Excess Churn in Integrated Labor Markets

The common European labor market encourages worker mobility that enhances allocative efficiency, but certain institutional features may trigger inefficient migration. As a job in one of Europe's high-income countries typically also entails coverage in a generous welfare and social insurance system, migrants' reservation wages may lie below their opportunity cost of labor. This represents an externality because employers and migrant workers can pass some of their remuneration costs onto the welfare state. Once welfare benefit entitlement is secured, the reservation wage of the migrant worker is expected to rise, giving the firm an incentive to replace the worker with a new migrant willing to accept lower pay. This leads to excess churn—the reallocation of labor within firms simultaneously involving the flow of employees to unemployment insurance and the hiring of similar workers. Based on Norwegian data, we present evidence of high excess churn rates in firms with many workers from the new EU member states.