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In contrast to the existing partial equilibrium literature considering the effects of a trade cost reduction on unionised wage under a given market structure, we show the effects by determining the domestic market structure endogenously. A lower trade cost reduces the number of active domestic firms, but it increases unionised wage in the active domestic firms under decentralised unions. Although a lower trade cost increases wage in the active domestic firms, it reduces domestic employment and total union utility at the free entry equilibrium. So, a trade cost reduction benefits domestic employed workers by increasing the unionised wage, but its effect on the total domestic workers is not favourable. If there is a centralised union, a lower trade cost reduces the number of active domestic firms, unionised wage, domestic employment and union utility.

Government policies and/or technological progress are reducing trade costs1 significantly in recent decades. While the general belief is that a trade cost reduction benefits the consumers and increases welfare of the importing country, there is concern about its adverse effects on wages. While the earlier literature has focused on competitive labour markets (Stolper and Samuelson, 1941),2 recent literature uncovers the effects on the unionised wage also. This concern is more severe in Europe, where the presence of labour unions is prominent in many countries. As documented in OECD (2004), the proportion of workforce under union agreements was 67% in Europe, while it was 14% in the USA. Rodrik (1997) points out that globalisation reduces the power of the trade unions and creates an adverse wage effect. As documented in Niblett (2005), the negative perception in the European Union towards increased globalisation is an important reason for the rejection of the European Constitution by French and Dutch voters. The theoretical results of Huizinga (1993) and Sørensen (1993) confirm this concern, yet there are other views suggesting that a trade cost reduction may increase the unionised wage. The factors attributed so far to the beneficial wage effect of a trade cost reduction are two-way trade cost reduction (Naylor, 1998, Naylor, 1999 and Gūrthzgen, 2002;3Munch and Skaksen, 2002), “efficient union-firm bargaining”4 (Gaston and Trefler, 1995), open shop unions (Bastos et al., 2009), trade in intermediate and final goods (Mukherjee and Liu, forthcoming) and formal–informal productions (Maiti and Mukherjee, forthcoming). The empirical evidence on this topic, although scarce, is also mixed (see, Gaston and Trefler, 1995; Konings and Vandenbussche, 1995). The theoretical papers with partial equilibrium analysis provide interesting insights on this topic, yet they are restrictive by considering a given market structure.5 We offer a new perspective by considering free entry in the domestic country, thus determining the domestic market structure endogenously. We consider decentralised (or firm-specific) and centralised (or an industry-wide) labour unionisation structures for our analysis.6 We show that a trade cost reduction reduces the number of active domestic firms, irrespective of the unionisation structure. However, it increases the unionised wage in the active domestic firms under decentralised unions, while it reduces the unionised wage under a centralised union. A lower trade cost creates two opposing effects under decentralised unions. For a given number of domestic firms, it reduces domestic wage, but it increases concentration in the domestic industry by reducing the number of active domestic firms. Fewer domestic firms following trade cost reduction tend to increase the unionised wage in the active domestic firms. We find that the latter effect dominates the former, and a unilateral trade cost reduction increases the unionised wage. Under a centralised union, wage is positively related to trade cost, irrespective of the number of domestic firms. While the above-mentioned wage reducing effect of a lower trade cost remains under a centralised union, it does not create the wage increasing effect. Thus, a trade cost reduction reduces the unionised wage under a centralised union. Therefore, the relation between a lower trade cost and domestic unionised wage depends on the unionisation structure. We also show that a lower trade cost reduces domestic employment and total union utility at the free entry equilibrium, irrespective of the unionisation structure. So, a trade cost reduction may benefit domestic employed workers by increasing the unionised wage, but its effect on the total domestic workers is not favourable. The remainder of the paper is organised as follows. Section 2 describes the model and derives the results under decentralised unions. Section 3 determines the effects of a trade cost reduction under a centralised union. Section 4 concludes.

Trade cost reduction creates concern about its effects on domestic labour markets and has attracted significant attention from the researchers. Although the existing literature has provided several important insights, it is restrictive by considering an exogenously given market structure. We provide a new perspective to this literature by determining the domestic market structure endogenously. We show that even if a trade cost reduction creates an adverse wage effect under a given market structure, if the domestic market structure is determined endogenously, a lower trade cost creates a favourable wage effect in the active domestic firms by reducing the equilibrium number of domestic firms if there are decentralised labour unions. In this situation, a trade cost reduction benefits domestic employed workers by increasing the unionised wage, yet its effect on total domestic workers is not favourable, since it reduces domestic employment and the total union utility. Under a centralised labour union, the unionised wage is independent of the number of firms. In this situation, a lower trade cost reduces the number of active domestic firms, the domestic unionised wage, domestic employment and the union utility. Hence, under an endogenous domestic market structure, the effect of a trade cost reduction on the domestic unionised wage depends on the unionisation structure. We have considered endogenous entry by the domestic firms only. Hence, it is implicit in our analysis that either there are no other foreign firms producing products which are substitutes to the products produced by the firms considered above or the costs of exporting to the domestic country are prohibitive for other foreign firms.16 However, if we relax these assumptions, it is natural that a lower trade cost may also encourage entry by other foreign firms. Since the net profits of the firms taking entry decisions are zero at the free entry equilibrium, it is intuitive that if there are free entry by both symmetric domestic and symmetric foreign firms and the marginal costs of the domestic and the foreign firms differ, only one set of firms (i.e., either domestic or foreign) remain in the market, depending on the trade cost. If the trade cost is very high, only the domestic firms produce. If only the domestic firms produce, a lower trade cost does not affect the domestic unionised wage until it encourages entry of the foreign firms. If the trade cost falls below a certain level, only the foreign firms produce. Hence, it is trivial that a significantly lower trade cost reduces domestic unionised wage compared to the situation with a significantly higher trade cost.