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Labour Market Implications of EU Product Market Integration Author(s): Torben M. Andersen, Niels Haldrup, Jan Rose Srensen, Samuel Bentolila and Jan van Ours Reviewed work(s): Source: Economic Policy, Vol. 15, No. 30 (Apr., 2000), pp. 105-133 Published by: Wiley on behalf of the Centre for Economic Policy Research, Center for Economic Studies, and the Maison des Sciences de l'Homme Stable URL: http://www.jstor.org/stable/1344724 . Accessed: 19/01/2013 06:09
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EU LABOUR MARKETS
107
Labour market implications of EU market product integration
TorbenM.Andersen,Niels Haldrup and Jan Rose S0rensen

of Aarhus;University of Aarhus of Aarhus,EPRUand CEPR;University University
1. INTRODUCTION The labour marketimplicationsof European integrationare of considerableimportance. Some people expect integration to raise the cost of labour market rigidities, forcing governments and unions to pursue greater labour market flexibility,paving the way for higher employment and growth. Others emphasize the threat to social relations and continued maintenance of a welfare society. One concern is that integration will undermine the social balance whereby employees supply labour peace in exchange for generous wages and social security systems (Rodrik, 1997). European labour marketsare in a state of flux. There has been an evident and rapid convergence in nominal wage increases following the low inflation policy adopted in most European countries. Trade unions seem to have accepted this move more swiftly than could be expected, presumably because they realized that the costs of excessive
wage claims have been increased by intensified competition within Europe (Fajertag,
1997, 1998). Pressurefrom unions and left-wingpartiesfor a social dimension in Europe can also be interpretedas reflectingthe evaporationof 'domesticpower' and the need to replace it with coordinated actions across Europe if social standardsare to be protected (Fajertag,1997, 1998).
We gratefullyacknowledge comments and suggestionsfrom Palle Schelde Andersen, Soren Bo Nielsen, Andrew Rose, Peter Birch Sorensen, Samuel Bentolila,Jan van Ours, the editors and a referee. We thank Runa Walder and Palle Schelde Andersen for supplyingdata and GeoffreyShuetrimfor providingpart of the Gauss-codeused for Kalman Filterestimationof state space models. KristinaVeno Rostbo and Anders Borup Christensenhave provided research assistance.
Ot 9eie<
SUMMARY
labour markets are in a stateofflux due to the changing market European This situation induced affects integration. process wageformation byinternational more market and increased competition mobility through fierce product ofjobs. is bysome Thisdevelopment taken to enforce observers labour marketflexibility, it signals an erosion standards andin turn others whilefor of social possibythe welfaresociety.Since labouris not vey mobilein Europe,the effectsof viaproduct market onlabour markets aremostly indirect international integration the channels which market We review integration through product integration. markets andperform an empirical and labour affects of theconvergence analysis in EU countries. We that find interdependencieswageformationamong andinducing is changing labour market structures integration wageconvergences butit is a gradual as wellas stronger Moreover, process. wageinterdependencies, will lead the does notsupport theviewthatinternational study integration present tothebottom' erode domestic labour markets nor toa 'race andrapidly standards, to labour market thatit will relieve of theneedto consider reforms politicians labour market performance. improve andJan RoseS0rensen M. Andersen, Torben NielsHaldrup
Economic Policy April 2000 Printed in Great Britain ? CEPR, CES, MSH, 2000.
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TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE SORENSEN
The emergence of a 'Europeanwage norm' is reflectedmost stronglyin the European Commission'sdrive for a European Wage Policy (EuropeanCommission, 1998), which not only addressesthe issues of maintainingnominal wage increasesin accordancewith the monetary policy objective of price stabilitybut also the need for flexibilityin wage setting. Stronger pressure for wage increases in conformity with wage developments elsewhere in Europe has led to direct initiativesin two countries. Sweden introduced a new wage model - The Europe Norm - stressingthat average unit labour costs ought not in the long run to increase faster in Sweden than in the rest of the EU countries (Hahnel, 1998). Belgium introduced a law on 'preventivesafeguardingof competitiveness and the promotion of employment for 1997-8', stipulating that nominal wage increasesshould not exceed the weighted average of expected pay increasesin Belgium's key tradingpartners - Germany, France and the Netherlands(Fajertag,1997; Delcroix
etal., 1997).
There is also direct evidence that labour marketrelationsare changing. One channel is the loss of union power as the mobility of firmsincreasewith internationalintegration. This is exemplified by the Renault case, where the plant in Vilvoorde, Belgium, was closed at the same time as the plant in Valladolid, Spain, was expanded. The power of firms is enhanced when they can relocate production across borders. The decision was taken against the backgroundof general excess capacity in the industryand a possibility of obtainingsupportfrom the regionalEU funds. Trade union reactionsto the relocation were aggressive,partly because the closure was unanticipated(no advance warning, in conflictwith rules)and partlybecause of the globalizationaspect. It was noteworthythat workersacross countries organized actions against Renault (Kuhlman, 1998). These developmentshave also induced unions to strivefor explicit cooperation across countries. The Belgian 'wage norm' prompted trade unions from Belgium, Germany, Luxembourgand the Netherlands to meet. National confederationsand major sectoral unions (includingmetal, construction, and private and public services)are strivingfor harmonizationof bargainingpolicies and exchange of information(Fajertag,1999). For example, the European MetalworkersFederation is defining a frameworkfor collective bargainingthat sets minimum standardsand rules, as well as quantitativeobjectives,for national negotiations. There are also initiatives to prevent working time becoming a subject of European competition. The aim of this paper is to take a closer look at the role integration may play for European labour markets. Europe is interestingbecause the process of integration has proceeded over several decades and has recently been reinforcedby the creation of the Single European Market and European Monetary Union. Financial markets are also closely integrated. However, we may expect that labour mobility between European countries is not likely to play a major role in the foreseeable future (Pedersen, 1996). Accordingly,labour marketsare primarilyaffected indirectlyby the effects of increased international integration of product markets. With more intensified competition in product markets,power in national or local labour marketsmay evaporate,makingthem more competitive. Most European workers need not fear that their wage will be
EU LABOUR MARKETS
109
determined in Beijing;but they may fear that it will be determined in Athens. Europe is not only well integrated but also fairly homogeneous in terms of factor supplies and technology.1 In the limit, the integrationprocess may lead to a single European labour market in which all countries follow a similar evolution of wages and labour costs. However, the theoretical proof that complete integration of output markets induces complete equalizationof input prices rests on strong assumptions,some at odds with the European reality. It cannot be assumed that both product and labour markets are perfectly competitive. Section 2 reviews theoretical insights about how product market integration affects labour markets when both markets are imperfectly competitive. Section 3 presents EU evidence on wages and trade. Our empirical analysis examines the extent to which wage setting reflectsinternationalintegration,and askswhether this has changed in recent decades. We show that increasing trade induces a stronger correlationof wages acrosscountries.Section 4 exploreshow this has changed over time. Section 5 discussespolicy implications. 2. HOW DOES PRODUCT MARKET INTEGRATIONAFFECT THE LABOUR MARKET? Under imperfect competition, it is not trivial to show how increased product market integration affects the labour market. We introduce some key ideas within a simple model, which can then be extended. Consider a single trade union that suppliesworkers to two kinds of firms. Those producing non-traded goods face no foreign competition; those producing traded goods face competition from foreign firms. Labour demand in both sectors depends on the domestic wage, w, but labour demand in traded goods also depends on the foreign wage, w. Total labour demand is the sum of labour demand for traded and non-traded goods. The trade union maximizes the utility arisingfrom the additional income it generates for its members,2 the product of total employment and the excess of the domestic wage over some alternativewage, w, that union members would otherwise have earned (e.g. unemploymentbenefit).Assume the trade union unilaterallysets the wage, the monopoly union model (Oswald, 1985).3 This leads to the standardresultthat the optimal choice of the wage is
-(1)
1 trade. The formeris more relevantfor European countriesmay be affecteddifferentlyby changes in inter- and intra-industry southern European countries,the latter for northern Europe. For a discussionof how trade with emerging economies affects Europe see Bean et al. (1998). For general surveyson how internationalintegrationaffects unskilledand skilled groups in the labour market see Freeman (1995) and Slaughter and Swagel (1997). 2To simplifywe disregardtaxes. The interplay between tax structure,product market integration and wages has yet to be analysed. 3The alternativeassumptionof Nash bargainingover wages (McDonald and Solow, 1981; Nickell and Andrews, 1983) yields results qualitativelysimilar to those in the simpler monopoly union model.
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TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE S0RENSEN
The wage is a mark up on the alternativewage. The mark up is higher the lower the numerical value of the aggregate labour demand elasticity e, which itself is simply the employment-weighted average of the labour demand elasticities in traded and nontraded goods. The elasticity is likely to be higher for traded goods than for non-traded goods. Equation (1) implies that, the more integrated the economy is in internationalproduct markets(largeremployment share in traded goods, and hence larger e), the lower is the wage. However, this elasticityeffect is not the only channel through which integration has a labour market effect. Interpretproduct market integrationmore broadly as a reduction in costs associated with internationaltrade. These costs may be transportcosts, tariffs,taxes, costs of border control, information costs about foreign markets, and costs of product approval in 4 It is useful to divide these differentcosts into two qualitativelydifferent foreign markets. fixed or start up costs associated with exporting, and variable costs costs kinds, proportional to the level of exports. Reductions in these two kinds of costs may have qualitativelydifferentimplicationsfor wages. 2.1. Lower export costs without market entry Consider first the effect of lower export costs for a given distributionof goods between traded and non-traded,and hence an absence of marketentry. Naylor (1998) shows that a decrease in variable export costs may give rise to a higher wage. Why? For a given wage, lower transport costs lead to higher employment because the variable costs of producing export goods decrease. This in turn implies that the elasticity of labour demand, e decreases, and the trade union responds by increasing the wage rate. In other words, a decrease in the transportcosts gives rise to a higher labour demand, and the trade union takes some of the benefits in the form of a higher wage rate. A critical assumption for this result is that the labour demand function is linear. Although a particularexample, it reminds us that greater integrationdoes not always reduce wages when there is imperfect competition. 2.2. Lower export cost and market entry Allowingfor marketentry changes the reasoningabove. Lower export costs make it more for firmsto enterforeignmarkets,and goods that used to be non-tradedbecome attractive tradedgoods. The implications of marketentrycan most easilybe analysedby considering a reductionin fixed costs associatedwith exporting.Huizinga (1993) and Sorensen(1993) illustratethe implications of market entry by comparing autarchy to fully integrated markets(all goods traded, and hence all employmentin traded goods). Since the latter is achieved by assuminga fall infixedcosts, labour demand elasticitiesin the two sectorsare
4Flam (1992) discussessome of the trade costs saved by the creation of the internal market.
EU LABOUR MARKETS MARKETS EU LABOUR
1l1 111
unaffected and the increase in employment in traded goods with the higher elasticity unambiguouslyreducesthe wage mark up in equation (1).Andersenand S0rensen(1999) derive the exact formulafor how the union's choice of the domesticwage depends on the alternativewage w, labour productivityq, variableexport costs t, and foreign wages w w = bow T)w + bl(aT, t)q+ b2(a (2)
where bois a positive constant, and the size of (the positive values of) bl and b2depends on the employment share at in traded goods, and on export costs t. For given trade costs, the wage chosen by the union riseswith alternativeincome, with labour productivity,and with the foreign wage. However, since the productivityeffect bl fallswith the traded goods employment share a T, but the foreignwage effect b2increases with this employment share, the effect on the domestic wage of a larger employment share in traded goods is ambiguous. If foreign and domestic countries are similar, Andersen and Sorensen show that an increase in the employment share in traded goods definitelylowers the wage. Since the foreign wage effect b2 increases with the traded goods employment share, domestic wages become more sensitive to changes in foreign wages, and we should see wage convergence when integration implies that a larger fraction of the economy becomes affected by trade. Andersen and Sorensen also show that wages become more sensitive to changes in productivityif trade costs increase (bl rises with t). The share of traded goods (a ) may increase not only because fixed export costs decrease. A decrease in variable export costs (t) may also make it attractiveto export goods that used to be non-traded. Then, the wage is affected by the effect found in Naylor (1998) and the effect of a higher share of traded goods discussedabove. Hence, it is ambiguous whether the wage rate increases or decreases. 2.3. Entry and exit of firms In an integratedmarket area, it becomes less importantwhere firms locate. The market can be suppliedby firmsfrom anywherewithin the integratedmarket.Firmswill tend to move to areas where production costs are low, and leave high cost areas. Labour demand is more geographicallymobile, raisingthe long-run labour demand elasticity.If trade unions 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 is affected.It is useful to distinguishbetween horizontaland verticalinvestments(Markusen et al., 1996). Horizontal investment occurs when production is split between similar plants in different countries, vertical investment is the complementary organization of production in separate stages located in different countries. The literature on trade unions and foreign direct investment has focused largely on horizontal investment
112
(Bughin and Vannini, 1995; Zhao 1995, 1998; Naylor and Santoni, 1997), generally concluding that horizontal investment leads to lower wages, since each country faces a more elastic labour demand. However, for vertical investments,Skaksenand Sorensen (1999) show that the wage may increase since the labour demand elasticityis reduced as domestic wage costs becoming relativelyless important for the total costs of the firm. Foreign direct investment affects the labour market. It is less obvious how product market integration affects foreign direct investments. The main motive for horizontal investment is to avoid trade costs (Markusenet al., 1996), whereas vertical investment exploits differencesin productioncosts within the limits set by trade costs. Since product market integrationis induced by a decrease in trade costs, we should expect horizontal investmentsto decrease and verticalinvestmentsto increase. However, another aspect of product market integration may be lower costs of setting up new plants in foreign countries,tending to increaseboth kindsof foreign direct investments.Therefore, the net implicationsfor wages are ambiguous.5 2.5. The effective degree of centralization Labour market performance may depend criticallyon the degree of centralizationin wage formation (Calmforsand Driffill, 1988). Due to various forms of externalitiesin wage setting, including price effects, unemployment benefits and taxation, the labour demand elasticity faced by trade unions is relatively high when the degree of centralization is either low or high. In contrast, for a middle range of the degree of centralization,the labour demand elasticityis relativelylow. The implicationis a humpshaped relation between wages (and thus employment)and the degree of centralization. The degree of centralization falls when goods markets integrate: with more firms competing in the product market, the number of trade unions supplying labour to produce a certain type of good increases. This decrease in centralization has an ambiguous effect on wages (Driffilland Ploeg, 1993; Danthine and Hunt, 1994). If the labour marketbefore integrationwas relativelycentralized,the decrease in centralization gives rise to a higher wage, whereas if the labour marketbefore integrationwas relatively decentralized,the decrease in centralizationgives rise to a lower wage. Integrationmay affect countries differently depending on the labour market institutions. Finally, it is worth mentioning that internationalintegrationmay induce unions to cooperate across nations (cf. the examples given in the introduction),and this will counter the effect on the degree of centralization(Driffilland Ploeg, 1993). 2.6. Endogenous productivity
More intensified competition may affect productivity and technical progress. By 'defensiveinnovations'it may be possible to maintain competitivenessat the initial cost
5Afterestablishment of the internalmarket,foreigndirectinvestmentincreased,indicatingthat the lattereffectseemsto dominate.
EU LABOUR MARKETS
113
level. Are such innovations, as a response to new competitive pressure, consistent with economic theory:if such labour saving or cost reducing measuresexist, why weren't they already implemented? First,productivitydepends on effort,which is in turn endogenous. Given more intense competitive pressure, unions, facing a trade off between accepting wage cuts or increasing effort to maintain their jobs, may choose the latter, reducing overmanning, restructuring production, and increasing effort. Secondly, product marketintegrationmay increase incentivesfor innovative activities to obtain a competitive advantage. Increased international integration can promote technical progress and hereby reduce the need for wage moderation.6 Last, but not least, closer international integration makes the transfer of technological knowledge easier, both via improved information flows and through trade in capital goods. This tends to lead to technology convergence and thus to wage convergence. 2.7. Institutions Labour market performance depends not only on labour demand but on a variety of institutionalfactors, which may be criticalto the effect of internationalintegration.Yet institutionswill also have to adapt to the new situation. One obvious example is the tax system. Integration makes the tax base for certain forms of taxation more mobile, and thereby creates a need for tax reforms or adjustmentof public expenditures.This and other institutionalchanges may affectthe labour market,but it is in general impossibleto say in what direction and with what strength. A political economy perspectivemay give some indicationson the direction in which institutional changes may go. Intensified international competition may potentially worsen the unemployment problem in the absence of structuralchanges, and this may pave the way for structuralreforms to enhance labour market flexibility (Saint-Paul, 1996). There has been a tendency for the degree of unionizationto decrease (Neumann et al., 1991; Wallersteinet al., 1997), for less strike activity (Aligisakis,1997), for labour protection to be lowered (Saint-Paul, 1996), and for more activejob-creating measures (Barrelland Genre, 1999). Some or all of these changes may have been induced by internationalintegration, and all point to more flexible labour markets. 2.8. Conclusion We have reviewed the channels through which product marketintegrationaffectslabour markets. The implications for the level of wages and employment are in general ambiguous since they depend critically on the initial situation, the specific market
6For empirical evidence in favour of this hypothesis, see Lawrence and Slaughter, 1993; Learer, 1994; Sachs and Shatz, 1994; and Neven and Wyploz, 1996.
114
structureand the degree of internationalintegration.7 However, the theoretical work points to two important implications. First, product market integration implies a tendency for wage convergence. Secondly, wage interdependenciesare strengthened: domestic wages become increasinglysensitiveto foreign wages. In the following sections, we consider whether there is empirical evidence in support of these two hypotheses. 3. TRADE AND WAGES We first examine empirical evidence about international integration, as reflected by international trade, and wage formation in the EU countries.8 We use data for the manufacturingsector,where trade potentiallyplays a dominant role. Figure 1 shows the evolution of cross-country deviation.The average nominal wage growth and its standcard in a decline confirms nominal increases from the mid-1970s figure steady average wage to the end of the 1990s. This reflectsthe transitionfrom a high inflationregime to a low inflation regime. This change has been quite similaracross EU countries,hence the fall in the standarddeviation of wage increases, especially since the mid-1980s. As a more direct measure of wage interdependenciesamong the EU countries, we may look at wages in each country relative to wages in the rest of the EU. For each country, Figure 2 displays the evolution of the ratio of hourly wages to the (countryspecific)trade-weightedwage in other EU countries, where the 'foreign wages' are all
0.2 0.025
0.15 \___2
^~ \~\~'~~~~~~
0.02
-0.015
0.1 , X \
-_
0.05-
/\'--.
'
''
-0.01
" -0.005
0 1971
l 1973
Il 1975 1977 1979
l 1981
li ll 1983
iI 1985 1987 1989
I 1991 1993
I 1995
I 1997
Mean(left-hand scale) Figure 1. Annual deviation nominal wage growth
- - across
t. Deviation (right-hand scale) EU countries: mean and standard
Source: Own calculationsbased on Svenska Arbetsgivare Foreningen (SAF).
7Our data did not allow us to estimate and test the unambiguous implicationsfor changes in labour demand elasticities. 8Due to lack of data, Luxembourg and Portugal are not included in our sample. Our sample of EU countries is: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Spain, Sweden and UK.
EU LABOUR MARKETS
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denominated in a common currency.Hence, a ratio of one indicates identical nominal wages in the home country and the 'foreign'country. There is a tendency for the ratios to converge towards one over the sample period. Germany, Denmark and Greece are outliers;for the other countries,there is a clear trend fall in the ratio if it startsabove one, and a trend increase if it begins below one. This convergence in relative wages is also reflected in a decrease in the cross-countrystandard deviation of the ratios during the sample period; the mean of the ratios also converged a little, from 0.90 to 0.93. Can these developments be related to international integration? An important indicatorof product marketintegrationis the development of internationaltrade, which increased steadily. Figure 3 shows the cross-country average of EU manufacturing exports and imports as a share of value added, a measure of EU countries' trade with other EU countriesand with non-EU countries.Strikingly, total trade has been increased Since the value of the mid-1990s, steadily. average export and import has been higher than the value added in the manufacturingsector.9 We are mainly interestedin product marketintegrationwithin the EU. Figure 4 shows the fraction of EU countries' trade that is with other EU countries. Over 60% of EU countries'trade is with other EU countries. This share did increase, but mainly during 1981-7, and fell somewhat after 1991. These shifts are closely related to the European business cycle. Correcting for the cycle, trade shares are fairly constant despite the increase in the level of trade.
ratio
1.8
1.4 1.2
Denmark Germany
~ ~ I~~1~
~~~
\--
UK SSweden Belgium
Austria France Spain 0.4

-
/ ~
Greece Std deviation
0.2
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
1970 1974 1978 1982 1986 1990 1994
I I I
1998
I I I I
Figure 2. Ratio of domestic to foreign nominal wages

Note:For each countrythe foreign wage is the trade-weightedwages of wages in other EU countries.Wages are denominated in the same currency. Own calculationsbased on Svenska Trade Database 1998. Source: (SAF)and the OECD Bilateral Arbetsgivare Foreningen
9 In
addition, there has been more FDI (Barrell and Pain, 1997).
116
ratio
12U
110 -
100 90 -
80 -
70 -
I~~ I ~ ~~~ ~I ~~ I
Ia
II
II
60 EA 50u 1I-r 1970
I 1974
I 1978
I 1982
I 1986
I 1990
I 1994
I 1998
Year
Figure 3. Total EU trade: cross-country average of EU countries manufacturing exports and imports as a share of value added
Own calculationsbased on OECD STANADatabase 1998. Source:
ratio
1971
1975
1979
1983 Year
1987
1991
1995
EU countries. Figure 4. Trade between countries' trade with other EU countries
The
graph
shows
the
fraction
of EU
Source: Own calculationsbased on OECD Bilateral Trade Database 1998.
Section 2 emphasized that links between product market integration and labour market performance must be addressedwithin a frameworkof imperfect competition. International trade theories with imperfect competition stress intra-industry trade (Krugman, 1990), whereas inter-industry trade is probably better explained by comparative advantage based on technology or factor endowments. Figure 5 plots the
EU LABOUR MARKETS
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Grubel-Lloydindex of intra-EU trade, the share of intra-EU trade that is intra-industry. trade had become This share increasedsteadilyduring our sample period. Intra-industry over 50% of all intra-EU trade by 1983, though the largest increases took place in the 1970s. The evidence presented so far does not contradictthe hypothesisthat product market integration in the EU induced wage convergence. However, an explicit test would be more convincing. We extend a method developed by Frankel and Rose (1998), who examine whether international trade gives rise to more correlated national business cycles. We pose a similar question. Does increased trade give rise to more correlated wage increases?First,we divide our data period into three sub-periodsof equal length. Secondly, we compute correlationsp#- in wage increasesin manufacturingbetween each pair of countries i andj in subperiodr. Since each correlationlies between -1 and +1, we then transformeach correlation into a new unrestrictedvariable ri- for use in our subsequentregressionanalysis.10Thus, as p takes on values between -1 and + 1, r takes on values between minus infinity and plus infinity.Fourthly,we calculate the trade level tijr between each pair of countries in each sub-period as the sum of country 's manufacturedexportsto, and manufacturedimportsfrom, countryj, divided by the sum of global manufacturedexports and imports of countries i and j. Finally, we run the following regression
rr = -1+ 2c2D2 +
a3D3+ 6tir
+ Sr
(3)
index 0.6
0.55 -
0.5
0.45 -
0.4 -
0.35
1 1 1970
1 1 1974
1 1 1978
1 1 1982
1 1 1986
1 1 1990
1994
Figure
5. GL-index
for intra-EU
trade
Own calculationsbased on OECD Bilateral Trade 1998. Source: Database,
' Formally, rr= ln((Pr + 1)/2/[1 - ( pr + 1)/2]).
118
Table 1. Wage correlation equation

al r2
a3 -0.29 (0.18) 0.10 (0.15)
6 15.63** (3.62) 7.86* (2.99)
R2 0.45 0.05
Hetl 0.13 0.89
Het2 0.17 0.98
Reset 0.37 0.93
JB 0.00 0.70
Nominal wages Real wages
2.88** (0.14) 0.14 (0.12)
-2.13** (0.18) 0.32* (0.15)
Note:* signifiessignificanceat 5% level, ** at 1% level. Numbers in parenthesesare standarderrors.Hetl and Het2 reportp-valuesfor White heteroscedasticity tests, whilst Reset andJB reportp-values for functionalform and the Jacque-Bera normalitytest.
where D2 is a dummy variable for period 2, D3 is a dummy variable for period 3, and e#y is a disturbance term. The parameter 6 measures the effect of trade on wage interdependencies. By pooling the data for the three sub-periods, we get a total of 234 observations. 1 We run the above regression using nominal wages as well as real product wages; results are reported in Table 1. Both the nominal and real wage equations appear reasonably well specified. For both cases, the coefficient 6, the effect of trade integration, is positive and significant.12 Greater trade between two countries implies more closely correlated wage increases across countries.
4. WAGECONVERGENCE
Section 3 indicated that international integration has induced wage convergence. If this is correct, we should be able to find direct evidence that the wage interdependencies have increased across countries: foreign wages should play a larger role in domestic wage setting. This issue cannot be assessed by standard time-series equations in which it is assumed that parameters are stable; international integration gradually changes economic structures. Accordingly, we estimate time-varying parameters, where the parameters of the wage equations are generated according to a stochastic process. Because the parameters are allowed to evolve gradually over time, convergence can be captured empirically by the evolution 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 exchange rate data. To our knowledge no empirical studies have been conducted using this technique 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-differenced wages to remove a trend component in wages, we also used the Hodrick-Prescott filter to detrend the data. These results appeared to be qualitativelysimilarto those reported above.
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Box 1. Estimating time-varying effects of foreign wages

The models under considerationare of the general form:
o yt -= At=
+ ^Zt + 3tXt + Ut (4)
t- 1 + Vt
'
(5)
UVt
Think ofyt as the domestic real wage, and of Ztand xtas exogenous variableswith fixed and time-varying parameters, respectively. We interpret Zt and xt as productivityand trade-weightedforeign (real)wages. The time-varying parameter model (see Harvey, 1989; Hamilton, 1994), is form. Equation (4) is the measurement equation, displayed above in state-space the transition-equationdescribing the evolution of the state variable equation (5) pt (the time varying parameter).The model has been simplifiedby allowing only one parameter to vary since there are only 29 observations available for estimation for each country. The parameters are estimated by maximum likelihood (for technical details, see again Harvey, 1989; Hamilton, 1994). The Kalman filter is used recursively to extract the state variables conditional on information up to time t- 1. Full sample information can be used to estimate the latent state variables by implementation of a smoothing updating algorithm. These smoothed state variables are extracted to represent the time-varying parameters. A number of theoretical assumptions underlie the state-space model (4)-(6). The right-hand side variables are considered exogenous, and error terms iid Gaussian noise. There is no clear guidance in the literaturewhat to do if these assumptionsare not met. Any generalizationgreatly complicates the estimation. With some reservations,we simply estimate the simpler form (4)-(6).
This is motivated partly by theoretical concerns, partly by the fact that nominal wages largely pick up simultaneousconvergence of European monetary policy, which does not Our estimation necessarilymean labour marketshave become more closely integrated.13 14 are: equations
Model 1: Model 2: In Wt/Pt = ca+ ft In Wf/Pt + Ut In Wt/Pt = a + Pt In Wtr/Pf + ut
13 We also estimated the model with nominal wages; resultsclose to those reported for Model 1. 14A log-formulation avoids normalization problems arising as a result of using index-numbers, and makes 3-coefficients (elasticities) comparable across countries.
120
The basic model (Model 1) relatesthe domesticproduct real wage to the foreignproduct real wage, defined in terms of domesticproducerprices. Penetrationof foreign firmsinto the domestic product marketdepends on this measure of profitability. Model 2 considers as an alternativethe productreal wage defined in termsof domesticproductpriceswhich is the conventionalway of defining this variable,1516 and which is a measure often used in comparativestudies. These specifications reflect dynamic patterns in the wage-formation process of the home country, especially with respect to the dependency of the (trade-weighted) foreign wages. Increased (relative) convergence between wage settings in the home country and the foreign country is identified when 1t tends towards unity over time. Observe that /t tending to one does not necessarily mean that the wage rates are converging in absolute terms because the intercept may be country specific.17 Figures 6-9 display the smoothed state variables (time varying parameters), and a 95% confidence band. The resultsfor Model 1, reported in Figure 6 (differentfigures have differentscales), reveal that coefficients to foreign wages did vary over time, lending support to the approach taken here. Convergencefrom below is observedfor Austria,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 sample period. A notable finding is that countries in the periphery or newcomers to the EU (Austria,Finland, Greece, Ireland and Spain) have experienced a large increase in the influence of foreign wages: European integration has had a clear effect on wage formation. Until the early 1980s, the UK diverged from the rest of the EU, but subsequently this has been reversed. A similar pattern can be observed for Ireland. Convergence is even more apparentfrom estimationof Model 2 (Figure 7) which shows important structuralchanges for all countries which all evolve in the direction of wage convergence. Note the significantchange for Spain after EU membership in 1986. The resultsof estimatingthe time-varyingparametersconfirm that structuralchanges have taken place and that internationalinterdependenciesin wage formationhave been strengthened.This convergence can be the direct result of changes in market structures and marketpower, as discussedin Section 2, but may also reflect a more easy flow and transfer of information and technological knowledge. In the latter case, wage convergence simply follows from the fact that internationalintegrationmakes countries more similar. To discriminate between these two interpretations of why wage
15 This specificationraises an index number problem. We have hourly pay in domestic currencybut only a price index. We make wages comparable across countries by measuringthem in DM in the base year 1992. Given the log-specification,any level differencesin prices will be picked up by the constant term.
16International comparisons are often based on unit labour costs. This approach is problematic: for Cobb-Douglas technology, unit labour costs are independentof the wage. We do not reportresultsfor unit labour costs, since we were unable to constructconsistent series for our countries during our sample period. 17This mimics the distinctionbetween the absolute and the relative PPP-hypothesis.
EU LABOUR MARKETS
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122

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18 productivity and foreign wages. However, this was not been possible. The results for
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124
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findings for Model 4, plotted in Figure 9 show that the effect of productivity on wages is generally declining. Section 2 argued that this should happen when markets get more integrated. Hence, the effect of integration may have been to induce some convergence of productivity but simultaneously to reduce the effect of productivity in domestic wage setting 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 wage convergence in Europe, but leaves open whether international integration primarily affectswage formation by inducing convergence in technology and thus productivity,or by affecting market structuresand powers.
5. CONCLUSION Internationalintegrationof product marketshas implicationsfor labour marketsthrough variouschannels, includingfiercerproduct marketcompetitionand increasedmobilityof jobs. The evidencepresentedin the presentpaper yieldssupportfor the view that increased integrationinduces a more similarwage developmentand strongerwage interdependencies. This is a gradualand ongoing process that will continue in the years to come. The present situation is, however, far from the one predicted by the hypothesis of factor price equalization.First,while wages are following each other more closely across European countries,the levels are not the same. There are still differencesin the level of wages, irrespectiveof how these are measured,but some tendency for wage differencesto become smaller. Secondly, wage convergence is not tantamountto elimination of either market power or rigiditiesin labour markets. What are the lessons for economic policy? Fear that integration will lead to major downward pressure on wages or devalue social provisions is not supported by our empirical evidence. There still is a role, therefore,for a domestic labour market and for social policy at the level of the nation state. Nor can internationalintegrationbe counted on automaticallyto make labour markets more flexible. Market power is being slowly eroded, but will still exist in product and labour marketsfor a long time to come. Even though integrationmay enforce some adjustmentin the wage setting process, this need not lead to better employmentperformance.In countrieswith an initialpoor competitive position,jobs may be lost during the process in which wage setting is put under pressure by the intensified competition induced by internationalintegration. Our empirical evidence documents changing labour market performance, but also shows that this adjustmentprocess is fairly slow. Since changes will not be abrupt, there remains a significantwindow in which structurallabour market reforms can enhance labour market performance.The danger is that politicianswill underestimatethe need for policy initiatives,believing that the market will do everythingfor them.
Discussion Samuel Bentolila

CEMFI, Madrid Andersen, Haldrup and Sorensen (AHS) have written a paper on a highly topical issue, the interactionbetween internationaltrade and labour markets.They study the case of
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the EU, which has experienced a trend reduction in barriersto within-areatrade since 1960. Most EU countries also show poor labour market performance,in terms of their unemployment rates, over the last 25 years. Thus, it seems natural to examine the role product market integration may have played in EU labour market developments. Thinking ahead, this link might for example help us in guessingthe labour impact of any furtherproductmarketintegrationresultingfrom the euro. AHS have chosen a narrower focus, the impact of trade on wage convergence in Europe, an interestingand underresearchedtopic. In general, their findings are quite suggestive. Theories of trade and labour markets AHS startwith a brief surveyof models on the interactionbetween trade and wages. The main message is that, by raisingthe sensitivity(elasticity) of firms'demand for labour, the increase in trade is likely to induce lower labour union wage markupsand thus lead to lower wages. This is indeed the key effect we should expect. AHS note that trade also worksthroughother channels,which could actuallylead to it having ambiguously signed effects on wages. Among the various mechanisms they mention, let me focus on the one due to the authors themselves,since it also underpins some of their empirics. Andersen and Sorensen, in another paper (1999), derive a relationshipbetween the domesticwage and two variables,domesticproductivityand the foreign wage. The effects of both these variables are found to vary with the share of tradablegoods in national production,proxied by the correspondingemployment share. Since the impact goes in a differentdirectionfor each of the two variables,they conclude that the effect of trade on the domestic wage is ambiguous. Let me questionthis conclusionon two grounds.First,the argumentwould go through for given paths of productivityand foreignwages. But this condition is undermined a bit later, in Section 2.6, where AHS argue that increasedopenness may force labour unions to choose between accepting wage cuts or increasingeffort to maintain their jobs. The latter option implies that in effect the path of productivityresponds (positively)to the tradablegoods share. Secondly, such share is itself endogenous, depending on primitives like the costs of internationaltrade. Indeed, variable costs - as opposed to fixed costs appear in their model, and are found to raise the effect of productivitybut not to reduce the effect of the foreignwage. Thus it is not fully clear that the alleged ambiguityobtains. Even if more trade does not necessarilyimply lower wages, AHS claim that all the models imply a tendency for wage convergence and strongerwage interdependencies. While reasonable, this conclusion is somewhat informal, because the survey does not focus on these two issues. Moreover, the impetus for convergence may depend on another feature, namely the share of intra-industry trade. Inter-industry trade, in which the tendency for wage (factorprice) equalizationacrosscountriesshould be stronger,has probably been relevant mostly for the poorer EU members (Greece, Ireland, Portugal and Spain),which are relativelylabour-abundant.But regardingwithin-EU trade, it has trade, which tends to exploit steadilybeen giving way - as AHS show - to intra-industry
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economies of scale and product differentiation,so that labour costs are less important. This should generate less pressure for wage equalization via trade. The empirical relationship between trade and wages The theoreticalsurveydoes not specifywhat definitionof wages we should look at when searching for convergence or interdependencies. For convergence, traditional trade theory directsus towardsnominal wage levels, possibly - as argued by Trefler (1993) corrected for productivity.For interdependencies,we might however want to examine real wages or labour costs, again possibly - if we follow Andersen and Sorensen (1999) controlling for productivity.Let me take them in turn. Nominal wage convergence in Europe is quite evident in Figure 2, except for three countries (one of the three being Germany, which is probably the defacto reference country).Is convergence related to trade?AHS start by asking whether intra-EU trade has actually increased. At first pass it has, if we compare the 1970s with the 1990s in Figure 4. Formal evidence on the link is provided by regressingthe correlationbetween wage changes for all country pairs on a measure of relative trade volumes. The results are mildly favourable to the hypothesis that increased trade has increased wage convergence. It should be noted, however, that a relativeproductprice index would have been a more appropriate regressor, since theory tells us that trade should not cause wages to change if relativeprices do not change. This point is forcefullymade by Leamer and Levinsohn (1995). Interdependenciesare examined in Section 4. AHS follow Andersen and Sorensen (1999), regressingdomestic wages on productivityand foreign wages. They then check whether the coefficientson these variables change in the way predicted by the model: down for the former, up for the latter. They do so with sophisticated econometric techniques (the Kalman filter),although the relativelyshort sample size (29 years)limits the accuracy that can be achieved in estimation. Before commenting on the results,let me point out a few issues about the empirical specification.First,as I indicated before, productivityis likely to be affectedby openness. If so, then the estimates of the productivity coefficient would be biased and an instrumentalvariablesestimationwould have been indicated. Secondly, the foreignwage is measured as a trade-weightedaverage of wages in the remaining EU countries. The weight assigned to each foreign country therefore increases if trade with that country grows.As a result,some of the effectsof trade might alreadybe capturedby the regressor rather than by the estimated coefficient. While there is no obvious solution to this problem, an alternativeestimationwith, say, wages in Germany would have provided a useful check on the results.Lastly, the empirical specificationused is essentiallya longrun one, but the equation is estimated on a yearly basis, and so the variabilityin the coefficients may be in part due to the omitted impact of domestic cyclical effects on wages. These limitationsimply that the variationin the coefficientsmay not be capturing the potential impact of increasing openness.
128
Empirically,the predictionthat the weight on the foreign wage should grow over time is found only for Finland, Greece, Ireland and Spain, mostly labour-abundantcountries Futurework examining more disaggregateddata might provide (as previouslyargued).19 a sharpertest of this hypothesis. All in all, the empirical results suggest that, although trade has induced some wage convergence, the effect has not been very strong. Thus, it is easy to agree with the authors'reading of the evidence, namely that product market integrationhas, thus far, not created major pressures on wages or the welfare state. This may be due to the conflicting effects they discuss or to some other causes.20 Andersen, Haldrup, and Sorensen's empirical resultsprovide us with a startingpoint for such an exploration.
Janvan Ours
CentER for Economic Research, Tilburg University, Tilburg This is an interestingpaper on a very importantpolicy issue, the increasingintegrationof the EU and the potentiallabour marketeffectsfor the countriesinvolved.This is not only importantfrom the point of view of a labour economist,but has a wider relevance.Or, as Freeman (1998) puts it: 'for the firsttime in a long time, the big issuesin economic policy are about the labour market'. The paper has a sand-glass structure: broad in the beginningand end, but narrowin the middle. In the beginning of the paper there are discussionson the possible effects of of maintaininga welfare integrationin termsof threatsto socialrelationsand the possibility society,on increasedproductmarketcompetitionand increasedmobilityof firmsandjobs, and so on. In the middle of the paper there are some stylizedfactsin termsof graphsand tablesand a few regressions gatheringevidenceon wage convergence.In the end there is a conclusionabout Europeanintegrationfrom a wider perspective.The bottom line of the paper is that there has been wage convergence in Europe, but in addition to that the authorsconclude that there is no supportfor the fear that the integrationprocesswill lead to major downwardpressureon wages and to devaluationof social standards. In my comments I focus on the empirical evidence presented. My main point is that the authors present evidence that suggests that increasing integration leads to wage convergence. However, the evidence is not always convincing and does not supportthe broad conclusions at the end. Let me give three examples. First, Figure 1 presents the evolution of mean and standard deviations of nominal wage growth across EU-countries,showing that both decline over the period 1971-98. Nevertheless, the ratio of the two, the coefficient of variation hardly changes, being around eight in both 1971 and 1998. So, what is the correct conclusion? Secondly, Table 1 presents parameter estimates of a model that relates wage correlation and a product integration variable. Wage correlation is defined as the
19Using the estimated 95% error band for 1976, so as to reduce the impact of the start-upestimate for the coefficient,one cannot find a statisticallysignificantchange in the case of Austria. 20Rodrik(1998) argues for a political economy story.
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correlationbetween - real or nominal - wage increases in two countries. The product integrationvariableis defined as the ratio of the sum of importsand exportsbetween two countries and the total imports and exports of those two countries. The idea is that if there is more product market integration there should be a closer correlation. That is indeed what the authorsfind. However, if I use the parameterestimatesof Table 1 to get an idea about the posed relationshipI find some resultsthat are difficultto interpret.If I take a country-pairwith no trade relationship(no imports and exports between the two countries) I find the calculated correlation between the nominal wages in the two countries to be 0.89 in the first period, 0.36 in the second period and 0.86 in the third period. How to interpret the high level in the first and third period or the differences between the two periods I do not know. Thirdly, in the wage convergence regressions domestic real wages are related to foreign real wages. Here, it turns out that the parameterof interestis in many cases close to one and converging to one either from above or below. Though as a general statementthis seems to be true, the authors do not go into an explanation of differences between countries. The coefficient in the regressionfor the Netherlands is less close to one than the coefficient in the regressionfor Greece. Still the Dutch economy is much more integratedin the EU than the Greek economy. So, where does the differencecome from? I think that the main conclusion that there is EU wage convergence is correct. I also think that this has to do with product marketintegration.But that is it. No more. I agree with the authorsthat there is no empiricalsupportfor the 'race to the bottom' hypothesis that posits that there is a huge competitive disadvantage to social regulations or institutionsso that firmsor countriesare 'forced'to lower standardswhen they tradewith countrieshaving lower standards.But, there is also no empiricalsupportto contradictthe hypothesis.I like to believe Freeman (1998)who statesthat 'the fabled race to the bottom - social dumping - about which some economists and union leaders worry is largely a myth', but find no support from this paper. In my heart I agree with the main conclusions. Fear of major devaluation of social standardsseems stronglyexaggerated,and there is still a role for domestic labour market and social policy. However, this is not something that comes out of this paper. In my head there is still doubt whether this is really no race to the bottom. As far as this is concerned, this paper moved some probabilitymass from my head to my heart but there is still a long way to go before my head is empty.
Generaldiscussion
When analysingthe question of whether trade has led to wage convergence,the fact that there was a considerableheterogeneityacrosscountriesin the period consideredmust be taken into account. Stefan Gerlach argued that cross-countryresultsmight be driven by
130
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 are geographically very close and traded extensively. In contrast, Spain, Portugal and Greece are geographicallyfar from the core countriesand did not trade very much with the others before entering the EU. So the inclusionof these three countriesfor the entire period may affect the results. Lucrezia Reichlin was critical of the authors' use of aggregate data rather than sectoral data. For instance, if integration leads to more specialization,we will not find convergence in the aggregate data. Such specialization may well have occurredbecause the capitalmarketacts as an insurancemechanism and, with increased opportunities of cross-country ownership, there is less need for CharlesWyplosz pointed to empiricalfindingsshowingjust the opposite, diversification. namely that integrationleads to less specialization. David Begg wanted to see some discussionof how to separatethe externalfactorsfrom those analysedin the paper. The authorsstressthat the paper does not deal with the issue of globalization and that all the empirical results are concerned with what is going on inside Europe. However, any increase in external competition might have forced narrowings or broadenings in European wages unrelated to the forces of integration within Europe. Paul Seabrightwas criticalof the authors'use of convergence.The paper asserts that the standard deviation of growth in nominal wages should fall in the convergence process. If wages start out different,then one would expect lower wages to catch up with the higher ones. Until the convergence process is completed, increasing integration can actually be expected to increase the dispersion of growth in nominal wages.Jordi Gali suggestedbasing the analysison the measure of labour income shares. There are many possible sources of convergence of real wages across countries. One drivingforce behind convergencecould be the degree of competitionin product markets as the paper pointed out. Alternatively,there could be convergencein the wages because labour productivityconverges across countries given the product market competition. Therefore, he suggested focusing on the possible convergence of labour income shares acrosscountries.Under certainassumptionsabout the underlyingtechnology, the labour income share is just the reciprocal of the mark-up in the product market and thus captureschanges in the degree of competition. Stefan Gerlachwanted to know why the authorslook at the real wage costs ratherthan looking at labour costs more broadly.Jakob de Haan suggestedlooking at unit labour costs,which are availablefor all OECD countries.The measurefor wages in the paper is very rough. What is needed is a measurefor hourly compensations.Lookingat both unit labour costs and productivitycould help to settle some of the remainingproblems. Paul Seabrightemphasizedthe significanceof the approachto modelling of the labour market. For example, if unions set wages and firms determine employment, wages and productivityare positively linked and, in particular,high market power leads to high productivity. However, there are some industries where market power is negatively linked to productivity.Not only is productivityendogenous, the direction of the effect is sensitive to what is going on in the underlyingbargaining.
EU LABOUR MARKETS
131
Georges de Menil felt that an important channel for the effects of European integration on the labour markets was left out in the paper, namely the possibility of institutional changes. The current political debate shows that labour market regulations might be reformed as a reaction to the changes in the economic environment. Stefan Gerlach pointed out that the relocation of production plants - as in the Renault 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 of potential union resistance rather than an example of any multinational strategizing.
APPENDIX. THE DATA

Countries 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 of data, Luxembourgand Portugalhad to be excluded. In most cases we could constructdata for the full period 1970-98 by spliningvarious data sources.A complete characterizationof the database is available from the authors upon request. Data for manufacturing wages (wages for time worked) are taken from Svenska Arbetsgivare Outlook Data for the early years, 1970-4. Trade Fireningen (SAF)jointly with OECD, Economic weights for the construction of 'foreign wages' were extracted from the OECD BilateralTrade Database1998. Producer prices were found from the ratio of value added in current and fixed and MainEconomic industrial analysis, (1990) prices. The sources were the OECD STANdatabasefor Indicators. sector)for Belgium, Productivityindex (1992 = 100) series(outputper hour in the manufacturing UK and the were extractedfrom US the Netherlands,Sweden, Denmark, France, Germany,Italy, of LaborStatistics, August 1999. (See Paul Krugmans's homepage Department of Labor, Bureau Data for Austria,Greece, Irelandand Spain were http://www.mit.edu/people/krugmanlindex.html). calculatedusing data for average annual hours worked in manufacturing(also US Department of Statistics, Labor, Bureau August 1999) jointly with data for value-added. The source of the of Labor Sectoral Database Finland data was OECD International ISDB, 1998.
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Aligisakis,M. (1997). 'Labour disputes in Western Europe: typology and tendencies', International Labour Review. Andersen, T. M. and Sorensen,J.R. (1999). 'Product market integration and wage formation', Integration, forthcoming. Journal of Economic Barrell,R. and V. Genre (1999). 'Employmentstrategiesfor Europe: lessons from Denmark and Economic Review. Institute the Netherlands', National Barrell, R. and N. Pain (1997). 'Foreign direct investment, technological change and economic growth within Europe', Economic Journal. Bean, C., S. Bentolila, G. Bertola andJ. Dolado (1998). Social Europe: OneforAll?, Monitoring European 8, CEPR. Integration Bughin, J. and S. Vannini (1995). 'Strategic direct investment under unionized oligopoly', International of Industrial Organization. Journal Calmfors, L. and J. Driffill (1988). 'Bargaining structure, corporatism and macroeconomic Policy. performance',Economic Danthine, J.-P. and J. Hunt (1994). 'Wage bargaining structure, employment and economic Journal. integration',Economic
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Labour market implications of EU market product integration

TorbenM.Andersen,Niels Haldrup and Jan Rose S0rensen

TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE SORENSEN

TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE S0RENSEN

EU LABOUR MARKETS MARKETS EU LABOUR

TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE S0RENSEN

TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE S0RENSEN

Il 1975 1977 1979

iI 1985 1987 1989

Mean(left-hand scale) Figure 1. Annual deviation nominal wage growth

t. Deviation (right-hand scale) EU countries: mean and standard

Source: Own calculationsbased on Svenska Arbetsgivare Foreningen (SAF).

Austria France Spain 0.4

Greece Std deviation

Figure 2. Ratio of domestic to foreign nominal wages

TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE S0RENSEN

60 EA 50u 1I-r 1970

EU countries. Figure 4. Trade between countries' trade with other EU countries

Source: Own calculationsbased on OECD Bilateral Trade Database 1998.

Own calculationsbased on OECD Bilateral Trade 1998. Source: Database,

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

TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE S0RENSEN

Table 1. Wage correlation equation

a3 -0.29 (0.18) 0.10 (0.15)

6 15.63** (3.62) 7.86* (2.99)

Hetl 0.13 0.89

Het2 0.17 0.98

Reset 0.37 0.93

Nominal wages Real wages

2.88** (0.14) 0.14 (0.12)

-2.13** (0.18) 0.32* (0.15)

Box 1. Estimating time-varying effects of foreign wages

TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE SORENSEN

,'C ~0o P \ e95

Slope. Germany,Log data

5',r *r.-n I07C

t7r - - 957. limit

Italy, Log data

Stole ) J----- Smoothed

Smoothed State X~~~~~~J l ee--

Smoothed Stote lowe- im t 95 Z upper limit

Smoothed Stote | ^ wer limit

0 0 5e-95 Zupper limit9

3t: In Wt/Pt= a + 3t In Wf/Pt

TORBEN M. ANDERSEN, NIELS HALDRUP AND JAN ROSE SORENSEN

0-0-000-0- 0-0 O 0S m o 0- t t 00-

. Loo,F.....,~,f 0-0-0-s o 70.

C~, Slope. Germany. Lo,~Z~_G rm.....~.ldm. Log data

o ' "9' u-' i' 95 Z

Slope, Greece, Log data

. Lo,0 ~_1,.~Ondr(..*~n..L; Logdata Slope, IreSand, 0_. 0- 0" 0-

Lopo2_l lm,.I*r~ldm.tkl Slope, Italy,Log data

- 0S 619 7 0 .... 2000

Log data L~..h(**..~,.k1p.Netherlands.

a LS~,S~ .p....( ,o 95' lo-' li)-.

data Stoaatcas~ Smoothed~~~__~ )-Sop. Swde.Log

Slop., UK,Log data

]8Attempts were made but the algorithm failed to converge.

Slope. Belgium,Log data e @ --S-_____ _

e-- ss'. ~~~~~~~~~~~~~~~~oo

_.e Smoothed St?te

ower imit imit

~~~~~~~_ ~ @ ~~~~ e--s