Dundee Discussion Papers in Economics 269: Trade costs, international competition and selection: the effects of unionisation on market size

Within a two-country model of international trade in which heterogeneous firms face firm-specific unions, we study the effects of different forms of trade liberalisation on market structure and competitive selection in the presence of inter-country asymmetries in size and labour market institutions. For given levels of trade openness, an increase in a country’s relative unions’ strength reduces the average productivity of its domestic producers but increases that of its exporters. Whilst an unfavourable union power differential, by increasing wages, weakens a country’s firms’ competitive position, the higher wages reinforce standard market access mechanisms to give rise to aggregate income effects. When the initial levels of trade openness are sufficiently low, this ‘expansionary’ aggregate effect can attract industry in the country with stronger unions and also result in an increase in the
extensive margin of exports. For sufficiently large inter-country differences in the bargaining power of unions, trade liberalization can then result in a pro-variety effect, with an increase in the total availability of varieties to consumers in both countries,
regardless of there being inter-country differences in size.