Do Regulatory Reforms in Product and Labour Markets Promote Employment?

New Evidence From OECD countries

Fondazione Rodolfo Debenedetti“Frontiers in labour economics

Bocconi University, Milan20 January 2005

Giuseppe Nicoletti, OECD

Stefano Scarpetta, World Bank

Outline• Competition and employment: theory and evidence

• Policy interactions: theory and evidence

• Labour market policies/institutions and employment: a reminder

• What’s new with our approach?

• Policies and employment: panel estimates

• Conclusions and future research

Competition and employment: theory

• Macroeconomic link made surprisingly recently

• But growing body of research – Krueger and Pischke, 1997; Nickell, 2000; Amable and Gatti, 2001; Pissarides, 2001; Spector, 2002; Blanchard and

Giavazzi, 2003; Messina, 2003; Ebell and Haefke, 2003

• Two main channels:

– Free entry increases equilibrium number of firms (or entrepreneurs) eliminates rents, expands long-run output and employment

• in both simple imperfect competition/bargaining and search equilibrium models

– More intensive competition increases labour market tightness and lowers unemployment

• in search equilibrium models

• But effect may also depend on other factors:

– Reservation wage may rise due to increased risk of lay-offs in bad states (Amable and Gatti, 2001)

– Interaction with labour market policies and institutions (see below)

Competition and employment: evidence• Relatively little empirical analysis, even less cross-country

• Proxies for competition (markups, HHI) are few, non-monotone, endogenous to market outcomes (and policy irrelevant)

• If well designed, measures of anticompetitive product market policies are monotone, less endogenous (and policy relevant)

– Peoples (1998), Bertrand and Kramarz (2002), Kugler and Pica (2004) used single-country sector-specific proxies for the stringency of regulation

– Boeri et al. (2000), Nicoletti et al. (2001) used cross-country OECD indicators of economy-wide regulation for 1998– Messina (2003) uses cross-country proxies of entry costs for 2000 by Djankov et al (2003)– Griffith et al. (2004) uses cross-country indicators by the Fraser Institute available for 1995 and 2000

• Results generally show a positive effect of competition-friendly policies on employment at both sector and macro levels

• However, existing empirical studies have three main limitations:

– No studies have looked at the macro effects of a broad range of reforms implemented over a long period of time

– Few studies control for other factors influencing employment and check for policy interactions

– Few robustness and sensitivity tests are usually performed

Policy interactions: theory

• Several sources of complementarity between product/labour market policies/institutions found recently:

– By lowering rents, deregulation reduces incentives to fight for capturing them (Blanchard-Giavazzi, 2003) or to secure them by increasing insider power (Saint Paul, 2002)

– Free entry makes it harder for firms to bear costs of EPL and reduces incentives to protect jobs due to the positive effect of competition on employment (Koeniger and Vindigni, 2004)

Product market reform facilitates labour market reform

– Positive real wage effects of deregulation are stronger when bargaining power and unemployment benefits are modest (Spector, 2003)

Labour market reform facilitates product market reform

• And one source of substitutability:

– Employment effects of deregulation may be smaller if rigidities related to efficiency-wage mechanisms remain: for given rigidities, firing costs should increase with deregulation (Amable and Gatti, 2001)

Policy interactions: evidence

• Nicoletti et al. (1999) highlighted a close correlation between a measure of economy-wide regulation and EPL in 1998

• The correlation is robust to changes in the time period and the definition of regulation

• It is also somewhat robust to accounting for a wider set of labour market policies

• Kugler and Pica (2003) show (a contrario) on Italian data that tight entry regulation curbs gains from easing of EPL

• Not aware of other empirical work so far exploring complementarity vs. substitutability issue

Labour market policies/institutions and employment rate: a reminder

• High tax wedges– Theory and evidence point to negative effect on employment rates

• Generous unemployment insurance– In theory negative on unemployment, but ambiguous on participation– Evidence mixed, need to define UI in comprehensive way and control for likely

trade off with EPL

• Strict EPL– Conflicting effects at work, but negative if costs are unpredictable and/or cost

shifting difficult– Mixed evidence, need to account for likely interaction with bargaining

• Bargaining systems– Evidence tends to support Calmfors-Driffil effect– Need to consider jointly with unionisation (though coverage would be better)

• Public employment– Crowding out of private employment likely under certain conditions– Evidence tends to support this effect, but endogeneity is a crucial issue

What’s new with our approach?

• Look at the employment effects of regulation over 1980-2002 using new time-series proxy for pro-competitive reforms in a large number of industries Used by Nicoletti-Scarpetta (2003) to study productivity and Alesina et al. (2003) to

study investment Updated to 2003 by OECD

• Control for the main known influences of labour market policies/institutions on employment (notably using new time series proxy for EPL and bargaining) Revised and updated to 2003 by OECD

• Account and test for interactions/complementarities between labour and product market policies/institutions

• Look at effects of regulation on shifts in trend of employment rate

• Look at robustness of results to outliers, changes in specification, omitted variables, multicollinearity

The empirical model• Standard Layard-Nickell-Jackman framework

• accounting for

– bargaining and market power (generated by anticompetitive regulations),– Calmfors-Driffill interactions between LM policies and institutions, – Interactions between product and labour market policies, and– country-specific time trends reflecting other factors affecting employment rates

(preferences, women participation, education, asymmetric effects of productivity growth)

• Fixed effects estimation with outlier control

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Panel estimates: baseline equation

Dependent variable

Independent variableswith control for

outlierswith country time trends

Lagged public employment rate 0.047 -0.031 0.289(0.108) (0.1) (0.165)*

EPL -2.068 -1.822 -0.753(0.398)*** (0.363)*** (0.419)*

Corporatism - low 1.853 1.518 0.435(0.545)*** (0.493)*** (0.599)

Corporatism - high 0.686 0.703 1.252(0.407)* (0.373)* (0.446)***

Union density -0.274 -0.268 -0.067(0.019)*** (0.018)*** (0.029)**

Tax wedge -0.147 -0.104 -0.255(0.034)*** (0.032)*** (0.033)***

Unemployment benefits -0.146 -0.12 -0.123(0.032)*** (0.029)*** (0.027)***

Output gap 0.451 0.432 0.419(0.039)*** (0.036)*** (0.026)***

Constant 71.141 69.533 57.069(1.823)*** (1.684)*** (2.551)***

Observations 445 433 433Number of countries 20 20 20R-squared 0.64 0.66 0.85

Country effects Yes Yes Yes

Country time trends No No Yes

Control for outliers No Yes Yes

Standard errors in parentheses. * significant at 10%; ** significant at 5%; *** significant at 1%

Baseline equationFixed effects estimation, 1980-2002

Non-agricultural business employment rate

Dependent variable

Independent variablesWith interactions EPL-

bargaining. With PM regulations

Lagged public employment rate -0.145 -0.074(0.103) (0.091)

Corporatism – low 2.049 1.682(0.503)*** (0.438)***

Corporatism – high 0.423 1.609(0.403) (0.369)***

Union density -0.26 -0.176(0.018)*** (0.018)***

Tax wedge -0.11 -0.151(0.031)*** (0.027)***

Unemployment benefits -0.107 -0.132(0.031)*** (0.027)***

Output gap 0.428 0.403(0.035)*** (0.031)***

EPL in low corporatist 2.079 1.636(1.058)* (0.919)*

EPL med corporatist -4.265 -2.612(0.721)*** (0.641)***

EPL high corporatist 3.846 4.303(0.874)*** (0.768)***

PM regulations -1.2(0.107)***

Constant 69.726 67.929(1.714)*** (1.487)***

R-squared 0.67 0.78

Country time trends No No

Equation with bargaining interactions and regulationFixed effects estimation, 1980-2002

Non-agricultural business employment rate

Panel estimates: with bargaining interactions and regulation

Summarising LM features and testing interactions

• Relationships among variables make identification and interpretation of effects difficult (collinearity):– LM features (e.g. bargaining and unionisation, EPL and UI) – complementarity between LM and PM features (e.g. EPL and PMR)

To address this we summarise LM policies and institutions by means of principal components

• Complementarity between PM and LM policies may make effects of regulation depend on LM regime

To address this we divide countries in three groups depending on LM policy regimes (highly restrictive, medium restrictive, liberal) and interact these regimes with our measure of product market regulation

Panel estimates: synthetic LM features and PM/LM interactions

Dependent variable

Independent variables With synthetic indicators of LM

institutions/policies

With LM institutions/ policies & PM reg.

With synthetic indicators of LM

institutions/ policies

With LM institutions/policies &

PM reg.

With PM reg. interacted with LM

policies

Lagged public employment rate -0.159 -0.315 0.276 0.48 0.505(0.102) (0.087)*** (0.157)* (0.168)*** (0.164)***

Output gap 0.581 0.54 0.469 0.469 0.454(0.045)*** (0.038)*** (0.026)*** (0.026)*** (0.025)***

LM institutions -2.01 -0.824 -0.66 -0.808 -0.788(0.356)*** (0.307)*** (0.390)* (0.388)** (0.377)**

LM policies -4.226 -2.047 -3.812 -3.118 -1.921(0.614)*** (0.540)*** (0.545)*** (0.581)*** (0.616)***

PM regulations -1.341 -0.769(0.101)*** (0.241)***

PM reg. with strict LM policies -1.009

(0.241)***

PM reg. with med. LM policies -0.747(0.246)***

PM reg. with lax LM policies -0.346(0.249)

Constant 50.668 57.711 42.683 44.56 44.065(1.244)*** (1.167)*** (1.874)*** (1.944)*** (1.891)***

R-squared 0.43 0.6 0.84 0.84 0.85Country time trends No No Yes Yes Yes

Equation with synthetic labour market policies/institutions and regulationFixed effects estimation, 1980-2002

Non-agricultural business employment rate

Without country trends With country trends

Dependent variable

Independent variables Without pub. employment

Without pub. employment & interactions

Output gap 0.466 0.451

(0.026)*** (0.026)***

LM institutions -0.903 -0.885

(0.390)** (0.380)**

LM policy -3.249 -2.096

(0.584)*** (0.620)***

PM regulations -0.509(0.225)**

PM reg. with strict LM policies -0.724(0.225)***

PM reg. with med. LM policies -0.456

(0.229)**

PM reg. with lax LM policies -0.086

(0.237)

Constant 48.803 48.497

(1.264)*** (1.240)***

R-squared 0.84 0.85

Country time trends Yes Yes

Sensitivity to public employmentFixed effects estimation, 1980-2002

Non-agricultural business employment rate

Panel estimates: sensitivity to public employment

Are the estimates reasonable?

• Given the sample variation of the summary policy indicators, the estimates suggest that product market reforms:– have half the impact on employment rates of good labour market

policies– have a larger impact than changes in LM institutions (perhaps

because changes in institutions are indirectly caused by PM reforms)

– over the past two decades have contributed to increase employment rates by (at most) around 3 per cent in certain countries (e.g. the UK)

– given policy interactions, employment rates could increase by 2 per cent in Italy if further PM reforms were to align with current best practice

• These are lower bound estimates because they only take into account the effects of reforms in non-manufacturing

Conclusions and future research

• Evidence supports recent theoretical insights on regulation/employment link

• There is also evidence of complementarity between LM and PM policies, but more work is needed on this

• Evidence broadly confirms previous results on effects of LM policies and institutions

• Overall, estimates seem reasonable and suggest that policy interactions are worth of consideration

But:• Need to explore role of public employment and perform

further sensitivity analysis (e.g. non-linearities)• Need to estimate fully-dynamic model including LM and

PM policies (data issue)

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.5 1 1.5 2 2.5Product market regulation, summary index

Employment rate and economy-wide regulation, 1998

Correlation coefficient = -0.4

P-value = 0.08

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1 2 3 4 5Product market regulation, time-series index

Employment rate and non-manufacturing regulation, 1998

Correlation coefficient = -0.55

P-value = 0.01

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2 3 4 5 6Product market regulation, time-series index

Employment rate and non-manufacturing regulation, 1980-2002

Correlation coefficient = -0.52

P-value = 0.02

EPL and economy-wide regulation in 1998Figure 4. Product market regulation and employment protection legislation1

Portugal

Greece

Italy

Norway

FranceSpain

JapanGermany

Netherlands

SwedenAustria

Finland Belgium

Denmark

Switzerland

New Zealand

Canada

IrelandAustralia

United Kingdom

United States

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Product market regulation

Employment protection legislation

Correlation 0.73t-statistic 4.72

1st cluster

2nd cluster

3rd cluster

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2 3 4 5 6Product market regulation (non-manufacturing)

correlation = 0.72p-value = 0.0003

EPL and non-manufacturing regulation 1980-2002

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correlation = 0.65p-value = 0.002

Labour market policies and non-manufacturing regulation 1980-2002

Principal components

Variable

Labour market institutions Variable

Labour market policies

weights weightscoordination 0.26 tax wedge 0.47centralisation 0.54 benefit generosity 0.10union density 0.18 epl 0.38

Principal components: Scoring Coefficients(based on rotated factors)