Globalization and European Labour Markets

This paper examines the linkage between trade and the dismal state of labour markets in Europe. On the face of superficial evidence, the nexus is weak and is overshadowed by more compelling evidence of skill-biased technical change. Yet a complete dismissal of globalization is inconsistent with current opinions of businessmen, policy-makers and workers in globalized industries. We propose an alternative model in which globalization - defined as the increase in world trade relative to other indicators of real economic activity - occurs along with deterioration of labour market prospects, especially for the less-skilled. As an alternative or complement to conventional trade and technology explanations, we model both the fragmentation of production and resulting reallocation of economic activity across national boundaries as equilibrium responses to trading opportunities as well as the technology of production. Increasing integration is therefore linked to both trade as well as pervasive skill-biased technical change. The model's predictions are consistent with a number of outstanding empirical puzzles in the trade-wages debate and can also explain the bimodal growth in services (high and low skill) observed in all OECD countries, and especially those with deregulated labour markets.