On labour standards and free trade

The authors investigate the effectiveness and efficiency of alternative measures to increase standards in low-income countries. The authors investigate the effectiveness and efficiency of alternative measures to increase standards in low-income countries. They do this in a two-country framework where (a) trade and standards in low-income countries are negatively related, and (b) free trade is no longer optimal for the high-income country due to a negative psychological externality that low standards in low-income countries exert. We find that any uncoordinated, unilateral action by the high-income country to decrease the psychological externality is dominated by coordinated action; both with respect to the psychological externality as with respect to the welfare consequences for both countries. Since any increase in the standard in the low-income country decreases their welfare, co-ordination is not always a feasible solution. Only when incorporated in the framework of the WTO, co-ordination can be made incentive compatible and gives rise to a situation where free trade again works to the advantage of both countries.