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IZA
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A Test of the 'Krugman Hypothesis' for the United States, Britain, and Western Germany
by
Patrick A. Puhani
(April 2003)
published as 'Transatlantic Differences in Labour Markets: Changes in Wage and Non-Employment Structures in the 1980s and the 1990s' in: German Economic Review, 2008, 9 (3), 312-338
Abstract:
Rising wage inequality in the U.S. and Britain (especially in the 1980s) and rising continental
European unemployment (with rather stable wage inequality) have led to a popular view in
the economics profession that these two phenomena are related to negative relative demand
shocks against the unskilled in the industrialised world, combined with flexible wages in the
Anglo-Saxon countries, but institutional rigidities in continental Europe (‘Krugman
hypothesis’). An alternative view stresses the importance of differing supply changes across
countries. However, empirical evidence on these questions is sparse. Furthermore, existing
international comparisons often rely on strong assumptions or compromise on data quality.
This paper uses large data sets from the U.S., Britain, and western Germany to test the
Krugman hypothesis for the 1990s, when unemployment in Germany increased (unlike in the
U.S. and Britain, where it fell). British and German evidence is further backed up with
alternative data sets for these countries. I find evidence for the Krugman hypothesis when
Germany is compared to the U.S. However, supply changes differ considerably between
countries, with especially Britain experiencing enormous increases in the relative supply of
skills and a relatively constant skill premium.
Text: See Discussion Paper No. 764
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