Unemployment, Labour Market Institutions and Shocks

This paper aims to explain the cross sectional differences in, and the time series evolution of, OECD unemployment from 1960 to 1995. We want to know how much of it can be accounted for by changes in labour market institutions, and the interactions of institutions and macroeconomic shocks. Our aim is also to verify the consistency of unemployment fluctuations with the labour cost results presented in Nunziata (2001). Our findings suggest that labour market institutions have a direct significant impact on unemployment in a fashion that is broadly consistent with their impact on real labour costs. Broad movements in unemployment across the OECD can be explained by shifts in labour market institutions, although this explanation relies on high levels of endogenous persistence. We cannot rule out a significant role for institutions through their interaction with adverse shocks, although the estimates do not appear extremely robust in this case. In contrast, the direct effect of institutions still holds when we include the possibility of interactions between shocks and institutions.