Wage Equalization and Regional Misallocation: Evidence from Italian and German Provinces

Italy and Germany have similar geographical differences in firm productivity—with the North more productive than the South in Italy and the West more productive than the East in Germany—-but have adopted different models of wage bargaining. Italy sets wages based on nationwide contracts that allow for limited local wage adjustments, while Germany has moved toward a more flexible system that allows for local bargaining. We find that Italy exhibits limited geographical wage differences in nominal terms and almost no relationship between local productivity and local nominal wages, while Germany has larger geographic wage differences and a tighter link between local wages and local productivity. As a consequence, in Italy, low productivity provinces have higher non-employment rates than high productivity provinces, because employers cannot lower wages, while in Germany the relationship between non-employment and productivity is significantly weaker. We conclude that the Italan system has significant costs in terms of forgone aggregate earnings and employment because it generates a spatial equilibrium where workers queue for jobs in the South and remain unemployed while waiting. If Italy adopted the German system, aggregate employment and earnings would increase by 11.04% and 7.45%, respectively. Our findings are relevant for other European countries.