NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Does European Unemployment Prop up American Wages?

Donald R. Davis

NBER Working Paper No. 5620
Issued in June 1996
NBER Program(s):   ITI

We consider trade between a flexible wage America and a rigid real wage Europe. In a benchmark case, a move from autarky to free trade doubles the European unemployment rate, while it raises the American unskilled wage to the high European level. Entry of the unskilled South to world markets raises unemployment in Europe. But Europe's commitment to the high wage completely insulates America from the shock. Immigration to America raises American income, but lowers European income dollar-for-dollar, while European unemployment rises one-for-one. We consider a stylized game of the choice of factor market institutions. Mitterand's Europe chooses a high minimum wage and Reagan's America chooses a flexible wage for the unskilled. Paradoxically, unskilled workers are worse off in Europe. Trade equalizes wages, but Europeans bear all of the unemployment required to sustain the high wage.

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Document Object Identifier (DOI): 10.3386/w5620

Published: American Economic Review (June 1998).

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