Liberalization of product and labour markets: Winners and losers

This paper studies the implications of higher flexi bility, or liberalization, in product and labour markets. We study both efficiency and distribution implications. The vehicle is a dynamic general equilibrium (DGE) model that incorporates heterogeneous agents (entre preneurs and workers) and imperfectly competitive product and labour markets. The combination of market power in the product market with agents’ heterogeneity influences the political feasibility of structural reforms. The model is solved numerically employing parameter values and fiscal data from the Euro Area. Regarding efficiency, our solutions show that per capita output, as well as per capita welfare, rises when we liberalize one or both markets. Moreover, the net income of both agents rises as we move to a more competitive economy, either in one or both markets. Thus, any form of liberalization,even incomplete, is Pareto superior. The crucial question is then who might gain more from this. Regarding distribution, inequality rises when liberaliza- tion of the labour market only takes place, while it falls when liberalization of the product market only takes place or when both markets become more flexible.