Chapter 1 7 : Economic Integration and Labour Market Institutions

© Baldwin&Wyplosz The Economics of European Integration

Chapter 17: Economic Integration and Labour Market Institutions


The message from OCA theory

• As an OCA, Europe mostly fails on the labour mobility criterion

• A substitute to labour mobility is labour market flexibility

• How does Europe do on this front?


Dismal labour market performance

Unemployment rate (%)

0

2

4

6

8

10

12

1970 1974 1978 1982 1986 1990 1994 1998 2002

EU Euro area USA


But beware of averages!

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

BIG 4 UK SMALL 8 US

1969 1985 2003


Many other indicators of trouble

• Not just the unemployment rate, also:– Low rates of labour participation– Youth unemployment– Duration of unemployment spells

• General picture– Many people do not hold jobs– People can remain unemployed for years

running– Problem deeper in larger countries, with recent

improvements in the UK and the smaller countries


Why?

• General assessment is that labour markets are rigid in most of Europe

• A simple illustration: real wage stickiness

Insert text fig 17-3


More generally

• Real wage rigidity just one example• Other features include

– Restrictions on hiring and firing– Restrictions on hours worked– Minimum wages– High unemployment benefits as disincentives to

search jobs


A deep conflict

• These features have been introduced to fight labour market imperfections and/or social objectives

• They make labour market rigid but serve other purposes

• No universal response to this deep conflict


A few examples (more details later)

Market failure Standard solution Economic Cost

Dominant power of employers

Minimum wages, labour protection laws, mandatory negotiations

Reduces competition on the labour market

Information asymmetry: no good knowledge of workers’ skills and effort at work

Collective wage negotiations

Reduces competition on the labour market

Workers are vulnerable to job uncertainty

Mandatory health and unemployment insurance, retirement benefits

Raises labour costs and reduces demand for labour


What is the link with economic integration?

• Deepening integration exacerbates competition

• Firms compete by reacting quickly and forecefully to opportunities or shocks

• Inflexible labour markets reduce the ability of firms to react

• Indirectly, social systems compete against each other

• The delicate balance achieved in each country becomes challenged


Labour market institutions

• Existing institutions differ from country to country

• They are the outcome of a long, and often conflictual, history

• A look at the most important ones illustrates the challenges posed by integration


Collective negotiations

• Social objective: protect workers from bosses’ excessive powers

• Economic impact: an illustration





• Economic impact: involuntary unemployment

• The role of the degree of centralization– Plant level: induces some wage restraint– National level: induces some wage restraint– Branch level: less restraint




• Economic impact involuntary unemployment

• The role of the degree of centralization





• Economic impact: unemployment• The role of the degree of centralization• The integration and monetary union impact

– One big market: current degree of coordination in collective negotiations decline

– One central bank: more wage discipline• Will trade unions respond by organizing at

EU level?


Minimum wage legislation

• Social objectives– Protect the weakest– Reduce inequality

• Economic impact: unemployment of the least skilled



Minimum wage legislation

• Social objectives– Protect the weakest– Reduce inequality

• Economic impact: unemployment of the least skilled

• The integration and monetary union impact– Enhanced competition favours low cost

countries– Accessions of CEECs will sharpen this aspect– Trade unions fear social dumping and call for

harmonisation of social norms


Unemployment insurance

• Social objective: protect workers from a major risk

• Economic impact:– Paid out of labour taxes: raises labour costs– Generous benefits reduce incentives to search

for jobs– Overall, less employment and more

unempoyment


Unemployment insurance

• Social objective: protect workers from a major risk

• Economic impact: more unemployment• The integration and monetary union impact

– Asymmetric shocks create temporary unemployment

– Generous insurance may prolong the adjustment

– Pressure to reduce generosity, mainly duration, of benefits. Trade unions fear social dumping


Employment protection legislation

• Social objective: protect workers from employers’ arbitrariness

• Economic impact– Reduces firing during downturns– Limits hiring during expansions– Overall no lasting effect on unemployment, but

reduces firms’ ability to deal with adverse shocks


Employment protection legislation

• Social objective: protect workers from employers’ arbitrariness

• Economic impact: no effect on unemployment but reduces firms’ flexibility

• The integration and monetary union impact– Harder to deal with adverse shocks– Pressure to reduce strictness of legislation.

Trade unions fear social dumping


Payroll taxes

• Social objective: solidarity among workers in fianncing unemployment, health, retirement

• Economic impact: raises cost of labour, or reduces wages, or both



Payroll taxes

• Social objective: solidarity among workers in financing unemployment, health, retirement

• Economic impact: raises cost of labour, or reduces wages, or both

• The integration and monetary union impact– Enhanced competition favours low cost

countries– Incentive to either reduce welfare payments or

raise other taxes. Politically difficult.


How to respond to deeper integration?

• Deeper integration desirable because it enhances competition on the good markets

• More competition raises the economic costs of many labour market institutions

• A sharpening of the conflict between economic effectiveness and social objectives

• Existing arrangements are threatened


Three possible evolutions

• Two-speed Europe

• Deep reforms

• Social harmonization


Possible evolution No.1

• Two-speed Europe– Some countries flex their labour markets, others

retain their highly social existing arrangements– Firms and risk-taking individuals move to the

most flexible countries– Welfare-conscious are attracted by welfare-

magnet countries– Part of Europe grows fast with low

unemployment, another part grows slowly with permanently high unemployment


Two-speed Europe: already there?Average annual rowth rates 1995-2003

0

0.5

1

1.5

2

2.5

3

3.5

4

Big Three UK USA CEEC Three Small Nine



• Deep reforms– Thatcher takes over Europe– Labour market institutions made more flexible– Labour axes reduced



• Social harmonization– The large countries export their welfare systems

through social norms applicabel to all EU countries


In the end

• There is no better way, just different socio-economic equilibria

• A somewhat arbitrary typology– The continental model– The Nordic model– The Anglo-Saxon model– The Southern European model– and the evolving accessing countries

Documents

Chapter 1 7 : Economic Integration and Labour Market Institutions