DP5100 | Making Sense of Bolkestein-Bashing: Trade Liberalization Under Segmented Labour Markets

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23/06/2005

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Abstract

Trade liberalization is often met with sharp opposition. Recent examples include the so-called ?Bolkestein? directive, which allows service providers from a given EU member to temporarily work in another member country. One way to view such a reform is that it simply widens the range of goods that are tradable. This kind of reform is analysed in a two-country Dornbusch-Fischer-Samuelson style model, where labour cannot relocate to another sector upon a non-expected increase in the range of goods that can be traded. The effect of liberalization on the terms of trade tend to favour the poorer country (the ?East?), if (as assumed) the most sophisticated goods are tradable before reform. Second, under ex-post liberalization, there exists a class of workers in the West who are harmed because they face competition from Eastern workers and cannot relocate to other activities. But if the East?s economy is relatively small, their wage losses are not very large. Things are different, however, if there exist asymmetries in labour market institutions, such that upon reform, labour can relocate in the East but not in the West. Some workers in the West can then experience very large wage losses. Thus, rigid labour markets in the West magnify opposition to reform there.