The Response of Wages and Labor Supply Movements to Employment Shocks Across Europe and the United States


WP/94/158-EA
The Response of Wages and Labor Supply Movements to Employment
Shocks Across Europe and the United States by Alun H. Thomas

This paper compares the degree of labor market flexibility across
geographical regions in the United Kingdom and the United States and across
four European countries (France, Germany, Italy, and the United Kingdom).
This comparison is motivated by the prospect of European Economic and
Monetary Union, within which the ability to vary bilateral exchange rates
will be eliminated. This will necessitate a greater reliance on other forms
of adjustment for countries within the Union.

The paper uses a multivariate VAR framework to assess the degree to
which relative regional and national wages and labor forces adjust to
employment shocks. The paper finds that the responsiveness of wages to
employment shocks in the United States and in Europe is minimal but that
there are large differences in the response of the labor forces in both
areas. There is a high degree of interregional migration in the United
States, so that when a region experiences a large reduction in employment, a
sizable fraction of the labor force moves to surrounding regions. This
movement is sufficient to prevent persistent unemployment differences across
U.S. regions. In Europe, the German and French economy-wide labor forces
and the British regional labor forces adjust to a limited degree to
employment shocks, but the magnitude of the adjustment is insufficient to
prevent the appearance of persistent unemployment rate differences. There
is very little adjustment of the British and Italian economy-wide labor
forces to employment shocks.

The paper concludes that Europe must promote measures to stimulate
interregional and international migration to facilitate its adoption of a
common currency.