Dynamic Behaviour of Wages and Employment: A Bargaining Model Introducing Adjustment Costs

The central objective of this paper is to assess the empirical relevance of labour adjustment costs arising from institutional rigidities and to compare their importance across countries. It thus develops a simple dynamic bargaining model of the union monopoly type that, for the first time, introduces explicitly, labour adjustment costs. Several variants of this model are estimated and tested for a group of OECD countries. The results obtained are extremely satisfactory. All versions of the model are validated by the data and the parameters are precisely and robustly estimated with values consistent with the theoretical model. One main result is that the importance of legal restrictions on hiring and firing varies significantly between the countries considered. Moreover, our classification of countries according to the importance of labour adjustment costs is roughly consistent with common priors on the subject and with some survey evidence.