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  • The editor in charge of this paper was Fabrizio Zilibotti.

  • Acknowledgments: We are grateful to Pol Antràs, Gordon Hanson, Peter Neary, Barbara Petrongolo, Steve Redding, Tony Venables, Jaume Ventura, and seminar participants in Alicante, Banco de España, Bocconi, Brescia, Cambridge, Edinburgh, ERWIT, Harvard, Lancaster, LSE, NBER, Nottingham, Oxford, Pompeu Fabra, Princeton, Stockholm, Valencia, the AEA 2006 Meeting, and the EEA 2006 Meeting for helpful discussions and suggestions. Kalina Manova, Martin Stewart, and Rob Varady provided superb research assistance. We thank Davin Chor for graciously sharing his data on external finance dependence. All errors remain ours. Cuñat gratefully acknowledges financial support from Spain’s CICYT (SEC 2002-0026 and ECO 2008-04669). Melitz thanks the International Economics Section at Princeton University for its hospitality while this paper was written.

E-mail: (Cuñat); (Melitz)


This paper studies the link between volatility, labor market flexibility, and international trade. International differences in labor market regulations affect how firms can adjust to idiosyncratic shocks. These institutional differences interact with sector specific differences in volatility (the variance of the firm-specific shocks in a sector) to generate a new source of comparative advantage. Other things equal, countries with more flexible labor markets specialize in sectors with higher volatility. Empirical evidence for a large sample of countries strongly supports this theory: the exports of countries with more flexible labor markets are biased towards high-volatility sectors. We show how differences in labor market institutions can be parsimoniously integrated into the workhorse model of Ricardian comparative advantage of Dornbusch, Fischer, and Samuelson (1977, American Economic Review, 67, 823–839). We also show how our model can be extended to multiple factors of production.

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