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As an example, take Germany and Czech Republic. Both are members of the EU and therefore trade barriers between the two countries are minimal. However the median salary in Germany is nearly 3 times as much as in Czech Republic. How can that be?

Are the Germans three times more productive than the Czechs? Do they produce products that cost three times as much on the global market? If so, does this mean that Switzerland (which has a median salary twice as big as Germany) is twice as productive as Germany and six times more productive than Czech Republic?

I simply don't understand where the monetary difference comes from, especially in neighboring countries with open borders. It's certainly easy to understand in case of oil-rich nations (e.g. Saudi Arabia vs. Jordan), but not in manufacturing-based economies.

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  • $\begingroup$ Maybe it's simply that data on the Wikipedia page you quote are not reliable (indeed it is marked as needing cleanup to meet Wikipedia's quality standards). According to this Wikipedia page, the GDP per capita (PPP) gaps between Switzerland, Germany, and the Czech Republic are much smaller — \$58,647 vs \$46,974 vs \$32,076 (IMF, 2015). There are still gaps to be explained, but the gaps are now much smaller and can thus reasonably be ascribed to differences in productivity. $\endgroup$
    – user18
    Commented Oct 15, 2016 at 5:10
  • $\begingroup$ @KennyLJ the basic question is why the absolute amounts of money in Switzerland are larger than the amounts in Germany and Czechia. GDP PPP does tell us that purchasing power is relatively equal between Germany and Switzerland, but it doesn't explain how Swiss employers can afford to pay twice as much in euros. $\endgroup$
    – JonathanReez
    Commented Oct 15, 2016 at 8:14

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The underlying reason are probably differences in labor productivity. Assuming decreasing marginal productivity of labor, the real question is why migration flows do not equate labor productivity and wages as would be predicted by simple GE models.

I can think of several factors:

  • Moving is costly
  • Czech people in Germany are not as productive as Germans in Germany, because they don't speak German.
  • People prefer to live in their home country even if that means earning lower wages.

That being said, I guess that wages in the Czech Republic have been growing much faster than in Switzerland or Germany and the gap is indeed closing slowly.

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As Tobias said, wages in general only adjust in neighboring regions if people move between the regions until expected utility (of working in either region) equalizes. If there is a (fixed) cost of moving, people will not move until move until expected utility equalizes, but until the difference in expected utilities from moving in either region is equal to the utility cost of moving.

In the extreme, if some people just cannot move due to regulations, cost of moving would be infinite, and you could sustain any difference in expected utility.

Differences between wages and productivity

Why do I keep saying expected utility instead of wages? That is because wages in general reflect more than just productivity. They also contain compensating differentials.

That is, jobs have different non-monetary benefits (happiness you gain besides wages). To get a worker to do a job that is really not fun to do, you'd have to pay him more than for a different job.

This is a general concept. You have to compensate workers for working longer hours, under more strict bosses, having a more frictional labor market or higher unemployment risk, lower non-salary compensations, higher costs of living.

Some of these factors (and potentially many more) may speak towards German companies having to compensate their workers more - especially the cost of living.

This does not deny potential productivity differences

However, at the same time, you could really think that in a structured well-disciplined and efficient country such as Germany, companies get more out of their workers than elsewhere - meaning that their workers are more productive. Since it's not easy to measure productivity and it's causes at the firm level, I'm not sure whether this question has been addressed empirically.

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