Lobbying, Regulation in Goods and Labor Markets, and Poisson Technical Change

Abstract

AbstractI consider an economy in which monopolistic firms produce differentiated products, using skilled and unskilled labor. There is monopolistic competition in the goods market, which determines the size of the rents. There is a self-interested government that determines the minimum wage for unskilled labor, either directly or through the support of labor unions, and the number of firms that can enter the market. Firms devote skilled labor to research and development (R&D) to escape production costs. Interest groups that represent workers and firms lobby the government paying political contributions that are conditional on the government's prospective policy. The labor market is regulated, if the minimum wage is high enough to cause unemployment, and deregulated otherwise.Technically, the model is solved as follows. Monopolistic competition is modeled as a Cournot-Nash game: each firm sets production given the production of the other firms. Because the outcome of R&D in each firm follows a Poisson process, a firm's investment problem is solved by stochastic dynamic programming. The interest groups that represent workers and firms maximize the present value of the workers’ and shareholders’ income, respectively, through their political contributions to the government, while the government maximizes the present value of the political contributions it receives from these. The interest groups act as leaders, but the government as a follower in a common agency game. The outcome of this game determines the government's policy, i.e. the number of firms and the unskilled workers’ minimum wage.The technical contribution of the paper is to show how the Cournot-Nash game, the Poisson technological change due to R&D and the common agency game can be considered within a unifying extended game. The economic prediction of the model is the following. The smaller (greater) the elasticity of substitution between skilled and unskilled labor in production, the more (less) likely there is regulation in the labor market. An increase in the elasticity of substitution between skilled and unskilled labor leads to deregulation in the labor market.