Trade Liberalisation, Subcontracting and Unionised Wage

Abstract

We develop a simple framework to show the effects of trade cost reduction on unionized wage, employment and domestic welfare when a domestic firm strategically chooses the amount of formal in-house production and subcontracting to the informal sector. We show that a lower trade cost increases unionized wage and domestic firm’s formal production and employment, and reduces its informal production. Free trade maximizes domestic welfare if the trade cost represents a transportation cost. However, if the trade cost represents a domestic tariff, the domestic welfare maximizing tariff is positive.