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Skills, labour costs and vertically differentiated industries: A general equilibrium analysis

  • Lutz, Stefan
  • Turrini, Alessandro

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. Though, high wages appear also 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 analyse 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 ZEI - Center for European Integration Studies, University of Bonn in its series ZEI Working Papers with number B 26-1999.

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Date of creation: 1999
Date of revision:
Handle: RePEc:zbw:zeiwps:b261999
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  1. d'ASPREMONT, Claude & DOS SANTOS FERREIRA, Rodolphe & GERARD-VARET, Louis-André, . "Unemployment in a Cournot oligopoly model with Ford effects," CORE Discussion Papers RP 858, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  3. JASKOLD GABSZEWICZ, Jean & VIAL, Jean-Philippe, . "Oligopoly "Ã la Cournot" in a general equilibrium analysis," CORE Discussion Papers RP 106, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  4. Murphy, Kevin M. & Shleifer, Andrei, 1997. "Quality and trade," Journal of Development Economics, Elsevier, vol. 53(1), pages 1-15, June.
  5. Lutz, Stefan, 1996. "Trade Effects of Minimum Quality Standards with and without Deterred Entry," CEPR Discussion Papers 1384, C.E.P.R. Discussion Papers.
  6. 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.
  7. 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.
  8. Gabszewicz, J. & Turrini, A., 2000. "Workers' skills, product quality and industry equilibrium," International Journal of Industrial Organization, Elsevier, vol. 18(4), pages 575-593, May.
  9. Jaskold Gabszewicz, J. & Thisse, J. -F., 1979. "Price competition, quality and income disparities," Journal of Economic Theory, Elsevier, vol. 20(3), pages 340-359, June.
  10. Shaked, Avner & Sutton, John, 1983. "Natural Oligopolies," Econometrica, Econometric Society, vol. 51(5), pages 1469-83, September.
  11. Katsoulacos, Y., 1984. "Product innovation and employment," European Economic Review, Elsevier, vol. 26(1-2), pages 83-108.
  12. repec:sae:niesru:v:111:y::i:1:p:48-61 is not listed on IDEAS
  13. Motta, Massimo, 1993. "Endogenous Quality Choice: Price vs. Quantity Competition," Journal of Industrial Economics, Wiley Blackwell, vol. 41(2), pages 113-31, June.
  14. Lionel Fontagné & Michaël Freudenberg & Nicolas Peridy, 1997. "Trade Patterns Inside the Single Market," Working Papers 1997-07, CEPII research center.
  15. 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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