Union behavior, industry rents, and optimal policies

This paper examines the welfare gains from strategic trade and industrial policy in the U.S. steel industry, focusing particularly on the potential gains from capturing labor rents. I take into account product market distortions such as price-setting firms, factor market distortions in the form of union-created labor rents, and the presence of fixed capital and underutilized capacity in U.S. steel production. ; The existence of underutilized capacity means that firms respond to protection by reducing the share of labor in production, eliminating the rents targeted by the policy and thus reducing the potential gains. At the same time, the union takes advantage of protection to "skim off" rents, further reducing the effectiveness of the optimal policy. Taking into account these endogenous responses substantially reduces the welfare gains from optimal policies. And simply reducing domestic labor market distortions results in a welfare gain nearly as large as that from optimal policies. This suggests that the focus on labor rents as the subject of U.S. trade and industrial policy is overstated, at least in manufacturing industries such as integrated steel.