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Keywords:

  • R23;
  • C31;
  • C33;
  • Regional labour markets;
  • dynamic spatial panel models;
  • spillover effects

Abstract

This paper extends the seminal Blanchard and Katz regional labour market model to include interaction effects using a dynamic spatial panel data approach. Three key contributions of this extended model are: (i) the unrealistic assumption that regions are independent of one another no longer has to be made, (ii) the magnitude and significance of so-called spillover effects can be empirically assessed, and (iii) both the temporal and spatial propagation of labour demand shocks can be investigated. Using annual data from 1986–2010 for 112 regions across eight EU countries, both the non-spatial and spatial models are estimated. It is found that the majority of the spillover effects are highly significant. Consistent with economic theory, the impact of a region-specific demand shock is largest in the region where the shock instigates. The shock also propagates to other regions, especially impacting the first and second-order neighbours.