Wage Inflation and the Distribution of Output Gaps in Europe: Insidersvs. 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. As a result wage bargainers now appear to focus more on their own domestic market conditions. That may deliver a better economic performance, but little extra integration.