This paper investigates the role that idiosyncratic uncertainty plays in shaping social preferences over the degree of labor market flexibility, in a general equilibrium model of dynamic labor demand where the productivity of firms evolves over time as a Geometric Brownian motion. A key result demonstrated is that how the economy responds to shocks, i.e. unexpected changes in the drift and standard deviation of the stochastic process describing the dynamics of productivity, depends on the power of labor to extract rents and on the status quo level of firing costs. In particular, we show that when firing costs are relatively low to begin with, a transition to a rigid labor market is favored by all and only the employed workers with idiosyncratic productivity below some threshold value. A more volatile environment, and a lower rate of productivity growth, i.e. "bad times," increase the political support for more labor market rigidity only where labor appropriates of relatively large rents. Moreover, we demonstrate that when the status quo level of firing costs is relatively high, the preservation of a rigid labor market is favored by the employed with intermediate productivity, whereas all other workers favor more flexibility. The coming of better economic conditions need not favor the demise of high firing costs in rigid high-rents economies, because "good times" cut down the support for flexibility among the least productive employed workers. The model described provides some new insights on the comparative dynamics of labor market institutions in the U.S. and in Europe over the last few decades, shedding some new light both on the reasons for the original build-up of "Eurosclerosis," and for its the persistence up to the present day.
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Find related papers by JEL classification: D71 - Microeconomics - - Analysis of Collective Decision-Making - - - Social Choice; Clubs; Committees; Associations D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Models of Political Processes: Rent-seeking, Elections, Legislatures, and Voting Behavior E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts J63 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Turnover; Vacancies; Layoffs J65 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment Insurance; Severance Pay; Plant Closings
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Stephen Coate & Stephen Morris, 1999.
"Policy Persistence,"
American Economic Review,
American Economic Association, vol. 89(5), pages 1327-1336, December.
[Downloadable!] (restricted)
Other versions:
Stephen Coate & Stephen Morris, .
""Policy Persistence '',"
CARESS Working Papres
95-19, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
[Downloadable!]
Stephen Coate & Stephen Morris, .
"Policy Persistence,"
CARESS Working Papres
97-2, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
[Downloadable!]