Working Paper: NBER ID: w5620
Authors: Donald R. Davis
Abstract: 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.
Keywords: European unemployment; American wages; trade; labor markets
JEL Codes: F16; J31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strategic choice of factor market institutions (D47) | Reagan-Mitterrand paradox (E65) |
| autarky (F00) | European unemployment (F66) |
| free trade (F10) | European unemployment (F66) |
| free trade (F10) | American unskilled wages (F66) |
| Southern labor entry (J45) | European unemployment (F66) |
| European wage rigidity (F16) | American insulation from shocks (G52) |
| immigration to America (K37) | American income (D31) |
| immigration to America (K37) | European income (N93) |
| immigration to America (K37) | European unemployment (F66) |