Variations in productivity across regions and sectors are features of most economies. The impact of such variation depends on the characteristics of these sectors, including the tradability (local, regional, or global) of sectoral output. This paper develops an analytical framework which shows how these sectoral characteristics determine regional outcomes, in real terms and as conventionally measured. We generate predictions about the effects of sectoral structure (in particular tradability), showing the positive effect of an area’s bias towards highly tradable activities on its average earnings. Empirical analysis of recent earnings data for the ITL3 areas of GB demonstrates the presence of this relationship. As suggested by the theory, two factors drive this effect. Approximately one-third is a direct result of sectoral composition – on average across GB, tradeable sectors pay higher wages. The remaining two-thirds is an equilibrium effect, arising as a productivity advantage in tradables translates into higher local employment and factor prices, whereas a similar advantage in non-tradables (facing a less elastic demand curve) can lead to lower local prices, cost-of-living, and nominal wages. While our primary analysis is on recent data, we show that our approach also captures the impact of the structural change that occurred in GB during the 1970s and 1980s on regional wage differentials.
Authors Tony Venables, Patricia Rice
This paper is a revised and extended version of TPI working paper 021, first published July 2022
