Do wages reflect labor productivity? The case of Belgian regions

Unemployment rates are significantly different across regions in Belgium. In the search for an explanation for this fact, we simultaneously estimate a wage and labor productivity equations where we include regional dummies as explanatory variables. We find that the wage-productivity gap reached 11% for Brussels and 4.2% for Wallonia in the years 2005-2012. This was driven by the negative performance in labor productivity of the firms in these regions relative to Flanders, which more than compensated for the advantage in unit labor costs they could profit from. On the other hand, the gap for Brussels is found to be currently decreasing in time thanks to a positive growth rate in labor productivity. The sign and magnitude of the wage-productivity gap is robust to the estimation of the relationship using hours worked instead of employees, and including benefits to salaries into the cost of labor. These results are coherent with the existence at the regional level of institutional barriers to the firm-level adjustment of wages to labor productivity. Among the possible explanations for this, our estimations suggest that a reduction in the gap between labor costs and productivity may be achieved through greater wage flexibility at the regional level.