Wage bargaining, trade and growth

We construct a North-South product-cycle model of trade with fully-endogenous growth and union wage bargaining. Economic growth is driven by Northern entrepreneurs who conduct R&D to innovate higher quality products. Northern production technologies can leak to the South upon successful imitation. The North has two sectors: a tradable goods sector (manufacturing) where wages are determined via a bargaining process and a non-tradable sector (services) where wages are flexible. The South has only a tradable goods sector where wages are flexible. We find that unilateral Northern trade liberalization, in the form of lower Northern tariffs on tradable goods, increases the rate of innovation but decreases both the flexible and bargained wages in the North relative to the South. Unilateral Southern trade liberalization is neutral on the innovation rate but increases the Northern wages relative to the South.  We also consider a variant of the model with Northern unemployment, driven by a binding minimum wage in the non-tradable sector. In this case, the results of unilateral Northern liberalization are reversed: the innovation rate decreases and the bargained wage rate increases. The model thus highlights the role of labor market institutions in determining the growth and wage effects of tariff reduction. We also study the effects on welfare. In the case of flexible wages in the Northern non-tradable sector, Northern trade liberalization reduces Northern welfare. Hence, for welfare, positive dynamic effects associated with higher innovation and lower goods prices are dominated by the static effects associated with lower Northern consumption expenditures and a higher fraction of Northern industries with monopoly pricing. In the case of a binding minimum wage in the Northern non-tradable sector, Northern trade liberalization again reduces Northern welfare.