Rigidity in the labour market, unemployment and growth

This paper engages in a critical review of the literature on labour market rigidities, developing a simple theoretical schema that allows unitary treatment of the different issues. It finds little theoretical or empirical support for a simple equation linking rigidities with unemployment. Nevertheless, the degree of rigidity does influence the dynamic, composition and duration of unemployment, with significant implications for the labour market, unemployment and the efficiency of the economy as a whole. It is therefore important to study the indirect effects of labour market rigidity and broaden the concept of rigidity to other aspects of the economic system. Accordingly, the paper analyzes the interaction between legislation and the protection of employed workers and wage determination, the effects of setting uniform wages across regions with differing productivity in a context of geographical immobility, and the consequences for capital formation and growth of the inefficient allocation of labour induced by a rigid system. The analysis shows that these aspects help to explain the disappointing performance of the European labour market in the last three decades, above and beyond the direct effects of restrictions on layoffs.