Labour market institutions Readings Agell Freeman Heckman You
Labour market institutions (Readings: Agell, Freeman, Heckman) You can replace (or complement) Freeman’s NBER paper and Agell’s article by their contribution in CESifo Forum 2004 • • • US model vs European? Eurosclerosis vs Jobs Miracle? Equity vs Efficiency? Welfare State vs Neo liberal Laissez Faire Capitalism? Institutions vs flexibility Or are these dichotomies not the right way to put the questions?
What are labour market institutions? • Laws regulating the employment contract: – Employment protection laws. – Minimum wage legislation. – Health and safety regulations – Regulations of working hours. – Equal opportunities (anti discrimination) legislation. and authorities enforcing these laws
• Legislation regulating of the rights of labour market organisations. • The organisations themselves and their behaviour. • Vocational training at different levels. • Unemployment insurance. • Active labour market policies. • Taxes on earnings. • Social insurance (sickness benefits, pensions, social security/welfare). • Social insurance contributions and this list is not exhaustive…
Very rough ordering according to type of labour market institutions Freeman: NBER Working Paper No. 13242 • The Anglo American (US, UK, NZ, Australia + Japan) at one end. • The Scandinavian at the other. • West Europe (Germany, France, Netherlands) in the middle. • Southern Europe (Spain, Portugal, Greece, Italy) depends on ´which institutions.
• OECD classifications of the degree of centralisation of wage setting results in a similar scale: US, UK, Canada & NZ least centralised, Scandinavia most centralised. • Globally: More difficult to measure in some countries laws and international conventions are said to be in force but not upheld in practise.
• Freeman: • Labour market institutions became central in debates on macroeconomic performance in the 1990 s. • Previously: Unemployment and growth had been discussed in the framework of macroeconomic (fiscal and monetary)policies. • From OECD Jobs Study 1994 de regulation of labour markets was put at the centre of attention.
Views of labour market institutions Regulation vs deregulation 1. For de regulation 2. Against deregulation
• IMF, 2003: “high unemployment is largely structural in nature … rather than cyclical…[with deregulation] unemployment [in Europe] could fall by about 6 ½ percent” • World Bank (1990): “Labor market policies – minimum wages, job security regulations, and social security – are usually intended to raise welfare or reduce exploitation. But they actually work to raise the cost of labor in the formal sector and reduce labor demand. . . and thus (depress) labor incomes where most of the poor are found. ” • The structural adjustment programs of the IMF implied a redistribution from wages to profits and from those with lower income to the better off – things that workers and unions might oppose.
• Nordic Model (Rehn Meidner): Wage increases should follow productivity gains in trade competing sector. This was best done through centralised wage bargaining. • ILO (1997): “The ILO also takes issue with the view that labour market rigidity has been the major cause of unemployment and that greater labour market flexibility is the solution. Labour market rigidities have not been increasing over the period of rising unemployment, and the rise in unemployment cannot be explained by labour market factors alone…There is little convincing evidence for the trade off between higher earnings and greater employment creation for the low skilled. • World Bank 2003: ““Workers who belong to trade unions earn higher wages, work fewer hours, receive more training, and have longer job tenure on average, than their non unionized counterparts. . On the other hand, temporary layoffs can be more frequent in unionized firms. At the macroeconomic level, high unionization rates lead to lower inequality of earnings and can improve economic performance”
A look at the empirics: • A number of studies have shown that unions, wage compression, job security etc result in lower productivity and higher unemployment. • A number of other studies show that if you make minor changes in how the earlier studies are done, these results disappear. • One of the few results everyone seems to agree on is that with strong unions there is less wage dispersion.
So what’s the problem? • Cross country comparisons – you’d want more observations. • Time series – you don’t want several things changing at the same time. • What observations should be treated as outliers? • How do we model the effect of one institution if it depends on context (other institutions, “configuration”). • Can you create a typology of countries? • Are methods and conclusions influenced by priors? • If observations and results that go against what you strongly believe, how far should you go to adjust your method?
• OECD has shifted position somewhat: • evidence of effects on employment protection laws on aggregate employment and unemployment is “mixed”. • It is still “plausible” that high wage/wage compression lead to fewer jobs but the evidence is “fragile”. • The effect of collective bargaining depends on the context. (Employment Outlook 2004)
• Others have not: • IMF (2003): Reforms of labour market institutions could reduce European unemployment by 3 percentage points and increase GDP by 5 percent. • US inspired labour market and product market reform could reduce unemployment in Europe to an average of 1. 5 %. (US unemployment at the time was 6%). • …. As Hamlet said: Methinks the lady does protest too much…
Freeman’s advice: • Recognise that analysis based on aggregate data is weak and use more micro economic evidence: – ”laboratory” or experimental evidence of how economic agents behave that mimicks reactions to institutions. – data on how firms, workers and unions act. • Not assume that labour markets could function as perfectly competitive markets and that anything which is not in line with this is bad.
Heckman: • Main thesis: European economies lack flexibility and ”are losing ground in the international economic race”. • Why? – Too much taxes, regulation and bureacracy lead to low investment in human capital and venture capital. This will have long run consequences for growth and wealth. – European economies are unable to respond rapidly to change. – Europe has ”extraordinarily high” levels of unemployment.
Recall earlier lecture: 10. 0 9. 0 8. 0 7. 0 6. 0 5. 0 4. 0 Sweden EU 27 US 3. 0 2. 0 1. 0 0. 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Age 15 -74
Main points (quoted from article): • 1. The incentives in European welfare states distort resource allocation and impair efficiency. • 2. The World Economy has become more variable and less predictive. • 3. Uniformity in the prices of traded goods dictates labor market outcomes. • 4. Diversity, heterogeneity of opportunities, and value of local knowledge.
Summary of Heckman’s argument: • 1. Cost of the welfare state: High taxes have lead to large dead weight losses. Regulations of business and banking and centralised wage bargaining contribute to less employment, effort and growth. • Benefits of the welfare state: Produces gains for insiders at the cost of outsiders.
• 2 & 3 The European welfare state institutions were compatible with growth and low unemployment in the stable economic environment of the 1950 s and 1960 s. • Today more countries have entered a more fierce international competition and technologies and demand for products change rapidly and unpredictably. • Regulated economies are not flexible enough to deal with that for example to let wage differention give incentives for labour to shift to new areas and invest in new skills. • With increased trade, prices and wages must become more equalised internationally.
• 4. Technologies and business opportunities have become more varied and require local and specific knowledge. Wages and hiring must be decided locally to take these conditions into account.
Agell on ”benefits from rigid labour markets” • What Agell does not say: – That wage compression, strong unions, centralised bargaining, employment protection or generous long term unemployment benefit are always good or have no efficiency costs. – That there are never special interests or rent seeking behaviour behind present labour market institutions. – That globalisation does not pose any problems for extensive welfare states and social insurance.
• What Agell does say: – That the claims that have been made that ”Eurosclerosis” is due to rigidities and inflexible labour market institutions are exaggerated. – That the debate has been one sided. – That there also efficiency gains from wage compression, strong unions, centralised bargaining, employment protection or generous long term unemployment benefits. – That this should be brought out to balance the discussion.
Main points: • Social norms, efficiency wage arguments and labour market reform. • Market failure, ”second best” and labour market institutions. – Wage compression and economic efficiency. • Labour market institutions as insurance: – Globalisation, uncertainty and labour market institutions.
1. Wage rigidity: • Wage rigidity may be caused by deeper social causes and social norms than just legislations or union policies. • Causality between norms and institutions may go both ways. • Efficiency wage theory gives reasons why employers might not want to cut wages even if they could get workers. • With ”imperfect labour contracts” employers need to motivate their employees.
Evidence? • Case studies in sociology and psychology. • Textbooks in human resource management. • Experiments on social norms, reciprocal behaviour and conceptions of fairness (ultimatum and sharing games). • Surveys of managers (US, UK, Sweden): Underbidding and wage cuts undermine work morale.
Implications: • If reduction of wages or firing incumbent workers to hire the lowest bidder is against social norms, harmful for worker productivity and for the firm’s reputation, then reducing minimum wages and union rights will have little effect. • Tax reductions for low paid workers and profit sharing schemes might increase employment without being seen as unfair.
2. Are institutions bad for efficiency? • Efficiency compared to what? • The standard to compare with is not perfect competion but real imperfect labour markets. • ”What is the second best alternative”? – The employment effects of minimum wages with monopsony power. – Work environment as a public good – collective bargaining to avoid free riding/underprovision. – Assymetric information and general, publicly funded social insurance.
Pay compression: • Across sectors: – Less ”pull” factor for moving to expanding industries. – More ”push” factor for moving to expanding industries. – Analogous to subsidising employment in new sectors – efficient if there are positive externalities and/or increasing returns to scale. • Across skills: – Less wage rate incentive to acquire skills. – More ”getting a job at all” incentive to acquire skills. – Less wage dispersion can be both cause and effect of less skill dispersion. • As social insurance.
Wage compression and human capital formation • Relatively high wages for low skilled workers firms will employ more skilled workers and fewer unskilled unemployment for low skilled workers incentives to acquire skills. • If a publicly funded education system high general level of education (skill distribution ”compressed from below”) then there will be less earnings dispersion.
Wage compression as social insurance • If people are risk averse there is demand for insurance against sickness, disability – or unemployment – The collective agreement on supplementary UE insurance (Trygghetsrådet) is an indication of demand. • So why not leave it to the market? • Assymetric information – only those most at risk would want to buy the insurance. • State provided insurance creates efficiency loss through its financing (taxes) but in itself can encourage job mobility, setting up new businesses etc. • But earnings compression also functions as an insurance against not finding a good job. • With more ups and downs and restructuring uncertainty will be greater.
3. The big question for the future: Globalisation. • What does globalisation imply for the efficiency and cost of today’s labour market institutions? • On the one hand, increased international competition makes it harder to maintain wages for the low skilled and costly institutions. • On the other hand, greater uncertainty will lead to greater demand for insurance.
So far, the relation between openness and strong institutions is positive. • A simple macro economic, cross country comparison (on 1980 s early 1990 s data): • Countries with large share of trade/GNP have – higher union density – more centralised wage bargaining – higher minimum wages relative to the average wage – Lower dispersion of wages and disposable income.
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