What determines wage differentials across the EU?

Abstract

We analyse determinants of the wage differentials observed between thirteen European countries using the European Community Household Panel (ECHP). The empirical decomposition is based on a proportional hazards model. The approach based on rank invariant estimators is borrowed from the literature on failure time data and has been adapted by Donald et al. (Rev Econ Stud 67:609–633, 2000) to analyse differences in wage distributions. Extending this approach and using natural splines to allow for nonlinear regression effects we isolate three different underlying forces for wage differentials: differences in characteristics, differences in weights of characteristics and differences in the returns-to-skill functions. The analysis reveals that country differences in returns-to-skill functions contribute most to observed wage differences while differences in observed characteristics contribute surprisingly little.