The persistent rise of European unemployment rates since the early 1970s has been accompanied by a striking rise in the dispersion of regional unemployment rates, as well as wage inequality across regions within European countries. In contrast, the US has shown no trend in the weighted standard deviation of unemployment rates over the past quarter-century, while wage inequality among regions has risen.

In Discussion Paper &nbspNo. 1020, Research &nbspFellow Michael Burda and Antje Mertens explain the divergent trends by considering `locational competition' as the efficient economic response of locales to the immobility of labour and regional variation of economic outcomes. The European outcome is rationalized within a model based on implicit contract theory. Demand for insurance against regional shocks arises, which can be provided by nationwide collective bargaining or other national institutions. This form of risk-sharing or `locational cooperation' is a feasible policy only as long as shocks are insurable, however. Real wage and other types of flexibility will be invoked by localities only in response to systematic shocks such as a change in the terms of trade. West German and other European experiences are consistent with an insurance contract interpretation, &nbspwhere the model predicts much more variability of unemployment in response to an increase in the variance of regional shocks than in the market clearing model. In contrast, US regional labour markets are characterized by high regional mobility, rendering insurance less relevant.

Locational Competition versus Cooperation in Labour Markets: An Implicit Contract ReinterpretationMichael Burda and Antje Mertens

Discussion Paper No. 1020, September 1994 (HR/IM)