GENERAL CONCLUSION
Five essays on performance and structural rigidities in European labour markets.
The thesis investigates the role of structural rigidities in recent labour market performance in Europe from various and complementary perspectives in five essays, presented as different chapters. The structural rigidities in Europe, especially in continental Europe, have been blamed for being responsible for weak labour market performance, especially compared with the United States. By structural rigidity, we mean a lasting feature caused by a set of institutions, which prevents a market from operating freely. The approach is essentially empirical and macro-economic, while the scope of the analysis is definitely European, which is technically reflected in the use of either euro area aggregates or a panel of European countries.
Literature on labour market institutions: importance of interaction, endogeneity and micro- economic features behind macro performances
In the first essay or chapter ‘Labour market institutions and labour market performance: a survey of the literature’, we intend to review the latest developments in the economic literature on the intricate and complex link between labour market institutions and labour market performances. The examination of the issue requires taking due account of the various dimensions it involves, including the role of interactions and political economy, that is, the political acceptability of reforms.
The first lesson of the literature is that the effect of institutions is complex both in stock models (considering the number of people with a given labour market status) and flow models (considering the transition between one labour market status and another). While the importance of institutions in influencing labour market performances is undisputed, there is no consensus on the actual impact of each of them and on the precise transmission channels.
In various empirical studies, unemployment is positively associated with generous unemployment benefits and high tax wedge and negatively associated with active labour market policies and high co-ordination of bargaining. The role of employment protection legislation and union density is generally uncertain. However, whereas labour market
institutions can account for a significant part of cross-country differences in labour market performance, a large part of the change in unemployment remained unexplained and the results mentioned above are not always robust. One major difficulty encountered by these studies is that indicators of labour market institutions are often varying slowly over time, which limits their explanatory power: certain institutions were already in place in the 1960s in many EU countries when the European unemployment was lower than in the US. This issue is aggravated by omitted variables (e.g. the efficiency of active labour market policy spending, the existence of eligibility rules conditioning unemployment benefits and their effective enforcement) and the use of the crude macro indicators of labour market institutions that blend altogether various institutional aspects and mechanisms. The measured institutional changes over time are thus unable to account alone for the development in unemployment in Europe.
Thus, as the second lesson of the literature, it is also crucial to take into account the interactions that institutions generate among themselves and those they create with macroeconomic shocks. A group of studies shows that transitory increases in unemployment due to macroeconomic shocks may be lasting because of labour market institutions that restrict labour market flows and protract the adjustment of real wages. Another group of studies shows theoretically that a wide range of institutions may have complementary effects on unemployment and finds empirical support to the view that institutions strongly affect performance only when their effects on employment reinforce each other. For instance, the existence of a positive interaction between labour taxes and the replacement rate of unemployment benefits suggests that different combinations of replacement rate and labour tax rate are consistent with the same unemployment rate. The effects of employment protection on the unemployment rate vary according to the bargaining level: they are negative when wages are set at the firm level, positive when bargaining is at the industry level and insignificant when wages are set at the national level. The presence of complementarities makes difficult to a priori predict the response of equilibrium employment to changes in the institutional variables, the overall effect on employment and unemployment depending on how the behaviour of rent-seeking agents (i.e. their bargaining position) and the existing interactions between wages and employment are influenced by such complementarities.
Moreover, the literature does not reach a complete consensus on the way the institutions interact with each other and with macroeconomic shocks.
The third finding is that institutions are often the result of an endogenous process. There are two direct consequences. First, labour market institutions cannot by themselves be considered as a structural rigidity, i.e. a hindrance to the flexible working of the labour market, given their evolving nature. Indeed, their impact and the balance of their costs and benefits may change over time: an institution is created to tackle a specific problem which exists at a given point in time but may cease to exist thereafter. In short, a good institution may turn bad (becoming not only useless but also counterproductive) when historical circumstances change. Second, institutions cannot be assessed from a purely economic standpoint, as they not only impact on economic efficiency but also often serve equity or redistributive purposes because of their substantial redistributive and welfare effects. Several non-mutually exclusive theories have been developed to explain the genesis of institutions.
The legal theory contends that labour market institutions and regulations are related to the historical origins of national laws. According to the social conflict view, institutions do not represent the interest of the society at large, but rather that of groups that shape institutions in ways that maximise their own rents. Institutions are designed in practice by powerful political groups, which may generate conflicts of interest between these groups over the choice of certain institutions, as they entail changes in the distribution of resources. Moreover, institutions are by themselves a source of rents, since the existence of rent-creating institutions encourages the development of rent-protecting institutions. According to the efficient institution view, institutions are chosen efficiently by weighing their social costs against their benefits. Lastly, the institutional configuration might be seen as the result of a second best equilibrium in the context of “inefficient” markets or in absence of corrective public mechanisms. For instance, the substitution between unemployment benefits and employment protection legislation with a view to providing insurance against labour market risks is related to the extent that individuals can self-insure against unemployment risks by accessing a developed financial market and to the existence of other instruments of insurance and income re-distribution. When redistribution policies are less efficiently managed through taxes and subsidies, insurance against income risks is usually provided via strong employment protection legislation.
The fourth finding is the considerable importance of efficient policy design. The chapter identifies general principles for achieving an efficient policy design at both the macro and micro level, while acknowledging that a one-size-fits-all approach is unrealistic and irrelevant. The literature has drawn the lessons of the economic history of the last decades.
Over recent years, several EU countries have started to change their labour market institutions in a partial way, often introducing reforms that only involve specific segments of the workforce. However, the experience of the most successful countries suggests that an effective reform requires major policy shifts at the macro and micro level. The shifts observed at the macro level occurred in the wage setting mechanism, through a redefinition in rules, norms and nature of contractual arrangements1, and in the characteristics of policy designed to protect workers from labour demand shocks (e.g. EPL or unemployment insurance schemes).
While the use of reforms packages rather than individual measures is often more efficient, because of its ability to exploit complementarities, it does not always appear politically feasible and might require a gradual scheduling of reforms. At the micro level, the successful changes to labour matket institutions were generally achieved by ensuring the adequate combination of measures: unemployment benefits for a short period of time coupled with an active role for public employment services (e.g. efficient and individualised job search advice, timely information on vacancies and job seekers) followed up with a range of measures targeted at those unable to find a job (e.g. retraining, literacy courses, traineeships). Therefore, the key principles at the micro level, underlying a better design of institutions, are the role of incentives, the need for targeting and the good functioning of institutions in charge of implementing labour market policies. However, these principles should take due account of the trade-off between efficiency and equity, which is likely to exist in some policies and some countries.
The merit of ex post analysis of market rigidities: macro-performance as informative of the poor functioning of institutions
The following two chapters are “ex-post” analyses focusing on the measurable performance of labour markets in Europe, which indirectly mirrors the quality of the functioning of labour institutions and may indicate the existence of structural rigidities in the labour market.
The second chapter ‘Underutilisation of labour in (continental western) Europe: a detailed GDP accounting perspective’ attempts to measure the degree of labour utilisation in Europe, both in terms of starting level and recent growth since 1995, covering all EU27
1 Theoretical and empirical analyses suggest that both highly centralised and decentralised bargaining systems perform better than intermediate ones (at the level of industries).
countries. For doing so, we develop a GDP accounting approach, in which labour is broken down into relevant components.
The level of labour utilisation in the EU, defined as total hours worked per capita, is clearly lower than that seen in the US and the 5 richest EU countries. The relatively low labour utilisation explains around two thirds of the gap in GDP per capita between the EU15 and the US (17 p.p. out of 26%). The utilisation of labour is much higher in the new member states, being only 9% below the US level and is even above that in the five richest EU member states. While the combination of lower productivity per hour and lower labour utilisation (i.e. hours worked per capita) is the cause of relatively low GDP per capita in euro area and EU15 countries, weak productivity remains the main concern in the new member states.
There is a sizeable heterogeneity in the level of labour utilisation across countries. The dispersion of labour utilisation in the EU15 is mainly related to average hours worked and (to a lesser extent) to labour market participation, while in the new member states the dispersion is broadly based across labour-market components.
Labour utilisation should also be assessed in terms of recent growth. We thus consider the developments in labour input (i.e. total hours worked in the economy) and its effect on GDP growth. Over the last ten years (1995-2006), the growth in labour input was the driving force behind one third of GDP growth in the EU15 as a whole. Labour input growth can be broken down into a demographic component and a labour market component. Migration explains the entire demographic component, which in turn amounts to almost half of labour input growth.
The strong contribution of both female and older-worker participation and, to a lesser extent the unemployment decline, strongly contributed to the labour market component, which represents over one half of labour input growth. However, the decrease in average hours worked per worker along with declining male participation exercised a negative effect on labour input growth. Over the period 1995-2006, GDP growth rates in the EU15 were lower than in the US, despite the labour market improvement vis-à-vis the US induced by dynamic participation and, to a lesser extent, the rising initial education of labour. In the new member states, the labour input and the initial education of labour explained only a very modest part of the buoyant GDP growth. The average growth rate in the new member states was over one percentage point higher than that in US in 1995-2006, owing to a much higher capital
accumulation, TFP growth and, to a lesser extent, average hours worked, the fast rising share of working population and increasing older worker participation.
The growth pattern was quite different across European countries. Most of the variation of GDP growth across EU27 countries in 1995-2006 was driven by the dispersion of TFP growth, while unemployment, youth and female participation, migration, the share of working-age population and average hours worked only played a secondary role.
The speed of economic convergence toward the US depends on whether the movements in the two components of per capita GDP (labour utilisation and hourly productivity) add up or offset each other. Unfortunately, they appear to have evolved in opposite direction, which might explain why the catch-up of European economies toward the US has been quite limited.
A first examination also suggests that, while the growth in labour utilisation is negatively correlated with the starting levels in both the EU15 and the new member states, the relationship between the level and growth of labour utilsation remains loose and does not appear valid for all countries.
The third chapter ‘Did the euro area experience a change in its aggregate employment pattern in the late 1990s?’ takes a longer perspective (1970-2005) and makes use of time- series analysis to explore whether the labour market was more job-intensive in the euro area in the second half of the 1990s and the first half of the 2000s than in the previous decades and what could be the reasons for that.
First, a standard employment equation is estimated for the euro area as a whole. This shows that the lagged impact of both output growth and real labour cost growth, together with a productivity trend and employment “inertia” (resilience of lagged employment growth), can account for most of the employment developments between 1970 and the early 1990s.
Conversely, these traditional determinants can only explain part of the employment developments seen in the more recent period (1997-2001).
Second, the paper shows sound evidence of a structural break in the aggregate employment equation in the late 1990s. The introduction of a break from 1997 onwards turns out to be statistically very significant, substantially improves the quality of the dynamic simulation and increases the stability of the equation. The forecasting performance of the equation also improves strongly. This break may be interpreted as the additional employment growth recorded between 1997 and 2001 which cannot be explained by traditional
determinants. Various robustness checks are carried out to control for the choice of the time sample, the use of different measures of employment (hours worked, full-time equivalent employment, job numbers) and the cross-country heterogeneity. Although the choice of the starting date of the break is somewhat arbitrary, its statistical significance is maximised when it starts in 1997. When the employment equation is re-estimated with employment measured in terms of full-time equivalent or hours worked instead of the number of people employed, the break is still significant, although of a lesser magnitude. This indicates that developments in part-time employment have contributed to the strong employment performance in the 1990s but cannot fully account for the break in the labour demand in the euro area. Taking account of the heterogeneity across OECD countries, panel data estimates show that most euro area countries (representing almost two thirds of euro area employment) have experienced a positive break in their aggregate labour demand since 1997. However, five euro area countries, including Germany, did not record any significant change in their employment equation in the late 1990s.
Third, the employment equation with a structural break helps to better understand the resilient employment development seen during the subsequent period of slowdown (2001- 2005). The employment resilience during the downturn in the first half of the 2000s appears to be mainly accounted for by the job-richer economic growth already recorded between 1997 and 2001 (long-term employment behaviour) rather than by a change in the cyclical response of employment (short-term employment behaviour) in the early 2000s slowdown compared with the upturn of 1997-2001. In brief, the structural change recorded in 1997-2001 was a long-run feature, which was still recorded in the subsequent period, albeit characterised by very different cyclical conditions.
Fourth, the chapter provides some tentative explanations for this change in aggregate employment developments. Albeit difficult to show clearly, labour market reforms and changes in institutions in many euro area countries may have played a role in the recent good employment performance in the euro area. The role of structural changes can be highlighted further by relating the cross-country difference observed in the employment pattern since 1997 to the change recorded in the sectoral composition of employment, institutions and active labour market policies in the second half of the 1990s. A clear negative relationship emerges between the level of tax wedge and the presence of a positive break in recent employment performance. Although the other variables are less tightly linked to the presence
of a positive break in employment pattern, the cross-country analysis confirms that the change in the sectoral composition of employment is correlated to employment performance. The strong decline in employment protection legislation in some countries may also partly explain their good employment performance. Moreover, the part-time employment rate and the subsidies to regular employment in the private sector may have helped to improve employment performance in some countries in the late 1990s. Conversely, other institutions such as the degree of unionisation, the unemployment benefit replacement rate, the duration of unemployment benefit or most of the active labour market policies do not display any obvious link with the employment performance in euro area countries in the late 1990s.
Overall, amongst the relevant factors likely to have contributed to rising aggregate employment in recent years are changes in the sectoral composition of euro area employment, the strong development of part-time jobs, lower labour tax rates and, possibly but with greater uncertainty, less stringent employment protection legislations and larger subsidies to private employment.
Therefore, the two “ex post” analyses on labour utilisation and the recent changes in employment pattern would suggest that the existence of different institutional settings and structural features across European countries, as well as their changes over time would have been important driving forces behind differing labour market performances across European countries. This assessment appears to be in line with the findings of the economic literature reviewed in the first chapter.
Focus on two labour market features characterising European labour markets: part-time employment and wage compression
The last two chapters of the thesis focus on some specific labour market institutions or structural features characterising many European labour markets: the increasing use of part- time employment and the compression of wage distributions. These chapters carry out an “ex ante” analysis of the drivers or magnitude of these structural features.
The fourth chapter ‘Why do Europeans work part-time? A cross-country panel analysis.’ makes a careful examination of the main drivers of part-time employment over the 1980s and 1990s, using a panel of EU15 countries. First, it aims at determining the role of the business cycle and of institutional and structural factors in the development of part-time
employment. This can incidentally cast some light on whether part-time jobs have been used by firms as a flexible work arrangement in the EU15, as shown for some specific countries and sectors. Second, it allows for measuring the relative contribution of each determinant of part-time employment over time. This justifies the macro perspective of the paper and its comprehensive approach, which covers a large set of determinants. A few important results emerge from the analysis.
First, the business cycle, as measured by both the output gap and real GDP growth, is found to exert a negative effect on part-time employment developments. This countercyclical pattern is consistent with firms utilising part-time employment as a way to adjust hours worked to changing economic conditions. The "flexibility" hypothesis contends that employers reduce the number of hours worked by current staff and/or hire new workers in part-time jobs during economic downturns, while net employment creation in upswings mostly consists of full-time jobs in order to meet the higher demand of firms for labour resources. Consistent with this, involuntary part-time employment turns out to be cyclical, being higher in economic troughs. Splitting our sample by age and gender groups reveals a very significant effect of the business cycle for young and male prime-age workers.
Conversely, the effect is unclear for women and clearly insignificant for older workers.
Second, looking at labour market institutions, changes in legislation favourable to part- time employment are found to be effective, having a strong impact on actual part-time employment developments. Moreover, while overall employment protection legislation has no clear-cut effect, the employment protection legislation for permanent contracts is found to be positively related to the part-time employment rate, which is consistent with the use of part-time work as a tool for enhancing flexibility in the case of rigid labour markets.
Third, as for other structural variables, the fertility rate is found to be strongly and positively correlated with the part-time employment rate. This may indicate that part-time work creates an opportunity for women to combine the care of their children with market work. In line with existing stylised facts, the share of the service sectors in the economy and the proportion of young people in tertiary education are also significant predictors of the part time employment rate. In addition, a cross-sectional analysis underscores the positive impact of the differential in hourly wages between part-timers and full-timers on the part-time employment rate. This suggests that recruitments in part-time relative to full-time would be
fairly sensitive to relative wages. This could also reflect that part-time work provides a
“precarious” and less paid form of employment, in line with the “insider/outsider” theory.
Fourth and finally, a contribution analysis, comparing the relative importance of each factor, finds that the main institutional and structural variables generally well explain the development in the part-time employment rate in EU countries over the full period 1983- 1998, which is not the case for the United States. This confirms one of the messages arising from the first chapter that many labour market institutions, such as part-time employment, are endogenous and influenced by other institutions. Moreover, in some EU countries such as United Kingdom, Ireland, the Netherlands and Portugal, other factors - not captured by the analysis - have also contributed to the increase in the part-time employment rate. While rising female participation appears to have been the main driving force behind the development in part-time employment, declining fertility rates have exerted a dampening effect on part-time work in some countries. Looking at labour market institutions, the relaxation of the legislation on part-time jobs in Belgium, Spain and France played the major role. Other institutions may also have played some part in Spain and Portugal (easing of EPL for permanent jobs) and in the Netherlands (cuts in child benefits). The change in part-time employment laws and in EPL for regular contracts only played a material role in the 1990s. Lastly, the effect of the business cycle contributed, albeit to a limited extent, to the generally stronger developments in part- time employment seen in the 1990s as compared with the 1980s. However, its influence was quite negligible over the full period, as cyclical peaks and troughs offset each other.
The fifth and last chapter entitled ‘Wage compression in Europe: first evidence from the structure of earnings survey 2002’ proposes a method to estimate the magnitude of wage compression in the EU27 in 2002, looking into specific occupations and educational attainments. As the relative marginal productivity and its position vis-à-vis relative wages cannot be directly observed across occupations or levels of education, the methodology is based on the derivation of a labour demand model, which is estimated by means of cross- sectional econometric analysis. A couple of interesting findings emerge from the chapter.
First, the compression of wages is not uniform across wage levels: there is more wage compression at the lower end of the earning distribution (across both occupations and educational attainments), which is line with the economic literature and the existence of minimum wages in many EU15 countries along with other institutions contributing to raising the reservation wage.
Second, looking across types of occupations, the econometric analysis gives some further support to the conventional view in the economic literature that there is a compressed wage distribution in Europe. The evidence appears fairly robust. The existence of wage compression is also broadly confirmed when the estimation is carried out for each type of occupation separately so as to allow the degree of substitution between employment and capital to differ across occupations. Although some caution should be called for when estimating the magnitude of wage compression, the compression coefficient would be around one 40%, meaning that relative wages (in logarithm) would be lower - by about that amount (i.e. 40%) - than what the relative productivity would normally allow.
Third, empirical findings also broadly confirm that the wage distribution is compressed in Europe across levels of education. The estimated coefficient of compression is broadly similar to that estimated across types of occupations. While lagged wages are used as instrumental variables in the estimations so as to correct for the endogeneity of wages, the existence of substantial wage compression across educational attainments in the EU15 and the euro area is confirmed. It should also be emphasised that the findings with respect to the levels of education are in particular very sensitive to the inclusion of dummies. This is most likely to be due to the fact that educational attainment is too coarse a measure to capture the various levels of professional skills. Furthermore, the level of education attained reflects the initial qualification formally recognised by a degree but not the actual skills accrued through vocational training, professional experience and on-the-job learning. It does not either necessarily reflect the set of skills actually required for the job currently occupied, which is indeed the most relevant variable regarding wage determination. Indeed, the phenomenon of over-qualification in some European countries might blur the overall picture.
Fourth, the wage compression by both type of occupation and level of education seems to be strong in the euro area and the EU15 and inexistent in the new member states, which is consistent with their more flexible and decentralised wage setting. Within the EU15, wage compression mainly occurs in continental and southern countries, whilst no compression is detected in Anglo-Saxon countries, which confirms the stylised facts often reported on these groups of countries. No wage compression is found either in Northern European countries (for the low-skilled at least), suggesting that the (small) wage spread in these countries matches the productivity spread.
Final concluding remarks
Summing up, the five chapters of this thesis investigate various empirical aspects related to the impact of structural rigidities on labour market performance in Europe. Several key messages stand out. A first message – stemming from the first chapter - is that the effect of institutions is complex owing to the various interactions they generate among themselves and with macroeconomic shocks, and to the key role of the microeconomic design of the institutions, which conditions their efficiency. This might explain why there is no consensus on their individual impact and transmission channels, while it is undisputed that they are collectively influencing overall labour market performances. Moreover, given their evolving nature, their impact and the balance of their costs and benefits may change over time: a good institution may turn not only useless but also counterproductive when historical circumstances change.
The second message is that the heterogeneity of labour market performances across EU countries in terms of level and growth rates might be attributable to the existence of different labour market institutions and structural features. The existence of large labour underutilisation in the euro area and the EU15 might also point to sizeable structural rigidities in their labour markets. Indeed, the average degree of labour utilisation in the EU15 is clearly lower than that seen in the US and the 5 richest EU countries and explains two thirds of the gap in GDP per capita in the EU15 vis-à-vis the US. While labour underutilisation particularly affects the euro area, the labour utilisation in the new member states is not so far from that of the US and stands above that of EU5. The analysis of recent improvement in employment performance in the euro area points out the existence of a structural break in the employment behaviour in the late 1990s and the first half of the 2000s, which is not explained by standard drivers (GDP growth and labour cost developments). This break might be related to institutional reforms and structural changes, such as the changes in the sectoral employment composition, the strong development of part-time jobs and lower labour tax rates.
The third message is that looking at particular institutional or structural features appears insightful. Part-time employment, which has a countercyclical pattern, is used by firms as a
“flexible” tool to adjust labour to changing economic conditions and to circumvent some labour market rigidities, such as the employment protection legislation. In the longer run, the rate of part-time employment is endogenous and influenced by changes in part-time
legislation and female participation, but also by employment protection legislations and the fertility rate. Wages are shown to be compressed in continental and southern EU15 countries (but not in the Anglo-Saxon countries and the new member states), which means that there is a mismatch between relative productivity and relative wages across occupations and educational attainments, especially for the low-wage earners. The absence of wage compression in the Anglo-Saxon countries and the new member states may tentatively be viewed as a partial piece of evidence of the better functioning of labour market institutions in these countries, which is more generally suggested by the better performance of their labour markets in terms of labour utilisation.
The fourth message is the importance of labour composition across various dimensions (working-time status, type of occupations and educational attainment) beyond the mere aggregate figures. The study of part-time employment shows that the rise in female participation changed the structure of employment towards a higher share of part-time jobs, leading to lower average hours worked by person. Moreover, while wage compression has no clear impact on total employment, it is likely to influence its composition at the expense of the low educated and the low-paid occupations. This reminisces about the impact of stringent employment protection legislations, which are found by the literature to hit the disadvantaged groups with no clear effect on overall employment.
Key messages Chapter I.
‘Labour market institutions and labour market performance: a survey of the literature’
- The effect of institutions includes the interactions generated among them and with macroeconomic shocks and is of endogenous and evolving nature.
- The quality of macro and especially micro-economic policy designs is key to the efficiency of institutions.
- Thus, while institutions indisputably influence labour market performances, there is no consensus on their individual impact and transmission channels.
Chapter II.
‘Underutilisation of labour in (continental western) Europe: a detailed GDP accounting perspective’
- The level of labour utilisation in the EU15 is clearly lower than in the US, explaining two thirds of the EU15 per capita GDP gap vis-à-vis the US.
- Labour underutilisation particularly affects the euro area but not the new member states and does not give rise to any clear catch-up in many countries.
- Labour input growth was the driving force behind one third of recent GDP growth in the EU15, as opposed to a negligible part in the new member states.
Chapter III.
‘Did the euro area experience a change in its aggregate
employment pattern in the late 1990s?’
- The standard drivers account for most of the employment development in the euro area between 1970 and the early 1990s, but not in the late 1990s.
- Robust evidence exists of a structural break in the employment behaviour in the late 1990s and early 2000s.
- Changes in the sectoral employment composition, the strong development of part-time jobs and lower labour tax rates would explain the break.
Chapter IV.
‘Why do Europeans work part- time? A cross-country panel analysis.’
- Part-time employment, used by firms as a “flexible” tool, has a countercyclical pattern.
- In the longer run, rising female participation and changes in legislation on part-time jobs are key institutional or structural drivers.
- The main factors well explain the development in the part- time rate in the EU15 countries, unlike in the US
Chapter V.
‘Wage compression in Europe:
first evidence from the structure of earnings survey 2002’
- The wage distribution in Europe is compressed across occupations and across levels of education.
- Wage compression is more pronounced at the lower end of the wage distribution (e.g. low educational attainments, low- paid occupations).
- Wage compression is particularly true in continental and southern EU15 countries.
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