Unemployment, Labour Market Institutions and Macroeconomic Shocks Luca Nunziata Nuffield College, University of Oxford New Directions in Labour Market Flexibility Research London, Wednesday 26 November

Some unemployment figures for 2003

An empirical dilemma If we try to explain OECD unemployment differentials through the role of adverse macroeconomic shocks we run into the following dilemma: the differences in the shocks across countries are not sufficient to explain the variation in OECD unemployment. Question: is there any role played by labour market institutions?

Summary of the presentation 1. How do we define and measure labour market institutions. 2. A brief look at the data. 3. Institutions and unemployment: what is known and what is still to know. 4. An empirical test of the ability of institutions to explain the time pattern of unemployment in OECD countries. 5. How robust are these results and what are the limitations. 6. Considering the interactions between institutions and macroeconomic shocks.

How do we define Labour Market Institutions? Labour Market Institutions can be defined as the set of rules, regulations, enforcement laws, and organizational patterns governing the labour market.

They can be classified in the following categories : Wage bargaining institutions. Unemployment benefits. Employment protection regulations. Labour Taxation.

How can we measure them? Recently the OECD and other researchers have provided extensive data on each of these institutional dimension. The data consists of time varying indicators for each of the major 20 OECD countries from the 1960s to the late 1990s.

Union bargaining power Union bargaining power can be empirically described by two major dimensions: 1. the proportion of employees covered by collective agreements (union coverage); 2. the union membership rate among active workers (union density). Ebbinghaus and Visser (2000) provide an account of the time series evolution of union density in the OECD.

Co-ordination in wage bargaining It represents the extent to which parties to wage bargaining are able to take account of the macroeconomic consequences of their decisions. An indicator of co-ordination is provided by the OECD and Nickell, Nunziata and Ochel (2002).

Unemployment benefit replacement ratio The Benefit Replacement Ratio represents the proportion of unemployment benefits, averaged over family types of recipients, of average earnings before tax. Provided by the OECD with one observation every two years for each country.

Unemployment benefit duration The Benefit Duration indicator measures the duration of the entitlement to unemployment benefits in each country: It is provided by Nickell, Nunziata and Ochel (2002).

Employment protection regulations Employment protection regulations (EP) are by definition the set of rules and procedures governing the treatment of dismissals of workers employed on a permanent basis. The OECD and Blanchard and Wolfers (2000) provide a time series indicator.

Fixed term contracts Fixed term contracts regulations (FTC) are by definition the set of rules and procedures governing fixed term contracts management. The OECD and Nunziata and Staffolani (2003) provide a time series indicator.

Temporary work agency regulations Temporary work agency regulations (TWA) are by definition the set of rules and procedures governing temporary work agencies. The OECD and Nunziata and Staffolani (2003) provide a time series indicator.

Labour taxation: the tax wedge (TW) The tax wedge is equal to the sum of the employment tax rate, the direct tax rate and the indirect tax rate. It is measured by the OECD.

Institutions and unemployment: what is known and what is still to know 1. The approach based on Institutions: Nickell (JEP, 1997), Elmeskov et al. (ECS, 1998), Belot and van Ours (JJIE, 2000). Certain institutional dimensions are associated with higher unemployment in the OECD.

Institutions and unemployment: what is known and what is still to know 2. The approach based on Institutions and Shocks: Layard, Nickell, Jackman (1991), Blanchard and Wolfers (EJ, 2000), Fitoussi, Jestaz, Phelps, Zoega (BPEA, 2000). Shocks may explain the general increase in unemployment in Europe, while the cross sectional variation across countries can be imputed to their different institutions.

This paper presents: An econometric model that provide a robust empirical test of the ability of institutions to explain the time pattern of unemployment in OECD countries. A comparison of the approach based on institutions only with the one where institutions are interacted with shocks, and an investigation on which one performs better.

The econometric model U = unemployment rate in percentage points, s = vector of controls for macroeconomic shocks, t = is a country specific time trend, μ = fixed country effect, λ = year dummy, ε = stochastic residual.

Specification and diagnostic tests Poolability: semi-pooled model. Nickell Bias in Dynamic Fixed Effect Models. Heteroskedasticity and Serial Correlation. Overconfidence in GLS Pooled Models. Panel cointegration: Maddala and Wu. Endogeneity: Durbin-Wu-Hausman augmented regression test, Stock and Watson methodology.

Results: the explanatory power of labour market institutions Dynamic simulations: labour market institutions can explain around 55 percent of the 6.8 percent increase in the average European unemployment rate from the 1960s to the 1990s. If we exclude Germany from this calculation, a country for which our model is not able to say much, we explain 63 percent of the rise in unemployment in the rest of Europe. Unemployment benefits and taxes contribute the most to the rise in unemployment. Employment protection is not significant. The impact of unions is offset by high levels of coordination.

Institutions and shocks: a general framework Institutions may have three distinct roles in explaining OECD unemployment: 1. direct effect as in previous model. 2. shape the impact of the shocks through the interaction. 3. effect on unemployment persistence through the lagged dependent variable coefficient

Results: does the augmented model perform better? The institutions/shock model explains the data quite well. However, the variables of this model make no real contribution to understanding unemployment changes when used to augment the simple institutional change model. Employment protection plays a significant role in increasing unemployment persistence.

What next? Shocks or scenarios? Labour and product market regulations Company start-up costs

New Directions in Labour Market Flexibility Research London, Wednesday 26 November