Working Paper: CEPR ID: DP2373
Authors: Stefan Lutz; Alessandro Turrini
Abstract: The effect of labour costs on industry profits, employment and labour income is at the heart of the current European debate on industry competitiveness. High wages paid in European countries such as Germany are generally considered harmful for industry profitability. Although, high wages also appear to be associated with high labour skills and then with superior product quality. Similarly, a reduction in labour taxes is often invoked as a tool to improve industry profitability, but this argument hardly takes into account the demand effects of such a tax reform. In this paper we analyze the trade-off between labour costs and industry profits by means of a simple general equilibrium model where one industry is oligopolistic and vertically differentiated. The manufacturing of products of a higher quality requires the employment of a larger amount of skilled labour. Given an underlying skills distribution, the model determines profits, wages and aggregate income and welfare. Results show that high net wages due to a low skills endowment in the economy are typically associated with low profits. Labour taxation unambiguously raises gross wages, but has little effect on net wages. Depending on how the tax revenue is redistributed, higher taxation may either depress or boost industry profits.
Keywords: vertical intraindustry trade; quality differentiation; skills; productivity; labour cost
JEL Codes: D40; D50; F10; F20; J20; L10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Labor costs (J30) | industry profits (D33) |
| Labor costs (J30) | product quality (L15) |
| Skilled labor endowment (J24) | product quality (L15) |
| product quality (L15) | industry profits (D33) |
| Labor taxation (H29) | net wages (J31) |
| Labor taxation (H29) | industry profits (D33) |
| High net wages (low skills endowment) (J31) | low industry competitiveness (L19) |
| Tax revenues retained by government (H29) | industry profits (D33) |
| Tax revenues fully redistributed (H29) | industry profits (D33) |
| Tax revenues fully redistributed (H29) | net wages (J31) |