How do shocks to economic fundamentals in the world economy aﬀect local labor markets? In a framework with a flexible structure of spatial linkages, we characterize the model-consistent shock exposure of a local market as the exogenous shift in its production revenues and consumption costs. In general equilibrium, labor outcomes in any market respond directly to the market’s own shock exposure, and indirectly to other markets shocks exposures. We show how spatial linkages control the size and the heterogeneity of these indirect eﬀects. We then develop a new estimation methodology - the Model-implied Optimal IV (MOIV) - that exploits quasi-experimental variation in economic shocks to estimate spatial linkages and evaluate their counterfactual implications. Applying our methodology to US Commuting Zones, we ﬁnd that diﬀerence-in-diﬀerence designs based on model-consistent measures of local shock exposure approximate well the diﬀerential eﬀect of international trade shocks across CZs, but miss around half of the aggregate eﬀect, partly due to the oﬀsetting action of indirect eﬀects.
Adão, Rodrigo; Arkolakis, Costas; and Espósito, Federico, "Spatial Linkages, Global Shocks, and Local Labor Markets: Theory and Evidence" (2019). Cowles Foundation Discussion Papers. 98.