DP1445 | Trade, Wages and the Persistence of Underdevelopment

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We consider a small, unionized economy which interacts with an economically larger one, and we study the growth implications of different institutional structures for the labour markets. We study three possible scenarios. Under decentralized bargaining in the large economy, the two countries converge to the same level of wages and income, even though these levels will be lower than under perfect competition. Under centralized bargaining in the large economy, the small one will end up with a higher capital to labour ratio and GDP in the steady state. This outcome will not necessarily be associated with higher wages and per capita GNP, however. Another possible scenario, with a competitive labour market in the large economy, predicts long-run equalization of per capita capital and production, but lower wages and per capita GNP in the small economy.