.3 uses the pruning algorithm of[START_REF] Andreasen | The Pruned State-Space System for Non-Linear DSGE Models: Theory and Empirical Applications[END_REF]

10[START_REF] Born | Risk matters: The real eects of volatility shocks: Comment[END_REF] use the term EMAS (the ergodic mean in the absence of shocks). It is the point of the state space where, in absence of shocks in that period, agents would choose to remain although they are taking future volatility into account.

According to survey design, each household remains in the sample for 36 months, and 1/36 of total households is renewed each month.

EAPS's rotation scheme allows us to match individuals across two consecutive months, and obtain gross ows across labor market states.

Note that our analysis focuses on monthly transitions between employment (E) and

Firms are owned by households and u C,t is the marginal utility of consumption. This ensures that rst order conditions are measured in the same units.

This is due to the ambiguous eect of a budget-neutral tax reform on the tax wedge: on the one hand, it reduces the tax wedge by lowering the taxes paid by the employers, on the other hand it increases it by increasing the tax on consumption.The impact on labor markets. Figure2.2 reports the eects of trade liberalization on labor markets when the government implements a budget-neutral tax reform. This scenario is represented by the red solid lines. Recall that wages in both sectors are determined by 10 To be more precise, changes in tax rates alter the equilibrium level of the production of intermediate goods. However, these changes have a second-order magnitude.

Uncertainty measures tend to rise in recessions and fall in booms. It is possible that uncertainty may reect bad economic times rather than an uncertain future. Then, I include equity returns as an additional

Acknowledgements

Lina Prevost, who has provided outstanding support in all admin-

We employ the Economically Active Population Survey (EAPS) conducted by Statistics Korea. It is cross-sectional monthly household survey, and the sample size consists of approximately 33,000 households per period (about 70,000 adult individuals). The main goal of EAPS is to reveal the characteristics of that population with regards to the labor market.

In particular, based upon the main activities indicated for the reference week, Statistics Korea classies respondents as follows: those working or absent from work as employed, those looking for work as unemployed, and all others as inactive. Among inactive, those who worked for the money more than 1 hour or worked more than 18 hours as non-paid family worker are classied as employed and those who searched for job during last 4 weeks are classied as unemployed.

A.1.2 Measuring transition rates

We use EAPS from January 1986 through December 2015 to construct the series of worker ows.

Chapter 2 How Can Taxes Help Ensure a Fair Globalization? more rms to export, thereby increasing labor demand and real wages. As in the developed economy, this leads to high share of exporters and informality in emerging economy.

In the long run, when the developed country has reached its long-run level of iceberg costs, in the emerging country trade expansion is still ongoing. In the emerging country, revenue growth is now driven by iceberg cost reduction which takes place only in the emerging country and still generates growth gains. Growth gains, in this phase, are obviously more modest than during the rst phase of trade expansion. However, the emerging country still benets from decreasing iceberg costs. Hence, its competitiveness is restored and the real exchange rate increases (see Figure 2.1).

The medium to long-run adjustments on the labor markets. In the medium run, the increasing participation of both countries in the world trade, by increasing incomes and thus the demand for goods, boosts labor demand (see Figure 2.2) and reduces unemployment (see Figure 2.3).

In the long run, when trade costs drop only in the emerging country, income growth generated by new exports is marginal: employment gains become smaller and smaller in both countries (i.e. developed and emerging) and both sectors (i.e. formal and informal).

When iceberg costs converge to their long-term levels in both countries, variables converge towards the new steady-state levels. This phase is characterized by an over-adjustment, which is the result of vacancy-posting strategies adopted by rms (see Figure 2.2). As long as prot opportunities grow, there are strong incentives to post vacancies to benet from growth. This competition leads rms to over-hiring. Once growth falters, employment starts decreasing through the exogenous rate of destruction and the slowdown in new job opportunities. This process takes time and explains why, after the strong employment gains recorded during the period of trade expansion, both countries enter a phase characterized by a contraction on the labor market (see Figure 2.2). Since the separation rate is higher in the informal sector than in the formal sector, this decline in employment is faster in the informal sector, which explains the rise in the share of formal employment in this phase of the long-term adjustment (see Figure 2.2).

Tax reform

In order to reduce the increasing incidence of informality induced by trade liberalization, both countries should introduce incentives to develop businesses in the formal economy. • Stock market series come from the monthly database of MSCI and Bloomberg.

• OECD indicators of employment protection legislation