A tale of two neighbour economies : does wage flexibility make the difference between Portuguese and Spanish unemployment?

Abstract

Portugal and Spain are two neighbour economies which share many characteristics. However, Spanish unemployment more than doubles Portuguese unemployment. In this paper we provide an explanation for this difference in two steps. First, we estimate the degree of nominal and real wage rigidity in both countries and the dynamic response of various labour market variables to different types of shocks using structural VAR techniqies. Our results show that real wage flexibility is higher in Portugal, and that, although shocks hitting both economies since the beginning of the eighties were not too dissimilar, their effects on unemployment were much more long-lasting in Spain than in Portugal. And secondly, we use individual data from the Spanish and Portuguese Household Budget Surveys to measure the loss in consumption suffered by unemployment workers relative to employed workers. We find that this loss is much more sizeable in Portual, wich could explain the higher degree of wage flexibility shown by the Portuguese labour market.