Heterogeneity in labor mobility and unemployment flows across countries

Empirical studies of labor-market flows suggest cross-country differences in long-run aggregate unemployment inflows and outflows of a strikingly large magnitude. The canonical search-and -matching framework of Mortensen and Pissarides (1994, 1999b; the MP model) features small elasticities of steady-state unemployment flows with respect to firing costs, at odds with the idea that labor-market institutions such as employment protection policies are a primary driver of this variation. This paper shows that introducing permanent match-quality heterogeneity in the standard MP model substantially amplifies these elasticities. It then develops a quantitative search model with worker and job heterogeneity consistent with U.S. worker-flow data. This model implies that employment protection differences plausibly account for most of the long-run unemployment-flow variation across high-income countries. In sharp contrast, shutting down heterogeneity implies that large changes in matching efficiency are required to explain the same cross-country variation.