European Integration
A common labour market?

Liberalizing cross-border movements of workers within the European Community has had no discernible effect on labour markets, largely on account of remaining cultural and linguistic barriers to mobility. In Discussion Paper No. 694, Research Fellow Jean-Pierre Danthine and Jennifer Hunt argue that European economic integration will nevertheless affect labour markets. Recent empirical work suggests that countries with highly centralized wage-bargaining structures (Austria and the Nordic countries) and those with highly decentralized labour market institutions (Japan, Switzerland and the US) exhibit stronger employment performance than those `in between' (including most EC member states). This will clearly assume policy relevance if the EFTA countries join the Community.

Danthine and Hunt consider how increased product market competition modifies the optimal strategies of unions that exert significant market power, and hence employment and wages. As two fully centralized economies integrate to form one, their unions must merge to maintain a `corporatist' structure. Bargaining at the `wrong' level in an imperfectly integrated world entails high employment costs, but it is less damaging as competition intensifies; as the trade-off between wages and unemployment deteriorates, unions attach less weight to high wages. Integrating corporatist economies has a discrete negative impact on their efficiency as national unions impose externalities on one another, but this is offset by strong international competition, which reduces the unions' margin for manoeuvre and substitutes market discipline for global vision.

Danthine and Hunt then consider competition between alternative models within the single market. Results from their two-country model suggest that a corporatist economy will suffer from imperfect integration with a more decentralized competitor, whose performance is less sensitive to its partner's wage-bargaining structure; but the harmful effects of bargaining at the `wrong' level diminish as integration proceeds. Full economic integration therefore need not threaten the coexistence of different national systems of wage setting. The authors caution, however, that the similar performance of these two labour markets after integration conceals very different processes of adaptation. Centralized economies must undergo much more price and wage adjustment than decentralized ones for the equilibrium price level finally to stabilize below the level that prevails initially in the decentralized economy, while wage differences also fall sharply. Real-world unions will therefore adapt more slowly than the rational unions in this model; in centralized economies, unions may find it difficult to alter long-standing practices, so the effects of integration on unemployment are likely to be less favourable than this model suggests.

Wage Bargaining Structure, Employment and Economic Integration
Jean-Pierre Danthine and Jennifer Hunt