JOINING THE EU: CAPITAL FLOWS, MIGRATION AND WAGES

What is the impact of joining the European Union on a small, less developed economy? This is the generalquestion driving this research paper. In particular, the role of factor movements in explaining real wagebehavior in Portugal after its entry in the European Union (EU) is quantitatively evaluated. For this purpose,we develop a simple theoretical model featuring a neoclassical aggregate production function a la Krusell et al(2000), which distinguishes between skilled and unskilled labor, as well as capital equipment and structures.Estimation of the implied aggregate elasticities of substitution is performed and used in simulating both typesof wages and the skill premium. This constitutes an empirical test of the proposed technology, which findsan important role for capital-skill complementarity. Based on these results, counterfactual simulations areperformed to measure the impact of foreign investment and emigration on skilled and unskilled wages between1985 and 1999. We find a small role for labor movements, and a more important one for capital inflows.This should constitute a good starting point to think about the consequences of the Eastern enlargement ofthe EU and of other integration experiences that abolish barriers to factor mobility....