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Centre for Economic Policy Research

Center for Economic Studies

Maison des Sciences de l'Homme

Labour Market Implications of EU Product Market Integration

Author(s): Torben M. Andersen, Niels Haldrup, Jan Rose Srensen, Samuel Bentolila and Janvan OursReviewed work(s):Source: Economic Policy, Vol. 15, No. 30 (Apr., 2000), pp. 105-133Published by: Wiley on behalf of the Centre for Economic Policy Research, Center for Economic Studies,and the Maison des Sciences de l'HommeStable URL: http://www.jstor.org/stable/1344724 .

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EU LABOUR MARKETS 107

Labou r m a r k e t implications fE U produc t m a r k e t integration

TorbenM.Andersen,NielsHaldrupnd Jan Rose S0rensenUniversity f Aarhus,EPRU and CEPR;University f Aarhus;University f Aarhus

1. INTRODUCTIONThe labour marketimplicationsof Europeanintegrationareof considerableimportance.Some people expect integration to raise the cost of labour market rigidities,forcinggovernmentsand unions to pursue greaterlabour marketflexibility,paving the way forhigher employment and growth. Others emphasize the threat to social relations andcontinued maintenance of a welfare society. One concern is that integration willunderminethe social balance whereby employees supplylabour peace in exchange forgenerouswages and social securitysystems(Rodrik,1997).

Europeanlabour marketsare in a state of flux. There has been an evident and rapidconvergence in nominal wage increasesfollowing the low inflation policy adopted inmost Europeancountries.Trade unions seem to have acceptedthis move more swiftlythan could be expected, presumablybecause they realized that the costs of excessivewage claims have been increased by intensified competition within Europe (Fajertag,1997, 1998).Pressure romunions and left-wingpartiesfor a social dimensionin Europecan also be interpretedas reflecting he evaporationof 'domesticpower'and the need toreplaceit with coordinated actions acrossEuropeif social standardsare to be protected(Fajertag,1997, 1998).We gratefullyacknowledgecomments and suggestions rom Palle Schelde Andersen, Soren Bo Nielsen, AndrewRose, PeterBirch Sorensen, Samuel Bentolila,Jan van Ours, the editors and a referee. We thank Runa Walder and Palle ScheldeAndersenfor supplyingdata and GeoffreyShuetrimforprovidingpartof the Gauss-codeused for Kalman Filterestimationofstate space models. KristinaVeno Rostbo and AndersBorup Christensenhave providedresearch assistance.

107U LABOUR MARKETS

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9eie< SUMMARYOt

Europeanabourmarkets re in a stateofflux due to thechangingmarketsituationnducedby nternationalntegration.hisprocessffects ageformationthrough oreierceproductmarketompetitionnd increased obilityfjobs.Thisdevelopments bysome bserversaken oenforceabourmarketflexibility,whilefor therst signals n erosionfsocial tandardsnd n turn ossiby hewelfare ociety.Since labour s not vey mobile n Europe, he effectsofinternationalntegrationn abourmarketsremostlyndirectiaproduct arketintegration. e reviewhe channelshrough hichproductmarketntegrationaffectsabourmarketsndperformnempiricalnalysis ftheconvergencendinterdependenciesn wage ormationamongEU countries.Wefind thatintegrations changingabourmarkettructuresnd nducing ageconvergencesas wellasstrongeragenterdependencies,ut t is agradualrocess.Moreover,thepresenttudy oesnot upportheview hat nternationalntegrationill leadtoa 'raceothebottom'ndrapidlyrode omesticabourmarketstandards,orthat t will relieveoliticiansf theneed o considerabourmarketeformsoimproveabourmarketerformance.

TorbenM. Andersen,ielsHaldrup ndJan RoseS0rensen

Economic Policy April 2000 Printedin Great Britain? CEPR, CES, MSH, 2000.


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TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE SORENSEN

The emergenceof a 'Europeanwage norm'is reflectedmost strongly n the EuropeanCommission'sdrivefor a European Wage Policy (EuropeanCommission, 1998),whichnot only addresses he issuesof maintainingnominalwage increases n accordancewiththe monetary policy objectiveof price stabilitybut also the need for flexibility n wagesetting. Strongerpressurefor wage increases in conformitywith wage developmentselsewherein Europehas led to directinitiatives n two countries. Sweden introduced anew wage model - The EuropeNorm - stressing hat averageunit labour costs oughtnot in the long run to increase faster in Sweden than in the rest of the EU countries(Hahnel, 1998). Belgium introduced a law on 'preventive safeguardingof competitive-ness and the promotion of employment for 1997-8', stipulatingthat nominal wageincreasesshould not exceed the weightedaverageof expectedpay increases n Belgium'skey trading partners- Germany,France and the Netherlands(Fajertag,1997;Delcroixetal., 1997).There is also direct evidence that labour market relationsare changing.One channelis the loss of union power as the mobilityof firms ncrease with internationalintegration.This is exemplified by the Renault case, where the plant in Vilvoorde, Belgium, wasclosed at the same time as the plant in Valladolid,Spain,was expanded.The power offirms is enhanced when they can relocateproductionacross borders.The decision wastakenagainstthe backgroundof generalexcesscapacityin the industryand a possibilityof obtainingsupport romthe regionalEU funds. Trade union reactions o the relocationwere aggressive,partlybecause the closurewas unanticipated(no advance warning, inconflictwith rules)and partlybecauseof the globalizationaspect.It was noteworthythatworkers across countriesorganizedactionsagainstRenault (Kuhlman, 1998).These developmentshave also induced unions to strivefor explicit cooperationacrosscountries.The Belgian 'wage norm' prompted trade unions from Belgium, Germany,Luxembourgand the Netherlands to meet. National confederationsand majorsectoralunions (includingmetal, construction,and private and public services)are strivingforharmonizationof bargainingpoliciesand exchange of information Fajertag,1999).Forexample, the EuropeanMetalworkersFederationis defining a framework or collectivebargainingthat sets minimum standardsand rules,as well as quantitativeobjectives, ornational negotiations.There are also initiatives to prevent working time becoming asubjectof European competition.The aim of this paper is to take a closer look at the role integrationmay play forEuropeanlabour markets.Europe is interestingbecause the processof integrationhasproceededover several decades and has recentlybeen reinforcedby the creation of theSingle European Market and European Monetary Union. Financial markets are alsoclosely integrated.However, we may expect that labour mobility between Europeancountriesis not likely to play a major role in the foreseeable future (Pedersen,1996).Accordingly, abourmarketsare primarilyaffectedindirectlyby the effectsof increasedinternational integration of product markets. With more intensified competition inproductmarkets,powerin nationalor local labour marketsmay evaporate,makingthemmore competitive. Most European workers need not fear that their wage will be

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determinedin Beijing;but they may fear that it will be determinedin Athens.Europeisnot only well integratedbut also fairly homogeneous in terms of factor suppliesandtechnology.1In the limit, the integrationprocess may lead to a single Europeanlabourmarketin which all countries follow a similarevolutionof wages and labour costs.

However, the theoreticalproof that complete integrationof output markets inducescomplete equalizationof input pricesrests on strongassumptions,some at odds with theEuropean reality. It cannot be assumed that both product and labour markets areperfectly competitive. Section 2 reviews theoreticalinsightsabout how product marketintegration affects labour markets when both markets are imperfectly competitive.Section 3 presentsEU evidence on wages and trade. Our empirical analysisexaminesthe extent to which wage settingreflects nternationalintegration,and asks whether thishas changed in recent decades. We show that increasing trade induces a strongercorrelationof wages acrosscountries. Section 4 exploreshow this has changedover time.Section 5 discussespolicy implications.

2. HOW DOES PRODUCT MARKETINTEGRATIONAFFECT THE LABOURMARKET?

Under imperfectcompetition, it is not trivial to show how increasedproduct marketintegration affects the labour market. We introduce some key ideas within a simplemodel, which can then be extended. Consider a singletrade union that suppliesworkersto two kindsof firms.Those producingnon-tradedgoods face no foreign competition;those producingtraded goods face competitionfrom foreign firms. Labour demand inboth sectorsdepends on the domesticwage, w, but labour demand in tradedgoods alsodepends on the foreign wage, w. Total labour demand is the sum of labour demand fortraded and non-tradedgoods.The tradeunion maximizesthe utilityarisingfrom the additional income it generatesfor its members,2the productof total employmentand the excess of the domesticwageover some alternativewage, w, that union members would otherwise have earned (e.g.unemploymentbenefit).Assume the trade unionunilaterally ets the wage, the monopolyunion model (Oswald,1985).3This leads to the standardresultthat the optimalchoice ofthe wage is

-(1)

1Europeancountriesmay be affecteddifferentlyby changesin inter- and intra-industryrade. The former s more relevantforsouthernEuropeancountries,the latter for northernEurope.For a discussionof how trade with emergingeconomies affectsEurope see Bean etal. (1998). For general surveyson how internationalintegrationaffectsunskilledand skilledgroupsin thelabour market see Freeman (1995) and Slaughterand Swagel (1997).2To simplifywe disregardtaxes. The interplaybetween tax structure,product marketintegrationand wages has yet to beanalysed.3The alternativeassumptionof Nash bargainingoverwages (McDonaldand Solow, 1981;Nickell and Andrews, 1983)yieldsresultsqualitatively imilarto those in the simplermonopoly union model.



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TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE S0RENSEN

The wage is a markup on the alternativewage. The markup is higher the lower thenumericalvalue of the aggregatelabour demand elasticitye, which itself is simplytheemployment-weightedaverage of the labour demand elasticities in traded and non-tradedgoods.The elasticity is likely to be higher for traded goods than for non-traded goods.Equation(1) impliesthat, the more integratedthe economy is in internationalproductmarkets(largeremploymentsharein tradedgoods, and hence largere), the lower is thewage. However, this elasticityeffect is not the only channel throughwhich integrationhas a labour market effect.

Interpretproductmarketintegrationmore broadlyas a reductionin costs associatedwith international rade. These costsmay be transportcosts, tariffs, axes,costs of bordercontrol, information costs about foreign markets, and costs of product approval inforeignmarkets. It is useful to divide thesedifferentcosts into two qualitativelydifferentkinds, fixed costs or start up costs associated with exporting, and variable costsproportionalto the level of exports.Reductions in these two kinds of costs may havequalitativelydifferentimplicationsfor wages.

2.1. Lower export costs without market entryConsiderfirst the effect of lower export costs for a given distributionof goods betweentradedand non-traded,and hence an absenceof marketentry. Naylor (1998)showsthata decrease in variableexport costs may give rise to a higher wage. Why? For a givenwage, lower transportcosts lead to higher employment because the variable costs ofproducing export goods decrease. This in turn implies that the elasticity of labourdemand, e decreases,and the trade union responds by increasingthe wage rate. Inotherwords,a decreasein the transportcostsgivesrise to a higherlabourdemand, andthe trade union takes some of the benefits in the form of a higher wage rate. A criticalassumptionfor this result is that the labour demand function is linear. Although aparticularexample, it reminds us that greater integrationdoes not alwaysreduce wageswhen there is imperfect competition.

2.2. Lower export cost and market entryAllowingformarketentrychangesthe reasoningabove. Lowerexportcosts makeit moreattractiveor firms o enterforeignmarkets,and goodsthat used to be non-tradedbecometradedgoods.The implications f marketentrycan mosteasilybe analysedby consideringa reduction n fixed costsassociatedwith exporting.Huizinga(1993)and Sorensen(1993)illustratethe implicationsof market entry by comparing autarchyto fully integratedmarkets all goods traded,and hence all employment n tradedgoods).Since the latter isachievedby assuminga fall infixedcosts,labour demandelasticitiesn the two sectorsare4Flam (1992) discussessome of the trade costs saved by the creation of the internal market.

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unaffected and the increase in employment in traded goods with the higher elasticityunambiguously educesthe wage markup in equation(1).Andersenand S0rensen(1999)derive the exact formula or how the union'schoice of the domesticwage dependson thealternativewage w, labourproductivityq,variableexportcosts t, and foreign wages ww= bow+ bl(aT, t)q+ b2(a )w (2)where bo s a positiveconstant,and the size of (thepositivevalues of) bl and b2dependson the employmentshare at in tradedgoods, and on export costs t.For giventradecosts,the wage chosenby the union riseswith alternative ncome,withlabourproductivity,and with the foreignwage. However, since the productivityeffectblfalls with the tradedgoods employmentshare aT, but the foreign wage effectb2 ncreaseswith this employment share, the effect on the domestic wage of a larger employmentshare in traded goods is ambiguous. If foreign and domestic countries are similar,Andersenand Sorensen show that an increasein the employmentsharein tradedgoodsdefinitely owers the wage.Since the foreignwage effect b2increases with the traded goods employment share,domesticwages become more sensitiveto changes in foreignwages, and we should seewage convergence when integration implies that a larger fraction of the economybecomes affectedby trade. Andersen and Sorensenalso show that wages become moresensitiveto changes in productivity f trade costs increase (bl rises with t).The share of traded goods (a ) may increase not only because fixed export costsdecrease.A decrease in variable export costs (t) may also make it attractive to exportgoods that used to be non-traded.Then, the wage is affectedby the effect found inNaylor (1998)and the effect of a highershare of tradedgoods discussedabove. Hence, itis ambiguouswhether the wage rate increasesor decreases.

2.3. Entry and exit of firmsIn an integratedmarketarea, it becomes less importantwhere firmslocate. The marketcan be suppliedby firmsfromanywherewithin the integratedmarket.Firmswill tend tomove to areas where production costs are low, and leave high cost areas. Labourdemand is more geographicallymobile, raisingthe long-runlabour demand elasticity.Iftradeunions take this into account,wages decrease(Drifftlland Ploeg, 1995).

2.4. Foreign direct investment

Foreign direct investment is another channel through which the labour market isaffected.It is usefulto distinguishbetween horizontaland vertical nvestments Markusenet al., 1996). Horizontal investment occurs when production is split between similarplants in differentcountries,vertical investmentis the complementary organizationofproduction in separate stages located in different countries. The literature on tradeunions and foreign direct investment has focused largely on horizontal investment

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(Bughinand Vannini, 1995; Zhao 1995, 1998; Naylor and Santoni, 1997), generallyconcludingthat horizontalinvestment leads to lower wages, since each countryfaces amore elastic labour demand. However, for verticalinvestments,Skaksen and Sorensen(1999)show that the wage may increase since the labour demandelasticity s reducedasdomesticwage costsbecoming relatively ess importantfor the total costs of the firm.

Foreign direct investment affects the labour market. It is less obvious how productmarket integrationaffectsforeign direct investments.The main motive for horizontalinvestmentis to avoid trade costs (Markusenet al., 1996), whereas vertical investmentexploitsdifferences n productioncosts within the limitsset by trade costs.Sinceproductmarketintegration s inducedby a decreasein trade costs,we should expect horizontalinvestments o decreaseand vertical nvestments o increase.However,anotheraspectofproduct market integration may be lower costs of setting up new plants in foreigncountries, endingto increaseboth kinds of foreigndirectinvestments.Therefore,the netimplicationsfor wages are ambiguous.

2.5. The effective degree of centralizationLabour marketperformancemay depend criticallyon the degree of centralization nwage formation(Calmforsand Driffill, 1988). Due to various forms of externalities nwage setting, includingprice effects,unemploymentbenefits and taxation, the labourdemand elasticity faced by trade unions is relatively high when the degree ofcentralizationis either low or high. In contrast,for a middle range of the degree ofcentralization, he labour demand elasticity s relatively ow. The implication s a hump-shaped relationbetweenwages (andthus employment)and the degree of centralization.The degree of centralizationfalls when goods marketsintegrate:with more firmscompeting in the product market, the number of trade unions supplyinglabour toproduce a certain type of good increases. This decrease in centralization has anambiguouseffect on wages (Driffilland Ploeg, 1993; Danthine and Hunt, 1994). If thelabour marketbeforeintegrationwas relativelycentralized, he decreasein centralizationgivesriseto a higherwage, whereasif the labourmarketbeforeintegrationwas relativelydecentralized, he decreasein centralizationgives rise to a lower wage. Integrationmayaffect countries differentlydepending on the labour market institutions.Finally, it isworth mentioningthat international ntegrationmay induce unions to cooperateacrossnations(cf.the examples givenin the introduction),and thiswill counter the effecton thedegree of centralization Driffilland Ploeg, 1993).

2.6. Endogenous productivityMore intensified competition may affect productivity and technical progress. By'defensive nnovations' t may be possibleto maintaincompetitivenessat the initial cost5Afterestablishment f the internalmarket, oreigndirect nvestmentncreased,ndicating hat the lattereffectseems to dominate.

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level. Are such innovations,as a responseto new competitive pressure,consistent witheconomictheory: f such laboursavingor costreducingmeasuresexist,why weren'ttheyalready implemented?First,productivitydependson effort,which is in turnendogenous.Given more intensecompetitive pressure, unions, facing a trade off between accepting wage cuts orincreasingeffortto maintain theirjobs, may choose the latter,reducing overmanning,restructuringproduction,and increasingeffort.

Secondly, productmarket ntegrationmay increase incentivesfor innovative activitiesto obtain a competitive advantage. Increased internationalintegration can promotetechnicalprogressand hereby reduce the need for wage moderation.6Last, but not least, closer international integration makes the transfer of

technological knowledge easier, both via improved information flows and throughtrade in capital goods. This tends to lead to technology convergence and thus to wageconvergence.

2.7. InstitutionsLabour marketperformancedepends not only on labour demand but on a varietyofinstitutional actors,which may be critical to the effect of international ntegration.Yetinstitutionswill also have to adapt to the new situation. One obviousexample is the taxsystem. Integrationmakes the tax base for certain forms of taxation more mobile, andthereby creates a need for tax reforms or adjustmentof public expenditures.This andother institutionalchangesmay affectthe labourmarket,but it is in general impossible osay in what direction and with what strength.A politicaleconomy perspectivemay give some indications on the directionin whichinstitutional changes may go. Intensified international competition may potentiallyworsen the unemploymentproblem in the absence of structuralchanges, and this maypave the way for structuralreforms to enhance labour market flexibility(Saint-Paul,1996).There has been a tendency for the degreeof unionization to decrease(Neumannetal., 1991; Wallersteinetal., 1997), for less strikeactivity(Aligisakis,1997), for labourprotectionto be lowered (Saint-Paul, 1996), and for more activejob-creatingmeasures(Barrelland Genre, 1999). Some or all of these changes may have been induced byinternational ntegration,and all point to more flexible labour markets.

2.8. ConclusionWe have reviewedthe channelsthroughwhichproductmarketintegrationaffects abourmarkets. The implications for the level of wages and employment are in generalambiguous since they depend criticallyon the initial situation, the specific market6For empiricalevidence in favour of this hypothesis,see Lawrence and Slaughter, 1993; Learer, 1994; Sachs and Shatz,1994; and Neven and Wyploz, 1996.

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structureand the degree of international ntegration.7However, the theoretical workpoints to two important implications. First, product market integration implies atendency for wage convergence. Secondly, wage interdependenciesare strengthened:domesticwagesbecome increasingly ensitive o foreignwages. In the followingsections,we consider whether there is empiricalevidence in supportof these two hypotheses.

3. TRADE AND WAGESWe first examine empirical evidence about internationalintegration, as reflectedbyinternationaltrade, and wage formation in the EU countries.8 We use data for themanufacturing ector,where tradepotentiallyplaysa dominant role. Figure 1 showstheevolution of cross-country veragenominalwage growthand its standcardeviation.Thefigureconfirmsa steadydecline in averagenominalwage increasesfrom the mid-1970sto the end of the 1990s. This reflects he transition rom a high inflationregimeto a lowinflationregime.This change has been quite similar across EU countries,hence the fallin the standard deviationof wage increases,especiallysince the mid-1980s.As a more direct measure of wage interdependenciesamong the EU countries,wemay look at wages in each countryrelative to wages in the rest of the EU. For eachcountry, Figure2 displaysthe evolution of the ratio of hourly wages to the (country-specific)trade-weightedwage in other EU countries,where the 'foreignwages' are all0.2 0.025

\~'~~~~~~ / \~ \~- 0.020.15 \___2-0.015

0.1 , X \-_ \'--. ' -0.01

0.05- '' "-0.005

0 l l Il l lli iI I I I 01971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997

Mean left-handcale) - - - t.Deviationright-handcale)Figure 1. Annual nominal wage growth across EU countries: mean and standarddeviationSource: wn calculationsbased on SvenskarbetsgivareoreningenSAF).

7Our data did not allow us to estimate and test the unambiguous mplications or changes in labour demand elasticities.8Due to lack of data, Luxembourgand Portugalare not included in our sample. Our sample of EU countriesis: Austria,Belgium,Denmark,Finland,France, Germany,Greece, Ireland,Italy,Netherlands,Spain, Sweden and UK.

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denominatedin a common currency.Hence, a ratio of one indicates identical nominalwages in the home countryand the 'foreign'country.There is a tendencyfor the ratiosto converge towards one over the sample period. Germany,Denmark and Greece areoutliers; or the othercountries, here is a clear trend fallin the ratio if it startsabove one,and a trend increaseif it begins below one. This convergencein relativewages is alsoreflectedin a decrease in the cross-country tandard deviation of the ratios during thesample period;the mean of the ratios also convergeda little, from 0.90 to 0.93.Can these developments be related to international integration? An importantindicator of productmarket ntegration s the developmentof international rade,whichincreased steadily. Figure 3 shows the cross-country average of EU manufacturingexportsand importsas a share of value added, a measure of EU countries' trade withotherEU countriesand with non-EU countries.Strikingly,otal trade has been increasedsteadily.Since the mid-1990s, the averagevalue of export and importhas been higherthan the value added in the manufacturingsector.9We aremainlyinterested n productmarket ntegrationwithin the EU. Figure4 showsthe fraction of EU countries'trade that is with other EU countries.Over 60% of EUcountries' trade is with other EU countries.This share did increase,but mainly during1981-7, and fell somewhatafter 1991. These shiftsare closelyrelated to the Europeanbusiness cycle. Correcting for the cycle, trade shares are fairly constant despite theincreasein the level of trade.

ratio1.8

Denmark1.4 - Germany

1.2UKI~~1~~ ~~~ --- SSwedenBelgium

AustriaFranceSpain

0.4 - / Greece~ Std deviation0 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 I I I I I I I I I1970 1974 1978 1982 1986 1990 1994 1998

Figure 2. Ratio of domestic to foreign nominal wagesNote:For each countrythe foreign wage is the trade-weightedwagesof wages in other EU countries.Wagesaredenominatedin the same currency.Source: wn calculationsbased on SvenskarbetsgivareoreningenSAF)and the OECD Bilateral radeDatabase 998.

9In addition, there has been more FDI (Barrell and Pain, 1997).

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TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE S0RENSENratio12U

110 -100 -

90 -

80 -

70 -

60 -

50u 1I-r I1970 1974 1978 1982 1986 1990 1994 1998YearFigure 3. Total EU trade: cross-country average of EU countries manufacturingexports and imports as a share of value addedSource: wn calculationsbased on OECD STANADatabase998.

ratio

1971 1975 1979 1983 1987 1991 1995Year

Figure 4. Trade between EU countries. The graph shows the fraction of EUcountries' trade with other EU countriesSource: wn calculationsbased on OECD BilateralTradeDatabase 998.

Section 2 emphasized that links between product market integration and labourmarketperformancemust be addressedwithin a frameworkof imperfectcompetition.International trade theories with imperfect competition stress intra-industrytrade(Krugman, 1990), whereas inter-industrytrade is probably better explained bycomparative advantagebased on technologyor factor endowments.Figure5 plots the

I I I I I I I I I I I I I I I I I I I I I

116

I~~ ~~~~~ ~ I I I II I a I I I I I II

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Grubel-Lloyd ndex of intra-EUtrade,the share of intra-EU trade that is intra-industry.This shareincreasedsteadilyduringour sample period.Intra-industryrade had becomeover 50% of all intra-EU tradeby 1983, though the largestincreasestook place in the1970s.The evidencepresentedso far does not contradict he hypothesisthat productmarket

integrationin the EU induced wage convergence. However, an explicit test would bemore convincing. We extend a method developed by Frankeland Rose (1998), whoexamine whether international trade gives rise to more correlated national businesscycles. We pose a similarquestion. Does increased trade give rise to more correlatedwage increases?First,we divide our data period into three sub-periodsof equal length.Secondly,we computecorrelationsp#-in wage increases n manufacturingbetween eachpair of countriesi andj in subperiodr. Since each correlation ies between -1 and +1,we then transform each correlation into a new unrestrictedvariable ri- for use in oursubsequentregressionanalysis.10Thus, as p takes on valuesbetween -1 and + 1, rtakeson values between minusinfinityand plus infinity.Fourthly,we calculate the trade leveltijrbetween each pair of countries in each sub-period as the sum of country 'smanufacturedexportsto, and manufacturedmportsfrom,countryj, dividedby the sumof global manufacturedexportsand importsof countries i andj.

Finally,we run the followingregressionrr = -1+ 2c2D2+ a3D3+ 6tir + Sr (3)

index0.6

0.55-

0.5

0.45-

0.4 - /

0.35 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 11970 1974 1978 1982 1986 1990 1994Figure 5. GL-index for intra-EU tradeSource: wn calculationsbased on OECD BilateralTradeDatabase, 998.

' Formally,r= ln((Pr + 1)/2/[1- (pr + 1)/2]).

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TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE S0RENSENTable 1. Wage correlation equation

al r2 a3 6 R2 Hetl Het2 Reset JBNominal wages 2.88** -2.13** -0.29 15.63** 0.45 0.13 0.17 0.37 0.00

(0.14) (0.18) (0.18) (3.62)Real wages 0.14 0.32* 0.10 7.86* 0.05 0.89 0.98 0.93 0.70(0.12) (0.15) (0.15) (2.99)Note:*signifiessignificanceat 5%level, **at 1%level.Numbersin parenthesesare standarderrors.Hetl andHet2 reportp-valuesforWhite heteroscedasticityests,whilst Reset andJB reportp-valuesfor functionalformand theJacque-Bera normalitytest.

where D2 is a dummy variable for period 2, D3 is a dummy variable for period 3, and e#yis a disturbance term. The parameter 6 measures the effect of trade on wageinterdependencies. By pooling the data for the three sub-periods, we get a total of 234observations. 1We run the above regression using nominal wages as well as real productwages; results are reported in Table 1.

Both the nominal and real wage equations appear reasonably well specified. For bothcases, the coefficient 6, the effect of trade integration, is positive and significant.12Greater trade between two countries implies more closely correlated wage increasesacross countries.

4. WAGECONVERGENCESection 3 indicated that international integration has induced wage convergence. If thisis correct, we should be able to find direct evidence that the wage interdependencieshave increased across countries: foreign wages should play a larger role in domestic wagesetting. This issue cannot be assessed by standard time-series equations in which it isassumed that parameters are stable; international integration gradually changeseconomic structures.

Accordingly, we estimate time-varying parameters, where the parameters of the wageequations are generated according to a stochastic process. Because the parameters areallowed to evolve gradually over time, convergencean be captured empirically by theevolution of estimated parameters, a process that remains ongoing today.

The econometric approach we pursue was initially suggested by Haldane and Hall(1991) and has been implemented in a number of empirical studies including Hall et al.(1992), Serletis and King (1997), and Holmes (1998), mainly on financial and exchangerate data. To our knowledge no empirical studies have been conducted using thistechnique on labour market data. Box 1 gives technical details. We focus on real wages.l Due to lack of data Ireland is not included, and the time span only covers 1970 to 1994.12As an alternative to the use of log-differencedwages to remove a trend component in wages, we also used theHodrick-Prescott filterto detrend the data. These resultsappearedto be qualitatively imilarto those reportedabove.

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Box 1. Estimating time-varying effects of foreign wagesThe models under considerationare of the general form:

yt -= + ^Zt+ 3tXt + Ut (4)At= t- 1+ Vt (5)

UVt 0 aThinkofyt as the domestic realwage, and of Ztand xtas exogenousvariableswithfixed and time-varying parameters, respectively. We interpret Zt and xt asproductivityand trade-weighted oreign (real)wages.The time-varying parameter model (see Harvey, 1989; Hamilton, 1994), isdisplayed above in state-spaceorm.Equation (4) is the measurement equation,equation (5)the transition-equationdescribingthe evolution of the statevariablept(the time varying parameter).The model has been simplifiedby allowingonlyone parameter to vary since there are only 29 observations available forestimation for each country. The parameters are estimated by maximumlikelihood (fortechnical details, see again Harvey, 1989; Hamilton, 1994). TheKalman filter is used recursivelyto extract the state variables conditional oninformationup to time t- 1. Full sample informationcan be used to estimatethe latent state variablesby implementation of a smoothingpdating algorithm.These smoothed state variables are extracted to represent the time-varyingparameters.A number of theoretical assumptionsunderlie the state-spacemodel (4)-(6).The right-hand side variables are considered exogenous, and error terms iidGaussiannoise. There is no clear guidance in the literaturewhat to do if theseassumptionsare not met. Any generalizationgreatlycomplicatesthe estimation.With some reservations,we simplyestimatethe simplerform (4)-(6).

This is motivatedpartlyby theoreticalconcerns,partlyby the fact that nominal wageslargely pickup simultaneousconvergenceof Europeanmonetarypolicy,which does notnecessarilymean labourmarketshave become more closelyintegrated.13Our estimationequationsare:14Model 1: In Wt/Pt = ca+ ft In Wf/Pt + UtModel 2: In Wt/Pt = a + Pt In Wtr/Pf + ut

13We also estimatedthe model with nominal wages;results close to those reportedfor Model 1.14A log-formulationavoids normalizationproblems arising as a result of using index-numbers,and makes 3-coefficients(elasticities) omparableacross countries.

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The basic model (Model 1)relates the domesticproductrealwage to the foreignproductrealwage, definedin terms of domesticproducerprices.Penetrationof foreignfirms ntothe domesticproductmarketdependson thismeasure of profitability.Model 2 considersas an alternative he productrealwage definedin termsof domesticproductpriceswhichis the conventionalway of definingthis variable,1516 and which is a measureoften usedin comparativestudies.These specificationsreflect dynamic patterns in the wage-formationprocess of thehome country, especially with respect to the dependency of the (trade-weighted)foreign wages. Increased (relative)convergence between wage settings in the homecountry and the foreign country is identified when 1t tends towards unity over time.Observe that /t tending to one does not necessarilymean that the wage rates areconverging in absolute terms because the intercept may be country specific.17Figures6-9 display the smoothed state variables (time varying parameters),and a95% confidence band.

The resultsfor Model 1, reportedin Figure6 (different igureshave differentscales),reveal that coefficients to foreign wages did vary over time, lending support to theapproachtakenhere. Convergencefrombelow is observed forAustria,Finland, Greece,Ireland and Spain and from above for Sweden. In Denmark, Belgium, Germany,France, Italy, the Netherlands and the UK there is no major change over the sampleperiod. A notable finding is that countries in the peripheryor newcomers to the EU(Austria,Finland, Greece, Ireland and Spain)have experienceda large increasein theinfluence of foreign wages: European integration has had a clear effect on wageformation. Until the early 1980s, the UK diverged from the rest of the EU, butsubsequentlythis has been reversed.A similarpattern can be observed for Ireland.Convergenceis even more apparentfromestimation of Model 2 (Figure7)which showsimportantstructuralchanges for all countries which all evolve in the directionof wageconvergence.Note the significantchange for Spain after EU membershipin 1986.The resultsof estimatingthe time-varyingparametersconfirmthat structuralchangeshave takenplace and that internationalinterdependenciesn wage formationhave beenstrengthened.This convergencecan be the directresult of changes in market structuresand marketpower, as discussed n Section 2, but may also reflect a more easy flow andtransfer of information and technological knowledge. In the latter case, wageconvergence simplyfollows from the fact that internationalintegrationmakes countriesmore similar. To discriminate between these two interpretations of why wage

15This specificationraisesan index numberproblem.We have hourly pay in domesticcurrencybut only a price index. Wemake wages comparableacrosscountriesby measuringthem in DM in the base year 1992. Given the log-specification,anylevel differences n priceswill be picked up by the constantterm.16International comparisons are often based on unit labour costs. This approach is problematic: for Cobb-Douglastechnology,unit labourcosts are independentof the wage. We do not reportresults or unit labourcosts,sincewe were unableto construct consistent seriesfor our countriesduringour sample period.17This mimics the distinctionbetween the absolute and the relativePPP-hypothesis.

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EU LABOUR MARKETSLoxo2,_Be,iumr.ol.. Slope, Belgium,Log dota

o P \ e- - 95 er limitX .1----J--r . mtea ate

r- ' t

~0-'Ci-'~ r - - - - g7-oer aim.t 6-- 95 2 upper limit

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,

. , O0c-- g l i:

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1970 1975 980 1985 1990 1995 2wo I C...... eal.lkf Slope, Greece, Lo9 data

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ro0970 1975 1980 1985 990 1995 2

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9-

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_ t3_O Smoothedtote0 - e-- ^ werimit

5- e-- 95 Zupperimit9S _ D-, -0oa ~~9-~~~@ ~ ~ \

rv ID z jR j _

? t970 1975 1980 1985 l990 1995 2000

095 z ,, limitl500l

Figure 6. Time varying 3t: In Wt/Pt= a + 3t In Wf/Pt +ut

convergence occurred, we augment our earlier models to control also for changing levelsof productivity q.Model 3: In Wt/Pt = a + 7 In qt+ Pt In W/Pt + utModel 4: In Wt/Pt =t a + t In q nIn /Pt + ut

121

*r.-n I07C norza 109; *ron scric 7nnn

-,a- - --

0 ,o--I0-- ,e--A e

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o 19~70 2000 t~~oI? 1970 1975 1980 1985 1990 1995 2000 ? 1970 1975 1980 1985 1990 1995 20

I; . . ,?1970 1975 1980 1985 1990 1995 2000 e 1970 1975 1980 1985 1990 1995 2(LoIo2'_Net..r... rdI t.,* Slope, Netherlands, Log data

I e, - -G- ', ,,e e..e0;r a - ' -S ' -_ Smoothed Stote

_- 95Z lowe- im t-- 95 Z upper limit

D-- -'e- ----'e'e-- e-- --e--o,r3_ t

1970 1915 1980 1985 1990 1995 2000


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0~~~~~~0)o , '

0 0- 0- 0a 9-....- .-/ ,- .

Lo.,-1,*,1 lm, Slope. Finlan,d. ogdata

- 0 0_.

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"9' ' u-- 95 Z''

6

6 1970 1975 1980 1985 1990 1995 2000Lwo2,_ ........ Slope, Greece,Logdata

~- m5 o. --c -95 -7

o 9 0 1 2000

Figure 7. Time varying ft: In Wt/P= a + t In Wf/PIPf+ ut

Thus, in Model 3 the effect /3 of foreign wages varies over time, while in Model 4 theeffect y of productivity varies over time, but foreign wages now have a constant effect.

Ideally we would like to allow simultaneously for time varying coefficients to bothproductivity and foreign wages. However, this was not been possible. 18 The results for

]8Attempts were made but the algorithmfailed to converge.

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TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE SORENSENC'~Q20_A.'6Of,0.~"'r Slope, Austria,Lag data

',~..o"' "o, c~ 'o

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9 9 9 9 - - 95 I f

.19.0 195 ,9'80 1985 1990 1995 2000

Figure 9. Time varying yt: In W/tIP a + yt In q+ /3 In WfPt + Ut

findings for Model 4, plotted in Figure 9 show that the effect of productivity on wages isgenerally declining. Section 2 argued that this should happen when markets get moreintegrated. Hence, the effect of integration may have been to induce some convergenceof productivity but simultaneously to reduce the effect of productivity in domestic wagesetting and increase the effect of foreign wages.

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The bottom line of this is that the analysis shows that there has been wageconvergence in Europe, but leaves open whether internationalintegration primarilyaffectswage formationby inducing convergencein technologyand thusproductivity,orby affectingmarketstructuresand powers.

5. CONCLUSIONInternationalntegrationof productmarketshas implications or labour markets hroughvariouschannels,includingfiercerproductmarketcompetitionand increasedmobilityofjobs.The evidencepresented n thepresentpaperyieldssupport or the viewthat increasedintegration nducesa more similarwage developmentand strongerwage interdependen-cies. This is a gradualand ongoing processthat will continuein the yearsto come.The present situationis, however, far from the one predicted by the hypothesisoffactorprice equalization.First,while wages are followingeach other more closelyacrossEuropeancountries,the levelsare not the same. There are stilldifferences n the level ofwages, irrespectiveof how these aremeasured,but sometendencyforwage differences obecome smaller.Secondly, wage convergenceis not tantamountto eliminationof eithermarketpower or rigidities n labour markets.What are the lessons for economic policy? Fear that integrationwill lead to majordownward pressure on wages or devalue social provisions is not supported by ourempiricalevidence. There still is a role, therefore,for a domesticlabour marketand forsocialpolicy at the level of the nation state. Nor can international ntegrationbe countedon automaticallyto make labour marketsmore flexible. Marketpower is being slowlyeroded, but will still exist in productand labour markets or a long time to come. Eventhough integrationmay enforce some adjustment n the wage setting process, this neednot lead to betteremploymentperformance.In countrieswith an initialpoor competitiveposition,jobs may be lost duringthe processin which wage settingis put underpressureby the intensifiedcompetitioninduced by international ntegration.Our empirical evidence documents changing labour marketperformance,but alsoshowsthat this adjustmentprocessis fairlyslow. Since changeswill not be abrupt,thereremains a significantwindow in which structural abour market reforms can enhancelabour marketperformance.The danger is that politicianswill underestimatethe needfor policy initiatives,believingthat the marketwill do everythingfor them.

DiscussionSamuelBentolilaCEMFI, Madrid

Andersen,Haldrupand Sorensen(AHS)have written a paper on a highly topical issue,the interactionbetween international rade and labour markets.They studythe case of



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the EU, which has experienceda trend reduction in barriers o within-areatrade since1960. Most EU countriesalso show poor labourmarketperformance, n terms of theirunemploymentrates,over the last 25 years.Thus, it seems naturalto examine the roleproduct market integration may have played in EU labour market developments.Thinkingahead, thislinkmightforexample help us in guessingthe labourimpactof anyfurtherproductmarket ntegrationresulting rom the euro.AHS have chosena narrowerfocus, the impact of trade on wage convergence in Europe, an interestingand under-researchedtopic. In general, their findingsare quite suggestive.

Theories of trade and labour marketsAHS startwith a briefsurveyof models on the interactionbetween trade and wages.Themain messageis that,by raisingthe sensitivity elasticity) f firms'demand forlabour,theincreasein trade is likelyto induce lower labour union wage markupsand thus lead tolower wages. This is indeed the key effectwe should expect.AHS note that trade alsoworksthroughotherchannels,which could actually ead to ithaving ambiguously signed effects on wages. Among the various mechanisms theymention, let me focus on the one due to the authorsthemselves,since it also underpinssome of their empirics. Andersen and Sorensen, in another paper (1999), derive arelationshipbetween the domesticwage and twovariables,domesticproductivityand theforeign wage. The effectsof both these variables are found to vary with the share oftradablegoods in nationalproduction,proxied by the correspondingemploymentshare.Since the impact goes in a differentdirectionforeach of the two variables, heyconcludethat the effect of trade on the domesticwage is ambiguous.Let me questionthis conclusionon two grounds.First, he argumentwouldgo throughfor given pathsof productivityand foreign wages. But this condition is undermineda bitlater,in Section 2.6, whereAHS arguethat increasedopenness may forcelabour unionsto choose between acceptingwage cuts or increasingeffortto maintain theirjobs. Thelatter option implies that in effect the path of productivityresponds(positively) o thetradablegoods share.Secondly,such shareis itselfendogenous,dependingon primitiveslike the costs of international rade. Indeed,variable costs - as opposed to fixed costs -appearin theirmodel, and are foundto raisethe effectof productivitybut not to reducethe effectof the foreignwage. Thus it is not fullyclearthatthe alleged ambiguityobtains.Even if more trade does not necessarily mply lower wages, AHS claim that all themodels imply a tendency for wage convergence and stronger wage interdependencies.While reasonable,this conclusion is somewhat informal,because the surveydoes notfocus on these two issues. Moreover, the impetus for convergence may depend onanotherfeature,namely the share of intra-industryrade.Inter-industry rade, in whichthe tendencyforwage (factorprice) equalizationacrosscountriesshould be stronger,hasprobablybeen relevantmostly for the poorer EU members (Greece,Ireland,Portugaland Spain),which are relatively abour-abundant.But regardingwithin-EUtrade,it hassteadilybeen giving way - as AHS show - to intra-industryrade,which tendsto exploit

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economies of scale and product differentiation, o that labourcosts are less important.This should generate less pressurefor wage equalizationvia trade.

The empirical relationship between trade and wagesThe theoreticalsurveydoes not specifywhat definition of wages we should look at whensearching for convergence or interdependencies.For convergence, traditional tradetheorydirects us towardsnominalwage levels,possibly- as argued by Trefler(1993) -correctedfor productivity.For interdependencies,we might however want to examinerealwagesor labourcosts,again possibly- if we follow Andersenand Sorensen(1999) -controllingfor productivity.Let me take them in turn.

Nominal wage convergence in Europe is quite evident in Figure2, except for threecountries (one of the three being Germany, which is probably the de acto referencecountry).Is convergencerelated to trade?AHS startby askingwhether intra-EU tradehas actuallyincreased.At firstpass it has, if we compare the 1970s with the 1990s inFigure4. Formal evidence on the link is providedby regressing he correlationbetweenwage changes for all countrypairs on a measure of relative trade volumes. The resultsare mildly favourable to the hypothesis that increased trade has increased wageconvergence.It should be noted, however,thata relativeproduct priceindex would havebeen a more appropriate regressor,since theory tells us that trade should not causewages to change if relativepricesdo not change.This point is forcefullymade by Leamerand Levinsohn(1995).

Interdependenciesare examined in Section 4. AHS follow Andersen and Sorensen(1999), regressingdomesticwages on productivityand foreignwages. They then checkwhether the coefficientson these variableschange in the way predicted by the model:down for the former, up for the latter. They do so with sophisticatedeconometrictechniques(the Kalman filter),althoughthe relativelyshortsamplesize (29 years) imitsthe accuracythat can be achieved in estimation.

Before commentingon the results, et me point out a few issues about the empiricalspecification.First,as I indicatedbefore,productivitys likelyto be affectedby openness.If so, then the estimates of the productivity coefficient would be biased and aninstrumentalvariablesestimationwould have been indicated.Secondly,the foreign wageis measured as a trade-weightedaverage of wages in the remainingEU countries.Theweight assigned to each foreign country therefore increases if trade with that countrygrows.As a result,some of the effectsof trademight alreadybe capturedby the regressorrather than by the estimated coefficient. While there is no obvious solution to thisproblem,an alternativeestimationwith, say, wages in Germanywould have providedauseful check on the results.Lastly,the empiricalspecificationused is essentiallya long-run one, but the equation is estimated on a yearly basis, and so the variability n thecoefficientsmay be in part due to the omitted impact of domestic cyclical effects onwages. These limitations mplythat the variation n the coefficientsmay not be capturingthe potential impact of increasingopenness.

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Empirically, he predictionthat the weighton the foreign wage shouldgrowover timeis found only for Finland,Greece, Ireland and Spain, mostlylabour-abundantcountries(aspreviouslyargued).19Futureworkexaminingmore disaggregateddata might providea sharpertest of this hypothesis.All in all, the empiricalresultssuggestthat, althoughtrade has induced some wageconvergence, the effect has not been very strong. Thus, it is easy to agree with theauthors'readingof the evidence, namely that productmarketintegrationhas, thus far,not created major pressureson wages or the welfare state. This may be due to theconflicting effects they discuss or to some other causes.20Andersen, Haldrup, andSorensen'sempiricalresultsprovideus with a startingpoint for such an exploration.

JanvanOursCentER for Economic Research, TilburgUniversity, TilburgThis is an interestingpaperon a veryimportantpolicyissue,the increasing ntegrationofthe EU and the potential abour marketeffects orthe countries nvolved.This is not onlyimportant rom the pointof view of a laboureconomist,but has a widerrelevance.Or, asFreeman(1998) puts it: 'for the firsttime in a long time, the big issues n economicpolicyare about the labourmarket'.

The paperhasa sand-glass tructure: roadin thebeginningand end, but narrow n themiddle. In the beginning of the paper there are discussionson the possible effects ofintegrationn termsofthreats o socialrelationsand thepossibility f maintaininga welfaresociety,on increasedproductmarketcompetitionand increasedmobilityof firmsandjobs,and so on. In the middleof the paperthere are some stylized acts in termsof graphsandtablesand a fewregressions atheringevidenceon wage convergence. n the end thereis aconclusionabout European ntegration rom a widerperspective.The bottom line of thepaper is that there has been wage convergencein Europe,but in addition to that theauthorsconclude that there is no support orthe fear that the integrationprocesswill leadto majordownwardpressureon wages and to devaluationof social standards.

In my commentsI focus on the empiricalevidence presented. My main point is thatthe authors present evidence that suggests that increasing integrationleads to wageconvergence.However, the evidence is not alwaysconvincingand does not supportthebroad conclusionsat the end. Let me give three examples.

First,Figure 1 presents the evolution of mean and standarddeviations of nominalwage growthacrossEU-countries,showingthat both decline over the period 1971-98.Nevertheless,the ratio of the two, the coefficient of variation hardly changes, beingaroundeight in both 1971 and 1998. So, what is the correct conclusion?

Secondly, Table 1 presents parameter estimates of a model that relates wagecorrelation and a product integration variable. Wage correlation is defined as the

19Usingthe estimated95% error band for 1976, so as to reduce the impact of the start-upestimatefor the coefficient,onecannot find a statistically ignificantchange in the case of Austria.20Rodrik 1998) arguesfor a political economy story.

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EU LABOUR MARKETS 129correlationbetween - real or nominal - wage increases in two countries.The productintegrationvariable s defined as the ratio of the sum of importsand exportsbetween twocountriesand the total importsand exportsof those two countries. The idea is that ifthere is more productmarketintegrationthere should be a closer correlation. That isindeed what the authorsfind.However,if I use the parameterestimatesof Table 1 to getan idea about the posed relationshipI find some results hat are difficult o interpret.If Itake a country-pairwith no trade relationship no importsand exportsbetween the twocountries)I find the calculated correlation between the nominal wages in the twocountries to be 0.89 in the firstperiod, 0.36 in the second period and 0.86 in the thirdperiod. How to interpretthe high level in the first and third period or the differencesbetween the two periodsI do not know.

Thirdly, in the wage convergence regressionsdomestic real wages are related toforeignrealwages. Here, it turns out that the parameterof interest s in many cases closeto one and converging to one either from above or below. Though as a generalstatementthis seems to be true,the authors do not go into an explanationof differencesbetween countries.The coefficientin the regressionfor the Netherlands is less close toone than the coefficientin the regressionfor Greece. Still the Dutch economy is muchmore integrated n the EU than the Greekeconomy. So, where does the differencecomefrom?

I think that the main conclusionthat there is EU wage convergenceis correct.I alsothinkthat this has to do with productmarketintegration.But that is it. No more. I agreewith the authorsthatthereis no empiricalsupport or the 'race to the bottom'hypothesisthat posits that there is a huge competitive disadvantage to social regulations orinstitutions o that firmsor countriesare 'forced' o lower standardswhen theytrade withcountrieshavinglower standards.But, thereis also no empiricalsupport o contradict hehypothesis.I like to believe Freeman(1998)who statesthat 'thefabled race to the bottom- social dumping - about which some economists and union leadersworryis largelyamyth', but find no supportfrom this paper.

In my heart I agree with the main conclusions.Fear of major devaluationof socialstandards eems stronglyexaggerated,and thereis still a role for domestic labourmarketand social policy. However, this is not somethingthat comes out of this paper. In myhead there is still doubt whether this is really no race to the bottom. As far as this isconcerned,thispapermoved some probabilitymass frommy head to my heart but thereis still a long way to go before my head is empty.

GeneraldiscussionWhen analysing he questionof whether tradehas led to wage convergence,the fact thatthere was a considerableheterogeneityacrosscountries n the periodconsideredmust betakeninto account. Stefan Gerlacharguedthat cross-country esultsmightbe drivenby

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just a few countries.For instance,wages, both nominal and real, in the Netherlands,Belgium, Austria and Germany moved in very similar ways. These countries aregeographically very close and traded extensively. In contrast, Spain, Portugal andGreece are geographically ar fromthe core countriesand did not tradeverymuch withthe othersbeforeenteringthe EU. So the inclusion of these three countries or the entireperiod may affect the results. Lucrezia Reichlin was critical of the authors' use ofaggregate data rather than sectoral data. For instance, if integration leads to morespecialization,we will not find convergencein the aggregatedata. Such specializationmaywell have occurredbecause the capitalmarketacts as an insurancemechanismand,with increased opportunities of cross-country ownership, there is less need fordiversification.CharlesWyplosz pointed to empiricalfindings showingjust the opposite,namely that integration eads to less specialization.David Beggwanted to see some discussionof how to separate he externalfactors romthoseanalysed n thepaper.The authorsstress hat the paperdoes not deal with the issueof globalizationand that all the empiricalresults are concerned with what is going oninside Europe. However, any increase in external competition might have forcednarrowingsor broadeningsin European wages unrelated to the forces of integrationwithinEurope.Paul Seabrightwas criticalof the authors'use of convergence.The paperasserts that the standard deviation of growth in nominal wages should fall in theconvergence process.If wages start out different, hen one would expect lower wages tocatch up with the higher ones. Until the convergenceprocess is completed, increasingintegrationcan actuallybe expected to increase the dispersionof growth in nominalwages.Jordi Gali suggestedbasingthe analysison the measureof labour income shares.There are many possible sources of convergence of real wages across countries. Onedrivingforcebehindconvergencecouldbe the degreeof competition n productmarketsas the paperpointedout. Alternatively,here could be convergence n the wagesbecauselabour productivityconverges across countriesgiven the product marketcompetition.Therefore, he suggested focusing on the possible convergence of labour income sharesacross countries.Under certainassumptionsabout the underlying echnology,the labourincome share is just the reciprocalof the mark-upin the product market and thuscaptureschanges in the degree of competition.StefanGerlachwanted to knowwhy the authors ook at the realwage costs rather hanlooking at labour costs more broadly.Jakob de Haan suggested ooking at unit labourcosts,which are available or all OECD countries.The measureforwages in the paperisvery rough.What is needed is a measure for hourlycompensations.Lookingat both unitlabour costs and productivity ould help to settle some of the remainingproblems.

PaulSeabrightemphasizedthe significanceof the approachto modellingof the labourmarket. For example, if unions set wages and firms determineemployment, wages andproductivityare positivelylinked and, in particular, high marketpower leads to highproductivity.However, there are some industrieswhere market power is negativelylinked to productivity.Not only is productivityendogenous,the direction of the effect issensitive to what is going on in the underlying bargaining.

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EU LABOURMARKETS 131

Georges de Menil felt that an important channel for the effects of Europeanintegration on the labour markets was left out in the paper, namely the possibility ofinstitutional changes. The current political debate shows that labour market regulationsmight be reformed as a reaction to the changes in the economic environment.

Stefan Gerlach pointed out that the relocation of production plants - as in theRenault case - may not only be driven by production costs but also by demand shifts.Georges de Menil argued that the Renault case is more relevant as an example ofpotential union resistance rather than an example of any multinational strategizing.

APPENDIX. THE DATACountries in the empirical study are Austria, Belgium, Denmark, Finland, France, Germany,Greece, Ireland,Italy, the Netherlands,Spain, Sweden and the United Kingdom. Due to lack ofdata, Luxembourgand Portugalhad to be excluded. In most cases we could constructdata for thefullperiod 1970-98 by spliningvarious data sources.A completecharacterization f the databaseis available from the authorsupon request.

Data for manufacturing wages (wages for time worked) are taken from SvenskaArbetsgivareFireningenSAF)jointly with OECD, EconomicOutlook ata for the early years, 1970-4. Tradeweights for the constructionof 'foreign wages' were extracted from the OECD BilateralTradeDatabase1998. Producerprices were found from the ratio of value added in currentand fixed(1990) prices.The sourceswere the OECD STANdatabaseforndustrialnalysis, nd Main EconomicIndicators.

Productivityndex (1992 = 100)series(outputper hour in the manufacturing ector) orBelgium,Denmark, France,Germany,Italy,the Netherlands, Sweden, and the UK were extracted rom USDepartment of Labor, Bureau f LaborStatistics, ugust 1999. (See Paul Krugmans's homepagehttp://www.mit.edu/people/krugmanlindex.html).ata forAustria,Greece,Irelandand Spainwerecalculatedusing data for averageannual hours workedin manufacturing alsoUS DepartmentofLabor, Bureau f Labor tatistics, ugust 999)jointly with data for value-added.The source of theFinlanddata was OECD Internationalectoral atabaseSDB, 1998.

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