International Political Spillovers: The Case of Labour Market Regulation

This paper explores how the political support for Labor Market Regulation (LMR) is affected by economic and political integration in a two-country overlapping generations model where countries behave strategically. We model LMR as wage regulation and analyze three institutional settings: Autarchy, Economic Union and Political Union. We show that, if the economy is dynamically efficient, the support for labor regulation is lower in the Economic Union - characterized by capital mobility - than in Autarchy. This decreases the welfare of the owners of the less mobile factor (labor) even in a setting where today workers are next period capitalists. A Political Union restores, under symmetry, the autarchic outcomes and welfare levels. The asymmetric case is also analyzed