Capital market integration and optimal employment protection policies

This study analyzes the effect of capital markets integration on labor market policies. To that end, it incorporates imperfect labor markets into a tax competition model. There exist two types of households, types 1 and 2, that are risk-averse. Each type of household is endowed with one unit of a worker. Additionally, households are endowed with capital. Type 2 households own lager amounts of capital than type 1 households. The government can choose the following policies: unemployment benefits and layoff, payroll, and capital subsidies or taxes. When capital markets are integrated, households can invest their capital in foreign capital markets. This study shows that the integration of capital markets leads to ine￠ cient policies under which labor productivity is high, but income inequality within a country and the risk of job loss are also high. As a result, the social welfare of each country in integrated capital markets is lower than in non-integrated capital markets