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Skills, Labour Costs and Vertically Differentiated Industries: A General Equilibrium Analysis

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  • Lutz, Stefan
  • Turrini, Alessandro Antonio

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2373.

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Date of creation: Feb 2000
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Handle: RePEc:cpr:ceprdp:2373

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Keywords: Labour Cost; Productivity; Quality Differentiation; Skills; Vertical Intra-Industry Trade;

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  1. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, vol. 49(1), pages 3-13, January.
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  8. GABSZEWICZ, Jean & TURRINI, Alessandro, 1997. "Workers’ skills, product quality and industry equilibrium," CORE Discussion Papers 1997055, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  9. Claude d’ASPREMONT & Rodolphe DOS SANTOS FERREIRA & Louis-André GÉRARD-VARET, 1989. "Unemployment in a Cournot Oligopoly Model with Ford Effects," Discussion Papers (REL - Recherches Economiques de Louvain) 1989012, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
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  12. H. Lutz, Stefan, 2000. "Trade Effects of Minimum Quality Standards with and without Deterred Entry," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 15, pages 314-344.
  13. Courakis, Anthony S, 1991. "Labour Skills and Human Capital in the Explanation of Trade Patterns," Oxford Economic Papers, Oxford University Press, vol. 43(3), pages 443-62, July.
  14. Copeland, Brian R. & Kotwal, Ashok, 1996. "Product quality and the theory of comparative advantage," European Economic Review, Elsevier, vol. 40(9), pages 1745-1760, December.
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