Labor-Management Bargaining, Labor Standards and International Rivalry

Transcription

1 Labor-Management Barganng, Labor tandards and Internatonal Rvalry Jung Hur Laxun Zhao Abstract Usng labor unon s barganng power as an ndcaton of government polcy on labor standards, ths paper analyzes the competton between a domestc (orth) frm and a foregn (outh) frm, and ther relatonshp wth labor standards. Frst, we show that an ncrease n labor standards rases the domestc frm s profts and reduces that of the foregn frm, f the labor unon s suffcently employment-orented. On the contrary, f the unon s suffcently wage-orented, a race to the bottom of labor standards may occur and t becomes more ntensfed under free trade than under a protectve trade system. econd, orthern labor standards are hgher than outhern ones on condton that the orthern unon s more employment orented than the outhern unon. Thrd, the orth s mposng a tarff to force the outhern government to rase ts labor standards s effectve only f the outhern unon s wage-orented. Thus, n order to rase outhern labor standards, both countres may need some form of economc ntegraton, f the orth does not want to abandon ts free trade system. Key Words: Labor-Management Barganng, Labor tandards, Labor Unon, Duopoly, Tarff, Economc Integraton JEL Classfcaton: F1, F16, J5, J8, L13 Department of Economcs, Faculty of Arts and ocal cences, atonal Unversty of ngapore, A 1 Arts Lnk, ngapore 11757; Emal: ecshurj@nus.edu.sg; Tel: ; Fax: (Correspondng author) Research Insttute for Economcs & Busness, Kobe Unversty, Kobe , Japan; Emal: zhao@reb.kobe-u.ac.jp; Tel/Fax:

2 1. Introducton As tarff barrers are decreasng worldwde, non-tarff barrers such as envronmental standards, health standards and labor standards are on the rse. Ths paper examnes the endogenous choce of labor standards (L) n a model of nternatonal duopoly where a domestc frm competes aganst a foregn exportng frm. ome argue that L ssues appear to be about humantaransm, but n fact they are about compettveness. Labor unons n the developed countres on the one hand have champoned L n the name of human rghts and socal justce n the developng countres. On the other hand, they perceve ncreased competton from poor countres as unfar because L there s low, hence urgng for trade sanctons aganst countres that do not enforce a set of agreed standards n the workplace. They argue that weak standards and nadequate enforcement of standards are means for generatng artfcally low wages and augmentng the natural comparatve advantage that low-wage countres have n labor-ntensve goods. In ths model, we analyze L n the context of labor-management negotatons, and treat the labor unon s barganng power as an ndcaton of how mportantly governments vew L ssues. In other words, we assume that the level of L n each country s endogenously determned by ts government. Ths postulate s based on several stylzed facts and studes. Frst, one of the four Core Labor tandards presented by the Internatonal Labor Organzaton (ILO) s freedom of assocaton and the effectve recognton of the rghts to collectve barganng, 1 whch bascally represents how strong the unon s v.s. the frm. econd, accordng to studes by Moene and Wallersten (3), weden and orway have experenced almost full employment after World War II. They attrbute ths extraordnary phenomenon to the unon s strong barganng power, whch s a symbol of hgh L n candnava. Thrd, some governments n the developed countres want to nclude L ssues n WTO (the World Trade Organzaton) negotatons, hopng to rase the labor costs/wages n the developng countres and n turn reduce ther compettveness. For nstance, the U.. and France campagned for L and a socal clause at WTO meetngs n ngapore n 1996 and eattle n 1999; The European Unon also brought such ssues to the WTO s Doha conference n 1. We allow the labor unon to have a based preference towards ether wages or employment. It s argued that unons tend to be employment-orented durng recesson, when securng jobs s a prorty. In contrast, durng busness boom, they tend to be wage-orented and have stronger 1 The other three are () the elmnaton of all forms of forced or compulsory labor; () the effectve abolton of chld 1

3 demands for wage hkes. In an nterestng survey of Brtsh trade unons, Clark and Oswald (1993) fnd that unon preferences are more heavly weghted toward employment than would be mpled by the so-called rent-maxmzaton behavor (.e., maxmzng the sum of unon members rents), even though unon leaders care more about wages than employment. In addton, n a rch country, unons mght be concerned more about ncreasng the sze of unon membershp than wages, whle unon workers n poor countres mght be more nterested n the wage level, gven that many non-unon workers are earnng near exstence-level wages. Thus, we assume the unon and the frm negotate over two ssues, wages and employment, and the negotated equlbrum would depend on the unon s preference. Ths consderaton allows us to examne dfferent frm performances arsng out of the unon s preference, and how ths changes the government s optmal choce of L. Our man results can be summarzed as follows. Frstly, an ncrease n labor standards can rase the domestc frm s proft and reduce that of the foregn frm f labor unons are suffcently employment-orented. Ths arses because employment-orented unons are wllng to sacrfce some wage demands for hgher employment. The opposte s true, f labor unons are suffcently wage-orented. Furthermore, wth wage-orented labor unons, the so-called a race to the bottom of labor standards may arse and t becomes more ntensfed under a free trade system than under a protectve trade system. econdly, orthern labor standards can be optmally set at a hgher level than outhern ones, f the orthern unon s more employment-orented than the outhern unon. The ntuton s that compared wth wage-orented ones, employment-orented unons demand relatvely hgher employment, whch rases natonal welfare and frm profts under certan condtons. Thus the government s more wllng to grant hgher L/barganng power to more employment-orented unons. Lastly, the orth s mposng a tarff to force the outhern government to rase ts labor standards s effectve only f the outhern unon s wage-orented. Alternatvely, n order to rase outhern labor standards, both orth and outh may need a further economc ntegraton (.e., some form of jont welfare maxmzaton) f the orth does not want to gve up ts free trade system. These results shed lght on the current nternatonal debate on the enforcement ssue of hgh labor standards n poor countres. The debates bascally nvolve the followng two fundamental questons: Frst, can labor standards n poor countres be rased for better workng and wage condtons? econd, can employment n rch countres be secured wth the rased labor standards n labor; and () the elmnaton of dscrmnaton n respect of employment occupaton. ee ILO (1999).

4 poor countres? tern and Terrell (3) surveyed several emprcal studes and found that there s lttle compellng evdence to gve a postve reply to those questons: Frstly, a hgher labor standard does not necessarly mprove wages and workng condtons n poor countres. econdly, a low labor standard n poor countres does not necessarly destruct jobs n rch countres. Our theoretcal results provde plausble explanatons to why those emprcal fndngs are observed: the effects of labor standards depend on how labor-management relatons are resolved, and whether unons are more nterested n wages or employment. In the exstng lterature, L has been treated as a source of externalty n a general equlbrum framework (for nstance, see Bagwell and tager (1), Brown, Deardorff and tern (1996), Rodrk (1996) and rnvasan (1995)), whch s assumed to drectly ncrease consumer utlty or natonal welfare. In these analyses, nether workers nor frms are drectly postvely affected by an mprovement n L. Recently, Chau and Kanbur (6) show that whether a race to the bottom (of envronmental or labor standards) s possble or not depends on the orthern demand curve, the sze of bg exporters relatve to each other, and the relatve sze of the compettve frnge of small exporters. Zhao (6) models L as a frm s choce varable such as workng condtons n a partal equlbrum framework. Also, the mplcaton of chld-labor practces n developng countres for nternatonal trade has drawn qute some attenton (for nstance, see Brown, Deardorff and tern (3), Basu and Chau (4) and eumayer and oysa (5)). In contrast, we treat the barganng power of labor unons as a government polcy varable on labor standards, emphaszng the role of governments n L ssues. The rest of the paper s organzed as follows. ecton sets up the basc model of orth and outh trade wth labor-management negotatons ncorporated. ecton 3 nvestgates the equlbrum propertes wth regard to the economc effects of labor standards and mport tarffs. ecton 4 examnes optmal labor standards and tarff polces of governments. ecton 5 extends the model to a case of asymmetrc labor unons and also examnes the mplcatons of orth-outh economc ntegraton on the choce of labor standards. And fnally, secton 6 concludes.. The Basc Model etup Consder two countres, the orth () and the outh (), each havng one frm,.e., respectvely and. Both frms produce an dentcal product whch s sold n country only, under the nce L ssues arse out of orth s clams that low outhern L helps to mprove outh s compettveness n the orth, 3

5 followng nverse demand functon, p = p q + q ), wth p '<, where denotes the output ( of frm, for =,. The orthern government mposes a tarff t on mports from the outh. Frms: Labor s the only nput requred to produce the outputs n a one-to-one rato by a proper q choce of unts. Gven a wage rate of, frm s profts can be wrtten respectvely as: w π = ( p w ) q, π = ( p w ) q tq. Labor markets: In both countres, workers are organzed nto unons. The unon utlty n each country can be represented by ths smple functon: u = w q, () where > s a parameter for unon bas toward wages (ee Pemberton (1988), Mezzett and Dnopoulos (1991), and López and alyor (4) for a smlar defnton). That s, f > 1, then the unon s sad to be wage-orented (more nterested n wages than employment); f < 1, then the unon s sad to be employment-orented (less nterested n wages than employment); and fnally f = 1, then the unon s sad to be neutral. Wages and employment are negotated between the unon and the frm n each country. We adopt ash barganng to determne the negotaton equlbrum: G 1 ( w, q ) = ( u ) ( π ), (3) (1) where s the barganng power of the unon n country. For reasons dscussed n the ntroducton, we use to represent the L n country and assume that t s determned endogenously by country s government. Governments: The orthern and outhern governments respectvely care about the followng welfare functons: Φ = π + u( w, q) + v( q + q) ( q + q) p+ tq, (4a) Φ = π + u ( w, q ), (4b) where n the orth, t s the sum of frm profts, unon utlty, consumer surplus and tarff revenue. The term vq ( + q) s the utlty of consumng q + q, wth v'( ) = p. In the outh, snce there s no consumpton, natonal welfare s the frm profts plus unon utlty. we gnore what mght be gong on n the market, though t should be straghtforward to ntroduce a segmented market. 4

6 L Game structure: The game has two stages. In the frst stage, each government determnes ts smultaneously, and the orthern government also determnes the mport tarff mposed on outhern mports; and n the second stage, the labor unon and the frm negotate to determne wages and employment n each country smultaneously. To ensure consstency, the game s solved by backward nducton. Equlbrum olutons: The FOCs (frst order condtons) n the second stage are as follows, for =,, j, 1 G( w, q) 1 = ( q ) =, (5a) G w w π 1 G( w, q) 1 π = + =, G q q π q where π / q = pq + p w t < wth t = f = and t > otherwse. Usng (5a), one sees that (5b) mples (5b) w / + pq + p w = for the orth and w / + pq + p w t = for the outh. Wthout the unon, the frm could have maxmzed ts profts by settng π / q =. However, n (5b) we have π / q <, mplyng that n the barganng equlbrum each frm produces more than the level that would maxmze ts profts. Ths arses because wth postve barganng power, the unon can bargan for more employment as well as hgher wage. where The four FOCs (two for each country) can be further smplfed as, for =,, G w G q G wπ G w G w ( 1 ) π wq = (6a) w π + = q and G q π (1 ) G to obtan the four endogenous varables, ( w, q, w, varables, (,, the polces n stage 1. q (6b) G. We can straghtforwardly solve the FOCs q ) as functons of the three polcy t ), whch are gven n stage. Then we can endogenze the optmal choce of 5

7 3. Comparatve tatc Analyss ow we nvestgate the mpact of the three polces mposed by the orthern and outhern governments on frms and unons. Detaled dervatons are relegated to Appendx Effects on Outputs and Wages The mpacts of an ncrease n L are, for, j =, ; j, dw d >, (7a) dq 1 > f <, d < f > 1, dq j < f < 1, d > f > 1, dwj < f < 1, d > f > 1. Expresson (7a) says that an ncrease n L rases the negotated wage, as expected, snce the ncrease n L rases the unon s barganng power. Expresson (7b) states that an ncrease n country s L rases (reduces) frm s output f the unon s employment (wage)-orented. The reason s, an employment (wage)-orented unon demands a hgher level of employment (wage) at the expense of a lower wage (less employment). Ths effect s strengthened f L rses. Expressons (7c) and (7d) follow expresson (7b), reflectng the effects of an ncrease n country s L on country j s output and wages. pecfcally, the sgn of (7c) s the exact opposte of (7b), because outputs q j and q (7b) (7c) (7d) are substtutes. These effects further lead to correspondng changes of the negotated wage n the other country, resultng n (7d). In addton, the effects of the orthern tarff can be obtaned as follows: dq / dt >, dw / dt >, dq / dt <, and dw / dt <, as expected. The above results are mportant to warrant a lemma. Lemma 1: () An ncrease n country s L rases the negotated wage n the country, but t rases the output only f the labor unon s employment-orented, and lowers t f the unon s 6

8 wage-orented. () An ncrease n country s L reduces the output of the competng country f the unon s employment-orented, and rases t f the unon s wage-orented. We can draw some nterestng mplcatons from Lemma 1. There exsts a hypothess that a hgher L mght provde ncentves for workers to work harder and thus ncrease output. 3 Our results suggest that the ncrease n L does provde ncentves (n the form of a hgher negotated wage), but t leads to hgher output only f the unon s employment-orented. If the unon s wage-orented, then an mprovement n L would lower outputs nstead, because the unon mght sacrfce employment/output for a hgher wage. In addton, humantaran groups, labor unons and poltcans n some orthern countres clam that a lower L n the outh enables t to be more compettve and sell more n orthern markets. Thus, f outhern L were forced up, orthern frms could sell more and orthern workers gan more. Our results n (7c) and (7d) show that ths s only true f unons are employment orented. 3. Effects on Frm Profts How about frm s proftablty? Frst, let us check whether a rse n L n a country rases frm s producton costs n both countres. Dfferentaton gves: where C = dc dw dq = q + w, =, d d d wq.whle the frst term on the RH (rght hand sde) s postve snce dw / d > as n (7a), the second term s postve f < 1 and negatve f > 1 as n (7b). One can verfy that the net effect s postve for a large doman of, whch leads to the followng lemma. dc Lemma : > for a large doman of (, ) d wth (1 + 3, ). Proof: We only prove the case for the orth. That for the outh can be done analogously. Detaled calculatons yeld: 3 For nstance, n Zhao (6), an ncrease n L mproves workng condtons and nduces hgher work efforts, resultng n hgher outputs. 7

9 ( ) ( ) ( ) ( dc / d = ( 1) + 3 ( 1) ( 1) + qq p ' π + qw) /. The sgn of the expresson n square brackets depends on the value of. Frst, f <1, t s postve. econd, f >1, we set the expresson n brackets equal to zero and solve for, whch gves: = Here > for (,1). In ( )/( ) partcular, (1 + 3, ), and = 1+ 3 when = 1, whle = when =. Therefore, Lemma holds for a large doman of (, ) wth (1 + 3, ). QED The above result mples that the barganng power granted the unon works as a costly factor to frm s producton actvtes, whch s n lne wth the conventonal wsdom that an ncrease n L would rase producton costs and lower profts. ow we turn to the effects of L on frm profts, and show that the conventonal wsdom s only partally correct n the present model. Appendx proves the followng results: dπ d dπ d > f <, < f >, > f <, < f >, < where 1 where 1 <, (8a), (8b) dπ j < f < 1, where, j =, and j, (8c) d > f > 1, dπ dπ >, <. (8d) dt dt Frst, (8a) and (8b) say that an ncrease n L rases frm profts f the labor unon s suffcently employment-orented, but reduces them otherwse. The frst part s aganst conventonal wsdom. uppose that unons are employment-orented. The ncrease n orthern L rases the unon wage and employment by (7a) and (7b), but t also lowers the outhern frm s employment and thus output by (7c). The former two effects work negatvely to the orthern frm s profts through costs, whle the last effect ntensfes competton n the market. If the unons are suffcently employment-orented ( < for the orth and < for the outh), the competton effect may outwegh the cost effect and as a result the orthern frm s proft ncreases. ext, (8c) shows that an ncrease n L n a country reduces frm profts n the other country f 8

10 labor unons are employment-orented, but t rases them otherwse. uppose that unons are employment-orented. An ncrease n outhern L reduces the orthern employment by (7c), whch deterorates the orthern frm s compettveness n the market. Ths effect may domnate the benefcal effect on costs (as through (7c) and (7d)), and thus the orthern frm s proft decreases. Fnally, (8d) s as expected, sayng that the tarff ncreases the proft of the orthern frm but reduces that of the outhern one. We summarze these results as: Proposton 1: An ncrease n country s L, () lowers the proft of ths country, unless the unon s suffcently employment orented, n whch case t may rase the proft; () reduces (rases) the proft of the competng country f the unon s employment (wage) orented. Ths proposton mples that regulatons to rase the outhern L may hurt the orthern frm f the unon s employment orented, contrary to the orgnal ntensons of orthern labor actvsts and other orthern nterest groups who lobby to force up outhern L. However, such regulatons are effectve f unons are wage orented. 3.3 Effects on Unon Utlty ext, we look nto the effects of an ncrease n L on unon utlty. For =,, du u dw u dq = +. (9) d w d q d Whle the frst term on the RH s postve snce dw / d > as n (7a), the second term s postve f <1 and negatve f >1 as n (7b), whch leads to: du Lemma 3: d > for (, ). Proof: Agan we only prove the case for the orth. After some calculatons, usng dw / d, dq / d and the equalty of p ' q = w n Appendx 1, we can rearrange (9) as follows. du d 1 1 = ( p' ) ( q) quw ( π + qw) ( ( 1) + 3) ( ( 1) + ), 9

11 whch s postve for (( ) ) ( (, ), snce the expresson n square brackets s postve: ( ) ( ( ) ) 1/,1) and ( 1) + 3 > 1 + >. QED Ths lemma shows that a hgher L ncreases the unon s utlty regardless of ts preference towards wage versus employment. And the orthern tarff has the followng effects: du u dw u dq = + >, (1a) dt w dt q dt du u dw u dq = + <, (1b) dt w dt q dt because dw / dt and dq / dt are postve and dw / dt and dq / dt are negatve (see secton 3.1 and Appendx 1). As expected, a hgher tarff protecton of the orth aganst the outh would effectvely ncrease the orthern labor unon s wage, employment and thus utlty, regardless of the unon s preference towards wage and employment. And exactly the opposte apples to the outhern unon. 3.4 Effects on Consumer urplus nce output s consumed n the orth only, ts consumer surplus can be expressed as ϕ ( q + q ) v( q + q ) ( q + q )p. Dfferentaton yelds; where dϕ dq ( + q) = p'( q + q) d d ( )(( ) ) v ' = p and d( q + q )/ d = ( p' q / )( π + q w ) ( 1) /, whch s postve f <1 and negatve f >1. Thus, f the unons are employment orented, an ncrease n L rases the total quanttes provded by both frms, lowerng the market prce. As a result, consumers beneft. However, f the unons are based toward wages, a hgher L reduces ther negotated employments and the total quanttes provded n the market as well, ncreasng the market prce and lowerng consumer surplus. 4. Optmal L and Tarff 1

12 In ths secton we solve for optmal polces n terms of L and tarffs, by maxmzng natonal welfare consstng of consumer surplus, frm profts, labor unon utlty and the tarff revenue, wherever applcable. 4.1 The orthern Government By substtuton, the orth s welfare functon n (4a) can be rewrtten as: Φ = vq ( + q) pq wq + u( w, q) + tq. Dfferentaton yelds: Φ d( q + q) dq dq q dw dq = ( p pq ) p + t + ( w w) + ( w w) d d d w d d where v ' = p, d( q + q )/ d s postve f < 1 and negatve f > 1 (see ecton 3.4). If < 1, the frst square bracket on the RH s postve and the second one s negatve. If > 1, then the sgns are reversed. And regardless of, the last bracket s negatve. To fnd out the optmal orthern L, we may solve Φ / = for. Let us denote t by. On the other hand, the welfare-maxmzng optmal tarff s gven by: Φ d( q + q) dq dq q dw dq = ( p pq ) + t + q p + ( w w) + ( w w) t dt dt dt w dt dt ( ) where dq q dt pqq ( ) ( + )/ = ' <. The frst bracket s negatve. The second one s postve, provded that the tarff s small. And the thrd one depends on : It s negatve f < 1 and postve f > 1. However, we can show that the optmal tarff t must be postve. The proof s straghtforward: uppose Φ / =. ubsttutng t = nto the long expresson above for Φ / t, we obtan t t Φ / > because of t( dq / dt) <, resultng n a contradcton. t t= 4. The outhern Government Maxmzng (4b) yelds: Φ d( q + q) q dw dq dq = p' q + ( w w) + ( p t) + ( w w) d w d d d where dq q d ( pq )( qw) ( ) ( )(( ) ) ( + )/ = ' / π / s postve f 11

13 < 1 and negatve f > 1. If < 1, the frst bracket on the RH s negatve and the second one s postve; f > 1, the frst bracket becomes postve and the second becomes negatve. Regardless of, the last bracket s negatve. To fnd out optmal outhern L, we may solve Φ / = for. Let us denote t by. 4.3 The Analyss We are n a poston to state: Proposton : Regardless of the tarff system, the optmal L n each country s weaker f > 1 than f < 1. That s, <. > 1 < 1 Proof: We only prove the case for the orth. That for the outh can be done analogously. uppose + = 1 ε and = 1+ ε, where ε > and small. Denote the optmal L that satsfes + + Φ / = when = 1 ε, and that satsfes Φ / = when = 1+ ε. After some calculaton, we obtan the followng FOC: Then, Φ, ( )(( ) ) = pq / 1 ε π + q w A=, where 1 ε (( p p' q)( 1 ε) + ( p t) + ( w w)( ε) ) ε 1 ε A =. q 1 ε p' ( ( 1 ε) w w)( 3 ε) w + ow, changng = 1 ε to = 1+ ε n the above FOC yelds: Φ +, ( )(( ) ) = pq / 1+ ε π + q w B, ( ) ε 1+ ε ( p p' q)( 1+ ε) + ( p t) + ( w w)( + ε) 1 ε + where B =. q 1+ ε p' ( ( 1+ ε) w w)( 3+ ε) w Φ s not zero any more snce s the optmal L for the case of / +, 1

14 = 1 ε. To verfy the sgn, subtract the former from the latter. Then we have: Φ Φ +,, To see ths negatve sgn, note frst that / +, <. (11) B > A>. And the term n front of B n Φ s negatve and has a larger absolute value than a smlar term n front of A n Φ. Thus, (11) s negatvely sgned. Also, snce /, Φ s zero, we must /, have Φ <. Ths mples that / +, + + <. o n general, we have < > 1 < 1, whch s true under free trade as well. Refer to Fgure 1. QED Φ Φ = + = 1 + ε = 1 ε Φ + < + Fgure 1: L - wage vs. employment orented unons Proposton mples that each government may tend to choose weaker L when unons are wage-orented. Wage-orented unons pursue hgher wages at the expense of a lower negotated employment, rasng the frm s costs and lowerng ts proftablty. As a consequence, the government may try to reduce the unon s barganng power by choosng a lower labor standard. Ths fndng s assocated wth the argument of a race to the bottom, whch we wll further dscuss later n Proposton 4. ext, we nvestgate how the tarff affects the orthern L compared wth free trade. 13

15 Proposton 3: Each country s L s lower under the optmal tarff than under free trade f < 1, and the opposte s true f > 1. Formally, () If < 1, then < ; () If t > t = > 1, then >. t > t= Proof: Agan t suffces to prove the case for the orth only. Under the optmal tarff, t, the optmal L satsfes, p p' q ( 1 + 1) + ( p t ) ( w w )( ( 1) ) ( ) ( ) 1 Φ ( pq / )( qw = π ) =. q p' ( w w) ( ( 1) + 3) w ow consder a free trade system wth t=. Then from the above expresson one can verfy that Φ / t= > f < 1 and Φ / t= < f > 1, whch mples the proposton. These are llustrated n Fgure. QED [Case: < 1] [Case: > 1] Φ Φ = Φ Φ = Φ > t > t > Φ < t = t = Fgure : L - optmal tarff vs. free trade Proposton 3 mples that mposng a tarff to force the outh to rase ts L s only effectve f the unon s wage-orented. If the unon s employment orented, the outh would choose a lower 14

16 L n response to orthern pressure. Thus, t further mples that trade lberalzaton n the orth may rase outhern L n the latter case, whch s n lne wth the argument that the best way to rase outhern L s to keep orthern markets open. In addton, ths case confrms the emprcal fndngs of eumayer and oysa (6) that countres that are more open to trade have fewer rghts volatons than more closed ones. In the last part of ths secton, we look nto the ssue of a race to the bottom of L. We can establsh: Proposton 4: A race to the bottom of L arses only under two condtons: each government does not care about unon utlty, or the unon s suffcently wage-orented. In other cases, t does not arse. Proof: () Let us frst prove the case for the outh, whose welfare conssts of frm profts and unon utlty, snce consumpton occurs n the orth only. Fgure 3 shows that an ncrease n L rases frm profts and unon utlty f the unon s suffcently employment- orented (.e. f < ' n Fgure 3). If the unon s wage-orented ( > 1), then an ncrease n L reduces frm profts, but t stll rases unon utlty. Therefore, the optmal L can be stll postve. It becomes zero only f the unon s suffcently wage orented, at a pont '', where at '', Φ / = π / + u / =. Also, n the specal case that the government does not care about unon utlty, the unon utlty does not enter the government s objectve functon and thus the government chooses zero L f > ' (.e., Φ / = π / < f > ' ). () The proof for the orth s more complcated, snce orthern welfare ncludes consumer surplus and tarff revenue. Let us look at the case of near free trade,.e., t, then the effect on the tarff revenue dsappears. nce an ncrease n L rases consumer surplus ( dϕ / d > ) f < 1, t moves the pont for Φ / = to the rght of '', say a pont such as '''. That s, only f ''', then the orthern governme nt would choose a zero level of L. QED 15

17 dϕ / d >, d( tq )/ d < dπ / d > dϕ / d <, d( tq )/ d > dπ / d < ' 1 '' ''' du / d > Fgure 3: Welfare decomposton 5. ome Extensons In ths secton we ntroduce two extensons of the basc model. One s to ncorporate asymmetrc labor unons n terms of preferences across countres and the other s to look nto the effects of economc ntegraton. We analyze how these affect L choces n the two countres. 5.1 Asymmetrc Labor Unons o far, we have treated both labor unons as havng dentcal preferences towards wage versus employment. What f ths s not the case? Here we can consder four asymmetrc cases: Frstly, the orthern labor unon s wage-orented whle the outhern unon s employment-orented,.e., > 1 and < 1. econdly, the orthern unon s employment orented whle outhern unon s wage orented,.e., < 1 and > 1. Thrdly, the unon s more wage orented n country than that n country, j,.e., > > 1. Lastly, the unon s more employment-orented n country j than that n j,.e., < < 1. We also examne the frst two cases wth and wthout free trade. The results are summarzed as follows. j Proposton 5: When the labor unons n the two countres have asymmetrc preferences over wages and employments, the governments set ther optmal L as follows: () < < < > 1, t= > 1, t> < 1, t> < 1, t=, 16

18 () < < <, > 1, t= > 1, t> < 1, t> < 1, t= () ' 1 > j> < = j> 1 for a gven tarff t, and (v) < for a gven tarff t. = j< 1 ' < j< 1 Proof: uppose. Then, from Proposton 3, we have < and > 1, t= > 1, t> < < 1, t> < 1, t= ; and 1, < t> < < 1, t= and 1, > t= < > 1, t>. In addton, from Proposton, we obtan < and gven a level of the tarff. > 1 < 1 < > 1 < 1 Usng all these rankngs, we derve () and () n Proposton 5. For () and (v), t suffces to prove the case for the orth only. Frst, for (), suppose that = > 1 and the orth chooses a that satsfes the followng FOC condton: ' ( 1 + 1) + ( ) ( w w )( ( 1) ) ( ) ( ) 1 p p q p t Φ ( pq / )( qw = π + ) + + =. q p' ( w w) ( ( 1) + 3) w Gven, f further ncreases slghtly, then /, ' Φ < from the above FOC. The new optmal level of L for the orth becomes lower. As for (v), suppose that = < 1 and the orth chooses a that satsfes the above FOC. ow, f further decreases slghtly, we can smlarly verfy Φ / >. And the new optmal level of L for the orth, ' becomes hgher. QED It s qute common to observe that developed countres sustan relatvely hgher labor standards than developng countres. The above Proposton shows that ths may be a reflecton of dfferent preferences of ther labor unons: The orthern unon may be more nterested n employment than the outhern one. And n the extreme case that the orthern unon s employment orented whle the outhern one s wage orented, the L dfferental between the two countres s the hghest under free trade. 17

19 5. Economc Integraton and outhern L Does regonal economc ntegraton ncrease L? From Proposton 3, we learned that the outhern government may choose a hgher L under the optmal tarff system than under free trade system f labor unons are wage-orented. Put another way, ths mples that the orthern tarff on outhern mports s an effectve way to rase outhern labor standards f labor unons are wage-orented. In ths secton, we further nvestgate the ssue of economc ntegraton. In partcular, what we have n mnd s the effect of some outhern countres accessons to the World Trade Organzaton or to the European Unon, where member countres lose ther dscretonary choce of mport tarffs (.e., free trade s mandatory). And they may as well cooperate over non-tarff ssues such as labor standards. Our queston s whether such a deeper economc ntegraton ncreases ther L or not. To see ths formally, we change the game structure as follows. In the frst stage, both governments determne ther L cooperatvely, and the orthern government abdes by the agreed-upon zero tarff; and n the second stage, the labor unon and the frm negotate to determne wages and employment n each country smultaneously. The second stage of the game can be solved as n earler sectons. ow to fnd out the optmal L, both governments maxmze ther jont welfare choosng the two L, gven a zero-tarff system. They yeld the followng FOCs: Φ ( +Φ ) = and Let us denote the orthern optmal L as ( Φ +Φ ) =. E and the outhern one as E, where the superscrpt E stands for economc ntegraton. We are now n a poston to compare whether greater or smaller than the optmal L, L n prevous sectons. E s, under the full dscretonary regme over tarffs and Proposton 6: After economc ntegraton, f countres cooperate over L, () then they tend to choose hgher L than n the absence of the economc ntegraton f labor unons are wage-orented; () If labor unons are employment-orented, the effect of economc ntegraton on L s ambguous. Proof: When pluggng the ndvdual optmal L nto the FOCs, the followng equaltes must hold, 18

20 ( Φ + Φ ) Φ Φ Φ = + = +, ( Φ + Φ ) Φ Φ Φ = + = +. These equatons are not necessarly zero. To see ther sgns, note frst, Φ D+ E =, where d( q + q) dq 1 D p' q + p = p' q( π + qw) p+ p' q( ( 1 ) 1) d d, q dw dq and E ( w w) ( w w) w d + d. D s postve f > 1 and negatve f < 1, whle E s always postve. Therefore, f > 1, we have ( Φ +Φ )/ = Φ / > ; that s, the optmal L under economc ntegraton s greater than wthout ntegraton. If < 1, ( Φ +Φ )/ = Φ / s ether postve or negatve, dependng on the relatve sze of D and E. Φ G+ K econd, =, where G and K can be wrtten smlarly as D and E, wth the subscrpts and swtched. nce the orthern government cares about consumer surplus, G shows that an ncrease n the outhern L brngs ambguous effects. However, f we assume s not extremely hgh or small, the bracket n G becomes postve. Then, f > 1, Φ ( +Φ )/ = Φ / >, mplyng that the optmal L wth economc ntegraton s greater than wthout ntegraton; If < 1, ( Φ +Φ )/ = Φ / s ether postve or negatve, dependng on the relatve sze of G and K. QED The mplcatons of the above proposton are nterestng. uppose that labor unons are wage-orented. Then the free trade system of the orth results n a lower L n the outh as compared to under the optmal tarff, as shown n Proposton 3. And n order for the orth to rase outhern L, t must abandon the free trade regme and mpose a postve tarff aganst outhern mports. However, Proposton 6 says that f both countres cooperate over the L to maxmze ther 19

21 jont welfare under the free trade system, then t s possble for the orth to nduce the outhern government to choose a hgher L, wthout gvng up the free trade regme. 6. Concludng Remarks In ths paper, wth a settng of a orthern frm competng aganst a outhern exporter n the orthern market, we nvestgated how governments set labor standards when labor unons have a based preference towards ether wages or employment. The followng results are noteworthy. Frst, gven a level of labor standards and tarff, an ncrease n a country s labor standards rases the proft of the country and reduces that of the competng country, f labor unons are suffcently employment-orented. Otherwse (.e., wth wage-orented unons), the opposte s true. econd, gven any tarff level, governments choose hgher labor standards when labor unons are employment-orented than when they are wage-orented. Thrd, the outhern government chooses hgher labor standards when the tarff s at the orthern government s dsposal than when t s not (.e., under free trade), f labor unons are wage-orented. Otherwse, the opposte s true. Lastly, a race to the bottom of labor standards may arse f ether () each government does not care about unon s utlty or () the unon s suffcently wage-orented. A race to the bottom of labor standards s more lkely to arse under free trade than under an optmal tarff. We extended the analyss to two more nterestng cases. Frst, we consdered asymmetrc preferences of labor unons. We found that the orth sets hgher L than the outh, when the orthern unon s more employment-orented than the outhern unon. econd, we consder the effect of economc ntegraton between the orth and the outh on ther L decsons. We showed that both countres cooperatvely choose hgher L n order to maxmze ther jon welfare even f ther labor unons are wage-orented. Another nterestng extenson would be to ntroduce multnatonal corporatons and foregn drect nvestment, where the orthern frm has a outhern branch and t bargans wth the outhern labor unon. The orthern multnatonal frm can use ths stuaton as a threat aganst the orthern labor unon as well as the outhern one, n case ether of the negotatons breaks down. The threat of gong multnatonal would reduce the unon wage premum regardless of unon preferences. However, the outhern labor unon has a better poston than the orthern one snce t deals wth two frms, the outhern frm and the outhern branch of the orthern frm. Ths would postvely affect the negotated wage and employment. The fnal effect mght be ambguous. We leave t for future studes.

22 Appendx 1 Totally dfferentatng the FOCs (6a~6b) n the second stage yelds (for, j =, ; j ): G G π w w q q G 1 π π dw w q q q dq d G G π = d G G dw dt w t w q dq w w q G π 1 π q t q q q G π where = ( 1 ) q = ( 1 ) 1 q w w <, G π G = ( 1 ) w = w <, = π + wq >, w q q w G π G 1 G π = = pq ' <, =, = = p" q + p' <, w qj qj q w q q G π G G = = p" q + p' <, = q <, and = 1<. q q q q w t q t j j The determnant of the 4 by 4 matrx on the left hand sde can be expanded as: G G π π π π 1 π π G G = + w w q q q q q q q q w q w q We have π = (1 ) qw for =, from (6a), and w / + p' q + p w = and w / + p' q + p t w = from (6b). Multplyng to the second equatons n (6b) and π G usng π = (1 ) qw, we obtan pq + w =. Ths mples = qj w q, makng the nd bracket on the RH of zero. Hence, > provded that the own effects (the 1st term n 1st bracket) domnate the cross effects (the rest of terms n 1st bracket). For smplcty we evaluate the comparatve statc results at p " =. (Our results hold as long as the margnal revenue s decreasng n output,.e., as long as p '' s not extremely postve.) Then we obtan the results shown n secton 3.1 as follows. For, j =, and j; dw = ( j( 1) + 3 )( p' ) qj( π + qw ) >, d 1

23 dq f 1 1 > < = ( j( 1) + ) pq ' j( π + qw ), d < f > 1 dw f 1 < < = ( 1 ) ( p' ) q( π j + qjwj), d j > f > 1 dq f 1 1 < < = pq ' ( π j + qw j j), d j > f > 1 dw ( ') dq = p qq >, = pqq ' >, dt dt dq dw dq = ( ( 1) + ) pqq ' <, and = p ' <. QED dt dt dt Appendx Proof for (8a) and (8b): dπ (( π qw) p' q / )[( 1)( ( 1) )( p w) p' q( ( ) (1 )) ]. d = After some calculaton, we can verfy that dπ / s negatve f > and postve f <, where (,1) s a crtcal value of that gves dπ / d =. The proof of exstence of the crtcal value s as follows. uppose dπ / d =, mplyng: d ( 1)( ( 1) )( ) ' [( ) (1 negatve, + p w = p q + + )]. It s clear that snce the RH s n the LH must be less than 1 (by defnton t s greater than ). And (9b) can be proved analogously, by replacng dπ / d =. QED wth, where s a crtcal value of that yelds Proof for (8c): dπ 1 = q( π + qw) p'[ p' q(1 ) ( p w)]. d Here, dπ / d < f < 1and dπ / d > f > 1. We can straghtforwardly prove for the case of dπ / n a smlar way. QED d Proof for (8d): dπ = ( pqq ' / )[ ( p w) pq ' ( 1)] >. dt The proof for dπ / dt < can be done n a smlar way straghtforwardly. QED

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