Trade Liberalisation and Labour Market Institutions

Who does trade liberalisation benefit?

Critics of economic globalisation in the political arena and the political economy literature recently converged in depicting trade liberalisation as a policy choice that concentrates wealth in the hands of the few, at the expense of the many. Indeed, open trade policies have been demonstrated to produce significant gains only for a small subset of highly productive “superstar” exporters and globally engaged firms.

Such “superstar” firms and the high-skilled workers they employ tend to be the winners of the current era of globalisation. In contrast, small, relatively unproductive firms and unskilled workers have seen little benefit from trade openness and, in fact, their economic conditions have deteriorated over the past 30 years in advanced economies.

How can the gains of liberalisation be better distributed?

Our research focuses on this phenomenon and aims to better understand the conditions under which open trade policies produce more (or less) uniform gains across different economic systems. We start from the intuition that economic globalisation and trade liberalisation are not bound to have the same impact everywhere; the distribution of gains and losses is not identical across economies, and domestic institutions matter.

More specifically, we show that domestic labour market institutions affect the way in which gains from open trade policies are realised across firms. Our article points to the joint effect of coordination in wage bargaining and state-subsidised vocational training that help mitigate the “winner-takes-all” effect of trade openness, thus producing more uniform gains from trade.

Our theory combines the insights of the New New Trade Theory with the insights of the Variety of Capitalism. We argue that in coordinated market economies such as Germany, which feature the presence of an institutionalised wage ceiling and the availability of subsidised vocational training, wages grow less as a result of trade liberalisation, which helps them better withstand foreign competition. We therefore posit that gains from trade are significantly more even in coordinated market economies than in liberal market economies such as the UK.

What the data show

We offer two sets of evidence in support of our claims. First, we use firm-level data from EU countries (available data from 2003 to 2014; including more than 800,000 firms), looking at the combined effect of firm productivity, tariff reduction, and coordination of wage bargaining on firms’ revenues. We find that, for productive firms, gains from trade are 20 per cent larger in countries with liberal market economies than they are in coordinated market economies.

This indicates that in liberal market economies, where wages are governed by market arrangements, gains from trade agreements at the firm level are much more concentrated in the hands of large, productive firms who accrue the lion’s share of benefits. In contrast, we show that in countries with coordinated market systems, winners from trade openness are distributed more equally across firms. This finding points towards the importance of domestic institutional mechanisms, which help cushion the impact of economic globalisation.

Second, we look at the effect of this cross-country difference in distribution on individual preferences. Here we investigate whether or not more or less uniform gains from trade liberalisation also shape preferences over distributive policies.

In theory, demands for redistribution should be higher in countries that face starker distributional consequences from trade liberalisation. This is simply because in such cases the economic impact of open trade policies would result in higher concentrations of gains, leaving more people exposed to (real or threatened) economic hardships. In order to shed light on this expectation we rely on European Social Survey data and show that indeed, trade liberalisation triggers a differential demand for redistribution at the individual level across different labour markets and regions, which is in line with our firm-level analysis. Individual demands for redistribution resulting from the negative impact of trade liberalisation are significantly lower in coordinated market economies than in liberal market economies.

Real-world implications

Our findings have important real-world implications. The conventional wisdom has it that labour market frictions tend to produce high unemployment and sluggish economic growth. Our piece shows that labour market frictions can produce long-term benefits too, efficiently complementing compensation policies designed to mitigate the backlash against globalisation within developed democracies.

While certain political systems might prefer bolstering superstar “champion” firms that benefit from higher concentration of gains from international trade, others might find that more even distribution of gains across firms can help better contain the backlash against globalisation.

 

Authors’ biographies:

Leonardo Baccini is an Associate Professor in the Political Science Department at McGill University and a Research Fellow at CIREQ. He is a National Fellow at the Hoover Institution at Stanford University in the 2020-21 academic year. His research interests are in the area of international political economy and comparative political economy.

Mattia Guidi is an Assistant Professor of Political Science at the Department of Social, Political and Cognitive Sciences of the University of Siena. His research focuses on public policy, European Union politics, globalisation and the politics of regulation.

Arlo Poletti is an Associate Professor in the Department of Sociology and Social Research at the University of Trento. His research interests are in the area of international relations and political economy with a focus on interest group mobilisation, trade policy, and regulatory cooperation.

Aydin B. Yildirim is a Marie Curie Postdoctoral Fellow at the World Trade and a Visiting Fellow at the European University Institute. His research focuses on political economy of international trade, multinational corporations, and international organisations.