The General Equilibrium Effects of Labor Market Institutions (joint withAndrea Gerali and Danilo Liberati)

Abstract:

Labor market institutions (LMIs) are key determinants of the equilibrium unemployment rate but the specific impact of each of them is often unclear. In this paper we study the interaction of four different LMIs: i) employment protection on regular contracts (EPR), ii) employment protection on temporary contracts (EPT), iii) collective bargaining coverage (CBC) and iv) unemployment benefits replacement rate (RR). Cross-country stylized facts show that LMIs interact in a non trivial way, pushing up unemployment when imposing restrictions on the adjustment of both heads and wages. Strong EPR is associated with higher unemployment only when extensive CBC or high RR limit firms' ability to adjust wages downwards. The effects of partial reforms easing employment protection by the introduction of temporary contracts are ambiguous. To rationalize these findings we build a DSGE model with labor market frictions which embeds the previous LMIs. Firms may stipulate regular and temporary contracts in segmented markets. The first ones are subject to firing costs in case of endogenous separation, while the latter have limited duration and can be endogenously converted into permanent jobs at expiration. CBC prevents the wage to fully adjust to idiosyncratic productivity shocks, increasing the probability of separation and inducing firms to substitute regular with temporary jobs. In line with the data the model predicts that the effects of each LMI on equilibrium output and employment depend on the degree of flexibility of the overall institutional context.