We present a model consistent with the stylized fact that "rigid Europe" has witnessed higher unemployment and a more compressed wage structure than "flexible America". A distinguishing feature of the present paper is that it endogenises the labour market regulations that account for this divergent experience. We use our political economy model to investigate the policy responses to globalization, i.e. to an increase in international capital mobility. It turns out that labour market institutions are not necessarily scaled down in the course of globalization; rather, the direction of the globalization-induced policy response is determined by the relative strength of the politically active groups.
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Find related papers by JEL classification: J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements P50 - Economic Systems - - Comparative Economic Systems - - - General
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