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Aggregate Scale Economies, Market Integration, and Optimal Welfare State Policy

  • Hassan Molana
  • Catia Montagna

Using a two-sector-two-country model with aggregate scale economies and unionisation, we show that optimal welfare state policy entails positive levels of unemployment benefits under free-trade and capital mobility. In this setting, economic integration does not reduce the revenue raising capacity of governments and thus does not lead to a race-to-the- bottom in social standards. Instead, trade and capital flows interact with welfare state policies in increasing welfare even when each government acts independently (non-cooperatively) in determining its optimal welfare payment. Cooperation is shown to improve upon noncooperative outcomes by raising both the generosity of the welfare state and aggregate welfare.

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Paper provided by Economic Studies, University of Dundee in its series Dundee Discussion Papers in Economics with number 172.

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Date of creation: Sep 2004
Date of revision:
Handle: RePEc:dun:dpaper:172
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