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Uncertainty and the Politics of Employment Protection

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  • Andrea Vindigni
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    Abstract

    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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    Bibliographic Info

    Paper provided by LABORatorio R. Revelli, Centre for Employment Studies in its series LABORatorio R. Revelli Working Papers Series with number 77.

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    Date of creation: 2008
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    Handle: RePEc:cca:wplabo:77

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    Keywords: employment protection; firing costs; productivity; political economy; rents; volatility; growth; institutional divergence.;

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    References

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    1. Bertola, Giuseppe, 1990. "Flexibility, Investment and Growth," CEPR Discussion Papers, C.E.P.R. Discussion Papers 422, C.E.P.R. Discussion Papers.
    2. MacLeod, W Bentley & Malcomson, James M & Gomme, Paul, 1994. "Labor Turnover and the Natural Rate of Unemployment: Efficiency Wage versus Frictional Unemployment," Journal of Labor Economics, University of Chicago Press, University of Chicago Press, vol. 12(2), pages 276-315, April.
    3. Brugemann, Bjorn, 2006. "Does Employment Protection Create Its Own Political Support?," Working Papers, Yale University, Department of Economics 20, Yale University, Department of Economics.
    4. Caballero, Ricardo J. & Hammour, Mohamad L., 1998. "Jobless growth: appropriability, factor substitution, and unemployment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 48(1), pages 51-94, June.
    5. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 61(3), pages 397-415, July.
    6. Gilles Saint-Paul, 1993. "On the Political Economy of Labor Market Flexibility," NBER Chapters, in: NBER Macroeconomics Annual 1993, Volume 8, pages 151-196 National Bureau of Economic Research, Inc.
    7. John Hassler & José Vicente Rodríguez Mora, 2003. "A Positive Theory of Geographic Mobility and Social Insurance," Working Papers 97, Barcelona Graduate School of Economics.
    8. Stephen Coate & Stephen Morris, . "Policy Persistence," Penn CARESS Working Papers, Penn Economics Department 8a66677895e9fcb3f6d813c0c, Penn Economics Department.
    9. Andrea Vindigni, 2002. "Uncertainty and the Politics of Employment Protection," Working Papers, Princeton University, Department of Economics, Industrial Relations Section. 844, Princeton University, Department of Economics, Industrial Relations Section..
    10. Acemoglu, D. & Ticchi, D. & Vindigni, A., 2006. "Emergence and Persistence of Inefficient States," Papers, Princeton University, Research Program in Political Economy 12-02-2006, Princeton University, Research Program in Political Economy.
    11. Diego Comin & Thomas Philippon, 2005. "The Rise in Firm-Level Volatility: Causes and Consequences," NBER Working Papers 11388, National Bureau of Economic Research, Inc.
    12. Blanchard, Olivier & Wolfers, Justin, 2000. "The Role of Shocks and Institutions in the Rise of European Unemployment: The Aggregate Evidence," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 110(462), pages C1-33, March.
    13. Fernandez, Raquel & Rodrik, Dani, 1991. "Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty," American Economic Review, American Economic Association, American Economic Association, vol. 81(5), pages 1146-55, December.
    14. Ljungqvist, Lars & Sargent, Thomas J., 1997. "The European Unemployment Dilemma," Working Paper Series, Research Institute of Industrial Economics 481, Research Institute of Industrial Economics.
    15. Hopenhayn, Hugo & Rogerson, Richard, 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 101(5), pages 915-38, October.
    16. Peter Gottschalk & Robert Moffitt, 1994. "The Growth of Earnings Instability in the U.S. Labor Market," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(2), pages 217-272.
    17. Pedro Portugal & Olivier Blanchard, 2001. "What Hides Behind an Unemployment Rate: Comparing Portuguese and U.S. Labor Markets," American Economic Review, American Economic Association, American Economic Association, vol. 91(1), pages 187-207, March.
    18. Hassler, John & Rodriguez Mora, Jose V., 1999. "Employment turnover and the public allocation of unemployment insurance," Journal of Public Economics, Elsevier, Elsevier, vol. 73(1), pages 55-83, July.
    19. Gilles Saint-Paul, 2002. "The Political Economy of Employment Protection," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 110(3), pages 672-701, June.
    20. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, American Economic Association, vol. 74(3), pages 433-44, June.
    21. repec:iza:izadps:dp1067 is not listed on IDEAS
    22. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 57(3), pages 381-402, July.
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    Cited by:
    1. Vincent Anesi & Philippe De Donder, 2013. "A coalitional theory of unemployment insurance and employment protection," Economic Theory, Springer, Springer, vol. 52(3), pages 941-977, April.

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