US model vs European? Eurosclerosis vs Jobs Miracle? Equity vs Efficiency?

1. 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?

2. 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

3. 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…

4. Very rough ordering according to type of labour market institutionsFreeman: 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.

5. 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.

6. Freeman: • Labour market institutions became central in debates on macroeconomic performance in the 1990s. • 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.

7. Views of labour market institutionsRegulation vs deregulation • For de-regulation • Against deregulation

8. 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.

9. 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 labour­market factors alone…There is little convincing evidence for the trade­off between higher earnings and greater employment creation for the low­skilled. • 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”

10. 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.

11. 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?

12. 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)

13. 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…

14. 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.

15. 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.

16. Recall earlier lecture: Age 15-74

17. 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.

18. 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.

19. 2 & 3 The European welfare state institutions were compatible with growth and low unemployment in the stable economic environment of the 1950s and 1960s. • 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.

20. 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.

21. Agell on ”benefits from rigid labour markets” • WhatAgelldoesnotsay: • That wagecompression, strong unions, centralisedbargaining, employmentprotection or generouslong-termunemploymentbenefit are alwaysgood or have no efficiencycosts. • That there are never special interests or rent-seekingbehaviourbehind present labour market institutions. • That globalisationdoes not pose any problems for extensive welfarestates and social insurance.

22. 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 are also efficiency gains from wagecompression, strong unions, centralisedbargaining, employmentprotection or generouslong-termunemploymentbenefits. • That this should be broughtout to balance the discussion.

23. Main points: • Social norms, efficiencywage arguments and labour market reform. • Market failure, ”second best” and labour market institutions. • Wagecompression and economicefficiency. • Labour market institutions as insurance: • Globalisation, uncertainty and labour market institutions.

24. 1. Wage rigidity: • Wagerigiditymay be caused by deeper social causes and social norms than just legislations or union policies. • Causalitybetween norms and institutions may go bothways. • Efficiencywagetheory gives reasonswhyemployersmight not want to cutwageseveniftheycould get workers. • With ”imperfectlabourcontracts” employersneed to motivatetheiremployees.

25. Evidence? • Case studies in sociology and psychology. • Textbooks in human resource management. • Experiments on social norms, reciprocalbehaviour and conceptions of fairness (ultimatum and sharing games). • Surveys of managers (US, UK, Sweden): Underbidding and wagecutsundermine work morale.

26. Implications: • Ifreduction of wages or firingincumbentworkers to hire the lowestbidder is against social norms, harmful for workerproductivity and for the firm’s reputation, thenreducing minimum wages and union rights willhavelittleeffect. • Tax reductions for lowpaidworkers and profit sharingschemesmightincreaseemploymentwithoutbeingseen as unfair.

27. 2. Are institutions bad for efficiency? • Efficiencycompared to what? • The standard to compare with is not perfectcompetionbut real imperfectlabour markets. • ”What is the second best alternative”? • The employmenteffects of minimum wages with monopsony power. • Work environment as a public good – collectivebargaining to avoidfree-riding/underprovision. • Assymetric information and general, publiclyfunded social insurance.

28. Pay compression: • Acrosssectors: • Less ”pull” factor for moving to expandingindustries. • More ”push” factor for moving to expandingindustries. • Analogous to subsidisingemployment in new sectors – efficientifthere are positive externalities and/or increasingreturns to scale. • Acrossskills: • Less wagerate-incentive to acquireskills. • More ”getting a job at all”-incentive to acquireskills. • Less wage dispersion can be both cause and effect of less skill dispersion. • As social insurance.

29. Wage compression and human capital formation • Relatively high wages for lowskilledworkers firmswillemploymoreskilledworkers and fewerunskilled  unemployment for lowskilledworkers  incentives to acquireskills. • If a publiclyfundededucation system  high general level of education (skill distribution ”compressed from below”) thentherewill be less earnings dispersion.

30. Wage compression as social insurance • Ifpeople are risk-aversethere is demand for insuranceagainstsickness, disability – or unemployment • The collectiveagreement on supplementaryUE-insurance (Trygghetsrådet) is an indication of demand. • So why not leave it to the market? • Assymetric information – onlythosemost at risk wouldwant to buy the insurance. • State providedinsurancecreatesefficiency loss throughitsfinancing (taxes) but in itselfcanencouragejobmobility, setting up new businesses etc. • Butearningscompressionalsofunctions as an insuranceagainst not finding a goodjob. • With moreups and downs and restructuringuncertaintywill be greater.

31. 3. The big question for the future: Globalisation. • Whatdoesglobalisationimply for the efficiency and cost of today’slabour market institutions? • On the one hand, increased international competition makes it harder to maintainwages for the low-skilled and costly institutions. • On the other hand, greateruncertaintywilllead to greaterdemand for insurance.

32. So far, the relation between openness and strong institutions is positive. • A simple macro-economic, cross-countrycomparison (on 1980s-early 1990s data): • Countries with largeshare of trade/GNPhave • higher union density • morecentralisedwagebargaining • higher minimum wages relative to the averagewage • Lower dispersion of wages and disposableincome.