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Are labor market rigidities responsible for Europe’s unemployment

Yes, according to the OECD, IMF, and the conventional view among many academics. The simple intuition that if you make it more difficult to fire workers employers will be less willing to create new jobs, and that in a dynamic economy this will lead to higher unemployment, seems compelling enough. Plus, there is a large number of cross country econometric studies that apparently show labor market protections, particularly unemployment benefits, to be correlated with unemployment levels.

A new paper by Howell, Baker, Glyn, and Schmitt reviews this empirical literature and finds it badly wanting.

The main culprits are held to be protective institutions, namely unemployment benefit entitlements, employment protection laws, and trade unions. Our assessment of the evidence offers little support for this orthodox view. cheap nfl jerseysThe most compelling finding of the cross country regression literature is the generally significant and robust effect of the standard measure of unemployment benefit generosity, but there are reasons to doubt both the economic importance of this relationship and the direction of causation. The micro evidence on the effects of major changes in benefit generosity on the exit rate out of unemployment has been frequently cited as supportive evidence, but these individual level effects vary widely across studies and, in any case, have no direct implication for changes in the aggregate unemployment rate (due to “composition” and “entitlement” effects). Finally, we find little evidence to suggest that 1990s reforms of core protective labor market institutions can explain much of either the success of the “success stories” or the continued high

unemployment of the large continental European countries. We conclude that the evidence is consistent with a more complex reality in which a variety of labor market models can be consistent with good employment performance.

In his comment on this paper, Jim Heckman agrees that the cross national evidence is weak and fragile. But:

In the absence of better data, and better measurement frameworks, prior beliefs will continue to dominate how one interprets the evidence. This is not as

much about dogmatism or conspiracy as it is about good science. In the absence of empirical evidence, logically consistent stories that accord with intuition have great appeal. At both an intuitive level and at the level of formal economic theory, incentives matter. If a person is paid not to work, the person will likely not work. If the costs of hiring a worker rise, fewer workers are likely to be hired. The microevidence supports these basic predictions of theory. Like the controversy over the effects of minimum wages, disagreements are not over qualitative predictions of the theory, but are about quantitative empirical responses.

HBGS are splendid critics. However, they do not offer a constructive empirical alternative to existing practices in the literature. They have not proved that institutions do not cause the pattern of European unemployment. They have, instead, shown that the current data base and models are too weak to decide the issue.

In at least one area of labor market intervention, employment protection (firing restrictions), the orthodox expectation is not the only “logically consistent” story that accords with economic intuition. If you make it harder to fire an employee, you essentially give that employee some property rights over the job he occupies. Now, according to the Coase theorem, how property rights are allocated (to the employer versus the employee) has no effect on efficiency in the absence of bargaining and other transaction costs. If eliminating a job is the efficient thing to do, an employer can do it either by fiat or by paying the employee to leave. There are distributional implications (obviously the employer is worse off in the latter case), but nothing to stop the efficient thing from getting done. This is an idea I associate with my Harvard colleague Richard Freeman.

In the real world, there are of course transaction costs,http://www.elitejerseyscheapnfljerseys.comand bargaining between worker and employer is not costless. But automatic dismissal has its own costs. Ultimately an evaluation of the “protective” regime vis a vis the liberal model is not that straightforward.

Yet, with some adjustments under Schroder and now under Merkel, Germany export engine is at its peak now> can it be that social market regidities are not the real culprit?

In my opinion, EU ( with exception of UK and Scandinavians) does not regard its social market economy as a constraint to expansion and growth.

Space here is limited to go into details but your fellow economists make a mistake by comparing EU internal market with US.

The intuition that Heckman draws on regards jobs as created by firms and offered, at a moment in time, to workers. A lower price for labor means a larger offer. But in workplaces in which worker performance has an effect on productivity, workers also, in a sense, create jobs. They do this by improving firm performance, which has employment consequences. It is not difficult to come up with a counterintuition about employment security, worker investment and performance. In fact, this is how lots of people think about this question in social market economies.

Empirically this is difficult to get at, since labor productivity has many determinants over which workers have no control. We are interested in the net effect of employment relations systems, but net of what? Of course, there is an enormous literature on this question, which Rick Freeman knows well (and has contributed mightily to).

I get the impression, however, that this large body of economic research is simply ignored by much of the profession, which can see the world only through the lens of instantaneous, impersonal supply and demand.

Thinking intuitively if I own a house most people would say that I take better care of it than if I rent. Wouldn this be the same for an employee who has a greater proprietary right to his or her job, particularly if getting another one will be hard to do. Job holders will want to see that the job lasts. The employer will also want to see that employees are well trained since it will be harder to replace them.

A few years back I read that France mandates employers to spend a certain percentage of their yearly profits to train their employees I believe it was 2% or pay an equivalent tax to the state. Yet, thinking intuitively, even if France employment transaction cost are higher there should be less of them.

I forgot to mention: the Coase template has been shown not to apply in the case of employment protection, at least in some of the articles collected in Behavioral Law and Economics (Sunstein ed., Cambridge UP, 2001). One interesting tidbit: most US workers erroneously think they have employment protection. They don realize they can be legally dismissed without any justification, so of course they won bargain for protection.

A second point will be familiar to academics who follow this blog. Tenure for professors is justified, among other reasons, by the role faculty play in university governance: employment protection enables them to be freer agents when it comes to exercising their governance powers. A parallel argument can be made in European countries with a degree of co management, with Germany the most obvious example. I will grant, however, that protection is also strong in many countries with no provisions for worker participation.

There is no single labour market in many European countries, there are two. The insiders have protected jobs and generous benefits if they are unemployed or retire early. But most people under 25, immigrants and (sometimes) women are not covered by the job protection or eligible for the benefits.

So the reason that HBGS can find evidence that generous benefits raise unemployment might be that France, Germany, etc have kept their generous benefits for insiders, but made it harder to get them. So unemployment falls as students and immigrants are forced into poorly paid, insecure jobs . . . while the insiders get benefits worth 80% their previous salary.

This could be a lasting adaptation: after all, lots of young Europeans (and grad students) are willing to work as unpaid interns if it helps them break into the inside market!

I do not understand how your example contradicts Heckman comment, because it would seem that the distributional effects do matter when employers are making hiring decisions. Even if workers will still be fired when it is efficient to do so, the costs of firing will be higher, which will discourage employers from hiring in the first place. I agree that the effects will be softened when transactions costs are lowered, perhaps by institutions that facilitate bargaining, but our best model still predicts a negative employment effect of employment protection.

I don think we can conclude from the above reasoning that employment protection is a bad idea, but it was not Heckman intention to make a normative judgment.

Do you have any other logically consistent models that suggest there will be no negative employment effect?

Indeed one of the most amazing aspects of this discussion (which frequently makes me want to puke) is the fact that in most companies, the employees who enjoys the highest degree of job protection is, by far, the CEO. Yet the same economists who fulminate against the little of job protection that ordinary workers have in countries like Germany (it is little, and it certainly doesn prevent employers from frequently making mass layoffs), those are usually the same who will cite the most absurd arguments in support of wildly exaggerated CEO compensation.