Abstract
Within a two-sector-two-country model of trade with aggregate scale economies and unionisation, a more generous welfare state in one country increases welfare in that country and can have positive spillover effects on the other. Furthermore, synchronised expansions of social security are more welfare enhancing than unilateral ones. Our results counter the fears that a race to the bottom in social standards may result from the ‘shrinking-tax-base’ entailed by international capital mobility. While affecting trade patterns and income distribution, capital mobility interacts with welfare state policies in increasing welfare, even when capital flows out of the country that initiates the shock.
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Notes
Examining the effects of social policy on employment and growth, van der Ploeg (2003) argues that the distortion of imperfectly competitive labour markets may be corrected by social policies financed by (distortionary) progressive taxation and shows that conditional unemployment benefits may spur job creation. In Acemoglu and Shimer (2000), unemployment insurance improves allocative efficiency by enabling workers to pursue riskier and more productive options.
Existing empirical evidence reveals the importance of inter-industry connections as a source of external returns to scale in manufacturing (e.g., Caballero and Lyons 1992 and Bartelsman et al. 1994). For theoretical work on the role of vertical linkages see, for instance, Ethier (1982), Matsuyama (1995) and Venables (1996).
In de Grauwe and Polan (2005) social expenditure affects workers’ productivity by entering directly the production function of the private sector. In our model the effects of government policy on aggregate efficiency emerges endogenously and does not result from an a priori link between social transfers and productivity.
A large (small) J indicates a large (small) number of small (large) unions. For a given J, the fixed labour endowment implies that the membership of each union is constant. Hence, despite the fact that the mass of firms covered by each union varies with N, its size is constant and changes in N have no implications for the assumption of decentralised union behaviour.
Following the literature, we assume that unemployed workers from other unions cannot be employed in a given union’s sector before the latter’s unemployed members are hired.
We have assumed that unemployment benefit payments are not taxed, i.e. they are net transfers, so as to reflect a progressive income tax system. Assuming a lump-sum benefit or indexing the benefit to the after tax wage would not qualitatively alter the results.
Mathematically, it can be shown that a sufficient condition for the UU to slope positively is that the unions’ monopoly power, (*), is sufficiently inelastic in L (L*). This condition—which is in line with the assumption of small unions—also ensures a trade-off in Eq. 22 between the real wage set by the unions and the employment level set by firms. It is worth noting here that the shapes of the GG and UU ensure existence and uniqueness of equilibrium, whilst the direction of arrows above and below the curves ensures stability.
The proof is not provided here but is available from the authors on request.
These results are reported in an earlier version of the paper which is available on request from the authors.
We have also examined the (t, q *) case, which is reported in an earlier version of the paper available on request from the authors.
Although with fully harmonised policy shocks there will not be any international reallocation of capital even when capital mobility is allowed for (due to the assumed symmetry between the two countries), with capital mobility the existence of the interest parity condition imposes a restriction on the adjustment of the rate of returns to capital or on the capital tax rates. As a result, the multipliers with and without capital mobility will be quantitatively different whichever instruments governments choose to use.
Interestingly, however, despite the differences in the theoretical set-up—which prevent direct comparability of the results—our conclusions are broadly consistent with those studies that pinpoint the role of social protection in determining the sectors in which a country specialises (e.g. Estevez-Abe et al. 2001, where the welfare state affects skill formation).
See, for instance, Dreher (2006).
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Acknowledgement
We thank two anonymous referees and the Editor of the Journal for useful comments and suggestions. The British Academy Research Grant (Ref SG-32914) is gratefully acknowledged.
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Molana, H., Montagna, C. Welfare State, Market Imperfections, and International Trade. Open Econ Rev 18, 95–118 (2007). https://doi.org/10.1007/s11079-007-9003-2
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DOI: https://doi.org/10.1007/s11079-007-9003-2