Inter‐country wage differences in the European Union

• Date: 01 March 2018
• DOI: http://doi.org/10.1111/ilr.12014
• Published date: 01 March 2018
• Author: Aurora GALEGO,João PEREIRA

International Labour Review, Vol. 157 (2018), No. 1

Copyright © The authors 2018

Journal compilation © International Labour Organization 2018

* Department of Economics, University of Évora, Portugal. Email: jpereira@uevora.pt

(corresponding author) and agalego@uevora.pt. The authors gratefully acknowledge the support

of the Foundation for Science and Technology (FCT, Portugal, grant UID/ECO/04007/2013)

and the European Regional Development Fund Operational Competitiveness Programme (POCI-

01-0145-FEDER-007659). This study uses data from 2008 EU-SILC (rev.4) provided by Eurostat.

Eurostat has no responsibility for the results and conclusions of the authors’ ndings.

Responsibility for opinions expressed in signed articles rests solely with their authors, and

publication does not constitute an endorsement by the ILO.

Inter-country wage differences

in the European Union

João PEREIRA* and Aurora GALEGO*

Abstract. This article investigates the determinants of wage gaps between Euro-

pean Union countries along the wage distribution, applying the methodology pro-

posed by Firpo, Fortin and Lemieux (200 9) and Fortin, Lemieux and Firpo (2011).

The authors conclude that both wage structure and composition effects contribute

to explaining wage differentials, but that the wage structure effect is more impor-

tant. This latter effect would appear to derive from differences between unknown

factors, while the composition effect can largely be explained by differences in the

following areas: education, proportion of workers with supervisory responsibilities,

occupational structure, and, to a lesser extent, industrial structure.

Economic, social and territorial cohesion is a fundamental aim of the

European Union. In recent decades, various programmes have trans-

ferred resources between Member States, in an attempt to accelerate economic

convergence and promote cohesion. However, sizeable economic disparities

among Member States remain – some progress notwithstanding – and marked

broad regional differences in wages and per capita income can be observed, not-

ably between the northern countries and their counterparts in the east, south

and west. Economic and social cohesion hinge on the creation of an integrated

labour market to stimulate the free movement of workers. A comprehensive

understanding of the microeconomic determinants of European wages is thus

of crucial relevance, not only to the creation of the labour market, but also to

the formulation of an appropriate European migration policy.

According to the competitive model, wages depend on productivity (mar-

ginal productivity) which in turn depends not only on workers’ skills (com-

prising education, experience, and unobserved skills) but also on job attributes

International Labour Review102

(including quality of management, production technology, capital invested) and

natural resources. Hence, a worker endowed with more human capital should

be more productive and earn a higher wage (Mincer, 1974; Becker, 1993). The

extension of this framework to the international level implies that countries

with higher levels of productivity – mainly in the tradable sector – should have

higher wages and prices (Balassa, 1964; Samuelson, 1964).

It can be argued that labour market institutions will cause a deviation

from that model, whereby minimum wages, employment protection legisla-

tion and union membership leave certain groups of workers more favour-

ably placed than a purely competitive model might otherwise suggest. The

evidence, however, reveals that unions have lost power in recent decades,

wage dispersion (inequality) has increased, and wages seem to be more sen-

sitive to market forces (OECD, 2004; Leuven, Oosterbeek and van Ophem,

2004). Moreover, an OECD study (2004) shows that overall earnings are not

systematically affected by wage setting institutions, trade union density, cover-

age by collective agreements, and the centralization and coordination of wage

bargaining. Nevertheless, there is evidence that institutions may have some

impact on the relative earnings of certain groups (women, younger and older

workers).

Despite its key role in labour market integration, the structure of wages

is poorly understood, as are the determinants of wage differences between

European countries. In particular, few microeconomic studies have sought to

explain why it is that two analogous workers, identically placed on the wage

distribution (at the mean, for example, or a specic quantile) earn very dif-

ferent wages in different European countries.1 To the best of our knowledge,

only Behr and Pötter (2010) and Brandolini, Rosolia and Torrini (2011) have

looked into the question. The former use a proportional hazard model to de-

compose wage differences between European countries at different quantiles,

with data from the European Community Household Panel for 2001. They con-

clude that, in explaining wage differences, returns-to-skill functions predomin-

ate, while differences in individual workers’ characteristics account for very

little, even for low-wage countries. Brandolini, Rosolia and Torrini (2011), in

turn, analyse the distribution of earnings using the European Union Statistics

on Income and Living Conditions (EU-SILC) for 2007. They estimate recen-

tered inuence function regressions of wage equations for some percentiles

and for the variance (as demonstrated by Firpo, Fortin and Lemieux, 2009).

They also undertake an aggregate decomposition of the variance differences,

but not the corresponding decompositions for the wage gaps between coun-

tries at each percentile.

This article seeks to ll a signicant gap in the literature through fur-

ther analysis of wage differences between European countries. We compare

wages in several European countries with those in the United Kingdom, at

1 This contrasts with a growing literature on differences in wage inequality among the coun-

tries (Budría and Pereira-Telhado, 2011; Simón, 2010).