Optimal trade policy, equilibrium unemployment, and labor market inefficiency

Abstract Under which circumstances is using trade policies to prevent job losses welfare improving? To answer this question, I incorporate a frictional labor market into the Heckscher–Ohlin model. The results suggest that (a) a country that has an inefficient level of unemployment may experience welfare losses from free trade; (b) having search‐generated unemployment is not sufficient to justify a use of trade policy, because free trade is still optimal when the labor market is constrained‐efficient; and (c) a small country that has an inefficient level of unemployment can use trade policy to improve its welfare.