Italy and Germany have similar geographical differences in productivity – North more productive than South in Italy; West more productive than East in Germany – but have adopted different models of wage bargaining. Italy sets wages based on nationwide contracts that allow for limited local wage adjustments, while Germany has moved toward a more flexible system that allows for local bargaining. The Italian system has significant costs in terms of forgone aggregate earnings and employment because it generates a spatial equilibrium where workers queue for jobs in the South and remain unemployed while waiting. Our findings are relevant for other European countries.
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