International spillovers of labour market policies

Abstract

This paper uses a dynamic open-economy model to analyse the domestic and international spillover effects of policies aiming at reducing domestic labour costs, e.g., through cuts in labour taxes and unemployment benefits, when labour markets are unionized. Domestically, unionization dampens the downward wage adjustment due to unions' strategic rent-seeking and leads to a more muted expansion relative to a frictionless setting. Externally, the rent-sharing mechanism ensures that the terms of trade improvement benefits both firms and workers, and thus increases hiring. This is in contrast to the spillover effect in a frictionless setting, where the terms-of-trade induced wealth effect reduces individual labour supply, increases wages, and reduces hiring. When the model is enriched with sticky prices and a common monetary policy across countries, I find that the domestic dampening and positive spillover effects are further reinforced in the short run. Copyright 2013 Oxford University Press 2012 All rights reserved, Oxford University Press.