Asymmetric Labor Markets, Southern Wages, and the Location of Firms

This paper studies the behavior of firms towards weak protection of labor standards in developing countries (South). A less than perfectly elastic labor supply in the South gives firms an oligopsony position in the labor market tempting them to strategically reduce output to cut wages. In an open economy, competitors operating where labor standards are recognized meanwhile enjoy less aggressive competitors and raise output. Delocation also increases Southern wages and triggers a competition effect, lowering ex post output and hence potential profits of a relocating firm. These effects reduce relative profitability of moving production to the South casting doubts on traditional beliefs that multinationals are attracted to regions with lower wages. Moreover, adopting a minimum wage policy in the South eliminates the oligopsony distortion and improves competitiveness of Southern firms in the world product market. It also enhances consumer and wage surplus in the South and hence unambiguously raises Southern welfare.