Can “1992” reduce unemployment in Europe? On welfare and employment effects of Europe's move to a single market

Abstract

This paper provides a general-equilibrium investigation of welfare and employment consequences of Europe's move to a unified market, using a static multicountry, multisector applied general equilibrium model with imperfect competition, increasing returns to scale and product differentiation at the firm level. Following Smith and Venables (1988), “Europe 1992” is interpreted as the elimination of the possibility for oligopolistic firms to price-discriminate between client countries within the Community. Experiments are performed under alternative noncompetitive behavior (Bertrand-Nash vs Cournot-Nash), industry structure (fixed vs variable number of firms) and wage determination mechanism (flexible wages with fixed employment vs rigid real wages with endogenous unemployment). The results suggest that with flexible wages the gains for consumers should prove modest even though unambiguously positive. In contrast, with the alternative wage setting arrangement, the “1992” program could provide a significant impetus to employment recovery in Europe: productivity gains would then be absorbed by employment creation rather than wage increases, so that the reduction in unemployment is estimated between 2.7 and 0.5 percent depending on the country considered (with an EEC average of 1.5 percent) and welfare gains range between 2.1 and 0.4 percent. The paper also provides some methodological innovations that may prove useful to applied general equilibrium modelers not interested by “Europe 1992.”