Debunking labour market “rigidities”

Neoclassical economics, when looking at the labour market, plots its supply and demand curves, with all of their loaded and unrealistic assumptions, and finds an equilibrium wage and employment. Then it finds that anything added on to this simplistic and flawed model – taxation, unions, minimum wages – perturbs that equilibrium. Therefore those things must be bad!

A new paper from the Washington, DC think tank, The Center for Economic and Policy Research takes a critical look at labour market “rigidities” that are deemed to be at the root of Europe’s relatively high unemployment. The abstract follows:

July 14, 2006
Are Protective Labor Market Institutions Really at the Root of
Unemployment? A Critical Perspective on the Statistical Evidence

David R. Howell, Dean Baker, Andrew Glyn and John Schmitt
It is widely accepted that the rigidities created by labor market institutions explain the
pattern of unemployment across countries. A rapidly expanding recent literature has explored the statistical support for this orthodox view. This paper offers a critical perspective on the evidence.

We focus on the protective institutions that are the usual suspects: unemployment benefit entitlements, employment protection laws, and trade unions. Given the dominance of this view, the simple correlation evidence offers remarkably little support.

The most robust finding of the cross-country regression literature points to a potentially important role for unemployment benefits generosity, but there are reasons to doubt the strength of this relationship and even the direction of causation.

The micro evidence on the effects of major changes in benefit generosity on the duration of unemployment (and the exit rate into employment) is much less supportive of a sizable impact of benefit generosity on the aggregate unemployment rate than is often suggested.

Finally, we find little evidence to suggest that changes in the strength of these protective labor market institutions can explain either the success of the “success stories” or the continued high unemployment of the four large continental European countries.

In reference to the final point, the authors find that the Scandinavian countries that do everything the right hates – high taxes, lots of unionization, big welfare state – fare about as well, if not better, on standard labour market indicators than a group of Anglo-American countries including Canada and the USA.