Abstract
Using longitudinal micro-data from Finland, a country with a geographically dispersed population and relatively long distances between local labor markets, this paper examines the responsiveness of the pay level to local unemployment conditions. In particular, this study tests the hypothesis that the pay level is more responsive to the unemployment level in less agglomerated and more remote regions as might be expected if employers have a higher degree of monopsony power in such regions. The results consistently suggest that the pay level is lower in localities with a higher unemployment level and, hence, provide strong support for the so-called wage curve hypothesis, which predicts that a negative relationship exists between local unemployment and the pay level. Although the results provide some evidence that the magnitude of the regional pay–unemployment relationship varies across different regions of the country, the findings do not provide consistent support for the monopsony power hypothesis. In particular, after controlling for unobserved worker heterogeneity, the responsiveness of the pay level to the local unemployment conditions is similar across regions with different degrees of economic agglomeration.
Highlights
Empirical literature has extensively confirmed the wage curve hypothesis proposed by Blanchflower and Oswald (1990, 1994), which suggests that wages are lower in local labor markets with higher unemployment
Our results suggest that the greater responsiveness of the pay level to local unemployment conditions in less agglomerated regions disappears when we account for unobserved worker heterogeneity
Our results suggest that once worker fixed effects are included, the wage curve slopes are similar across regions with different degrees of economic agglomeration
Summary
Empirical literature has extensively confirmed the wage curve hypothesis proposed by Blanchflower and Oswald (1990, 1994), which suggests that wages are lower in local labor markets with higher unemployment. In contrast to the findings of their pioneering empirical work, the magnitude of this inverse relationship seems to vary considerably across countries (see, e.g., Nijkamp and Poot 2005) Based on their empirical findings, Blanchflower and Oswald argued that the responsiveness of wages to local unemployment is not affected by differences in the labor. One potential explanation is provided by Longhi et al (2006), who argued that within-country variation may arise from local monopsony power Their reasoning relies on the assumption that the bargaining power of an employee is likely an increasing function of his or her outside job opportunities (i.e., job opportunities in firms other than the current firm). If the size of the composition bias varies across regions with different degrees of economic agglomeration, using regional aggregate data to analyze within-country variation in wage curve slope may lead to incorrect conclusions. Our results suggest that the greater responsiveness of the pay level to local unemployment conditions in less agglomerated regions disappears when we account for unobserved worker heterogeneity
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