Unemployment, Labour Market Institutions and Macroeconomic Shocks

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Unemployment, Labour Market Institutions and
Macroeconomic Shocks

• Luca Nunziata
• Nuffield College, University of Oxford

  New Directions in LabourMarket Flexibility
ResearchLondon, Wednesday 26 November
2003http//www.dti.gov.uk/er/emar/events.htm    
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Some unemployment figures for 2003
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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?

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Summary of the presentation

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

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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.

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They can be classified in the following
categories

• Wage bargaining institutions.
• Unemployment benefits.
• Employment protection regulations.
• Labour Taxation.

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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.

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Union bargaining power

• Union bargaining power can be empirically
  described by two major dimensions
• the proportion of employees covered by collective
  agreements (union coverage)
• 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.

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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).

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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.

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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).

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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.

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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.

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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.

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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.

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Institutions and unemployment what is known and
what is still to know

• 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.
  

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Institutions and unemployment what is known and
what is still to know

• 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.

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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.

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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,
• ? year dummy,
• e stochastic residual.

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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.

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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.

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Institutions and shocks a general framework

• Institutions may have three distinct roles
  in explaining OECD unemployment
• direct effect as in previous model.
• shape the impact of the shocks through the
  interaction .
• effect on unemployment persistence through the
  lagged dependent variable coefficient

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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.

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What next?

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

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  New Directions in LabourMarket Flexibility
Research London, Wednesday 26 November
2003 http//www.dti.gov.uk/er/emar/events.htm