The Economics of Imperfect Labor Markets This page intentionally left blank The Economics of Imperfect Labor Markets Tito Boeri and Jan van Ours Princeton University Press Princeton and Oxford Copyright © 2008 by Princeton University Press Published by Princeton University Press 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press 6 Oxford Street, Woodstock, Oxfordshire OX20 1TW All Rights Reserved Library of Congress Cataloging-in-Publication Data Boeri, Tito. The economics of imperfect labor markets / Tito Boeri and Jan van Ours. p. cm. Includes bibliographical references (p. ) and index. ISBN: 978-0-691-12449-0 (alk. paper) 978-0-691-13735-3 (pbk. : alk. paper) 1. Labor market. I. Ours, J. C. van. II. Title. HD5706 .B648 2008 331.12–dc22 2008062104 British Library Cataloging-in-Publication Data is available This book has been composed in Times Roman Printed on acid-free paper. ∞ press.princeton.edu Printed in the United States of America 10987654321 Contents Preface xi Symbols and Acronyms xvii 1 Overview 1 1.1 A Few Key Definitions 2 1.2 A Competitive Labor Market 4 1.2.1 Labor Supply and the Reservation Wage without Hours Restrictions 4 1.2.2 Aggregate Labor Supply 7 1.2.3 Labor Demand and Wage Determination 9 1.2.4 Equilibrium 11 1.3 Labor Market Institutions 14 1.3.1 Acting on Prices 14 1.3.2 Acting on Quantities 15 1.3.3 Institutional Interactions 17 1.3.4 Why Do Labor Market Institutions Exist? 18 1.3.5 Product Market Competition and Institutional Reforms 21 1.4 Technical Annex: A Simple Static Framework 24 1.4.1 A Competitive Labor Market 24 1.4.2 Labor Market Institutions 25 1.4.3 The Wedge 26 1.4.4 Product Market Competition and the Employment Bias of Institutions 27 2 Minimum Wages 29 2.1 Cross-Country Comparisons 30 2.2 Theory 33 2.2.1 A Competitive Labor Market 33 2.2.2 A Noncompetitive Labor Market 34 2.3 Empirical Evidence 38 2.3.1 Studies Based on Firm-Level Data 38 2.3.2 Studies Based on Natural Experiments 39 2.3.3 Studies Based on Workers’ Histories 43 2.4 Policy Issues 44 2.4.1 Should the Minimum Wage Be Reduced or Increased? 44 2.4.2 Is the Minimum Wage Effective in Reducing Earnings Inequality and Poverty? 45 2.5 Why Does a Minimum Wage Exist? 46 vi Contents 2.6 Suggestions for Further Reading 47 2.7 Review Questions 47 2.8 Technical Annex: Fine-Tuning of the Minimum Wage 48 3 Unions and Collective Bargaining 51 3.1 Measures and Cross-Country Comparisons 52 3.1.1 Union Density 52 3.1.2 Coverage and Excess Coverage 54 3.1.3 Coordination 56 3.2 Theory 56 3.2.1 Collective Bargaining 57 3.2.2 Endogenous Membership 61 3.3 Empirical Evidence 66 3.3.1 Effects of Unions on Wages 67 3.3.2 Bargaining Coordination, Union Density, and Unemployment 71 3.4 Policy Issues 72 3.4.1 Do Unions Increase Efficiency? 72 3.4.2 Should Collective Bargaining Be Decentralized? 74 3.5 Why Do Unions Exist? 75 3.6 Suggestions for Further Reading 76 3.7 Review Questions 76 3.8 Technical Annex: How Strong Should Unions Be in Order to Be Efficient? 77 4 Payroll Taxes 81 4.1 Measures and Cross-Country Comparisons 82 4.2 Theory 86 4.3 Empirical Evidence 90 4.4 Policy Issues 92 4.4.1 Negative Income Taxes or In-Work Benefits? 92 4.4.2 Tax Credits or Wage Subsidies? 96 4.5 Why Do Payroll Taxes Exist? 97 4.6 Suggestions for Further Reading 98 4.7 Review Questions 98 4.8 Technical Annex: Taxes and Benefits in a Competitive Labor Market 98 5 Regulation of Working Hours 101 5.1 Measures and Cross-Country Comparisons 101 5.2 Theory 102 5.2.1 Regulating Weekly Working Hours 104 5.2.2 Part-Time Work 107 5.3 Empirical Evidence 109 5.3.1 Working Hours 109 5.3.2 Part-Time Work 113 5.4 Policy Issues 116 5.4.1 Should Governments Regulate Working Hours? 116 5.4.2 Should Governments Stimulate Part-Time Labor? 117 5.5 Why Does Regulation of Working Hours Exist? 117 5.6 Suggestions for Further Reading 118 5.7 Review Questions 118 5.8 Technical Annex: Reduction of Standard Working Hours 119 Contents vii 6 Retirement Programs 121 6.1 Measures and Cross-Country Comparisons 122 6.2 Theory 124 6.3 Empirical Evidence 125 6.3.1 Age and Employment 125 6.3.2 Age and Productivity 132 6.4 Policy Issues 134 6.4.1 Should the Mandatory Retirement Age Be Increased? 134 6.4.2 Should Early Retirement Programs Be Phased Out? 135 6.5 Why Do Early Retirement Programs Exist? 136 6.6 Suggestions for Further Reading 136 6.7 Review Questions 136 6.8 Technical Annex: Optimal Retirement Age 137 7 Family Policies 139 7.1 Measures and Cross-Country Comparisons 140 7.2 Theory 142 7.2.1 Child Care Facilities 142 7.2.2 Parental Leave 142 7.3 Empirical Evidence 144 7.4 Policy Issues 150 7.4.1 Can Work and Family Life Be Balanced? 150 7.4.2 Is There a Trade-off between Fertility and Employment? 151 7.5 Why Do Family Policies Exist? 153 7.6 Suggestions for Further Reading 153 7.7 Review Questions 154 7.8 Technical Annex: Child Care Facilities and Hours of Work 154 8 Education and Training 157 8.1 Measures and Cross-Country Comparisons 158 8.2 Theory 160 8.2.1 Schooling 160 8.2.2 Training 163 8.3 Empirical Evidence 165 8.3.1 Returns to Schooling 165 8.3.2 On-the-Job Training 169 8.4 Policy Issues 170 8.4.1 Should Governments Subsidize In-Company Training? 170 8.4.2 Should There Be a Compulsory Schooling Age? 171 8.5 Why Do Governments Provide Education and Training? 171 8.6 Suggestions for Further Reading 172 8.7 Review Questions 172 8.8 Technical Annex: Schooling and Training 172 8.8.1 Optimal Years of Schooling 172 8.8.2 Who Pays for General Training? 174 9 Migration Policies 175 9.1 Measures and Cross-Country Comparisons 176 9.2 Theory 178 viii Contents 9.2.1 A Competitive Labor Market 179 9.2.2 An Economy with Wage Rigidities 180 9.2.3 Wage Rigidities and Unemployment Benefits 181 9.2.4 What Drives Migration Decisions? 182 9.2.5 Effects on Income Distribution of Skill-Biased Migration 183 9.3 Empirical Evidence 184 9.3.1 The Labor Market Performance of Migrants 189 9.3.2 Fiscal Effects 190 9.4 Policy Issues 191 9.4.1 Closing the Welfare Door? 192 9.4.2 Adopting a Points System? 193 9.5 Why Do Migration Policies Exist? 194 9.6 Suggestions for Further Reading 195 9.7 Review Questions 195 9.8 Technical Annex: Net Gains from Migration and the Option Value of Waiting 195 10 Employment Protection Legislation 199 10.1 Measures and Cross-Country Comparisons 200 10.2 Theory 204 10.2.1 A Neutrality Result 204 10.2.2 Removing Risk Neutrality 206 10.2.3 EPL with Rigid Wages 206 10.2.4 EPL as a Tax 209 10.2.5 Two-Tier Regimes 210 10.3 Empirical Evidence 211 10.3.1 Cross-Country Analyses 211 10.3.2 Within-Country Studies 213 10.3.3 Endogeneity of EPL 214 10.4 Policy Issues 215 10.4.1 How Much Protection Should EPL Provide? 215 10.4.2 Whom Should EPL Be Protecting? 218 10.5 Why Does Employment Protection Legislation Exist? 220 10.6 Suggestions for Further Reading 220 10.7 Review Questions 221 10.8 Technical Annex: EPL in a Search-Matching Model 221 10.8.1 A Simple Dynamic Framework 221 10.8.2 Present Discounted and Flow Values 221 10.8.3 Behavior of Workers 222 10.8.4 Matching 222 10.8.5 Firms 223 10.8.6 Wage Bargaining 223 10.8.7 Introducing EPL 223 10.8.8 Baseline Parameters 224 11 Unemployment Benefits 225 11.1 Measures and Cross-Country Comparisons 226 11.2 Theory 230 11.2.1 A Competitive Labor Market 230 11.2.2 An Imperfect Labor Market 234 Contents ix 11.3 Empirical Evidence 238 11.3.1 Effects on Reservation Wage 238 11.3.2 Effects on Unemployment Duration: Aggregate Data 239 11.3.3 Effects on Unemployment Duration: Microeconomic Data 240 11.3.4 Effects of Unemployment on the Generosity of UBs 243 11.4 Policy Issues 244 11.4.1 Why and When Should UBs Be Publicly Provided? 244 11.4.2 What Is the Optimal Structure of UBs? 246 11.5 Why Do Unemployment Benefits Exist? 247 11.6 Suggestions for Further Reading 248 11.7 Review Questions 248 11.8 Technical Annex: UBs in a Search-Matching Model 249 11.8.1 Effects of UBs in a Two-Sided Job Search Model 249 11.8.2 Optimal Job Search Intensity 249 11.8.3 Vacancies and the Matching Function 250 11.8.4 Wage Bargaining 251 11.8.5 Labor Market Participation 251 11.8.6 Balanced Budget 253 11.8.7 Numerical Simulations 253 12 Active Labor Market Policies 255 12.1 Measures and Cross-Country Comparisons 256 12.2 Theory 258 12.3 Empirical Evidence 263 12.3.1 Experimental Studies 264 12.3.2 Nonexperimental Studies 268 12.4 Policy Issues 270 12.4.1 Do We Need Public Employment Services? 271 12.4.2 Do We Need Activation Policies? 271 12.5 Why Do Active Labor Market Policies Exist? 272 12.6 Suggestions for Further Reading 272 12.7 Review Questions 273 12.8 Technical Annex: Activating Unemployed Workers 273 13 Institutional Interactions 277 13.1 Taxes and Unions 278 13.2 Employment Protection and Unemployment Benefits 280 13.3 Unemployment Benefits and Active Labor Market Policies 282 13.4 Employment Protection and Unions 284 13.5 Taxes and Unemployment Benefits 285 13.6 Education and Retirement Programs 287 13.7 What Future for These Institutions? 288 References 291 Index 313 This page intentionally left blank Preface Is it good for employment to increase the progressivity of taxation? Does it make sense to contrast “active” and “passive” labor market policies? Who gains and who loses from employment protection legislation? Why are minimum wages generally diversified by age? Is it better to have decentralized or centralized bargaining systems in monetary unions? Should migrants have access to welfare benefits? Should governments regulate working hours? Current labor economics textbooks do not address these relevant policy issues.