Market power, Growth and Unemployment
Unemployment occurs when some agents, say unions, have control over the wage and set it above the market-clearing level. In other words, it is generated by their exercise of market power. What if, in addition, firms have control over prices in the product market? In this case, market power of wage setters interacts with market power of price setters. Understanding this interaction sheds new light on the effects of policy interventions on unemployment and growth. Reforms that result in lower labor costs reduce unemployment and boost growth because they expand the scale of the economy and generate more competition in the product market. The reduction in unemployment is larger than one would expect if the pro-competitive effect of the reforms were ignored. These reforms, thus, are even more attractive when one considers the endogenous structure of the product market. If they are implemented jointly with a reduction of barriers to innovation in the product market, an even larger reduction in unemployment and increase in growth is achieved.
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