Flexibility in wage setting under the threat of relocation

Relocation of production to countries with low labour cost have induced increased labour market flexibility, which has been praised as a silver bullet for economic growth and low unemployment. Within a unionised oligopoly framework, in which a multi-national firm has the option to relocate its production to a foreign country, we analyse the welfare implications of both centralised and flexible wage setting regimes. For very low foreign wages, wage flexibility leads to higher welfare than a rigid centralised regime. In contrast, for “intermediate” wage levels in the foreign country, an industry-wide uniform wage leads to higher social welfare than flexible wages.