National labour market policies and international trade : Does policy coordination pay ? ∗

National labour market institutions interact across national boundaries when product markets are global. Labour market policies can thus entail spill-overs, a fact widely ignored in the academic literature. This paper studies the effects of wage subsidies in an international duopoly model with unionised labour markets. We document both positive and negative spill-over effects and discuss the benefits and costs from international policy coordination. While such coordination has been discussed among policy makers, especially within the European Union, little progress has been made in its implementation. Our results suggest that institutional differences could sign responsible for the slow speed at which labour market policy coordination has progressed so far. Not only does cooperation reduce the capability of governments to adapt their policies to country-specific institutions, the benefits and costs are also unevenly distributed among cooperating countries. International policy cooperation can thus be difficult to enforce, even if it increases aggregate welfare.