On the Political Economy of Industrial, Labor and Social Reforms as Complements

We study the coordination between industrial, labor and social policy when voting determines policy choices. Firms choose to invest in either an old or a new sector. Most workers have skills constraining them to work in the old sector. A minority of workers are more productive in the new sector, and choose to be active where they expect a higher wage. Aggregate surplus is higher if firms invest in both sectors and workers are employed where they are the most productive. We identify conditions for such a modernized economy to develop. First, any labor policy must give workers enough bargaining power to have incentives to find the right job. Second, for an industrial policy to stimulate the new sector, a social policy involving both workers and firms must compensate the losers of modernization. Third, policies must be delegated to a social planner able to commit to the joint implementation of reforms and transfers.