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Uncertainty and the Politics of Employment Protection

  • Andrea Vindigni
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    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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    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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    1. Lars Ljungqvist & Thomas J. Sargent, 1995. "The European unemployment dilemma," Working Paper Series, Macroeconomic Issues 95-17, Federal Reserve Bank of Chicago.
    2. Daron Acemoglu & Davide Ticchi & Andrea Vindigni, 2006. "Emergence and Persistence of Inefficient States," NBER Working Papers 12748, National Bureau of Economic Research, Inc.
    3. Ricardo J. Caballero & Mohamad L. Hammour, 1997. "Jobless Growth: Appropriability, Factor Substitution, and Unemployment," NBER Working Papers 6221, National Bureau of Economic Research, Inc.
    4. 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, vol. 110(462), pages C1-33, March.
    5. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
    6. Brügemann, Björn, 2006. "Does Employment Protection Create Its Own Political Support?," IZA Discussion Papers 2286, Institute for the Study of Labor (IZA).
    7. Hassler, John & Mora, José V Rodríguez & Storesletten, Kjetil & Zilibotti, Fabrizio, 2001. "A Positive Theory of Geographic Mobility and Social Insurance," CEPR Discussion Papers 2964, C.E.P.R. Discussion Papers.
    8. Pedro Portugal & Olivier Blanchard, 2001. "What Hides Behind an Unemployment Rate: Comparing Portuguese and U.S. Labor Markets," American Economic Review, American Economic Association, vol. 91(1), pages 187-207, March.
    9. Stephen Coate & Stephen Morris, . "Policy Persistence," CARESS Working Papres 97-2, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
    10. Saint-Paul, Gilles, 1999. "The Political Economy of Employment Protection," CEPR Discussion Papers 2109, C.E.P.R. Discussion Papers.
    11. Giuseppe Bertola, 1991. "Flexibility, Investment, and Growth," NBER Working Papers 3864, National Bureau of Economic Research, Inc.
    12. Diego Comin & Thomas Philippon, 2005. "The Rise in Firm-Level Volatility: Causes and Consequences," NBER Working Papers 11388, National Bureau of Economic Research, Inc.
    13. Hopenhayn, Hugo & Rogerson, Richard, 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 915-38, October.
    14. Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers dp0110, Centre for Economic Performance, LSE.
    15. Saint-Paul, Gilles, 2004. "Did European Labour Markets Become More Competitive in the 1990's? Evidence from Estimated Worker Rents," CEPR Discussion Papers 4327, C.E.P.R. Discussion Papers.
    16. 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.
    17. Andrea Vindigni, 2002. "Uncertainty and the Politics of Employment Protection," Working Papers 844, Princeton University, Department of Economics, Industrial Relations Section..
    18. 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.
    19. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 381-402, July.
    20. repec:iza:izadps:dp1067 is not listed on IDEAS
    21. 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, vol. 12(2), pages 276-315, April.
    22. Fernandez, Raquel & Rodrik, Dani, 1991. "Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty," American Economic Review, American Economic Association, vol. 81(5), pages 1146-55, December.
    23. Hassler, John & Rodriguez Mora, Jose V., 1999. "Employment turnover and the public allocation of unemployment insurance," Journal of Public Economics, Elsevier, vol. 73(1), pages 55-83, July.
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