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Uncertainty and the politics of employment protection

  • Vindigni, Andrea
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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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    File URL: http://polis.unipmn.it/pubbl/RePEc/uca/ucapdv/vindigni117.pdf
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    Paper provided by Institute of Public Policy and Public Choice - POLIS in its series POLIS Working Papers with number 106.

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    Length: 48 pages
    Date of creation: May 2008
    Date of revision:
    Handle: RePEc:uca:ucapdv:106
    Contact details of provider: Web page: http://polis.unipmn.it

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    1. Brügemann, Björn, 2006. "Does Employment Protection Create Its Own Political Support?," IZA Discussion Papers 2286, Institute for the Study of Labor (IZA).
    2. Daron Acemoglu & Davide Ticchi & Andrea Vindigni, 2011. "Emergence And Persistence Of Inefficient States," Journal of the European Economic Association, European Economic Association, vol. 9(2), pages 177-208, 04.
    3. 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.
    4. Giles Saint-Paul, 2005. "Did European Labor Markets Become More Competitive in the 1990s? Evidence from Estimated Worker Rents," Central Banking, Analysis, and Economic Policies Book Series, in: Jorge Restrepo & Andrea Tokman R. & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Edi (ed.), Labor Markets and Institutions, edition 1, volume 8, chapter 8, pages 281-300 Central Bank of Chile.
    5. Stephen Morris & Stephen Coate, 1999. "Policy Persistence," American Economic Review, American Economic Association, vol. 89(5), pages 1327-1336, December.
    6. Lars Ljungqvist & Thomas J. Sargent, 1995. "The European unemployment dilemma," Working Paper Series, Macroeconomic Issues 95-17, Federal Reserve Bank of Chicago.
    7. repec:iza:izadps:dp1067 is not listed on IDEAS
    8. Diego Comin & Thomas Philippon, 2005. "The Rise in Firm-Level Volatility: Causes and Consequences," NBER Working Papers 11388, National Bureau of Economic Research, Inc.
    9. Ricardo J. Caballero & Mohamad L. Hammour, 1997. "Jobless Growth: Appropriability, Factor Substitution, and Unemployment," NBER Working Papers 6221, National Bureau of Economic Research, Inc.
    10. 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.
    11. Saint-Paul, G., 1993. "On the Political Economy of Labor Market Flexibility," DELTA Working Papers 93-02, DELTA (Ecole normale supérieure).
    12. 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.
    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. 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.
    15. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, volume 1, number 5474.
    16. 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.
    17. 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.
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