Macro Workshop

Du 12/11/2015 de 15:00 à 16:00

MSE Campus (106-112 boulevard de l’Hôpital, 75013 Paris), room B. 3.1

ARABZADEH Hamze (PARIS 1 - PSE)

The political economy of twin deficits and wage setting centralization

Global current account imbalances is, to large extent, shaped by government decisions and sovereign to sovereign transactions. This paper aims to provide a theoretical framework to investigate the impact of wage centralization on the governments’ political incentives to widen or correct external balance through managing the budget balance. An increase in budget deficit, when financed by external resources (twin deficits), leads to some symptoms of Dutch disease : real appreciation of the currency, loss in competitiveness of Tradable sector (T-sector) and, if labor market is frictional, an increase (a decline) in the real wage in N-sector (T-sector). The opposite happens when the government improves the two balances. Therefore, the workers in N-sector relatively support (oppose) more the policies which lead to widening (reforming) the two deficits. Centralization of wage bargaining moderates these evaluations by compressing the wage gap between the sectors : The more centralized is the wage determination, the less N-sector workers support (oppose) widening (reforming) the two deficits. Relying on the majority rule, it will be argued that policy makers follow the preferences of N-sector workers (who constitute the majority in developed countries). Therefore, the governments in the countries with higher degree of wage centralization will have less political incentives to widen twin deficits and more political support for improving the two balances. This prediction is confirmed by facts reported in the paper.