Offshoring, unemployment, and wages: The role of labor market institutions

a r t i c l e i n f o It is shown that when wages are determined through collective bargaining, there is a non-monotonic relationship between the cost of offshoring and unemployment. Starting from a high cost of offshoring, a decrease in the cost of offshoring reduces unemployment first and then increases it. The non-monotonicity of unemployment in the cost of offshoring does not obtain if wages are determined by individual Nash bargaining instead of collective bargaining. The non-monotonic relationship between the cost of offshoring and unemployment is verified through a calibration exercise performed using parameters for Sweden. The calibration exercise predicts that a decrease in the cost of offshoring, starting from the present level, would reduce unemployment in Sweden. In a two country framework of offshoring (source country and host country) it is shown how changes in the labor market institutions in one country affect labor market outcomes in both countries. There has been a resurgence of interest in analyzing the impact of globalization on unemployment. Most papers use models of search unemployment where wages are set through individual Nash bargaining between the worker and the employer, and therefore, do not take into account the role of collective bargaining in the wage setting process. This is a serious omission because for many European countries collective bargaining plays an important role in the wage setting process. When thinking about the importance of collective bargaining in an economy , people usually think about union density which measures the fraction of workforce that is unionized. Union density varied among OECD countries from a low of 8% in France to a high of 71% in Sweden in 2007 (OECD, 2010). However, union density grossly understates the percentage of workers covered by collective bargaining. This is particularly so in some countries like France where despite a very low union density, approximately 95% of workers are covered by collective bargaining (Venn, 2009). In general, in many European countries like Austria, Belgium, Finland, Norway, and Sweden a very high percentage of workers are covered by collective bargaining, much in excess of union density. However, in countries like the U.S., Canada, and Japan only a small percentage of employees are covered by collective bargaining. 1 This motivates us to study the implications of different wage setting institutions for unemployment in a globalized world. The facet of globalization that we study in this paper is offshoring …