Welfare Policy in the Presence of Unionised Labour and Internationally Mobile Firms

In oligopolistic industries, increased cost saving opportunities via offshoring have a moderating effect on trade unions. In order to discourage mobile firms from leaving the country, unions accept lower sector wages. In effect, the negotiated wage becomes independent of workers’ bargaining power and their domestic outside opportunities. Hence, wage moderation - induced by deeper economic integration - creates leeway for the government to engage in redistributive policies even if this improves the workers’ outside options. Only if the latter become sufficiently attractive will redistribution induce some offshoring, and it is only at that level that further economic integration will lead to both wage moderation and offshoring activities. Therefore, our analysis suggests that rather than provoking a downsizing of the welfare state, offshoring defines an upper limit for the generosity of the welfare state below which redistribution becomes less instead of more distortive.