The Political Economy of the "Minimum-Wage Institution" in an Internationally Integrated Market

The paper explores the political economy of the “minimum‐wage institution (MWI)” in an internationally integrated product market. The authors consider a two‐sector Economic Union (EU) with a perfectly competitive agricultural sector and a unionized oligopolistic manufacturing sector in which there exist productivity asymmetries across firms. It is shown that efficient firms have an incentive to strategically opt for intercountry minimum‐wage agreements high enough to raise their inefficient rivals’ costs and thus gain business in equilibrium. The unions of workers in all countries also find these agreements in their best interest. As a consequence, the MWI may emerge as the equilibrium institutional resolution of alternative political processes (i.e., an EU‐wide referendum or special‐interest politics), despite its negative effect on aggregate employment.