Price and Wage Setting in an Integrating Europe NBB Colloquium, F. Abraham, J. Konings, S. Vanormelingen LICOS and Faculty Economics and Management KULeuven

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Motivation Accelerated process of economic integration  Euro  Enlargement  China in WTO  China and India new world powers  Internationalization of production: outsourcing, FDI, offshoring  Changing trade pattern towards low wage regions may have substantial effects on Western product and labor markets that are heavily unionized

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Trend trade and production

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Import Penetration according to Region

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Outsourcing

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Motivation continued International trade matters for labor markets:  Rodrik: Union bargaining power weakens as substitutability of workers increases  Outside options change  Spillovers between product and labor markets (Konings and Walsh, 1994; Abraham and Konings, 1999) Impact depends on structural rigidities and in particular on how price and wage setting mechanism works (Blanchard and Giavazzi, 2003)

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Contributions Estimate impact of globalization on both price-cost margins and union bargaining power Globalization is broadly defined:  import penetration according to region of origin  Outsourcing  Foreign ownership (international rent sharing)

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Structure Background Model (Blanchard) Data Estimation Results Conclusion

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 A Simple Framework of product and labor market interactions Wage Setting: W=PF(u,Z) Price Setting: P=(1+μ)W How does economic integration in the product market spill over to the labor market?  more product varieties (Krugman)  market shares of domestic firms fall Then μ falls Labor Market to Product Market?  Outside options: bargaining power falls, wage curve shifts in.

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Interaction between labor market and product market Price settingA B

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Estimation Hall Approach: Production Function: Union Bargaining:

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Equation that will be estimated

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Mark-up and bargaining power for manufacturing as a whole Robust standard errors in parentheses * significant at 5%; ** significant at 1%

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Mark-up per NACE 2 digit sector

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Union bargaining power per NACE 2 digit sector

Determinants bargaining power and mark-up Robust standard errors in parentheses * significant at 5%; ** significant at 1%

Imports according to region of origin

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 What about outsourcing? Outsourcing should increase rents, because of gains in efficiency (learning effects, variety effects) (Amiti and Konings, 2005)  also bargaining power should go up. Kramarz (2003): Hold up since outsourcing fixes quantities and prices for a period of between 6 months to a year. On the other hand, the option of outsourcing increases the threat point of the firm, which could lower bargaining power (substitution possibilities go up). Measure: Share of imported intermediate inputs in total intermediate inputs used (I/O tables 1995 and 2000).

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Effects of outsourcing

Price and Wage Setting in an Integrating Europe NBB Colloquium October 2006 Conclusion Union power and mark-ups are positively related Import penetration reduces mark-ups and bargaining power This effect is strongest for imports that come from the low wage countries Outsourcing tends to have a positive effect on mark- ups and bargaining power