Wage Inflation and the Distribution of Output Gaps in Europe: Insiders vs. Outsiders

This paper examines whether Europe's monetary union framework of "ins" and "outs" reflects differences in market structures underpinned by relatively immobile labour. Such a situation could give rise to sufficient nominal convergence to satisfy the entry requirements to EMU, but little real convergence and hence a significant incentive for some to stay outside. Using models of wage leadership vs. locational competition, we examine the extent and strength of integration in labour market costs using a sample of data covering the 1980s and 1990s - i.e. for the run up to EMU. This exposes a conflict between real and nominal convergence which is ultimately incompatible with further integration. The empirical evidence suggests that wage bargainers now appear to focus more on their own domestic market conditions. That may deliver a better economic performance, but little extra integration.