Harvard’s Dani Rodrik in a recent post questioned the role of labor market rigidities (such as restrictions on firings and generous unemployment) in Europe’s higher unemployment. (As an aside, readers will know even that factoid is disputed. Barry Ritholtz has argued that if we calculated unemployment the same way Europeans did, the rates wouldn’t be very different, and one reader pointed out employment/population ratios for working age men also shows that supposedly sclerotic France has higher workforce participation than the US).
Rodrik cites an article by David R. Howell, Dean Baker, Andrew Glyn, and John Schmitt, “Are Protective Labor Market Institutions at the Root of Unemployment? A Critical Review of the Evidence.” In short, the analyses that claim to prove that labor market restrictions lead to higher unemployment aren’t compelling. The abstract:
A rapidly expanding empirical literature has addressed the widely accepted claim that employment-unfriendly labor market institutions explain the pattern of unemployment across countries. The main culprits are held to be protective institutions, namely unemployment benefit entitlements, employment protection laws, and trade unions. Our assessment of the evidence offers little support for this orthodox view. The most compelling finding of the cross-country regression literature is the generally significant and robust effect of the standard measure of unemployment benefit generosity, but there are reasons to doubt both the economic importance of this relationship and the direction of causation. The micro evidence on the effects of major changes in benefit generosity on the exit rate out of unemployment has been frequently cited as supportive evidence, but these individual level effects vary widely across studies and, in any case, have no direct implication for changes in the aggregate unemployment rate (due to “composition” and “entitlement” effects). Finally, we find little evidence to suggest that 1990s reforms of core protective labor market institutions can explain much of either the success of the “success stories” or the continued high unemployment of the large continental European countries. We conclude that the evidence is consistent with a more complex reality in which a variety of labor market models can be consistent with good employment performance.
Rodrik provides some observations, starting with comments made on the paper:
In his comment on this paper, Jim Heckman agrees that the cross-national evidence is weak and fragile. But:
In the absence of better data, and better measurement frameworks, prior beliefs will continue to dominate how one interprets the evidence. This is not as much about dogmatism or conspiracy as it is about good science. In the absence of empirical evidence, logically consistent stories that accord with intuition have great appeal…..
In at least one area of labor-market intervention, employment protection (firing restrictions), the orthodox expectation is not the only “logically consistent” story that accords with economic intuition. If you make it harder to fire an employee, you essentially give that employee some property rights over the job he occupies. Now, according to the Coase theorem, how property rights are allocated (to the employer versus the employee) has no effect on efficiency in the absence of bargaining and other transaction costs. If eliminating a job is the efficient thing to do, an employer can do it either by fiat or by paying the employee to leave. There are distributional implications (obviously the employer is worse off in the latter case), but nothing to stop the efficient thing from getting done. This is an idea I associate with my Harvard colleague Richard Freeman.
The paper by Howell, Baker, Glyn, and Schmitt did not offer new theories in place of the prevailing one, but one way in which it may err is in viewing employees strictly as economic agents. People are social beings, and in a world where other institutions, like church and community, play diminished roles, work is the primary social network in many people’s lives. That fact alone might offset to a considerable degree the concern that citizens will suck on the tit of the state as long as they can, and work only if required to. It’s too bad the behavioral finance crowd hasn’t gotten around to labor market issues.
The notion that transferring property rights away from one party to another is a zero sum game also bears investigating. Consider a real estate example. New York city still has some apartments that are rent stabilized. That means that rent increases are regulated (they roughly track inflation) and the landlord cannot deny a tenant a lease renewal if they have paid their rent on time. There’s another wrinkle, that if the rent rises above a certain level and the tenant has sufficiently high income, the apartment is subject to “luxury decontrol,” meaning the landlord can charge a market rent.
Now most landlords in New York are very aggressive in trying to decontrol apartments, But I know of one (and he has the reputation of being stingy) who doesn’t. In fact, from what I have heard, they don’t even try.
Why would that be? Tenants in his building, who know they have property rights (remember, the landlord cannot deny lease renewal), often fix up the apartments on their own. And I don’t mean paint. One tenant spent well over a million dollars on renovations.
Trying to decontrol apartments would make any tenant think twice about putting even a penny into his unit. The landlord finds it better to keep good tenants in place, since a high proportion have invested in their apartments, which benefits him. But don’t expect him to spend money on the lobby.