We study a model in which management and a union bargain sequentially, first choosing a rule that will later determine the level of employment, and then choosing a wage. The government then chooses an output or an employment subsidy. An exogenous natural turnover rate in the unionized sector creates unemployment whenever the union wage exceeds the competitive wage. Government intervention can increase both the equilibrium amount of unemployment and worsen the intersectoral allocation of labour, because of the induced change in the endogenous wage. Unemployment weakens but does not eliminate the possibility of a "labour-management conspiracy".

We analyze a model in which a government uses a second best policy to affect the reallocation of labor, following a change in relative prices. We consider two extreme cases, in which the government has either unlimited or negligible ability to commit to future actions. We explain why the ability to make commitments may be unimportant, and we illustrate this conjecture with numerical examples. For either assumption about commitment ability, the equilibrium policy involves gradual liberalization. The dying sector is protected during the transition to a free market, in order to decrease the amount of unemployment. Our results are sensitive to the assumptions about migration.

In familiar models, a decrease in the friction facing mobile factors (e.g., lowering their adjustment costs) increases a coordination problem, leading to more circumstances where there are multiple equilibria. We show that a decrease in friction can decrease coordination problems if, for example, a production externality arises from a changing stock of knowledge or a changing environmental stock. In general, the relation between the amount of friction that mobile factors face and the likelihood of multiple equilibria is non-monotonic.

We model adjustment costs in a general equilibrium setting using a “transport sector”. This sector provides services needed to re-allocate a factor of production across wo other sectors. A market imperfection in the transport sector causes adjustment to occur too slowly in the absence of government intervention. The government has a restricted menu of second best policies to remedy this imperfection. Given this restricted menu, the optimal policy choice depends on the government’s ability to make commitments. The key to these results is our replacement of the black box of adjustment costs with an explicit model of these costs.