DP528 | Post-Reform East and West: Capital Accumulation and the Labor Mobility Constraint

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01/03/1991

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Abstract

Assuming that economic reforms are successful in Eastern Europe, what will be the effects on Western Europe? The focus is on the wage pressure that the threat of migration from East to West is likely to impose. The paper adopts a Ramsey model of intertemporal choice, for both individuals and firms. Costs of adjustment in the rate of capital accumulation allow for a study of both the transition period and the long-run equilibrium which arises when the East's productivity of capital has reached the Western level. The effects on the West take the form of an initial rise in the real interest rate, an early slow-down in investment and temporarily declining real wages. In the long run, Western wealth rises through lending to the East. All these effects are reduced by the migration-induced wage pressure as less capital is accumulated in the East, with a correspondingly higher level of unemployment, both during the transition and in the long run. Conversely, wage rigidity in the West leads to more capital accumulation in the East as the rise in the world-wide real interest rate is met in the West by higher unemployment.