The consequences of labour market flexibility: Panel evidence based on survey data

We introduce a new data set on hiring and firing restrictions for 21 OECD countries for the period 1984-90. The data are based on surveys of business people in the countries covered, so the indices we use are subjective in nature. Controlling for country and time fixed effects, and using dynamic panel data techniques, we find evidence that increasing the flexibility of the labor market increases both the employment rate and the rate of participation in the labor force. A conservative estimate suggests that if France were to make its labor markets as flexible as those in the US, its employment rate would increase 1.6 percentage points, or 14% of the employment gap between the two countries. The estimated effects are larger in the female than in the male labor market, although both groups seem to have similar long run coefficients. There is also some evidence that more flexibility leads to lower unemployment rates and to lower rates of long-term unemployment. The analysis of inflows and vacancies present some inconsistencies, although there is some evidence that the correlation between inflows and the business cycle is stronger in more flexible labor markets (again this is stronger for females). We also find some evidence consistent with the hypothesis that inflexible labor markets produce “jobless recoveries” and introduce more unemployment persistence.