Regional labor markets are characterized by huge disparities with regard to employment development, unemployment and wages. The scale of such disparities between regions is comparable to that between national states. While institutional differences are often held responsible for disparities between national labor markets (Blanchard and Wolfers; 2000), they can only account for a minor fraction of disparities between regional labor markets. This goes back to the fact that labor market institutions vary only marginally between regions of a national state (Blien and Sanner; 2006).
In the literature, different approaches for modeling regional labor markets exist. Blanchard and Katz present the perhaps most comprehensive model for explaining disparities between regional labor markets (Elhorst; 2003). Blanchard and Katz (1992) regionalize a wage-/price-setting model. They discuss how regional labor markets adjust to shocks in labor demand via reactions of employment, participation, unemployment and migration. The model is based on the wage curve approach of Blanchflower and Oswald (1990).
Since labor market institutions vary only marginally on the regional level, the wage curve has to be similar for all regions as well. Under this assumption disparities of regional labor markets are predominantly the result of differences in labor demand between the regions. Regional labor demand in turn is derived from regional production. However, Blanchard and Katz (1992) do not endogenously explain why labor demand and production differ between regions. Instead, the authors discuss the impacts of shocks in labor demand on regional labor markets. They do not discuss how disparities endogenously arise.
Overman and Puga (2002) empirically show that disparities of regional unemployment rates in Europe are ascribed to labor demand. If differing labor demand is the reason for regional labor market disparities, then differences between regional goods markets play a key role for these disparities. The New Economic Geography analyzes how disparities of regional goods markets endogenously arise. Models of the New Economic Geography are traced back to the basic core-periphery model by Krugman (1991). Krugman (1991) models centrifugal and centripetal forces and discusses how regional disparities of goods markets endogenously arise through their interaction. However, such models usually assume cleared labor markets and ignore unemployment.
Many empirical studies supply evidence in favor of the existence of a wage curve in western economies (Blanchflower and Oswald; 1990). The concept of the wage curve is a prevalent concept in economic theory and is frequently applied for modeling frictions in (regional) labor markets.
