Labor policy and multinational firms: The “race to the bottom” revisited

This paper revisits the “race to the bottom” phenomenon in a simple game theoretic framework. We consider one multinational firm, which requires two inputs that are imperfect substitutes, and two countries. In the benchmark model the labor of each country specializes in a distinct input. Seeking to maximize their labor incomes, countries simultaneously announce wages after which the firm chooses its labor employment in each country. We show that “race to the bottom” (countries setting minimum possible wages) is never an equilibrium. Moreover there are equilibria with “race to the top,” that is, countries set maximum possible wages. This result is robust in an extended model where prior to competing in wages, each country can make input‐specific investments to make its labor available for one or both inputs. Provided the production function of the firm is not asymmetrically intensive in either one of the two inputs, there are equilibria of the extended game with specialization (i.e., countries invest in distinct inputs) as well as “race to the top.”