We show the effects of a trade cost reduction on unionized wage, employment and domestic welfare when a domestic firm strategically chooses the amount of formal and informal outputs.
We develop a simple framework to show the effects of trade cost reduction on unionized wage, employment and domestic welfare when a domestic firm strategically chooses the amount of formal in-house production and subcontracting to the informal sector. We show that a lower trade cost increases unionized wage and domestic firm’s formal production and employment, and reduces its informal production. Free trade maximizes domestic welfare if the trade cost represents a transportation cost. However, if the trade cost represents a domestic tariff, the domestic welfare maximizing tariff is positive.
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Dibyendu Maiti and Arijit Mukherjee
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