Welfare and Employment in a United Europe: A Study for the Fondazione Rdolofo Debenedetti

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Edited by Giuseppe Bertola Tito Boeri Giuseppe Nicoletti

Welfare and Employment in a United Europe

A Study for the Fondazione Rodolfo Debenedetti

Welfare and Employment in a United Europe

Welfare and Employment in a United Europe A Study for the Fondazione Rodolfo Debenedetti

edited by Giuseppe Bertola, Tito Boeri, and Giuseppe Nicoletti

The MIT Press Cambridge, Massachusetts London, England Fondazione Rodolfo Debenedetti

©2001 Massachusetts Institute of Technology All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher. This book was set in Palatino by Best-set Typesetter Ltd., Hong Kong Printed and bound in the United States of America. Library of Congress Cataloging-in-Publication Data Welfare and employment in a united Europe : a study for the Fondazione Rodolfo Debenedetti / edited by Giuseppe Bertola, Tito Boeri, and Giuseppe Nicoletti. p. cm. Includes bibliographical references and index. ISBN 0-262-02483-7 (hc. : alk. paper) 1. Public welfare—European Union countries. 2. Labor market—European Union countries. I. Bertola, Giuseppe. II. Boeri, Tito. III. Nicoletti, Giuseppe. IV. Fondazione Rodolfo Debenedetti. HV238.W42 2000 361.6¢094—dc21

00-060070

To Lapo Anzillotti

Contents

Preface

ix

Introduction: Putting the Debate on a New Footing

1

Tito Boeri I EU Welfare Systems and Labor Markets: Diverse in the Past, Integrated in the Future? 23 Giuseppe Bertola, Juan Francisco Jimeno, Ramon Marimon, and Christopher Pissarides Comments

123

Charles Bean Comments

127

Gøsta Esping-Andersen II European Integration, Liberalization, and Labor-Market Performance 147 Giuseppe Nicoletti, Robert C. G. Haffner, Stephen Nickell, Stefano Scarpetta, and Gylfi Zoega Comments

237

Olivier Blanchard Comments André Sapir

245

viii

Contents

Conclusions: Is There a Role for Supranational Institutions?

251

Tito Boeri Appendix: Taking Stock of Social Policy Reforms in Europe Fondazione Rodolfo Debenedetti Index

287

257

Preface

The changes that have taken place in western Europe over the last twenty years are unprecedented. Fifteen national economies, with their own institutions and traditions, have removed most barriers to trade and migration and most forms of national discrimination in economic and social exchange. Many of them have also chosen to give up their national currency and their ability to conduct independent monetary and fiscal policies. How will this economic integration affect European social welfare systems and the regulatory environment in the labor and product markets? What will be the implications for labor-market performance in the European Union? Is there a potential for coordinating social policies, or should uncoordinated national policies continue unabated? These are the main issues addressed in this book. Unusual for an edited volume, it consists of two long studies, each written by a group of economists working in four different countries of the European Union. Part I reviews and describes the diversity of social welfare systems and recent reforms in the European Union (EU). It discusses the tensions that European integration is likely to introduce and suggests how EU-level and national policies could be structured to minimize such tensions. Any realistic policy reform in Europe has to respect the complexity of political-economic and social-economic interaction among national and supranational policymakers and market participants, and the study focuses on these issues. Part II shifts the emphasis to product markets and asks how the stronger competition that integration brings will affect labor markets. Will European unemployment increase or decrease? Are labor-market institutions likely to change as the removal of product-market regulations exposes them to European competition? The study draws on fresh

x

Preface

and still unpublished evidence on product-market regulations, recently assembled by the OECD, and brings it to bear on the influence that product-market regulation has on the performance of labor markets. Both studies were carried out for the first European conference of the Fondazione Rodolfo Debenedetti held in Genoa in July 1999. Fondazione Debenedetti is a new research institution, located at Bocconi University in Milan, focused on European labor-market and social policy reforms. In addition to organizing the conference and coordinating the two studies, Fondazione Debenedetti provided background material for the two research teams, producing an inventory of social welfare reforms in Europe summarized in the appendix. The main results of the work carried out at the Fondazione are summarized in the introductory chapter.

Introduction: Putting the Debate on a New Footing Tito Boeri

This book aims at putting the current debate on the future of (social) welfare and employment in a united Europe on a new footing.1 We need fewer apocalyptic statements, fewer Cassandras, more facts, and deeper theoretical perspectives. More balanced views and more careful ways to assess empirical evidence are also needed, as well as ways to carry out speculative thinking. Extreme views about the implications of European integration are not supported by evidence on past integration and social welfare reforms in the last fifteen years. Dramatic Perspectives The two most recurrent views of the future of employment and social welfare systems in a united Europe are rather extreme and dramatic. On the one hand, some argue that the single market and the monetary union (for the countries that belong to EMU) will make it more difficult to carry out badly needed structural reforms in Europe. The action of governments will be biased in favor of the status quo for a number of reasons. First, incentives to free-riding will increase as closer economic integration makes it easier for governments to shift the burden of their own structural inefficiencies onto other countries. The monetary union, in particular, will reduce incentives to reform labor-market regulations to cope with the inflationary bias associated with structural unemployment (Calmfors 1998). Since the European Central Bank (ECB) now determines monetary policy in the currency union as a whole, labor-market reforms in a given country will have only a small effect on the common rate of inflation.2 Second, Europe will be caught in a slow-growth, high-structural-rigidities equilibrium: to grow, structural rigidities and inefficiencies in European welfare systems should

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be removed, but structural reforms can be made only when macroeconomic conditions are favorable. Slow growth makes it more difficult, if not impossible, to reform because there is a stronger demand for social protection and job security—institutional features that structural reforms are supposed to reduce or, at least, make less automatic. Moreover, the benefits from structural reforms take more time to materialize when aggregate demand is weak (Minford 1994), and hence governments with relatively short time horizons may be discouraged from taking initiatives on this front. Tight macroeconomic policies imposed under the Stability Pact (for the members of EMU) and the Maastricht criteria (for the countries wishing to join the EMU) will not improve matters. On the other hand, some claim that closer market integration and the loss of monetary authority (for the countries that belong to the EMU) will force governments to deal with structural issues as there is hardly anything else to do. This is, in essence, a Thatcherian “there-is-noalternative” or TINA statement (the label comes from Calmfors 1998). Governments in the monetary union will have to concentrate their efforts on structural policies (Bean 1998). As monetary policy is decided elsewhere, countries will be able to cope with (asymmetric) shocks only if they increase the flexibility of their product and labor markets. This may be a desirable development since the rigidities of European markets, the so-called Eurosclerosis, often bears the blame for the dismal growth performance of the EU vis-à-vis the United States. However, the dismantling of European “social protections” will not be selective and may involve features of European welfare systems (for example, social assistance of the last resort) that remedy market failures and are essential to maintaining social cohesion. The removal of the remaining barriers to the mobility of goods and services and the greater price transparency involved by the adoption of a common currency in the core EU countries will increase competitive pressures on national fiscal systems, setting in motion a “race to the bottom” in social welfare provision (Sinn 1998) in an attempt to attract foreign direct investments (FDIs). The impossibility of adjusting parities vis-à-vis the main trading partners will also increase competitive pressures on employment protection and collective bargaining institutions.3 In a nutshell, European integration certainly will be bad for the unions (Burda 1999), but it is likely to be bad also for some features of the welfare state that should be kept in place.

Introduction

3

Lessons from European Integration Which of these two extreme views, if either, comes closest to reality? We may be able to learn something useful from the recent past. After all, product-market integration and monetary unions are not completely unknown in Europe. Countries like Austria, Belgium, and the Netherlands have maintained fixed parities with the D-mark, virtually sharing the same currency, for the last twenty years. The French franc has also been a “hard currency,” kept well within the narrow EMS bands since 1987. If these are not truly monetary unions, they are very close approximations. Thus the experience of the D-mark area and core EMS countries can be informative here. In particular, race-to-thebottom pressures on wages and bargaining institutions should have arisen within these “currency areas,” characterized from the very start by marked differences in unit labor costs and unemployment levels (hence also potential differences in the dynamics of wages). The countries that belong to such unions were also closely interconnected (e.g., one-third of Dutch exports go to Germany). Since the completion of the internal market in 1979, product-market regulations of current EU members have been significantly reformed, with the dismantling of many implicit barriers to the mobility of goods. Product-market regulations are commonly considered the most effective arena of operation for the European Commission. Policies like mutual recognition on case law have played a very important role in enforcing the single-market principles. Yet there are still product markets, notably services, in Europe that are relatively sheltered from competition, and these account for a significant component of EU GDP.4 Moreover, most of the sheltered sectors supply inputs to other products, for example, agriculture, energy, and automotive parts,5 which clearly reduces the scope of price competition in the industries heavily using these intermediate inputs. Yet price competition in manufacturing is relatively high and trade, notably of the intraindustry type, has been constantly increasing.6 FDIs have also increased: intra-EU foreign direct investment inflows currently account for more than 1 percent of the European Union GDP (from less than 0.25 percent of that in the late 1970s). Several measures of economic integration—for example, defined on the basis of clustering techniques over macroeconomic series and the structure of private consumption (OECD 1999)—point to increasing market integration within the EU. It follows that developments not only in the D-mark area and core EMS groups, but also

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Contributions as a percentage of gross wage

in the EU at large, are informative as to the likely consequences of integration on labor market and social welfare institutions. Figures I.1 to I.6 give some clues about the evolution of these institutions in the three areas listed above—D-mark zone, core EMS group, and EU as a whole—over the course of the last two decades. Top and bottom provisions in the mid–1980s and in the 1990s7 are highlighted to show the degree of convergence across countries and to better assess the presence of a race to the bottom. Figures I.1 and I.2 show the dynamics of statutory and actual social security contribution rates as a percentage of the gross wage bill. Actual social security contribution rates are obtained by taking the ratio of social security revenues to the total wage bill plus employers’ social security contributions. This measure is complementary to statutory contribution rates insofar as countries often grant some regions or lowskilled workers partial exemptions from social security payments in order to subsidize employment. For instance, in southern Italy employ-

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EMS Area Figure I.1 Compulsory social security contributions Note: Compulsory social security contributions paid by employees and employers as a percentage of the gross wage. The (Spearman) rank correlation coefficient between the initial and the final distributions is 0.91, which is statistically significant at 99 percent confidence levels. The standard deviation of the initial distribution is 14.74, and of the final distribution it is 10.43. Source: OECD, 1998a.

Contributions as a persentage of the labor tax base

Introduction

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EMS Area Figure I.2 Actual social security contributions Note: Total contributions paid by employees and employers as a percentage of the labor tax base (total wage bill + employers’ contributions). Data for Belgium, Canada, and Japan refer to the years 1985–1996. Data for Germany refer to the years 1985–1994. The (Spearman) rank correlation coefficient between the initial and the final distributions is 0.91, which is statistically significant at 99 percent confidence levels. The standard deviation of the initial distribution is 6.62, and of the final distribution it is 6.89. Source: OECD, 1998a.

ers did not have to pay a wide array of contributions. Hence the sum of statutory payroll taxes earmarked to the various funds may well hide declines in the actual fiscal pressure on labor associated with the financing of social security provisions. The visual impression given by figure I.1 is not quite one of fiscal competition eroding the contribution base for social policies. Statutory contribution rates have indeed increased in most countries over time, and the fact that such a tendency has been particularly pronounced within the D-mark zone, with Germany and Austria leading the “race to the top,” is quite revealing. The relative positions of the various countries in the incidence of payroll taxation do not appear to change significantly over time. The (Spearman) rank-correlation coefficients, reported at the bottom of the figure, together with the standard deviations of the two distributions, confirm this visual impression. The picture does not change substantially when the focus is on actual contribution rates. Just a few arrows point downward, in spite of the fact that some countries have recently shifted social security financing away from payroll taxes to income or indirect taxation. Overall, there

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is no visible sign that social security taxes were put under strain by European integration. Although the past offers a highly imperfect guide to the radical transformations about to occur, like the build-up of EMU, the fact that social security contributions have increased in the quasi-monetary unions of central Europe does not lend support to the race-to-the-bottom scenario. Figures I.3 to I.6 are on social expenditure, namely, on the generosity of the three basic components of social security: pensions, unemployment benefits, and social assistance. Figure I.3 shows the ratio between the (public) pensions received by people aged 65 to 74 and the disposable income of 55- to 64-year-old individuals. This is a summary measure of the contribution offered by public pensions to the replacement of preretirement earnings. Data come from national sources and have been assembled (in a way satisfying cross-country comparability requirements) by the OECD. If anything, the figure points to a mild degree of convergence in the generosity of public pension systems as the range of actual replacement rates narrows significantly (the 80

TOP 80s Fra TOP 90s

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EMS Area Figure I.3 Contributions of public pensions to the maintenance of income after retirement Note: Pensions received by persons aged 65 to 74 as a percentage of the total disposable income of persons aged 55 to 64. The (Spearman) rank correlation coefficient between the initial and the final distributions is 0.97 which is statistically significant at 99 percent confidence levels. The standard deviation of the initial distribution is 20.56, and of the final distribution it is 19. Source: OECD, 1998a.

Introduction

7

standard deviation of the distribution is lower in the final rather than in the initial years), and the countries with the more (less) generous arrangements are visibly cutting down (increasing) provisions vis-àvis earnings before retirement. This impression is conveyed by simple regressions of rates of changes in pension expenditure to GDP ratios against the initial levels.8 Note that this mild convergence does not appear to occur at the bottom of the distribution but toward its middle, for example, in the position initially occupied by the United Kingdom. This trend was paralleled by the increase in statutory and actual contribution rates documented above. Hence, rising replacement rates are not necessarily associated with higher returns from public pensions. Microsimulation studies9 suggest that rates of returns of public pensions are declining in all countries for which data are available. Figure I.4 offers a summary measure of generosity of unemployment benefits. Typically the OECD (e.g., in the context of the OECD Jobs Study10) produces such measures by taking simple averages of nominal

Figure I.4 Generosity of unemployment benefits Note: Average of gross replacement rates (gross unemployment benefits as a percentage of the gross wage) at two income levels (100 and 67 percent of average wage) for a single person during the first two years of unemployment. The (Spearman) rank correlation coefficient between the initial and the final distributions is 0.87 which is statistically significant at 99 percent confidence levels. The standard deviation of the initial distribution is 20.21, and of the final distribution it is 17.46. Source: Fondazione RDB estimates based on OECD, 1998b.

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replacement rates at different durations of unemployment. This is inaccurate, however, as the replacement rates offered in the second year of joblessness are clearly more important than, say, the benefits provided in the fifth year of unemployment. Moreover, no account is made by the OECD summary generosity measure of the actual coverage of benefits, which means that a very generous benefit given to 10 percent of the unemployed is accorded the same score in generosity as a lower subsidy offered to a larger fraction of the jobless population. The two biases work in the same direction insofar as coverage is decreasing with unemployment duration (not least because eligibility for benefits for long unemployment duration becomes conditional to passing an income and asset test). Hence in figure I.4 we have corrected the OECD measures in two ways. First, we focus only on the first two years of unemployment (in most countries, individuals with unemployment durations longer than twenty-four months are eligible only for meanstested social assistance, whose coverage and level are assessed in figure I.5). Second, we have weighted replacement rates for the second year of unemployment by the incidence of long-term unemployment. Thus in a country where 50 percent of unemployment is long term (lasts more than twelve months), a weight of 0.5 is given to replacement rates offered in the second year of joblessness.11 Figure I.4 suggests that there has been some tendency toward reducing the generosity of benefits, but this trend has not been uniform. Declines in the generosity are visible in the D-mark zone, but these are rather marginal; generosity is reduced by less than five percentage points on average. Figure I.5 provides information on trends in social assistance provision—cash transfer schemes aimed at satisfying the primary goal of social welfare, namely guaranteeing subsistence to people in need. This key function of welfare systems is often pointed out as being in danger of being dismantled by those who fear the consequences of a race to the bottom. The generosity measures are in this case provided by the ratio of social assistance expenditure12 to the number of people with incomes lower or equal to 50 percent of the average wage. Many arrows in this chart are oriented northward and the top of the distribution itself is shifting upward. Thus, in this primary field of social protection the visual impression is one of a race to the top rather than of a race to the bottom13. Social assistance is usually funded out of general government revenues, hence it will not be affected by possible reductions in statu-

Introduction

9

TOP 95 Social assistance to the unemployed as a percentage of previous wage

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EMS Area Figure I.5 Generosity of social assistance programs Note: Average of the gross replacement rates offered by social assistance at two income levels (100 and 67 percent of average gross wage) for three family types (single person, couple with only one worker, couple with one worker and children) from the second to the fifth year of unemployment. The (Spearman) rank correlation coefficient between the initial and the final distribution is 0.82 which is statistically significant at 95 percent confidence levels. The standard deviation of the initial distribution is 6.26, and of the final distribution is 9.59. Source: Fondazione RDB estimates based on OECD, 1998b.

tory and effective social security contributions paid for by employers on top of their wage bills. Finally, figure I.6 deals with employment protection regulations—the set of rules governing unfair dismissals, layoffs for economic reasons, severance payments, minimum notice periods, administrative authorization for dismissals as well as prior discussion with representatives of unions and/or labor market administrations. The measures provided in the figure are increasing in the guarantees offered to employees and have been recently revised (and updated) by the OECD14 in an attempt to capture the spread in many EU countries of temporary contracts. A number of caveats apply to these measures15; nonetheless they offer an overview of trends in barriers to dismissals, trends that are now, unambiguous. Almost all European countries show a decline in the extent of employment protection, while no changes are visible

Strictness of protection

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EMS Area Figure I.6 Employment protection legislation Note: OECD summary indicator of the strictness of employment protection legislation (weighted average of indicators for regular contracts and temporary contracts. The (Spearman) rank correlation coefficient between the initial and the final distribution is 0.92 which is statistically significant at 99 percent confidence levels. The standard deviation of the initial distribution is 1.23, and of the final it is 1.05. Source: OECD, 1999b.

outside the EU. Although this higher flexibility in employment adjustment is often the by-product of new contractual types rather than of reforms of regulations permanent workers, the tendency toward reductions in the degree of employment protection is noticeable and the standard deviation of the distribution is declining over time. Overall, there does not appear to be a uniform tendency toward reducing social welfare provisions across Europe. Some schemes, such as unemployment benefits, are becoming less generous, and there is a marked tendency toward the reduction of the system of job guarantees offered in the past to employees. In other fields, such as social assistance, the trend goes in the other direction: the generosity of provisions is increasing over time. More important, being in a quasicurrency union does not appear to matter much. Evolutions in social spending and social security taxation are, in most cases, broadly the same among D-mark area or core EMS countries and the remaining EU members. What can we conclude from this? Experience does not lend support to the view that European social welfare systems are challenged and at serious risk of being dismantled because of the competitive pressures

Introduction

11

associated with closer market integration and the EMU. Cuts to social spending are not uniform but selective, and they do not appear to be confined to currency unions. This may suggest that some rationalization is going on, but governments have some leverage in deciding which institutional features should be kept in place and which should be downscaled. Governments can, as in the case of income support of the last resort, even make existing provisions more generous over time. Needless to say, more careful analyses of the changes in the composition of social spending (as those carried out in the first part of this book) will shed more light on these selective interventions concerning the generosity of social welfare systems. Learning from Social Welfare Reforms How should one address the rather gloomy view that Europe will not be able to reform its welfare systems because it does not grow fast enough (and does not grow because it does not reform labor and social welfare institutions)? Based on a variety of sources (including country economic reviews carried out by the OECD, Income Data Source studies, EC-MISSOC reports, etc.), we have taken stock of reforms carried out in Europe in the field of nonemployment benefits (encompassing not only unemployment benefits but also the various cash transfers provided to individuals of working age16), pensions, and employment protection. Details on the inventory of social policy reforms produced at the Fondazione Rodolfo Debenedetti and on the single regulatory changes are offered in the appendix. Hence, we confine ourselves here to providing information on the criteria followed in the classification of the various reforms which is organized along two main dimensions. First, we distinguish reforms on the basis of their broad orientation, that is, whether they tend to reduce or increase the generosity of public pensions and nonemployment benefits and make employment protection more or less stringent. This is the same dimension along which figures I.1–I.6 have been organized. Second, we distinguish reforms depending on whether they are marginal or radical. This procedure is done in two stages. First, we rely on qualitative assessments, which are based on an evaluation of the scope of the various reforms. In particular, we classify as radical those reforms that satisfy at least one of the following criteria:

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reduce replacement rates at the average production worker (APW17) level by at least 10 percent; •

are comprehensive, that is, do not address just minor features of the cash transfer schemes (e.g., the minimum employment record required to qualify for unemployment benefits) but rather reform their broader design; and •

involve existing entitlements rather than being simply phased-in for the new beneficiaries of the various schemes (e.g., reforms of employment protection also should concern workers under permanent contracts). •

The second stage of the classification procedure looks at the actual behavior of the series that should be most affected by the reforms; only if we observe a change in the underlying trend of these series do we confirm our qualitative assessment. Clearly the second stage of this procedure can be implemented only for the reforms carried out before 1993, as a minimum number of observations are necessary establish whether a change in the underlying trend has occurred. Sometimes, even in the case of reforms carried out before 1993, the second-stage validation procedure cannot be implemented, as some reforms are followed just a few years later by regulatory changes moving in the opposite direction, thus undoing part of the initial institutional changes. In all the cases where the second-stage procedure cannot be implemented, only the first-stage assessment is used. The latter was validated in 85 percent of the cases. Which series was used in the empirical validation procedures? It clearly depends on the institutional features subject to reform. In the case of employment protection, we looked at labor-market flows, notably unemployment inflows, as previous work has found a strong negative correlation between employment protection and the incidence of unemployment.18 The impact of reforms on stocks (e.g., employment and unemployment levels or labor force participation rates) can only be appreciated when working with long series, something that is not within our feasibility set. In the case of pension reforms, we looked at the dynamics of pension expenditures and revenues earmarked for public pension funds: we expect radical reforms to significantly affect at least one of the two. Finally, in the case of nonemployment benefits, we used proxy outflows from unemployment19 (or outflows from the live registers to jobs in the countries for which such data are available): we expect radical reforms to significantly affect exit flows

Introduction

13

from unemployment (unfortunately we have no data on outflows from nonemployment). The main results of this exercise are summarized in table I.1. The first fact to notice here is that, contrary to popular wisdom and to the belief that labor-market and social welfare institutions cannot be modified, many changes have occurred over the observation period of twelve years. We counted almost 200 reforms; however, the changes have often been marginal (172 out 198 reforms, that is, roughly 85 percent of the regulatory changes did not pass the two-stage procedure identifying radical reforms). Moreover the reforms are almost evenly split between those reducing generosity and employment protection (107 out of 198, about 55 percent) and those increasing generosity and protection. It is also not infrequent to find reforms going against each other over a few years. These inconsistencies—which can be better appreciated by looking at the arrow charts in the appendix—and the marginal nature of most reforms have significantly increased the institutional complexity of the European social welfare landscape. In the field of employment protection, for instance, we have found a growing mumber of contractual types, with a number of fixed-term and unstable jobs going hand-in-hand with permanent and still heavily protected positions. All of this has increased the dualism of European labor markets, making them more segmented not only between insiders and outsiders but also among various types of outsiders. Another important fact revealed by table I.1 is that, among the seventy reforms that have tightened benefits or reduced employment protection, fifteen have been carried out during recessionary periods (negative GDP growth) and twenty-two under slow growth (zero to 1.5 percent GDP growth). During recessions or under slow growth it appears that it is more common to tighten generosity and reduce protection (37 reforms) than to proceed the other way (23 reforms), while strong pressure to increase generosity exists during relatively strong growth scenarios (GDP growing at more than 1.5 percent per year). Only four of the “unpopular” reforms, however, were radical among those carried out when GDP was growing less than 1.5 percent per year. Overall, the view that slow growth prevents reforms does not find support from this analysis. It is true that radical and unpopular reforms are difficult under these circumstances, but when macroeconomic conditions are not favorable it is more likely that regulatory changes will move toward reducing the generosity of benefits and employment protection rather than in the other direction. A tentative explanation for

Marginal Radical

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Nonemployment benefits

Public pensions

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GDP growth 150% Pensions 11 6 20 14 15 26 21 25 14 Unemployment benefits 5 5 29 7 5 24 11 12 3 Other social transfers 14 3 19 11 13 23 13 7 6 Household members 13 9 17 14 14 16 17 13 18 Total income 27 20 35 29 15 37 37 30 38

(3) percent Transfers going to households with income after transfers relative to national average 1), the elasticity of profits with respect to wages is -(n - 1). If we suppose a simple Nash bargaining model where the firm contribution to the Nash objective is profits, Pi, and the union contribution is (W - A)Ni, A being the alternative reward available in the outside labor market, the mark up of the bargained wage over A is given by (2n - 1)-1. More general models have much the same implications (see, for example, Dowrick 1989 or Layard et al. 1991, chapter 2). It is safe to argue therefore that if a single unionized firm faces increased product-market competition, its labor demand elasticity will tend to rise and its bargained wage will tend to fall. Given both the fall

European Integration, Liberalization, and Labor-Market Performance

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in the wage and the outward shift in the labor demand curve mentioned earlier, employment in the firm may also be expected to rise (at a given level of capital). If wages are bargained collectively within a firm, we may expect a rise in product-market competition to lead to the firm paying lower wages and employing more workers. Since most workers in Europe are covered by collectively bargained wages, this is the most relevant framework. It is worth investigating, however, whether the same outcome arises in firms where wages are set unilaterally by managers, as in the efficiency wage model. In fact, in most standard forms of the efficiency wage model, the wage outcome is independent of the market power of the firm. For example, consider the standard effort model where real revenue is R(Ei Ni), Ei being effort. Then if effort depends on wages relative to outside opportunities, so Ei = e(Wi/A), e¢ > 0, wages are determined by the Solow condition e(Wi A) = e ¢(Wi A)Wi A

(5)

This implies that wages are a fixed markup on outside opportunities with the markup depending only on the arguments of the effort function. Similarly, efficiency wage models that assume higher wages are paid to reduce the costs of quitting (or the costs of turnover more generally) lead to wages being a markup on outside opportunities, with the markup depending only on the arguments of the quit or turnover functions. For example, in models of the Shapiro and Stiglitz (1984) type, the firm’s wage is based on the no shirking condition and depends on outside opportunities and the factors determining the monitoring technology. In none of these cases does there appear to be any obvious mechanism by which the market power of the firm can enter the story. Even in this context, however, there are two, possibly remote, cases in which firms might chose to pay higher wages when they have market power and are earning higher monopoly rents. First, the effort function may depend negatively on the level of market power, and workers will put less effort into production activity if they do not share in the monopoly rents. The second alternative is that managers spend part of the monopoly rents on higher wages to make their lives more tranquil. This is an aspect of expense-preference theory (see Smirlock and Marshall 1983) and requires the existence of some mechanism whereby managers can act against the best interests of shareholders.

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Nicoletti, Haffner, Nickell, Scarpetta, and Zoega

In summary, it is perfectly plausible that in firms where wages are bargained collectively, an increase in product-market competition will tend to lower wages and raise employment in the firm. In firms where wages are determined competitively or are set by managers, however, this outcome is far less likely. These are partial equilibrium results. So what happens if all firms in the economy face an increase in productmarket competition? 2.1.3 Product Market Competition, Wage, and Employment Determination: General Equilibrium At the firm level it is natural to think that an increase in product market competition leads to a fall in wages and an increase in employment. And the amount by which employment increases depends on the labor demand elasticity. It is argued that in a world of unionized firms, however, where the unions bargain over employment as well as wages, if there is a general rise in product-market competition the loss of rents would be shared by the firms and workers with no overall impact on employment (see Geroski et al. 1997, for example). This argument can be readily dismissed. In a general equilibrium framework, the outside option, A, becomes endogenous. Thus, as Layard and Nickell (1990) demonstrate, the equilibrium unemployment rate in a world where unions bargain on wages and employment can be either lower or higher than that where unions bargain only over wages and the firm sets employment. Indeed, in a Cobb-Douglas constant elasticity world, equilibrium employment is exactly the same in both cases. Furthermore, it is decreasing in union power and increasing in product-market competition (see also Gersbach 1998). Another interesting general equilibrium question concerns the impact on wages of a universal increase in product-market competition throughout the economy. While an increase in product-market competition can lead to a reduction in wages at the individual firm level, this is not likely to occur in the case of an economywide increase in competition. Product-market competition reduces wages relative to the outside option, but a universal rise in product-market competition (rise in demand elasticities) also raises aggregate labor demand via the outward shifts of the firm’s labor demand curves. This leads to a large initial fall in unemployment that drives up wages across the board and in the new equilibrium, while unemployment is somewhat lower, labor demand is high enough to imply higher wages and lower profits. Thus while a rise in product market competition at the individual firm level


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can be detrimental to workers in that firm, an overall rise appears to benefit all the workers in the economy by raising both employment and wages.21 2.2 The Impact of Product-Market Competition on Macroeconomic Stability The previous section focused on a comparative static analysis in which we assumed an exogenous change in product-market competition. Labor and product-market dynamics, however, are also important. Product-market competition affects the way in which both prices and wages respond to market pressures and, in the presence of rigidities in the labor market, a slower adjustment of prices and wages may transform cyclical variations in unemployment and employment into structural changes. With price-setting, demand effects on prices tend to be stronger if firms operate in a more competitive environment (see, for example, Encaoua and Geroski 1986, or Brack 1987). Similarly, on the wages front, a higher degree of product-market competition will reduce the power of insiders in wage bargaining and thus outside conditions will have a greater impact on the wage bargain (see Layard et al. 1991, chapter 4). To see how this could affect macroeconomic stability and labor-market performance, we focus on a simple macroeconomic model. Consider the following log-linear model: aggregate demand

y=m-p

production (Okun’s law) y = -u price-setting

p - w = b 0 + b 1 y + b 11 Dy - b 2 (p - p e ) + z p

wage-setting

w - p = g 0 - g 1u - g 11 Du - g 2 (p - p e ) + zw

where y is the deviation of real output from trend, m is the money stock, p is the price level, u is the unemployment rate, zp is the supply shock to prices, zw is the supply shock to wages. This is a standard framework that is explained in detail in Layard et al. (1991), chapter 8. The key parameters are b2, g2 which capture the extent of nominal inertia (pricewage stickiness), b11, g11 which reflect the temporary impact of market tightness on prices and wages, and b1, g1 which capture the permanent effect of market tightness on prices and wages. These two latter parameters are positively influenced by the extent of product market competition.

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To analyze macroeconomic stability in the context of this model we suppose that it is subject to the following shocks: money supply supply shock

m = m-1 + em zp = z w + ep; zw = z w + ew

where em, ep, ew are iid random variables. Then if we define equilibrium unemployment, u*, as the value of u for which Du = 0, p - pe = 0, ep = ew = 0 we find u* = (b 0 + g 0 + z p + zw ) (b 1 + g 1 ) It is then possible to show that under rational expectations, the response of unemployment to the various shocks is given by:

(u - u*) =

e p + e w (b 2 + g 2 ) b 11 + g 11 (u-1 - u*) + em , b 1 + g 1 + b 11 + g 11 D D

D = b 2 + g 2 + b 1 + g 1 + b 11 + g 11 So, if b1 and g1 are increasing in product-market competition, we find that a rise in product market competition will: (1) reduce the real impact of all the shocks, since D is increasing in b1 and g1; and (2) reduce the degree of persistence of all the shocks, since the coefficient on the lagged dependent variable is decreasing in b1 and g1. It is plausible that a rise in product-market competition, therefore, increases the stability of the macroeconomy by reducing the impact of both demand and supply shocks and by lowering the persistence of these shocks (see section 4). In turn, stable macroeconomic conditions are likely to contribute to falling unemployment in countries with rigidities in the labor market where increases in unemployment that are initially cyclical tend, over time, to become structural.22 Indeed, across countries there is a positive correlation between the degree of annual volatility of unemployment and the extent of the rise over time in structural unemployment (Elmeskov et al. 1998). 2.2.1 Product-Market Competition and Self-employment In the previous section, the analysis was exclusively concerned with dependent employment. The relationship between product-market competition and self-employment is rather different. In so far as increases in product-market competition arise from the easing of product-market regulations that impose restrictions on entry, then increases in self-employment may well follow. The mechanism is


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straightforward. Product-market regulations, in the form of regulatory and administrative barriers, are likely to inhibit the creation and development of new businesses and so impede the growth of selfemployment. In many instances, however, relatively high levels of selfemployment result from the attempt to avoid excessive regulations on corporations (concerning either employment protection or administrative procedures). In these cases, regulatory reform and administrative simplification may well lead to a reduction in the share of those who are self-employed. The share of self-employment will often be more sensitive to the existence of regulatory distortions than to the overall stringency of the regulatory framework. The net effect of the latter on self-employment depends crucially on the way in which the creation of dependent and independent employment is affected by different regulations and administrative procedures. If, as is often the case, product-market and employment protection regulations as well as administrative burdens are relatively less onerous for small firms, this will encourage selfemployment and the extent of this encouragement will be reduced if these regulations are eliminated. 2.2.2 Product-Market Competition and Labor-Market Institutions Market structure and competition are likely to interact with regulations in the labor market. When firms face more competition, they are under pressure to respond more rapidly to fluctuations in the markets in which they operate. Furthermore, they have fewer monopoly rents to distribute to their employees in the form of higher wages or lower effort. This may have consequences for a number of labor-market institutions, notably unions, employment protection, and unemployment benefits. It is clear that an increase in product-market competition will reduce the rewards that unions are able to extract from firms on behalf of their members. This could lead to a fall in membership that would be reinforced if the fall in entry barriers to traditionally unionized sectors led to an increase in the number of new nonunion firms. This would be particularly important in those countries where unions are essentially synonymous with their membership, as in the United Kingdom or the United States. By contrast, in those countries where unions have a wider social or political role, as in most of continental Europe, we might expect increases in product-market competition to have less of an impact. A good example of the impact of product-market competition

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is provided by the sharp decline in union membership in the United Kingdom since 1980, which has been almost exclusively due to the exit of unionized establishment and the entry of nonunion establishments. Changes in the status of continuing establishments from unionized to nonunionized are extremely rare. Another aspect of union wage bargaining that might be influenced by product-market competition is the degree of centralization. Any form of cross-firm coordination in wage bargaining is likely to come under more pressure if the firms face higher levels of competition. This is true because, as each firm faces more competitive pressure, the likelihood that it will pay a firm to break away from a coordinated agreement will increase. For example, having a lower wage than that agreed to by the group may be the only way of surviving for less efficient firms. Thus, we might expect to see increasing pressure for decentralized wage bargaining as product market competition increases as well as the possibility of a decline in trade unionism. Turning now to employment protection legislation, if increased competition means that firms have to respond more rapidly to shocks, they will press for more flexibility in employment contracts. Workers, on the other hand, will feel that their jobs are less secure and may press for more protection, especially when the unemployment rate is high. One way around this would be for governments simultaneously to weaken employment protection legislation and raise the generosity of the unemployment benefit system. This passes on the costs of increased flexibility to the taxpayer. If this hypothesis is correct, we would expect to observe lower levels of employment protection and perhaps higher levels of benefits in those countries that encourage product-market competition by having lower levels of product-market regulation. The relationship between product-market competition/regulatory reforms and employment protection legislation (EPL) also works in the other direction. For example, the existence of thresholds for the application of EPL to collective or individual dismissals may affect the minimum efficient scale of firms (after accounting for the cost of regulations) and favor particular kinds of company structures (such as sole proprietor firms). This effect can be reinforced (or weakened) by a profile of administrative burdens favoring (or discouraging) the creation of individual firms. Different combinations of the regulatory regimes in the labor and product market, therefore, can be expected to result in different labor-market equilibrium configurations, potentially distorting the optimal level and composition of employment (e.g., between


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dependent and self-employment). At the same time, the effects of regulatory reform are likely to be different depending on the initial combination of regimes and on the sequencing of the reforms in the two markets. 3 The Impact of Product and Labor-Market Regulations on Labor Market Performance: An Empirical Investigation This section provides some empirical evidence on the relationship among product-market competition, regulations, and economic performance. It should be stressed that the degree of product-market competition is not observable and the available proxies are often endogenous to the economic performance variables to be explained.23 Here, therefore, indicators of labor-market performance are directly related to some of the policy determinants of market structure and product-market competition, such as regulatory provisions restricting entry and favoring large, possibly state-controlled, incumbents. Moreover, we consider certain regulations in the labor market (e.g., EPL) that are assumed to affect the behavior of agents in the product market, interact with product market regulations, and affect labor-market outcomes. The potential linkages between the regulatory environment in the product and labor markets and outcomes in the labor market are manifold and complex. Product-market regulations may affect firm behavior in three main ways: by increasing the costs of producing any given level of output (e.g., compliance or avoidance costs); by affecting market structure (e.g., legal limitations on the number of competitors); and by changing the incentive structure (e.g., public ownership). In general, the influence of product-market regulation will be reflected in labor demand and/or wage determination. Labor-market regulations can have a powerful impact on labor-market outcomes by changing the set of constraints under which labor demand and supply decisions are taken. This section has two main objectives: (1) to assess whether available indicators of product and labor-market regulations help to explain cross-country/sector differences in performance in OECD countries; and (2) to empirically identify some of the channels through which the impact of regulation on performance may come about. The analysis is based on a novel set of cross-country comparable indicators of regulation in the labor and product markets. These

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indicators have been constructed using data collected from a variety of national and published sources (see box 1).24 Product-market indicators provide information on the degree of state control, barriers to entrepreneurial activity, and barriers to trade and investment. Labor-market indicators provide information on EPL for permanent and temporary workers and on other policies affecting the use of labor (such as the tax and benefit systems) as well as on institutional characteristics of the labor market, such as wage bargaining systems and unionization. It should be stressed at the outset that these indicators are rough approximations of the regulatory and institutional stance across OECD countries. They concern only economic and administrative regulations, ignoring other important regulatory areas in which the available crosscountry information is scarce, such as health, safety and environment, and they do not include information on financial market and land-use regulations. In addition, the indicators deal only with formal regulations and, therefore, cannot account for enforcement issues. Taking into account these additional factors could have repercussions on the country rankings in the different regulatory areas. It is also important to note that, with a few exceptions, the indicators of product market regulation used in this section concern the Box 1 A Classification of Product and Labor-Market Regulations This analysis is based on families of indicators established according to a taxonomy of regulatory interventions in the product and labor markets. The indicators have a pyramidal structure. At the top they summarize the regulatory environment in either the product or the labor market (as far as employment-protection legislation is concerned). At the next level they summarize information about broad classes of regulatory interventions (e.g., inward- or outward-oriented product-market regulations, EPL for permanent or temporary workers). At the intermediate and lower levels, they summarize information about types of interventions within these broad classes (e.g., state control of business-sector activity) as well as their specific modalities (e.g., public ownership or interference in private firms); at the bottom they coincide with individual features of the regulatory regimes (e.g., scope of the public enterprise sector or use of command and control regulations). The bottom level generally corresponds with the basic units contained in the regulation database. To minimize discretion in the weighting procedures, the summary indicators were constructed aggregating their lower-level components by means of factor-analysis techniques. Aggregation through factor analysis ensures


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that the weights assigned to the detailed indicators depend on the contribution of each indicator to the explanation of the total variance in the data. As a result, the amount of variance explained by the summary indicators is maximized. Up to seventy indicators on specific regulatory measures were used in the construction of the overall product and labor-market indicators. All indicators were ranked on a 0–6 scale going from least to most restrictive regulatory environments. See Nicoletti et al. (1999) for more details on the methodology used to construct the summary indicators. The following hierarchy of indicators was established: Product-market regulation Inward-oriented policies State control Public ownership Size of public enterprise sector Scope of public enterprise sector Control by legislative bodies Interference in private firms Special voting rights Use of command and control regulation Barriers to entrepreneurship Administrative Licenses and permits system Existence of simplification programs Communication and enforcement of procedures Administrative burdens on business Administrative burdens for corporations Administrative burdens for sole proprietor firms Legal barriers to entry Outward-oriented policies Barriers to trade and investment Regulatory and tariff barriers Regulatory barriers Tariffs Other trade barriers Non tariff barriers Ownership barriers Discriminatory procedures

Employment-protection legislation EPL for permanent workers Regular procedural inconveniences Procedures Delay to start a notice Notice and severance Notice period Severance pay Difficulty of dismissal Definition of unfair dismissal Trial period Difficulty at 20 years tenure Reinstatement obligations EPL for temporary workers Fixed-term contracts Valid dismissal other than “objective” Max. n. of successive contracts Max. cumulated duration Temporary work agency employment Types of authorised work Restrictions on n. of renewals Maximum cumulated duration

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nation-wide level and refer to a single year (1997 or 1998, depending on the country and the indicator). This makes it impossible to relate labor market outcomes to the evolution of the regulatory environment over time and to observed differences in industry-specific regulations, somewhat constraining the empirical analysis. On the other hand, more information on time patterns of labor market regulations and institutions is available, although full time-series are sometimes lacking. Specifically, indicators of EPL exist for the late 1980s and the late 1990s, but these data were supplemented with information about the timing of major reforms to construct a time-varying indicator for each country. 3.1 Regulation and Performance Patterns Across the OECD Despite regulatory reforms in most OECD countries over the past decade, product-market regulations still vary substantially across the OECD. Figure 3.1 shows cross-country differences in the overall regulatory environments and along three axes of regulation: state control, barriers to entrepreneurial activity, and barriers to trade and investment. The state control indicator summarizes public ownership patterns and command and control measures; the indicator of barriers to entrepreneurship summarizes legal and administrative obstacles to entry into product markets, such as limitations on the allowed number of competitors and administrative burdens on the creation of businesses; the indicator of barriers to trade and investment includes tariff and nontariff barriers as well as legal, regulatory, and procedural restrictions on FDI (see box 1). The highest cross-country variations are found in state control and (although to a lesser extent) in barriers to entrepreneurship, whose most variable component concerns administrative burdens on business start-ups.25 These two indicators are also significantly correlated across countries.26 By contrast, with a few exceptions, countries are more homogeneous in their attitudes toward trade policies, not least because of the different rounds of trade negotiations and participation of many OECD countries in multilateral agreements and supranational institutions. Differences in labor-market regulations are equally significant. These regulations are still determined essentially at the domestic level even in the EU, and (as shown in the next section) their convergence across countries can hardly be induced by market pressures from rising economic integration. Figure 3.2 shows the evolution of indicators of EPL for permanent and temporary workers during the past decade. Broadly


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Product-market regulation2

Ita Be l G re

Ire Jp n C an N et Sw e G er Au s D en Au t Sp a Po r Fr a Fi n

N Z

U K U SA

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State control3

U U K SA Jp Cn an Sw e N Z Ir Me ex G er Au s Sw i N et Au N t o Kor r Tu r H un Po r Fi n D en Sp Ca ze Fr a Be l Ita G re

6.0 5.0 4.0 3.0 2.0 1.0 0.0

Barriers to entrepreneurial activity3

a Be l

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re G er Jp n Fi n

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t et U SA N

Au

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Barriers to trade and investment3

D

en Fr a U K Ire Ita N e U t SA Be l N Z Sp a N or G er Fi n Jp n Sw i Au t Au s Is r Po r Tu r C an Sw e G re M ex

4 3.5 3 2.5 2 1.5 1 0.5 0

C

U

K

3 2.5 2 1.5 1 0.5 0

Figure 3.1 Differences in product-market regulation1 Notes: 1. Country scores reflect the results of factor analysis. Summary indicators are obtained weighting factors by their relative contributions in explaining the total variance of the factors. All variables were cast in 0–6 scale from least to most regulated. 2. Factor analysis applied to summary indicators of state control, barriers to entrepreneurial activity, and barriers to trade and investment. 3. Factor analysis applied to basic indicators.

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Panel A. Regular and temporary contracts Strictness of EPL in 1998 5

4

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Panel B. Regular contracts

4 5 Strictness of EPL in 1990

Panel C. Temporary contracts Strictness of EPL in 1998

Strictness of EPL in 1998 5

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NZ UK Can USA Irl

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 Strictness of EPL in 1990

Figure 3.2 Differences in employment-protection legislation Notes: 1. The indicator is the weighted sum of indicators referring to several aspects of employment protection legislation for regular contracts as well as for fixed-term and TWA contracts. The indicators range from 0 (least restrictive) to 6 (most restrictive). The weights are extracted from a factor analysis of basic indicators. Source: Nicoletti et al. (1999).


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speaking, there has been a tendency for a significant deregulation of temporary contracts, while only modest changes have been recorded for permanent contracts. Only Finland and Spain have significantly eased regulation for permanent workers. In a number of countries (e.g., Japan, Germany, Italy, Belgium, Finland, New Zealand, and Sweden) fixed-term contracts can now be used in a wider range of situations than at the beginning of the 1990s. Moreover, in Denmark and Sweden, all restrictions on the types of work for which temporary work agency employment is legal have been removed and in Italy and Spain temporary work agencies have become legal for certain types of work although they previously were illegal under all circumstances.27 Interestingly, restrictive product-market environments are matched by restrictive employment-protection policies (see figure 3.3). There is a strong correlation across countries between the overall indicator of product market regulation (including several of the specific regulations described above) and a summary indicator of EPL (including measures for both permanent and temporary workers).28 This finding tends to confirm the line of reasoning proposed in the previous section concerning the possible linkages between regulatory policies in the two markets. For example, restrictive product market regulations may make it less urgent for entrepreneurs to lobby for and for workers to accept an easing of EPL. On the other hand, by increasing the speed of Employment-protection legislation 4 Por 3.5 3

Jpn

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1.5

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Correlation = 0.76 t-statistic = 4.8

USA 1

1.5

Figure 3.3 Product and labor-market regulation

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labor market adjustment, less restrictive EPL may make regulatory reform in the product market easier to implement.29 The strong correlation between regulatory regimes in the labor and product markets also suggests that their influence may have compounded effects on labor market outcomes, making regulatory reform in only one market less effective than simultaneous reform in the two markets.30 In any event, the high correlation of the summary dimensions of regulation makes it difficult to identify empirically their specific effects on labor market performance. 3.2 The Impact of Regulation on Labor-Market Performance As argued in the previous section, overly restrictive product-market regulations may shift and twist the aggregate labor-demand curve possibly leading to lower aggregate employment. Similarly, unduly restrictive EPL can reduce the equilibrium level of employment and affect its dynamics over the business cycle (see box 2). The influence of regulation on the dependent and independent segments of the labor market, however, should also be distinguished. Labor-market regulations are likely to have a direct effect on dependent employment, while productmarket regulations can be expected to affect dependent employment indirectly through their effect on market structure and product-market competition. On the other hand, independent employment may suffer directly from overly restrictive product-market regulations, since regulatory and administrative barriers are likely to make the creation and development (and sometimes even exit) of businesses difficult. Labormarket regulations may only affect independent employment indirectly, especially when they are asymmetric, as is the case when regulations apply to workers in firms above an employment threshold which may encourage the creation of smaller-sized enterprises. Another way to look at the potential effects of regulations on labormarket performance is to focus on wages. Regulations on the labor and product markets affect wage formation by creating product-market rents that could be eventually shared with employees in the form of high wages. It is, however, difficult to disentangle the effects on wages of product-market rents from those stemming from other factors. Labor is not homogeneous and different industries require labor inputs of varying skill levels and other worker-specific characteristics. It is first necessary to adjust for the characteristics of the work force across industries, although such adjustment is bound to be incomplete. If such


Box 2 Employment-Protection Empirical Evidence

Legislation

and

Labor-Market

185

Performance:

In all OECD countries, rules and regulations govern the employment relationship between workers and firms. Those referring to hiring and firing practices are often referred to as employment-protection legislation (EPL). They concern unfair dismissals, restrictions on layoffs for economic reasons, compulsory severance payments, minimum notice periods, and administrative authorizations. EPL may affect the equilibrium level of employment as well as its dynamics over the business cycle in different ways. By reinforcing job security, EPL may enhance productivity performance as workers will be more willing to cooperate with employers in the development of the production process (Akerlof 1984). To the extent that EPL leads to long-lasting work relationships, it may encourage employers to provide training to workers with potentially beneficial effects on human capital and labor productivity. EPL may also be a way to internalize the social costs of dismissals by moving the social burden of reallocating a worker to another job closer to the firm’s profitability criteria (Lindbeck and Snower 1988). If these regulations are strict, however, as in many European countries, firms may become more cautious about adjusting their work force with the ultimate effect of reducing labor turnover, that is, movements from employment to unemployment and from unemployment back to employment (Bertola 1992). In addition, if hiring and firing costs are not transferred into lower wages, total labor costs for the firms increase and this may lead to a lower level of employment, other things being equal. Empirical evidence on the impact of employment protection legislation is mixed, not least because of the lack of suitable data on the enforcement and evolutions of regulations over time (Bertola et al. 1999). A clear distinction exists between the potential effects of EPL on employment turnover as distinguished from the equilibrium level of employment (unemployment) and its composition (temporary/permanent; youths /prime-age workers, etc.). There is consistent empirical evidence that strict employment protection legislation reduces unemployment turnover. Under strict EPL provisions, the unemployment pool is more stagnant, with fewer people being laid off, but also fewer unemployed people getting new jobs (Bentolila and Bertola 1990; Blanchard and Portugal 1998; and Nickell and Layard 1998). The effects on employment turnover are less clear cut: Bertola and Rogerson (1997) and Boeri (1999) found similar job creation and job destruction rates across countries with different EPL regimes but lower unemployment inflows in flexible labor markets. As stressed in Boeri (1999) and OECD (1999c), a possible explanation is that strict EPL may foster job-to-job shifts rather than overall (continued)

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employment turnover insofar as employers and workers will seek direct shifts from one job to another without intervening unemployment spells to avoid the associated dismissal and search costs. Some studies (e.g., Scarpetta 1996) suggest a detrimental effect of strict EPL on the level of employment to working-age population ratios. Nickell and Layard (1998) indicate that this may be partially due to the low participation rates in southern European countries, which also have strict EPL. Participation rates may be low, especially among youths, however, precisely because employment prospects are lower the stricter the EPL system. No consensus exists on the overall impact of EPL on unemployment. Part of the disagreement stems from the use of different models and/or indicators. Disagreement persists, however, even among authors using the same indicator (the OECD summary index, see OECD 1994a, 1994b, 1999a). A recent study (Elmeskov, Martin, and Scarpetta 1998) suggests a somewhat more robust effect, however, on unemployment if changes in EPL over the past two decades are taken into account. These studies are based on formal EPL but do not take into account the enforcement of this legislation. Here, Blanchard and Jimeno (1995) point to the very different degree of enforcement in Spain compared with Portugal despite similar summary indicators of the stringency of EPL. Di Tella and MacCulloch (1998) use data based on surveys of businesspeople over the 1980s and suggests a significant effect of strict EPL regulations on both unemployment and long-term unemployment. Their results, however, may be sensitive to changes in business’s perceptions over the cycle. Boeri (1999) also suggests that countries with stronger employment protection for regular contracts tend to display a bimodal tenure distribution with either very short or very long tenures. In countries where fixed-term contracts are liberalized, a large number of employees with fixed-term contracts tend to insulate permanent workers from adjustment (Bentolila and Dolado 1994), thereby increasing their bargaining power and the corresponding wage pressures.

adjustment still indicates the existence of wage premia, it may be that they arise from “efficiency wages” whereby employers voluntarily pay high wages to attract more committed and reliable workers. Higher wage rates are traded off against higher productivity and lower personnel administration costs. In that case, marginal costs in the long run might not be higher than if lower wages were paid to a lower quality work force. It is therefore also important to determine not only whether or not wage premia exist but also whether they arise from the sharing of rents from imperfect competition or efficiency wages being paid in an essentially competitive environment. In either case, though, (and the


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two are not mutually exclusive), there are likely to be interactions with labor markets that will vary in size and severity depending on institutional arrangements on wage bargaining and rigidities in labor markets. To test empirically the effects of regulations in the product and labor markets on performance we use simple bivariate correlations and econometric techniques. In the latter case, a two-stage approach has been used based on cross-country and sectoral data. In the first stage, we apply panel data techniques to estimate reduced-form or “structural” models accounting for those determinants of employment and wages for which time-series and/or sector-specific information is available. The aggregate employment equation includes policy and institutional factors as well as the time-varying indicator of EPL. The industry-specific wage equations include only “structural” factors (such as productivity), since no sectoral detail is available for EPL. In the second stage, unexplained country-specific effects are related (by means of simple bivariate correlations) to the indicators of labor and/or product market regulations. The analysis is performed on a sample of OECD countries (excluding Korea, Mexico, and the central and eastern European members, for which time-series data were lacking or unreliable) over the 1982–1995 period. Cross-sector estimates are based on a panel of eleven manufacturing and nonmanufacturing industries (at the two-digit level) and four service industries (at the one-digit level). The two-stage approach has the advantage of making the best use of the available information. The first stage exploits the cross-country, time-series—and for the wage equation the cross-industry—dimensions and makes it possible to identify the part of labor-market performance that can be explained by available structural indicators. The second stage relates the unexplained cross-country component to labor and/or product market regulations, for which only the economywide and cross-sectional information is available. The two-stage approach creates an implicit (and somewhat arbitrary) hierarchy between the effects of regulations on the product and labor markets. The existence of a time dimension in the EPL variable, however, makes it preferable to use it in the first stage since it is likely to lead to better identified estimates of the parameters of interest. The lack of the time dimension in the indicators of product-market regulation implies that only a random-effects specification might be estimated in one stage. The

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results of such a regression would suffer from multicollinearity due to the high correlation between the indicators of product market regulation and EPL. To assess empirically the impact of regulations in the labor and product markets on the composition of employment we look at the share of self-employment in total employment in the overall business sector as well as in industry and services.31 In this context, a single-stag approach seemed to be more appropriate, since the focus is on the determinants of cross-country differences in the long-run composition of employment, which are unlikely to be affected in the short run by changes in regulations. 3.2.1 Regulation and Employment Figure 3.4 considers the employment rates (employment over the working age population) in the total economy as well as in the nonagricultural sector and in the non-agricultural business sector in 1995. These employment rates are plotted against the summary indicators of labor and product market regulations. There are several reasons for excluding the agricultural sector. First, our regulatory indicators do not include provisions (such as those contained in national and supranational agricultural policies) that are most relevant for explaining employment in this sector. Second, the sensitivity of employment to economywide regulations is likely to have peculiar features in agriculture due to the predominant presence of self-employment. Finally, the exclusion of agriculture allows avoiding spurious relationships between employment and regulations insofar as, over the sample period, the largest declines in agricultural employment have been experienced by countries characterized by restrictive regulatory environments. We also focus on the business sector because this is where regulations are most likely to affect employment decisions.32 In the econometric analysis done thereafter we estimate a reduced-form employment equation in which we consider total employment but also control for the size of government sector employment. The bivariate plots suggest that countries with restrictive EPL and product-market regulation tend to have lower employment rates and the negative relationship is even stronger if nonagricultural business sector employment rates are considered. The inverse relationship between employment rates and labor and product-market regulations is confirmed by the calculation of the simple correlation coefficients of the nonagricultural business-sector employment rate (in 1995) and its

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Figure 3.4 Employment rates and regulation Notes: 1. Employment rates in 1995.

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60

65

UK

Employment rate

70

75

80

4

3.5

1 2

Spa

Net

25

35 30

40

50 45

55

60

70 65

75

0

2.5

Ita

Fin Fra

1

Ire

NZ

1.5

Aus

2

Den

Bel

2.5

Nor

3

Spa

Ita

Ger

Jpn

Net

Fin

Aut

Swe

3

Tur

Gre

4

3.5

Gre

Por

3.5

Fra

Bel

Employment-protection legislation (1998)

0.5

Can

USA UK

Pot

Aus Ger Aut

Den

Product-market regulations

1.5

Ire

NZ

Can

Jpn Swe

Nonagricultural employment rate

UK

USA

Nonagricultural employment rate

40 0.5

45

50

55

60

65

70

75

UK

1

Aus Ger

1.5

Ire

2

Spa

Net

Por

NZ Den Aut Swe

Can

Jpn

2.5

Fra Fin

Ita

20

25

30

35

40

45

50

55

60

65

0

0.5

Can

UK

USA

1

1.5

Den

Aus

Ire

NZ

2

Ger Aut Nor

2.5

3

Net Fin Spa

Bel

Swe

Bel

Jpn

Nonagricultural business employment rate

34 0.5

39

44

49

54

59

USA

Nonagricultural business employment rate 64

3.5

Tur

Gre

4

3.5

Gre

Ita Por Fra

3

European Integration, Liberalization, and Labor-Market Performance 189

190


growth rate against several indicators of product-market regulations and EPL (see table 3.1).33 Interestingly, both the level and the rate of growth of the employment rate display a significantly negative correlation across countries with the summary indicators of product and labor-market regulations. In particular, EPL regulations for both permanent and temporary workers are negatively correlated with the employment rates and those for permanent workers appear to affect negatively the changes in employment over the past decade. Inwardoriented product-market regulations are associated with both a lower Table 3.1 Simple correlations between regulatory indicators and employment rates (nonagricultural business sector)

Regulatory indicators

Employment rate, 1995

Growth in employment rate, 1982–1995

EPL Regular workers Temporary workers

-0.61* -0.44* -0.64*

-0.45* -0.46* -0.37*

Product market regulation Inward-oriented policies Outward-oriented policies

-0.71* -0.72* -0.08

-0.43* -0.42* -0.10

State control Public ownership Interference in private firms Size of public enterprise sector Scope of public enterprise sector Special voting rights Use of command and control regulation

-0.73* -0.71* -0.55* -0.62* -0.61* -0.43* -0.48*

-0.39* -0.44* -0.23 -0.69* -0.40* -0.04 -0.23

Barriers to entrepreneurship Administrative transparency Administrative burdens on business startups Legal barriers to entry Administrative burdens for corporations Administrative burdens for sole proprietor firms

-0.17 -0.04 -0.25 0.05 -0.37 0.06

-0.44* -0.55* -0.26 0.12 -0.15 -0.29

Barriers to trade and investment Regulatory and tariff barriers Other trade barriers

-0.20 -0.14 -0.18

-0.12 0.07 -0.49*

Source: Authors’ estimates. Note: * indicates significance at the 10 percent level. Observations range from 19 to 22 depending on the indicator.


191

level and a slower growth of employment in the business sector. Unsurprisingly, state-control regulations display a particularly strong negative correlation with the level of employment, while employment growth seems to be more affected by barriers to entrepreneurship and regulatory barriers in the area of trade and foreign direct investment. The correlations shown in table 3.1 are at best only suggestive of an underlying relationship, since employment rates and regulatory indicators may be all driven by other factors ignored in the bivariate analysis, which are either unrelated to public policies (such as institutional features of the labor market) or related to public policies not considered above (such as taxation and social policies). To account for some of these factors in exploring the possible linkages between regulation and the employment rate, the following reduced-form equation was specified: erit = m 0 + m i + a ergit + Â b k x kit + g zit + j git + n it

(6)

k

where i indexes countries, t the years, erit is the nonagricultural employment rate, ergit is the share of public employees in the working-age population (the public employment rate), xit is a k ¥ 1 vector of policy and institutional variables, zit is the summary measure of EPL, git is the output gap included to account for changes in the business cycle,34 m0 is a constant, mi is the country-specific effect not accounted for by the available explanatory variables, and nit is the usual error term. All explanatory variables are time varying. The equation can be interpreted as the reduced-form deriving from a labor-market equilibrium condition in wages and, therefore, relates employment to labor-market institutions, taxation and social policies, and regulations deemed likely to affect labor-market conditions. We include the public employment rate on the right-hand side of the equation to test for the hypothesis that only the business-sector employment rate is affected by policy institutions and labor and product-market regulations. In other words, a unitary coefficient on the publicemployment rate would fully justify the focus on the businesssector employment rate for the study of the effects of institutions and regulations on employment. Institutional variables include a measure of union density as well as a summary measure of wage bargaining that brings together the different features of coordination and the levels of bargaining into a single indicator. For example, the summary measure allows us to consider cases where cross-industry coordination

192


between employers and unions in an industry bargaining setting (e.g., Germany and Austria and, more recently, Ireland and the Netherlands with centralized incomes policy agreements) may be an alternative, or functionally equivalent, to centralized systems. Tax and social variables include a measure of the tax wedge and a synthetic indicator of the generosity of the unemployment benefit system. The labor-market regulation variable has been constructed combining the 1990 and 1998 summary indicators of EPL with information about the timing of EPL reforms (concerning both temporary and regular workers) in OECD countries.35 Table 3.2 shows the estimates of equation (6) on a panel of nineteen OECD countries over the 1982–1995 period.36 The F-test at the bottom of the table suggests that the null hypothesis of a unitary coefficient for the public employment rate is rejected at the 5 percent level. There is some evidence that, over the period of time considered in the analysis, public employment crowds out private employment but the estimated effect is rather modest.37 This is obviously a partial analysis, and to the Table 3.2 Reduced-form employment rate equation, 1982–1995 (nonagricultural employment/ working age population, fixed effects) Independent variables Government sector employment rate Unemployment benefits: repl. rate Union density Corporatism (intermediate) Corporatism (high) Employment protection legislation Tax wedge Output gap

Coeff. 0.71 -0.11 -0.07 -1.77 0.74 -1.35 -0.09 0.61

Number of observations Number of countries

223 19

F-test (fixed effects) F-test (gov. sect. empl. = 1)1

129.1*** 6.1**

St. err.

T-stat.

0.12 2.66 0.03 0.44 0.41 0.71 0.05 0.04

6.03*** -4.22*** -2.67*** -4.05*** 1.81* -1.91* -1.73* 17.1***

Source: Authors’ estimates. Notes: Each coefficient represents the change in the employment rate implied by a unitary change in the independent variable. ***: statistically significant at the 1% level; **: at the 5% level; *: at the 10% level. 1. The null hypothesis is that the coefficient of the government sector employment rate is equal to 1.


193

extent that public employment is financed by increased tax rates— whose coefficient is negative and statistically significant—the detrimental effect of public employment on business-sector employment may become larger. Moreover, the estimated coefficients for the measures of centralization-coordination (decentralized countries are the reference group) give some support to the hump-shaped hypothesis (Calmfors and Driffill 1988), whereby both highly centralizedcoordinated systems and fully decentralized systems help to restrain the wage claims of insiders, thereby leading to higher employment rates than in intermediate systems.38 The estimated coefficients of the other policy and institutional variables are generally significant and signed according to priors, with union density, unemployment benefits, and tax wedges having a negative impact on the employment rate. More importantly, even controlling for these factors, the time-varying measure of EPL retains a negative and significant (at the 10 percent level) impact on the employment rate, confirming the results of the bivariate analysis. Thus restrictive hiring and firing regulations appear to affect labor demand and supply in ways that reduce the equilibrium rate of employment. The influence of cross-country differences in product-market regulations on the comparative levels of the nonemployment rates were investigated by relating the estimated country-specific effects to the regulatory indicators. As expected, the significant correlations found in the previous bivariate analysis are weakened once controlling for several factors affecting cross-country differences in employment. Correlations generally remain correctly signed, however, and a few of them retain significance, especially when outliers are eliminated (table 3.3). Due to lags in the effects of structural policies on market outcomes, in countries (such as Ireland) where radical product-market reforms have been implemented toward the end of the sample period, the end-ofperiod measure of regulation necessarily bears little relationship with the average employment rate even if a strong causal link between regulations and employment were to exist. Therefore, bivariate correlations have been computed both with and without this country. Although the summary indicator of product-market regulation has a low level of significance, several of its components are significant at the 10 percent level (or less). The most important negative productmarket influences on the employment rate are the presence of a high degree of state control in business-sector activities, especially through regulations interfering in the activity of private (or privatized) business

194


Table 3.3 The employment rate: Simple correlations between country-specific effects and regulation (nonagricultural business sector, 1982–1995)

Regulatory indicators

Including outliers

Excluding outliers

Product market regulation Inward-oriented policies Outward-oriented policies

-0.16 -0.30 0.38

-0.30 -0.40 0.31

State control Public ownership Interference in private firms Size of public enterprise sector Scope of public enterprise sector Special voting rights Use of command and control regulation

-0.32 -0.21 -0.34 0.05 -0.33 -0.60* -0.17

-0.42* -0.24 -0.49* 0.01 -0.39 -0.67* -0.33

Barriers to entrepreneurship Administrative transparency Administrative burdens on business startups Legal barriers to entry Administrative burdens for corporations Administrative burdens for sole proprietor firms

-0.02 0.24 -0.36 0.26 -0.54* -0.17

-0.08 0.28 -0.53* 0.35 -0.72* -0.42

Barriers to trade and investment Regulatory and tariff barriers Other trade barriers Regulatory barriers Nontariff barriers

0.38 0.31 0.22 0.10 -0.12

0.31 0.28 0.14 0.04 -0.08

Source: Authors’ estimates. Note: * indicates significance at 10 percent levels. Outlier country is Ireland.

enterprises and administrative burdens on business start-ups. Hence, entry restrictions due to costly and opaque administrative practices and the distortion of market mechanisms associated with the excessive presence of the state in the business sector would appear to explain the pattern of employment rates across OECD countries over and above the policy, regulatory, and institutional factors specific to the labor market. These results should be seen in the light of the strong positive correlation between the summary measures of EPL and productmarket regulation, which makes it difficult to identify their separate contribution to the explanation of cross-country differences in employment rates.


195

3.2.2 Regulation and Wages Several empirical studies have found that wages differ systematically across sectors, even after controlling for observable worker characteristics.39 Evidence from micro studies suggests that industry-specific wage premia are a significant component of total compensation, particularly in Canada and the United States, while it is of lesser importance in many EU countries. Even in European countries, however, the industry-specific component in wages is estimated to be 10 percent or higher of total compensation of employees. Most studies also suggest that wage premia are persistent over time. Empirical studies devoted to wage premia often have a fine sectoral breakdown, focusing on the manufacturing sector in a given country. Significant differences exist across countries and sectors in real wages, however, even after controlling for labor productivity and differences in purchasing power (i.e., using comparative measures of unit labor costs). The principal aim here is to shed some light on the potential role played by EPL and product-market regulations in explaining crosscountry differences in industry-specific unit labor costs. To this end, we estimate wage premia across two-digit manufacturing sectors and across countries.40 The dependent variable is the log-wage (in US $) and the explanatory variables are the log-productivity (in sectoral PPPs), the expenditure for R&D, the share of self-employed in the industry, the degree of import penetration and an aggregate demand variable (the output gap).41 These estimates are certainly crude approximations of wage premia and are likely to offer only broad-brush indications, at least as compared with those obtained in other studies using microdata and much more detailed information on the human capital and demographic features of workers as well as work-place characteristics.42 Our analysis makes it possible, however, to relate the estimated wage premia to the available cross-country indicators of labor and productmarket regulations. As in the employment equations, we adopt a twostage approach in which industry-specific variables are used to estimate wage premia and the latter are correlated to the economywide indicators of EPL and product market regulation. The following equation was estimated for a panel of fifteen OECD countries in nine manufacturing industries over the 1982–95 period: rwist = ais + b1lpist + b2RDist + b3seist + b4impenist + b4gapist + eist

(7)

where: i indexes countries, s indexes the manufacturing industries, t indexes the year, rwist is the industry real wage (in PPP US $), lpist is the

196


industry real value-added per worker (in sectoral PPPs), RDist is the share of R&D expenditure in value added, seist is the share of selfemployed in total employment, impenist is the indicator of import penetration (that is the ratio of import to absorption adjusted by country size by regressing the indicator over the absolute level of GDP and a constant), gapist is the output gap. Two specifications are presented in table 3.4: one using logarithms of both real wages and real productivity, and one using real wages and productivity relative to their average values in United States manufacturing. The equation was estimated by panel data techniques and includes fixed effects (country-industry) to control for omitted specific effects. In a second stage, the industry-specific fixed effects are correlated sector by sector across countries with indicators of labor and productmarket regulations. Estimates of the relative wage specification are somewhat different but do not change the basic conclusions of this exercise. Apart from the output gap, the equations include only explanatory variables that have a sectoral dimension, since the principal aim of these first-stage estimates is to account for as much sectoral variation as possible. The regression results for the two specifications are shown in table 3.4. The F-tests reported at the bottom of the table always reject the null hypothesis that the effect of country-industry dummies is jointly zero, suggesting that the country-industry affiliation has a large impact on real wages, even after controlling for labor productivity and other structural factors. As expected, differences in labor productivity explain a great deal of the variations in real wages across industries and countries. The coefficient on labor productivity is close to unity and, indeed, this restriction cannot be rejected by a Wald test at conventional levels of significance. Therefore, in our sample a specification of the equation in which the dependent variable is the labor share could be considered to be equivalent to equation (7). The other structural factors also play an important role. The results provide some empirical support for the hypothesis that the introduction of new products or processes—proxied by the R&D intensity— gives rise to temporary market power, and that the quasi-rents can show up in wages.43 Somewhat surprisingly, the results also indicate a positive (although not significant) association between the real wages and import penetration. Given the high level of intraindustry trade within the countries included in the sample, this could be explained by the fact that high-import sectors are often those with the widest


197

Table 3.4 Wage equations, 1982–1995 (two digits manufacturing industries, fixed effects) Log equation1

Relative wage2

Independent variables

Coeff.

St. err.

T-stat.

Coeff.

St. err.

T-stat.

Labor productivity Research and development Share of self-employed Import penetration Output gap

0.97 2.84 -0.63 0.03 1.10

0.04 0.50 0.43 0.03 0.17

22.07 5.62 -1.47 1.24 6.32

0.33 0.27 0.15 0.03 1.07

0.07 0.03 0.30 0.02 0.12

5.05 9.66 0.49 1.41 8.98

Number of observations Number of sectors Number of countries

1,440 9 15

1,440 9 15

F-test (fixed effects)

12.6***

17.9***

Source: Authors’ estimates. Notes: ***: statistically significant at the 1 percent level; ** at the 5 percent level;* at the 10 percent level. 1. Real wages and labor productivity are in logarithm form. 2. Real wages and labor productivity are relative to the (PPP) U.S. manufacturing averages.

product differentiation, which may give rise to temporary market power much in the same way as in R & D intensive industries. Table 3.5 presents the simple correlations between the estimated country-sector specific effects and indicators of product and labormarket regulations for the nine two-digit manufacturing industries. The top panel includes correlations for all countries in the sample, while the bottom panel reports the same correlations excluding the countries that appeared to be outliers in the sample (Portugal in food and textile and Austria in basic metal industries). Overall, excess wages are positively correlated with both labor and product-market regulations. Many of the correlations, however, have relatively low levels of statistical significance. Using the whole sample of countries, correlations with product-market regulations are significant (at 10 percent levels) in the food industry, the paper and printing industry, the nonmetallic mineral industry, the fabricated metal products industry, and the other manufacturing industry, while significant correlations with EPL indicators can be detected in the food industry (after excluding the outlier country), the fabricated metal products industry, and the other manufacturing industry. Among

EPL (1998) EPL, permanent workers (1998) EPL, temporary workers (1998)

Barriers to trade and investment Regulatory and tariff barriers Nontariff barriers

Product market regulation State control Barriers to entrepreneurship Legal barriers to entry Administrative burdens for corporations Licences and pemits system Communication and enforcement of administrative procession

0.41 -0.45

0.46*

-0.49* 0.29 0.32

-0.05

-0.11

0.33

0.04

-0.08 0.41

0.05 0.25

0.03 0.04

0.13

0.29 0.40 0.17

0.27 0.43* -0.16

0.04

0.13

0.01 -0.05

-0.11 -0.08

-0.38 -0.26

0.24

-0.10 0.00

-0.02

0.18

0.36 0.30 0.36

0.37

0.16 0.09

0.13

0.01

-0.25 0.37 0.28 0.39

0.08

0.25

0.22 0.05

-0.54*

0.43 0.33 -0.05

3500 Chemical, petroleum, rubber, and plastic

0.58* 0.55* 0.05 0.47* -0.04

Paper and printing

3400

0.36 0.32 -0.16 -0.03

Wood furniture

Food, beverage, and tobacco

3300

3200 Textile, wearing, apparel, and leather

3100

Table 3.5 Regulation and wage premia1 (manufacturing industries, two digits)

0.10 0.24 0.27 0.16

-0.37 -0.26 -0.42

0.04

0.06

0.28 -0.26

0.15 -0.15

0.32 0.29 -0.02

Basic metal industries

3700

-0.66*

0.31

0.34

0.08 0.25

0.07 0.44* -0.50*

0.45* -0.63*

Nonmetallic, mineral

3600

0.66* 0.59* 0.61*

-0.54*

0.33

0.13

-0.17 -0.09

0.48* 0.13

0.56* 0.48* -0.02

Fabricated metal products

3800

0.67* 0.70* 0.55*

-0.42

0.60*

0.26

-0.06 0.61*

0.23

0.34 0.17 0.24 -0.08

Other manufacturing

3900

-0.45*

-0.59* 0.29 0.32

0.23

0.41

0.46*

0.33

-0.08

-0.05

0.16

0.52* 0.29

0.14

0.41

0.44*

0.05 -0.28

-0.08

0.11 0.21

0.48 0.24

0.39

0.22 -0.11

0.29 0.40 0.17

0.17 0.49* -0.17

0.49 0.46 -0.16

0.01 -0.05

0.12 0.04

Notes: * indicate significance at the 10 percent level. Observations range from 19 to 22 depending on the industry and the statistical significance is affected by the sample size. 1. The wage premia is the country-sector residual identified by the relative wage equation in Table 3.4. 2. The outliers are: Portugal in sectors 3100 and 3200; Austria in sector 3700.


Product market regulation State control Barriers to entrepreneurship Legal barriers to entry Administrative burdens for corporations Licences and permits system Communication and enforcement of administrative procession Barriers to trade and investment Regulatory and tariff barriers Nontariff barriers

Excluding outliers2

200


product-market regulations, legal barriers to entry exert a strong effect on wage premia in both fragmented industries, such as food and nonmetallic mineral, and segmented industries, such as paper and printing. Regulatory and tariff barriers to trade are positively associated with wage premia in high import-high product differentiation industries, such as food and other manufacturing. And state control affects wage premia in the paper and printing and fabricated metal products industries. Surprisingly, some regulatory provisions display a significantly negative correlation with the estimated wage premia: nontariff barriers appear to be associated with lower wage premia in almost all sectors, while administrative burdens are associated with lower wage premia in the wood and nonmetallic mineral industries. Administrative burdens and opacities in fragmented industries may favor the development of individual enterprises for which costs and procedures are often lower (see below for more evidence on this), thereby lowering industry wages. On the other hand, the result on nontariff barriers appears harder to explain. 3.3 The Impact of Regulation on Employment Composition Differences in the regulatory environments faced by workers and firms may also affect the composition of employment (see box 2). Here we focus on the effect of EPL and certain kinds of product-market regulations on the share of self-employed in nonagricultural business employment (henceforth the self-employment rate). Specifically, we consider the effects of administrative burdens affecting the start-up of corporations and sole proprietor enterprises in an asymmetric way, thereby favoring the development of one or the other form of company structure. To the extent that excess burdens fall on corporations, the creation of individual enterprises will be encouraged, thereby increasing the self-employment rate. Figure 3.5 shows the cross-country bivariate plot of the selfemployment rate against an indicator of excess burdens on corporations.44 The self-employment rate appears to be positively related to excess burdens, safe for Belgium where self-employment is boosted by fiscal distortions despite the relatively high administrative burdens falling on start-ups of sole proprietor firms. Table 3.6 shows that the correlation between excess burdens and the self-employment rate is significant at the 10 percent level. This table points out that selfemployment rates are also significantly correlated with the summary indicator of product-market regulation, an indicator of the scope of the

Excess regulation for creation of corporations relative to sole proprietor firms1


2

Gre

Spa

1

Ire

Swe Aut Den Net Jpn Fra GBR

0 –1

USA

201

Por

Ita

Deu Fin Aus

–2

Correlation=0.63 t-statistic=3.2

Bel –3 0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

Share of self-employment in nonagricultural business employment

Figure 3.5 The self-employment rate and regulation Notes: 1. The difference between the indicators of administrative burdens on the creation of corporations and sole proprietor firms.

Table 3.6 Simple correlations between regulatory indicators and self-employment rates (nonagricultural business sector, 1982–1995) Regulatory indicators

Self-employment rate

Product market regulation Excess burdens on corporations Scope of public enterprise sector

0.39* 0.47* 0.37*


0.42* 0.13 0.58*

Source: Authors’ estimates. Notes: * indicates significance at 10 percent level. Observations range from 19 to 22 depending on the indicator, affecting the significance threshold.

public enterprise sector and, most importantly, EPL. Interestingly, correlations are particularly strong with EPL for temporary workers, suggesting that rigidities affecting this kind of work may result, especially in service sectors, in the choice of organizational structures based on the use of consultants and/or franchising. These correlations may not be robust, however, when accounting for other factors that determine cross-country differences in self-employment rates.

202


The determinants of self-employment are more difficult to pin down than those of dependent employment, partly due to the lack of comparative data. The ratio of self-employment to total employment can be affected by the stage of development and the structure of the economy as well as by policy and institutional variables that make selfemployment more advantageous relative to dependent employment. Unfortunately, little cross-country information is available on the role played by such variables as tax and benefit policies in the decision to be self-employed and, therefore, we focus solely on the effects of excess burdens and EPL. These factors capture the distortions in incentives caused by differences in the administrative treatment of the start-up of corporate firms versus sole proprietor firms and by differences in the legal treatment of dependent versus independent labor. Restrictive EPL and excess burdens on corporations should lead to a higher incidence of self employment. In any event, we expect that the effects of regulations on the employment mix differ in different sectors and compositional effects unfold slowly over time, with most of the information lying in the cross-country dimension of the data. Thus, we estimate equations for the overall business sector, manufacturing, and services and adopt a single-stage estimation approach in which regulatory indicators are introduced as fixed country-specific effects using the average values of EPL regulations over the two periods (1990 and 1998). The reduced-form equation for the self-employment rate was specified as follows: serit = m 0 + m i + Â b k w kit + dzi + g ri + jgit + n it

(8)

k

where serit is the self-employment rate, wki is a k ¥ 1 vector of variables on economic structure, zi is the summary indicator of EPL, and ri is the indicator of excess burdens for start-ups of corporate firms over soleproprietor firms. The other variables are defined as in equation (6). Structural variables include the share of agriculture in total GDP, the level of GDP per capita (in sectoral PPPs), and an indicator of the sectoral composition of nonagricultural GDP (value added mix), defined as an index (relative to the OECD average) of the extent to which the composition of GDP is twisted toward high-productivity sectors.45 The regression results are shown in table 3.7. Since regulatory variables lack the time dimension, a random effect specification was retained (the null hypothesis of lack of correlation between the specific effects and the explanatory variables could not be rejected at the 10

10.7**

1.4

Sources: Authors’ estimates. Notes: ***: statistically significant at the 1 percent level; ** at the 5 percent level.

B-P test Hausman test

14.1*** 949.9***

12.6*** 1,365.7***

F-test (fixed effects)

17

210

0.01 0.01 0.05

0.01 0.02

-0.01 0.04 0.00 0.03 0.04

St. err.

Coeff.

18

1.63 1.66 -0.30

14.42

T-stat.

235

0.03

0.05 0.01 0.02

St. err.

Number of countries

0.03 -0.01

0.02

0.66

Coeff.

Manufacturing

Number of observations

Output gap

Per capita GDP Composition of value added Share of agriculture EPL Excess regulation (corporate-sole proprietor)

Independent variables

Total economy

Table 3.7 Reduced-form self-employment rate equations, 1982–1995 (random effects)

2.40 0.85

9.3**

14.1*** 1,287.7***

18

217

0.04

0.04 0.02

0.03

1.53 0.37

0.01

-0.05

-0.97

0.02 0.02 0.04

0.02

St. err.

Coeff.

T-stat.

Services

2.65 1.00 1.24

-5.00 1.47

T-stat.


204


percent level). As expected, the regression results show that the overall self-employment rate increases with the share of agricultural GDP, while the sectoral rates decrease with GDP per capita. There is also some evidence that producing in high-productivity service sectors increases the self-employment rate in both manufacturing and services. The business sector self-employment rate appears to be positively affected by both EPL and excess burdens, although the level of significance of these two variables is low. Restrictive hiring and firing procedures may favor the self-employment rate in two ways. First the creation of small individual enterprises may be encouraged, especially when there are low work-force thresholds above which EPL applies. Second, as suggested above, the equilibrium level of dependent employment may be reduced relative to self-employment, especially in services. On the other hand, the presence of high administrative barriers relative to those faced for the creation of sole-proprietor enterprises may raise the self-employment rate by favoring this kind of organizational structure. These effects are better identified at the sectoral level. As expected, the effect of regulations is different in manufacturing and services. In manufacturing, the effect of excess burdens dominates, encouraging the fragmentation of the production structure in micro units. In services, the effect of EPL is stronger, encouraging an organization of work based on the use of consultants and on franchising. This confirms previous findings based on more anecdotal evidence.46 The combination of restrictive EPL and heavy administrative burdens may therefore contribute to explain the relatively high self-employment rates in some OECD countries. 4 The Implications of EMU for European Product and Labor Markets It is important to ask whether the creation of the EMU will provide additional incentives to agents and governments to adjust behaviors and policies in a direction that favors a more competitive environment in the labor and product markets, with possible beneficial effects on employment. Although both increased competition and monetary integration are likely to have direct and distinct effects on the functioning of labor markets, they are also related in that monetary integration is likely to affect the level of competition, for example by facilitating price comparisons across countries. This section discusses some of the likely structural changes that may be brought about by the EMU. First, the


205

possible direct effects of monetary integration on the degree of price competition are discussed and, second, the consequences of the single currency for the flexibility of product and labor markets. As underscored in the introduction to this book, these issues can be addressed empirically by looking at the past experience of subsets of EU countries that participated in exchange-rate stability zones, considering the latter as proxies for monetary unions. At the risk of oversimplifying complicated historical developments, in the following we distinguish between (1) the “D-mark area,” Germany and countries that succeeded in pegging their exchange rate to the D-mark over the past two decades (Austria, Belgium, the Netherlands, and Luxembourg); (2) the “core-EMS area” (D-mark area plus France); and (3) the “other EU area,” countries that entered EMS in 1979 but underwent frequent and significant adjustments of their parities within the exchange rate mechanism (eventually leading to their temporary or permanent exit from the system), countries that entered EMS at a late stage, and countries that never participated into the exchange rate agreement. In particular, we would like to detect if exchange-rate stability and the corresponding loss of monetary autonomy has brought about (1) a higher degree of price convergence than in other EU countries; (2) changes in behavior conducive to increased (nominal) wage and price flexibility; and (3) changes in institutions and structural policies that led to a reduction of real rigidities potentially affecting equilibrium unemployment. The presence of such changes could be interpreted as evidence that monetary integration encourages fundamental reforms in the labor and product markets, making the abandonment of independent monetary policy beneficial also on this ground. 4.1 Price Convergence The transition to a single currency should increase the transparency of prices for similar goods across countries participating in the currency union. In principle, increased transparency raises opportunities for arbitrage by consumers and competitive pressures for producers. As a result, the convergence of prices across countries should be accelerated, even though differences will remain due to factors related to location, tastes, and so forth (see section 1). Therefore, by looking at price convergence we can infer whether monetary integration has had any direct effect on product market competition.

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Looking back at the experience of EU countries, we check to what extent developments in price disparities have reflected differences in exchange-rate regimes. Specifically, it is useful to see whether those EU-countries where exchange rates have been relatively stable witnessed a stronger tendency for prices to converge (e.g., due to greater transparency of prices quoted in national currencies) than countries that have had relatively wide fluctuation bands or frequently adjusted central rates. Changes in exchange rates were particularly important at the beginning of the 1980s, with Portugal and Greece experiencing major depreciations of their currencies against the ECU. Exchange-rate fluctuations have remained important, however, in subsequent years in the majority of EU-countries, culminating in the EMS currency crisis of the early 1990s. Countries that witnessed relatively high stability in their bilateral exchange rates are Germany, the Netherlands, Belgium, Luxembourg, and Austria as the latter countries had essentially pegged their currencies to the Deutsche mark for more than a decade. As argued in section 1, an overall price convergence process took place in the EU over the 1985–1993 period. It is important to establish whether this overall process could have resulted merely from changes in exchange rates. While the countries in the D-mark area saw their currencies appreciate relative to the ECU since the mid–1980s, Greece, Portugal, Spain, and Italy experienced major depreciations against the ECU. According to the theory of (relative) purchasing power parities, changes in the exchange rate between two currencies should, in the long run, equal the difference in the percentage changes of the national price levels. Given that the countries with relatively low prices were typically the countries that experienced exchange rate depreciations, in the vast majority of cases changes in exchange rates have favored an increased divergence in prices. For example, in 1980, the lowest price countrieswere Portugal, Spain, Greece, and Italy, whereas the highest price countries were Denmark, France, and Germany. In 1993, the lowprice countries were Portugal, Greece, and the United Kingdom, while the high-price countries were still Denmark, France, and Germany. Therefore, the observed convergence in prices between the low-price and high-price countries cannot be attributed to exchange-rate variations (EC 1997a). Is it possible to identify groupings of EU countries where price structures have become more similar over the period 1985–1996? Following up on the analysis in section 1, we investigate the changes in the degree of similarity in price structures, using the Grubel-Lloyd indicator


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Table 4.1 Country pairs with most similar and most dissimilar price structures, all goods, 1996 Twelve most similar price structures (similarity index > 90.7 Austria-Germany Austria-Belgium Austria-France Belgium-France

Belgium-Netherlands Belgium-Germany Belgium-Luxembourg France-Germany

Denmark-Norway Denmark-Sweden Norway-Sweden Italy-Spain

Twelve least similar price structures (similarity index < 70) Japan-Turkey Norway-Turkey France-Turkey Luxembourg-Turkey

Denmark-Turkey Finland-Turkey Germany-Turkey Japan-United States

Sweden-Turkey Austria-Turkey Canada-Japan Belgium-Turkey

Source: Authors’ estimates based on OECD Purchasing Power Parties and Real Expenditures.

applied to the time-series of OECD Purchasing Power Parities and Real Expenditures database. Table 4.1 presents some indicative results, showing the twelve country pairs with the most similar price structures and the countries with the least similar ones. Not surprisingly, the countries with similar price structures are all close, highly integrated neighbors of each other (e.g., the Scandinavian countries, the southern European countries, and the countries of the D-mark area), while the dominance of both Turkey and Japan in the low-similarity category underscores their differing economic structure. The presence of the countries of the D-mark area among the countries with highly similar price structures would suggest that a stable exchange-rate regime may contribute to price convergence. Table 4.2 shows that the overall level of price similarity is indeed higher among the D-mark area countries than among the other EU countries. Prices are highly similar across all goods categories, with the possible exception of services. Similarity in price levels, however, should be distinguished from convergence. What is relevant here is whether convergence in the D-mark area has been stronger after controlling for initial conditions. Progress toward increasing price similarity has been relatively low among the D-mark area countries compared to the other EU countries, suggesting that relatively far reaching reforms are needed to achieve further price convergence. Table 4.2 also suggests that countries in the D-mark area already formed a relatively integrated group before the start of the pegged exchange-rate regimes. To see whether this result is

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Table 4.2 Price similarity indices at the basic goods heading, 1985–1996 1985

1990

1993

1996

Change, 1985–1996

D-mark area All products Consumer goods Equipment goods Construction Services Energy

90.0 91.2 91.0 92.5 85.7 91.6

90.7 91.7 92.0 90.7 87.8 88.9

90.4 92.1 90.2 90.4 86.9 86.4

90.8 92.5 90.1 90.8 87.0 91.8

+0.9 +1.3 -0.9 -1.7 +1.4 +0.3

Other EU All products Consumer goods Equipment goods Construction Services Energy

81.2 82.2 88.3 84.7 74.3 83.4

80.7 81.3 87.8 84.5 75.0 77.3

84.0 85.4 88.5 85.5 78.7 76.4

84.0 85.3 89.7 84.3 78.8 77.9

+2.8 +3.1 +1.4 -0.4 +4.5 -5.5

Source: Author’s estimates based on OECD Purchasing Power Parties and Real Expenditures. Notes: D-mark area = Belgium, Germany, Luxembourg, the Netherlands, Austria. Other EU = ten remaining EU countries.

robust, after correcting for factors such as trade intensity and the initial level of similarity, we present some regressions in table 4.3 that explicitly test for the presence of a “D-mark effect.” We look only at this group of countries (excluding Luxembourg) and use the other EUcountries as a control group. Interestingly, the coefficient of the D-mark dummy variable is always close to the coefficient of the non-D-mark dummy variable, although the D-mark coefficient is always higher than for the other countries. This suggests that an important part of the difference in price convergence may indeed be due to catching up and differences in trade intensity. To test whether the degree of price convergence of Austria, Germany, Belgium, and the Netherlands differed from that of the other EU countries, we tested the null-hypothesis that the coefficient of the D-mark dummy is equal to the coefficient of the non-D-mark dummy. An F-statistic was calculated to test this hypothesis for the various subperiods (1985–1990, 1990–1993, and 1993–1996) and goods categories (corresponding to the specifications one to four in table 4.3). We find that in only one case, the null-hypothesis could be rejected at the 5 percent significance level (but not at the 1 percent


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Table 4.3 Estimates of bilateral similarity equations including EMS dummies (dependent variable: change in price similarity over 1985–1996) Specification independent variables

1

2

3

4

Initial similarity

-0.3 (-6.9)

-0.5 (-20.0)

-0.6 (-20.9)

-0.3 (-9.4)

1.4 (1.1)

1.5 (1.9)

4.0 (3.8)

3.6 (2.1)

Expenditure share Trade intensity

-0.3 (-1.4)

D-mark dummy

4.5 (2.8)

4.6 (3.8)

5.6 (5.4)

3.4 (2.4)

Other EU dummy

3.8 (6.6)

2.6 (6.4)

4.5 (12.3)

3.1 (6.6)

-0.4 (-0.6)

Construction Equipment goods

3.3 (5.1)

Energy

-6.3 (-10.4)

Services

-2.6 (-4.0)

High NTB

2.2 (5.2)

Medium NTB

1.6 (3.7)

Tradable

0.5 (0.9)

constant

24.3 (6.6)

39.6 (19.8)

47.1 (21.2)

21.7 (9.9)

Number of observations

210

1,050

630

420

F-statistic

16.1

77.7

87.8

22.2

F-test for equality DM non-DM coefficients

0.18

2.65

1.15

0.04

Source: Author’s estimates based on OECD Purchasing Power Parities and Real Expenditures. Notes: The D-mark dummy has the value one if the dependent variable corresponds to two countries from the following group: Austria, Belgium, Germany, and the Netherlands. The other EU dummy has the value one for all pairs of EU countries not belonging to the core EMS group. The 5 percent significance level for the equality of DM and non-DM coefficients is 3.84.

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level). In particular, for specification three for the period 1993–1996, the hypothesis that both coefficients are equal could be rejected. This result however, is not representative. In the majority of cases, it must be concluded that the D-mark area countries have not been able to achieve a significantly higher degree of price convergence than other EU countries. Two possible explanations can be given for this result. First, private agents might not have considered the EMS arrangement (even in the countries with relatively stable bilateral exchange rates) a credible monetary union. Exchange-rate uncertainty and a lack of price transparency may therefore have persisted with only limited price convergence as a result. As EMU is a much more credible and irrevocable form of monetary union, it may have a more substantial impact on price convergence. Second, the participation in the EMS arrangement implied a convergence in inflation rates (see below). Inflation rates indeed displayed a significant convergence as the final stage of EMU came closer and closer. Given that price structures were different to begin with, this convergence in inflation rates may have slowed down the pace of relative price convergence. This may also partly explain the result found in section 1 that the rate of price convergence appears to have slowed down during the most recent period (1993–1996), a result that holds for both D-mark area countries and non-D-mark area countries. In any case, whether the lack of incremental price convergence in the D-mark area is representative of the possible effect EMU may have on prices is an open question. Our results cast doubts, however, on the hypothesis that monetary union by itself will increase competition and therefore price convergence across Europe. Structural reforms appear to be a necessary condition to achieve further progress in this area. 4.2 Monetary Integration and Incentives for Reform From a theoretical standpoint, it is optimal for a country to join a currency area under three conditions: (1) demand or supply shocks must be symmetric to those of the other countries participating in the agreement; (2) labor must be mobile across countries; and (3) real wages must be flexible.47 These conditions should be seen in a dynamic context, however, in which decision rules of private agents and government authorities may respond systematically to changes in the monetary regime. Changes in incentives for private agents and policymakers could lead to modifications in institutions, market mechanisms,


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and even in government approaches to public policy. Hence one cannot keep behavior—such as unions’ objective functions—constant while contemplating giving up monetary authority or joining a single currency. Austria and the Netherlands, two countries in the D-mark area, provide historical examples of the possible effect of monetary integration on agents’ incentives. Hochreiter and Winckler (1995) find that the optimality conditions for joining a currency area failed to hold in Austria in the late 1970s. By looking at the 1980s and early 1990s, however, they find that wages (and unit labor costs) behaved differently than in the 1970s in the sense that wage settlements responded to low growth and structural problems in the 1980s but rose at a rate that exceeded productivity growth in the 1970s. Due to this wage moderation, unemployment in the 1980s did not rise to the high levels seen in neighboring countries and the variance of real exchange rates, unemployment, and the current account balance was low in the 1980s in comparison with other European countries such as Belgium, France, and Italy. The Netherlands is another success story in the D-mark area. Following the Wassenaar agreement in 1982, progress has been made to reduce the generosity of the social-security system, increasing the flexibility of the labor market, and improving public finances. At Wassenaar, employers’ and unions agreed on wage moderation, which was further stimulated by tax cuts. The tax cuts were on the one hand financed by sobering some of the most generous welfare programs (e.g., the matching of wage increases with equal increases in minimum social benefits) and on the other hand by broadening the tax base and reducing government consumption. In fact, the budget deficit tended to fall in the ensuing years. As a result of these policies, the rate of job creation increased resulting in a steady fall in the unemployment rate. Thus not only did the Netherlands escape hardship upon pegging its exchange rate to the D-mark they also made progress toward better labor-market outcomes.48 To what extent are the significant reforms in these two countries linked to their choice to peg their currencies to the Deutsche mark? To account for a larger pool of country experiences, table 4.4 summarizes labor-market reforms and institutional changes in EU countries over the 1986–1997 period. We report reforms using two different indicators: the first five columns show “reform accounts,” providing the number of reforms by country over the 1985–1995 period in three main areas

8 1 1 3

Core-EMS Area Denmark Finland Greece

20 3 4 0

18 2

5

2

6 2

Total D-mark Area France

4 5 4

0 1 3

Austria Belgium Germany The Netherlands

14 1 4 2

11 3

2 2 2 5

42 5 9 5

35 7

6 8 9 12

59.4 41.2 39.4

19.7

42.4 45.4 36.8 61.2

Percent of total

Total

EPL Pensions

Number of reforms1 (1986–1997)

Net benefits

Follow-through of OECD recommendations2 (1990–1998)

Table 4.4 Institutional change and reform in Europe (1986–1997)

High High

Intermediate

High Intermediate High Intermediate

1980s

High Intermediate

Intermediate

High

Intermediate High

High

1990s

Centralization/coordination in

Changes in bargaining systems (1985–1997)

212 Nicoletti, Haffner, Nickell, Scarpetta, and Zoega

4.5 4.0

2.8 3.2

1.5 1.6

2.1 1.9

2.8 2.8 2.0 2.3

18 32

0 5 1 1 3 1

8.8 8.4 6.9 7.4

62 104

5 11 4 7 10 6

46.5 41.1 47.2 45.0

64.5 47.9 26.9 35 26 84.8

Intermediate Low Intermediate High High Intermediate

Source: RodolfoDeBenedetti Foundation; OECD 1999c; Elmeskov et al. 1998. Notes: 1. Reforms increasing labor market flexibility or reducing the generosity of the unemployment benefit/pension systems. 2. Percent of recommendations implemented over the period.

Averages per area D-mark area Core-EMS Area Other EU countries Total EU Area

4

1

19 27

Other EU countries Total EU Area

25 45

4 2 0 3 5

1 4 3 3 2

Ireland Italy Portugal Spain Sweden United Kingdom Low

Intermediate Intermediate Intermediate

High High


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(EPL, unemployment benefits, and public pensions)49; the sixth column provides the percentage of the recommendations contained in the OECD Jobs Strategy implemented by each EU country over the 1990–1998 period.50 The last column shows changes in the level of centralization-coordination of the bargaining systems following the classification proposed by Calmfors and Driffill (1988). The evidence reported in table 4.4 does not lead to clear-cut conclusions as to the effects of monetary integration. The mere count of reforms and recommendations suggests that countries participating in the D-mark and core-EMS areas have on average implemented a higher number of reforms than other EU countries, providing prima facie evidence in favor of a positive effect of monetary integration on the drive for reform. When reforms are weighted according to their importance for labor-market outcomes, however, as in the account of the follow through of OECD recommendations, the evidence is much less clear, with core-EMS countries showing a weaker reform effort than other EU countries. Finally, although table 4.4 suggests that countries in the D-mark area tend to move away from intermediate levels of coordination-centralization that are generally thought to lead to inferior labor-market outcomes, the evidence is by no means conclusive. Clearly, comprehensive empirical evidence on these issues is difficult to collect and hard to interpret since institutional changes and reforms are multiform, may differ in intensity, and may be implemented and enforced in different ways. In addition, the relationship among integration, competition, and reforms may also be influenced by other factors, such as the initial levels of unemployment, which may significantly affect the political economy of the reform process. Indeed, what is most relevant is the impact that institutional change and regulatory reform may have had on labor-market flexibility and performance. We therefore turn to the analysis of cross-country differences and changes over time in the sensitivity of the macroeconomy to demand and supply shocks, as a proxy for the scope and depth of reforms implemented in EU countries. We look first at nominal flexibility and then turn to evidence concerning real rigidities. 4.2.1 Nominal Flexibility When the cost of gathering information and learning about the state of the economy is significant, the optimal strategy followed by firms involves time-dependent rules or contracts. The length of such con-


215

tracts—be they wage or price-setting rules—is likely to depend on the rate of inflation, the frequency of inflation shocks (proxied by the variance of inflation), and the size of aggregate-demand shocks. The optimal contract length, and the ensuing degree of nominal rigidity, is a decreasing function of the rate and the variance of inflation because the cost of maintaining prices and wages fixed in nominal terms (i.e., the cost of maintaining a suboptimal relative price of output or labor) is higher for a given contract length the higher the rate and the variance of inflation.51 On the other hand, larger demand shocks are likely to lead to shorter contract periods and increased nominal flexibility because the larger the size of demand shocks, the greater the incentives for firms to revise prices, due to increasing marginal costs of production, and for unions to renegotiate wages, due to decreasing marginal utility of employment and wages (i.e., the convexity of union indifference curves in the real wage-employment space). Since the loss of monetary independence is likely to affect the rate and the variance of inflation as well as the size of demand shocks, the economywide flexibility of nominal wages and prices is likely to be affected by the adoption of a single currency. As Calmfors (1998) has pointed out, however, the sign of the net change is uncertain since one could expect a currency union to result at the same time in a lower and more stable inflation with larger demand shocks. Indeed the historical experience of EU countries suggests that the abandonment of an independent monetary policy has led to both low average rate and low variance of inflation. Figure 4.1 plots the average rate of inflation against the standard deviation of inflation in a sample of OECD countries during the 1981–1998 period. Clearly, D-mark countries have had lower and more stable inflation than most of the other countries; this would tend to increase the length of contracts, increasing nominal rigidities. The loss of monetary independence, however, could also raise the size of aggregate-demand shocks, because monetary policy can no longer be used to counter country-specific disturbances, tending to reduce contract length and thereby raising nominal flexibility. The empirical literature suggests that the second effect tends to dominate, with the loss of monetary independence often resulting in increased flexibility. Bayoumi and Eichengreen (1996) found that wage changes were more rapid during the period of the gold standard; Anderton and Barrell (1993) found increased wage flexibility after Italy joined the EMS; and Muet (1996) found increased flexibility in France during the same period.

216


Standard deviation of inflation

8

Por 6 NZ Ire

Ita

4 Fra Swe Nor Spa Den Can Fin Aus Bel UK Net Aut Ger USA

2 Jap 0 0

2

4

6

8

10

12

Inflation Figure 4.1 Inflation patterns in OECD countries, 1981–1998

An increase in nominal flexibility is likely to amplify movements in wages and prices and lower the effect of demand shocks on real variables, affecting the magnitude of the business cycle. First evidence on the reaction of OECD economies to demand shocks can be gathered by looking at the cyclical variability of unemployment. Economies enjoying a wider flexibility of nominal wages and prices should display a lower cyclicality in unemployment. Figure 4.2 shows the variance of the changes in unemployment, a proxy for its cyclical behavior, during the 1960–1980 and 1981–1998 periods. In countries along the diagonal the cyclicality of unemployment has remained the same in the two periods, while in countries below (above) the diagonal the variance has increased (decreased) in the most recent period. It is interesting to note that, with the exception of Germany (which had an independent monetary policy and suffered from the shock of reunification), countries in the D-mark area succeeded in keeping the cyclicality of unemployment at a relatively lower level during both periods than in most other OECD countries. Another way to check whether monetary integration increased nominal flexibility is to compare the reaction of real output to demand shocks in countries participating in exchange rate stability zones and in

Variability of unemployment over the period 1960–80


217

2.1 1.9 1.7 1.5 1.3 1.1 0.9

Bel

0.7 0.5

Por Net

Lux

0.3 0.1 0.1

Den

USA

Jpn 0.3

Ita Fra Aut Swi 0.5

Can

Ger Nor

0.7

UK

Aus

Fin

Spa

Ire

Swe

NZ 0.9

1.1

1.3

1.5

1.7

1.9

2.1

Variability of unemployment over the period 1980–98 Figure 4.2 Variability of unemployment Note: 1. The cyclical variability of unemployment is measured by the standard deviation of yearly changes in actual unemployment rates. Source: OECD.

other OECD countries. Following Ball, Mankiw, and Romer (1988), we use the change in log nominal GDP as a measure of demand shocks and estimate their impact on real GDP to measure the degree of nominal flexibility.52 We estimate the following equation for a sample of nineteen OECD countries (i = 1, . . . , 19) during the 1960–1998 period, where t is a time trend, y is the log of real GDP, and Y the log of nominal GDP: yt = a 0i + a 1i t + a2i DYt + a3i yt-1

(9)

Table 4.5 shows the resulting estimates of the sensitivity of real output to demand shocks (a2), our measure of nominal rigidity, for two subperiods, before and after the creation of the EMS.53 The estimated coefficients should be taken with caution because, due to the small number of degrees of freedom, they are quite sensitive to the period covered and they are often not significant at conventional levels. A few (prudent) considerations, however, can be made. First, countries in the D-mark area appear to be characterized by higher nominal rigidity than elsewhere in the OECD. Second, relative to many other countries, their degree of nominal rigidity appears to be more stable over time.

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Table 4.5 Sensitivity to demand shocks Time periods Country

1960–1980

1981–1998

1960–1998

D-mark area Germany Austria Belgium Netherlands

0.69 0.80 0.72 0.62

0.79 0.83 0.75 0.52

0.77 0.73 0.64 0.55

Core-EMS France

0.28

0.35

0.26

Other OECD Australia Canada Denmark** Finland* Ireland Italy

0.33 0.40 0.99 0.46 0.19 0.19

0.61 0.68 0.48 0.75 0.59 0.06

0.43 0.51 0.69 0.53 0.12 0.21

0.38 0.33 -0.01 0.44 0.23 0.35 -0.04 1.26

0.47 0.79 0.20 0.39 0.86 0.76 0.65 0.84

0.21 0.37 0.24 0.18 0.22 0.39 0.07 0.69

0.46

0.60

0.42

New Zealand Japan* Norway Portugal* Spain Sweden United Kingdom United States Average

Source: Author’s estimates. Notes: * difference between time periods significant at 5 percent level, ** difference significant at 10 percent level.

Therefore, there is no prima facie evidence that membership in a currency area has fundamentally changed the way the D-mark economies adjust to nominal shocks.54 Since the D-mark countries have had lower and more stable inflation, it is possible that this nominal convergence may explain the higher level of nominal rigidity, due to the effect of a stable nominal environment on the features of wage contracts (see above). We checked this conjecture by running a cross-country/time-series regression of the estimated nominal sensitivity coefficients (a2) during the 1960–1980


219

and 1981–1998 periods on the corresponding average rates and variances of inflation.55 The results showed that the variance of inflation explains a large amount of the variance of the sensitivity across countries and across the two time periods, with a lower variance associated to higher nominal rigidity. To further explore the channels through which nominal convergence can increase nominal rigidity, we looked at the simple correlations between the estimated sensitivity coefficients and some of the features of wage contracts in OECD countries, such as their length, their synchronization, and the presence of indexation. The correlations had the expected signs, with the degree of nominal sensitivity-rigidity being positively related to contract length (R2 = 0.32) and negatively related to indexation (R2 = -0.55) and synchronization (R2 = -0.20). Only the correlation with indexation, however, was found to be statistically significant. We can conclude that, by lowering the variance of inflation, participation in the D-mark area is likely to have made more attractive contractual arrangements, such as lengthy and unindexed contracts, favoring a relatively high degree of nominal rigidity. In such a scenario, the effect of nominal convergence appears to have prevailed over that of larger demand variability in determining the behavior of unions and firms. We were unable to find hard evidence, however, that participation in the D-mark area actually changed the behavior of agents. As noted above, if anything, the D-mark countries appear to have enjoyed more stability in the sensitivity of real output to nominal shocks than other countries, a result that was also confirmed by the inspection of the recursive estimates of the sensitivity parameters. These conclusions must be taken cautiously, however, since they hinge on our measures of nominal rigidity, which are relatively poorly estimated. 4.2.2 Real Rigidities Cross-country differences in unemployment are widely believed to be grounded in differences in the rates of structural unemployment (OECD 1994b and 1999b). If high European unemployment rates are largely structural, it is particularly relevant to establish whether giving up monetary independence is likely to lead to labor and productmarket reforms and changes in labor-market institutions with a potentially beneficial effect on structural unemployment. On purely theoretical grounds, the question is unsettled. The potential effects of monetary union on labor-market reform and institutions are essentially of two types (Calmfors 1998). First, there may be incentives for policy-

220


makers to change legislations and regulations, such as the level and duration of benefits, eligibility criteria, and employment-protection rules. Second, the strategies of unions and employers may change as a result of the modification in the policy environment determined by the loss of monetary independence. As to incentives for labor-market reform, there are several possible arguments leading to either positive or negative conclusions concerning the effects of the EMU. On the positive side, there are three main lines of reasoning. The first has to do with hysteresis effects. To the extent that such effects are significant, it is in the interest of policymakers concerned by unemployment levels to minimize the extent to which nominal shocks tend to turn into real fluctuations. Since countryspecific shocks will tend to be larger when the monetary policy instrument is lost, EMU membership should provide additional incentives to reduce real rigidities through structural policies.56 The second is based on the observation that, once domestic monetary policy cannot be used anymore to buffer country-specific shocks, the cyclical variations in unemployment are likely to be larger, leading to a higher risk of the occurrence of very bad outcomes (Calmfors 1998). Under the assumption that policymakers are risk averse (e.g., because voters are particularly sensitive to bad outcomes), incentives to implement structural reforms will increase: successful reforms will lower the structural unemployment rate, improving the “risk-return” outcome. The third builds upon the assumption that the single currency, by increasing price transparency, multiplies the possibilities for consumers to arbitrage across countries, increasing the competitive pressures placed on firms operating in EMU countries.57 As a result, relative labor costs will be a decisive factor in deciding on the location of firms within the EMU area, and governments will be keener on implementing those structural reforms that reduce labor costs relative to other countries participating in the currency union (Bean 1998). Negative arguments are essentially of two kinds. The first is based on variants of the “inflation bias” argument (Barro and Gordon 1983).58 For a country participating in the EMU, the incentive to implement structural reforms to reduce the inflation bias (which is an increasing function of unemployment) is smaller since, by definition, having abandoned monetary independence there is no more such bias at the national level (Sibert and Sutherland 1997; Calmfors 1998). On the other hand, the possible bias at the EU level is not very significant both because the ECB is likely to be less inflation-prone than the domestic


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central bank and because the ECB determines monetary policy on the basis of EU-wide developments.59 Therefore, to the extent that an inflation bias existed outside the EMU, the single currency would weaken incentives for reforms aimed at reducing structural unemployment. The second negative argument is based on the assumption that there is complementarity between structural and monetary policies (Lindbeck 1996; Calmfors 1998). Successful reforms lead to a fall in equilibrium unemployment but actual unemployment only gradually converges to this new equilibrium. If the beneficial results of labormarket reform can be accelerated by the shrewd use of demand management policies, the loss of monetary independence will make it less attractive for policymakers (whose horizon is limited by their electoral term) to pursue structural policies. Similar arguments can be used to analyze the reaction of unions to monetary unification (Cukierman and Lippi 1999). A centralized labor union that dislikes inflation is likely to restrain real-wage demands to keep unemployment down and hence reduce the incentive to inflate. In a monetary union, this tendency is reduced as the union now has less to fear from a centralized bank both because it is likely to be less inflation prone than the national bank and because it takes into account unemployment in all member countries.60 The EC (1998) argues that this negative effect of EMU on wage restraint by a centralized union is likely to be more significant for large and relatively closed countries, since they will be able to externalize more of the inflation effect while at the same time incurring relatively minor consequences in loss of competitiveness vis-à-vis the other countries. It could also be argued that, by increasing the externalities caused by differential behavior of unions across countries, EMU could change the optimal locus of wage bargaining, from the national to the EU level. For instance, a large union could induce foreign companies to relocate in its country by pursuing a strategy of wage moderation, thereby raising domestic employment at the expense of foreign employment. This could call for some form of cross-border coordination in the wage formation process, at least among countries characterized by centralized bargaining. At the same time, as argued by Gros and Hefeker (1998), there might also be a tendency to coordinate wage-setting across countries on a sectoral basis, to the extent that sector-specific shocks dominate at the EU level. In conclusion, from a purely theoretical point of view, it is unclear whether EMU will induce governments and unions to pursue structural reforms and changes in labor-market institutions that would favor

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the reduction of European structural unemployment. It is possible that a combination of positive and negative incentive mechanisms could be operating, leaving the net effect on unemployment uncertain. Although the issue can hardly be settled empirically, we can try once again to use the experience of those European countries that pegged their currency to the D-mark as a guide to the likely net effects of a monetary union on incentives for structural reform and institutional change. One way of dealing with this issue is to focus on the sensitivity of unemployment to demand or supply shocks and on the degree of persistence of the resulting changes in unemployment as proxies for the degree of real rigidity present in the economy. Real rigidity may be caused by both the lack of real wage flexibility, that is a steep wage setting curve, and the lack of product-market competition, reflected in a steep labor demand curve (see section 2). Taking an agnostic stand on the nature of the shocks affecting unemployment (the productivity slowdown, biased technological change—between capital and labor or skilled and unskilled labor—oil-price increases, high real interest rates, or the behavior of mark-ups, to name a few) we specify the following reduced-form equation for each country in our sample (i = 1 . . . 19): Duit = l i (a i + g i D - uit -1 ) + e it

(10)

where u is the rate of unemployment, and D is a vector of dummy variables, one for each of the years from 1961 to 1998. The time dummies capture global shocks in each period, while the coefficient g measures the sensitivity of the unemployment rates to these shocks (i.e., the degree of real rigidity). We make no assumption about the nature of these shocks and estimate them directly from the unemployment series itself. The coefficient a measures cross-country differences in average unemployment while l measures the persistence of changes in unemployment over time. The data were pooled and the equation was estimated by nonlinear least squares. Figure 4.3 plots the estimated global shocks and their 95 percent confidence intervals. There are three main episodes of adverse shocks, either in the form of a negative demand or a supply shock. These are the mid–1970s (oil price shock), the early 1980s (interest rate and oil price shock), and the early 1990s (high interest rates among other things). We are not primarily interested in the nature of these shocks but we wish to find out whether the reaction of unemployment in different countries can be explained by their labor and product-market characteristics. As mentioned above, the value of the sensitivity coeffi-


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25

Percentage

20 15 10 5 0 –5 60

65

70

75

80 Year

85

90

95

Figure 4.3 Shocks to unemployment

cient may reflect rigidities in both the labor and the product market. Labor-market reform (e.g., changes in labor-market institutions, welfare programs, and/or legislation on employment protection) then may affect the sensitivity of unemployment to shocks by making the wage curve flatter, that is by decreasing the degree of real-wage rigidity. On the other hand, product-market reform may act to partially offset the sensitivity to negative supply shocks by making labor demand more elastic and shifting it outwards (see section 2). To cast light on the determinants of real rigidity, we follow Nickell and Layard (1998) and regress the estimated values of unemployment sensitivity (g) and persistence (l) on indicators of labor-market institutions (union coordination, union density), labor-market regulations (unemployment-benefit replacement ratio, duration of benefits, employment protection legislation) and product-market regulation (the summary indicator presented in section 3).61 To check for the possible effects of monetary integration on real rigidity, over and above those originating from existing institutions and regulations, we follow the same approach as in the previous analysis of nominal flexibility and also include a dummy for core EMS countries. The dummy may account for differences in the policy approaches and/or the attitudes of employers and unions that are not captured by our institutional and regulatory indicators. It may also account for the effects of increased price transparency on competitive pressures faced by entrepreneurs.

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The results of the cross-country regressions (table 4.6) suggest that labor-market institutions and regulations have significant effects on both unemployment sensitivity and persistence, confirming earlier findings by Layard et al. (1991), Scarpetta (1996), and Nickell and Layard (1998). As expected, generous unemployment benefits and lack of bargaining coordination increase sensitivity, while restrictive EPL translate into a higher degree of persistence. Interestingly, restrictive product-market regulations also have a significant impact on sensitivity, reflecting their negative impact on product-market competition and, hence, on labor demand elasticity. This confirms, in a dynamic framework, the results of the previous section. On the whole, core EMS countries tend to have a regulatory environment that is not favorable to flexibility (generous benefit systems, strong employment protection, high union coverage); however, their wage formation process tends to be centralized and coordinated, implying a low level of real-wage rigidity. It is noteworthy that our regression results associate membership in the core EMS with a lower sensitivity of unemployment to shocks. Although we are not in a position to gauge the net effects of participating in a hard currency area, the results suggest that monetary integration brings about Table 4.6 Determinants of real rigidity Unemployment parameter Sensitivity to shocks (g )

Persistence of shocks (l)

Institutional and regulatory indicators

Estimate

t-ratio

Estimate

t-ratio

Constant Replacement rate Benefit duration Union density Union coordination Employment protection legation Product market regulation Core-EMS dummy

-8.80 0.11 1.30 0.002 -2.09 -0.04 2.53 -1.81

-2.2 1.9 2.7 0.1 -1.6 0.1 1.9 -2.4

0.62 — 0.03 0.001 — 0.06 — —

5.2 — 1.7 1.1 — 3.2 — —

Observations R2

19 0.67

19 0.55

Source: Author’s estimates.


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changes in policies and behaviors that enhance the real flexibility of the economy. We further explored the possible consequences of monetary integration for policies and institutions affecting real flexibility by checking the stability of the unemployment equation over time and by relating changes in unemployment to a summary measure of the reform effort made by OECD governments. The stability analysis suggested that structural breaks in the sensitivity and persistence of unemployment can be detected at the time of the creation of the hard currency area in some countries (Germany, the Netherlands and, albeit at higher significance levels, Austria) but not in others (Belgium and France).62 Finally, using the estimates of the determinants of unemployment sensitivity (table 4.6), we constructed a summary indicator of changes in labor-market institutions and policies and tried to relate it to observed differences in average unemployment rates before and after 1980.63 Although the indicator of reform effort appeared to be negatively related to the change in average unemployment rates in the Netherlands and, to a lesser extent, Belgium, the relationship did not hold for the other core EMS countries. Overall, the cross-country correlation between our indicator and changes in unemployment was very weak. Notes 1. The opinions expressed in this book are those of the authors and do not engage the organizations to which they are affiliated. We thank Olivier Blanchard, Tito Boeri, Alan Krueger, and André Sapir, and two anonymous referees for their useful comments. We also thank Olivier Boyland for statistical support and Roberta Marcaletti for editorial assistance. 2. The introduction was drafted by Giuseppe Nicoletti, section one by Robert C.G. Haffner, and section two by Stephen Nickell. Section three was written jointly by Giuseppe Nicoletti and Stefano Scarpetta, and section four by Robert C.G. Haffner, Giuseppe Nicoletti, and Gylfi Zoega. 3. A similar hypotesis has been recently formulated by Krueger and Pischke (1998). 4. Efforts to do so include Molle (1997). 5. For instance, recent OECD (1997) estimates of the expected impact of regulatory reform in five sectors of the European economy (telecommunications, electricity, airlines, road transport, and distribution) point to expected gains ranging from 3 percent of GDP in Sweden to 6 percent of GDP in Spain. 6. For example, technological change in mobile communication, accompanied by regulatory reforms, has immensely changed the sources of competitive advantage in this market, the formerly dominant players now contested by the entry of new, low-cost providers of mobile communication.

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7. Haffner and van Bergeijk (1998). 8. Different sectors may be affected by integration to different degrees, depending on a number of structural, behavioral, and policy factors that will tend to differ across sectors and countries. 9. The similarity index between countries j and k is: n

Similarity index jk = 100 - Â w i i =1

p ji - p ki * 100 p ji + p ki

where pji and pki are the average prices of product category i in countries j and k respectively and wi is the weight assigned to product i in the calculations. The similarity index between m countries is. Similarity index m =

1 m Â Â similarity jk 2 j =1 k π j

Other measures sometimes used to perform bilateral comparisons of price structures, such as the correlation coefficient, are unsuitable here as they depend on the choice of the numeraire (e.g., the U.S. price level). A change in numeraire influences both the level of the correlations and the relative ranking of the countries in price similarity. 10. We have also calculated price similarity indices weighting the various product categories by their respective OECD-average expenditure shares. For all products, the degree of price similarity is slightly lower for the expenditure weighted results, indicating that price similarity is lower for those products for which expenditures are relatively high. 11. Information on NTBs in the late 1980s and early 1990s was gathered by EC (1997a) drawing on a questionnaire among 11,000 European enterprises and a horizontal study of technical barriers in six industries. The information was used to classify all industrial sectors into three groups according to the overall impact of NTBs. Among the 113 traded goods sectors, 18 belong to a high NTB industry (e.g., those where the public sector is a major purchaser) and 35 to a medium NTB industry (e.g., due to differences in standards or administrative and technical controls). 12. The results for non-EU countries should be interpreted with caution as the NTBclassification was derived for EU sectors only. 13. The general form of the estimated equation is: simt - simt-k = a0 + a1simt-k + a2trade + a3share + a4EU + a5dummy where the dependent variable is the change in the (weighted or unweighted) price similarity of the price structures of two countries (3 £ k £ 11), simt-k is the degree of price similarity between the two countries at the start of the period, trade is a measure of the bilateral trade intensity, share is a measure of the bilateral correlation between expenditure shares, EU is a dummy that has the value one if both countries are part of the EU and zero otherwise, dummy is a dummy variable measuring the effect of the kind of product (consumer goods, energy, services, construction, and equipment goods), the level of NTBs (high, medium, or low) and the tradability of the product (tradable versus nontradables) and a0 is a constant. 14. This can be attributed to the Balassa-Samuelson effect of lagging productivity growth in services; countries with a higher living standard (which generally coincides with a higher share of the service sector) tend to have a relatively high aggregate price level.


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15. In the last section of this book, we investigate whether EU-countries participating in a stable exchange rate area have displayed a significantly different pattern of price convergence compared to other EU countries. 16. We use the logarithm of this variable since it displays a considerable variance, ranging from almost zero (e.g., between Australia and Greece) to 7.1 percent for the trade between Belgium and the Netherlands. Data on aggregate bilateral trade flows refer to 1990 and 1994. 17. Luxembourg is excluded in the regressions due to lack of trade data. 18. Using the logarithm of the initial similarity level produces the same qualitative results. 19. EC (1999b) report that price disparities (as measured by the coefficient of variation) are about 40 percent higher in the EU than in the United States. 20. In these measures, markups are defined as margins over total production costs. 21. In Gersbach (1998), however, a model is presented where more intensive productmarket competition widens the wage differential between skilled and unskilled workers. 22. This would also occur if the impact of unemployment on wage inflation is nonlinear (the “Phillips curve”). For example, if changes in inflation are driven by the difference between the log of unemployment and the log of the natural rate, the average level of unemployment will be larger the greater the variance of unemployment, even if the log of unemployment is on average equal to the log of the natural rate. Indeed, if (log u–log u*) is normally distributed with mean zero and variance s2, then the expected value of u is: E(u) = exp(log u* + 1/2s 2). Turner (1995) presents estimates suggesting that, for three of the G7 countries, the inflationary effects of a positive output gap (output being above trend) are much bigger than the disinflationary effects of a corresponding negative output gap. 23. For instance, industry concentration may be a misleading measure of market power since industry-level Herfindhal indices have little meaning in markets open to foreign competition. Similarly, relating wage premia to markups is generally inappropriate because the two are determined together. 24. The indicators used in this section are the sole responsibility of the authors and do not engage the OECD or its member countries. They report the situation in OECD countries in 1997 or 1998, depending on the country and the indicator, and are based on the information available and country submissions as of June 1999. Nicoletti et al. (1999) revised and extended the indicators based on more recent data and provided a detailed description of the database and the methodology followed in their construction. 25. The average score of the United States along this axis of regulatory intervention depends on the relatively high number of administrative procedures and services involved in business start-ups. Our indicators do not include financial market regulations (such as those affecting the provision of venture capital) and land-use regulations, which are likely to be relevant for business start-ups and labor-market performance. 26. The correlation coefficient is 0.5 and is significant at the 5 percent level. 27. The reaction of employment to changes in EPL is likely to be larger where the initial regulatory stance was more restrictive. In addition small changes in EPL on temporary work may have large effects when EPL on regular contracts remains relatively

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restrictive. An example is Spain, where the legislation on temporary work contracts was eased in the late 1980s (from a virtually complete ban), while protection of regular employees remained restrictive. 28. The correlation coefficient is 0.75 and is significant at the 1 percent level. 29. A lax EPL regulation, however, may make workers’ resistance to regulatory reform stronger insofar as insiders would be less protected in the event of redundancies. 30. See OECD (1999b); Coe and Snower (1997); and Elmeskov et al. (1998) for a discussion of policy interactions. 31. For the purposes of this section the industry aggregate includes manufacturing, electricity, gas, and water, and construction; the service aggregate includes retail, wholesale and hotels, transport and communication, banking, insurance and business services, and private personal services. 32. Employment in the government and business sectors are not independent over the long-run to the extent that increases in government employment may crowd-out employment in the business sector either directly or through the increase in taxation required to finance it. Even in the short-run, employment in the two sectors may closely interact if governments try to compensate for employment losses in the business sector by inflating public employment. Some cross-country evidence supporting this kind of short-run interaction between the two employment rates is provided by Saint-Paul (1998). 33. It is important to note that in this table (as well as in table 3.3) not all indicators of product-market regulations are assumed to exert an independent influence on employment. Indeed, many of these indicators are strongly correlated and should be interpreted as representing different aspects of the same phenomenon. 34. The gap variable is defined as the proportional difference between actual and trend output, where the latter is estimated by applying the Hodrick-Prescott filter to GDP. To minimize possible problems in estimating trend output at the two extremes of the series (1983 and 1995), we have used longer time-series from 1970 to 1998. Moreover, the assumption of an identical parameter for the gap variable across all cross-sectional units does not affect significantly the estimated coefficients for the other explanatory variables. An alternative equation with country-specific coefficients for this variable produced similar results. Results remained unchanged also in another specification where the gap variable was instrumented with its lagged value to account for potential endogeneity problems induced by the simultaneous determination of employment and output along the business cycle. 35. Details on the construction of the institutional and policy variables can be found in Scarpetta (1996). Time varying indicators of the degree of centralization and coordination in wage bargaining are reported in Elmeskov et al. (1998). The methodology used to construct the time-varying EPL indicator is described in Nicoletti and Scarpetta (2000). 36. A diagnostic analysis based on the studentized residuals and the leverage values suggest that several observations significantly increase the standard error of the regression or affect the estimated coefficients. These observations have been removed from the sample: 1995 for Finland and Japan; 1994 for Ireland; 1987 and 1994 for Norway; 1987 for New Zealand; 1991 for Portugal; 1985 for Spain; and 1984 for the United States. See Scarpetta (1996) for details on the tests used to identify outliers in the data set. 37. There are several sources of potential bias that may explain why the coefficient of the public employment rate is less than unity. For instance, the use of public employ-


229

ment as a countercyclical policy measure will have the tendency to cause a spurious negative correlation between the dependent variable and the public employment rate; errors in measuring employment or specification errors in the equation will also tend to bias the coefficient of public employment downward. 38. In the tables the reference group includes countries with a low index of centralization-coordination. Therefore, the estimated coefficients on the other two groups refer to the performance of these systems relative to decentralized-uncoordinated bargaining systems. A positive coefficient implies, other things being equal, a positive effect on the employment rate of the bargaining system with respect to the decentralized system, and vice versa. 39. Among others see: for the United States, Krueger and Summers (1988); Katz and Summers (1989); for Japan, Tachibanaki and Ohta (1992); for Germany, Bellman and Möller (1993); for Canada, Gera and Grenier (1994); for Sweden, and a comparison with the United States, Edin and Zetterberg (1989); for Austria and Norway, Barth and Zweimüller (1992); for Switzerland, Ferro-Luzzi (1994); Katz and Summers also estimated rents going to capital owners in the United States and found that they are very small. 40. The extensive research on the effects of deregulation on sectoral employment and pay developments in the United States suggests that the relationship between restrictive regulations and wage premia is particularly strong in service industries (for an overview, see Peoples 1998). It was impossible to look at these industries, however, in the context of this book; international comparisons of service-sector productivity and wages are problematic and few cross-country details on regulation and market structure in service industries were available at the time of writing. 41. Throughout this section, we used the 1993 data on purchasing power parity (PPP) compiled jointly by the OECD and Eurostat to approximate product prices for manufacturing and services industries. To this end, a mapping was established from 202 basic expenditure headings (in which the collection of 2,000 expenditure prices of individual goods is aggregated) to the classification of industries of the international sectoral database (ISDB). 42. Microstudies often employ detailed data on job tenure, fine occupational and education breakdowns, data on geographical location, and so forth. Work-place characteristics include working hour schedules and data on other working conditions 43. This result is confirmed by Katz and Summers (1989) for the United States and Tachibanaki and Ohta (1992) for Japan, while the link between innovations and wages is confirmed at the firm level in the United Kingdom (Van Reenen 1994). 44. “Excess burdens” are defined as the difference between the indicators of administrative burdens on the creation of corporations and sole-proprietor firms. These indicators summarize several kinds of administrative requirements to be fulfilled to create the two kinds of firms: number of procedures (e.g., registration, licence, etc.) necessary before and after the establishment of the firm; number of levels of government to be contacted; minimum capital requirements; direct administrative costs, etc.). 45. Value-added mix indices were constructed that are specific to each of the three sectoral aggregates. Relative sectoral productivities were assumed to be those of the OECD average. 46. See Grubb and Wells (1993); OECD (1994b).

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47. See Mundell (1961). 48. Note that the employment-population ratio, however, is still fairly low due to low labor-force participation rates. Around 13 percent of the population is now counted as disabled, although this is mainly the result of policy errors in the 1970s. 49. Public pensions are included to account for the role of early retirement in providing income support to the unemployed. 50. In the context of the OECD Jobs Strategy, country-specific recommendations were formulated covering labor-market policies and education policies as well as policies affecting the business environment. Progress made in implementing these recommendations is discussed in OECD (1999b). In the table, the follow-through rate refers to reforms in the labor market only. 51. By contrast, in menu-cost models the effect of higher inflation on the frequency of price adjustment is indeterminate as—within the class of Ss rules—the size of the band of inaction is affected. 52. The implicit assumption is that the aggregate demand curve is unit elastic, making the product of prices (GDP deflator) and real output independent of supply shocks. 53. The EMS was created in 1979 with eight participating countries: Germany, France, the Netherlands, Belgium, Italy, Denmark, Ireland, and Luxemburg. At the end of 1979, however, there was a reajustment of the parities. 54. Recursive estimates of equation (g) also suggest that the evidence of changes in nominal flexibility in the EMS zone is weak. 55. We estimated the following equation using the thirty-eight observations: a 2i = b0 + b1p + b2sp + b3DY + dEMU The coefficient of sp had a negative sign and a t-statistic of -3.7. The coefficients of the other variables were insignificant. The EMU dummy was included to check whether participation in the hard-currency area would have effects on nominal flexibility independent of those implied by nominal convergence. 56. The popular belief that the loss of the exchange-rate instrument would imply that there is no alternative but to implement structural policies is implicitly based on a similar argument. In fact, unless hysteresis effects are significant, exchange-rate depreciations are no substitute for structural policies since they can only smooth out cyclical unemployment with no effect on its structural component (Calmfors 1998). 57. The evidence on price convergence in the D-mark area presented in this section suggests, however, that the effect of price transparency on competitive pressures cannot be taken for granted. 58. Inflation bias occurs when the incentive to inflate is larger at higher rates of structural unemployment (because voters and policymakers do not differentiate between a high cyclical and a high structural unemployment). Therefore, the pressure to undertake fundamental labor-market reforms is higher in countries that have a discretionary monetary policy since this is likely to reduce the temptation to inflate. 59. In the EMU, high structural unemployment in one country imposes a negative externality in the form of an inflation bias on other countries, and a low level of structural unemployment in any one country imposes a positive externality on other countries in


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the monetary union because of a reduced inflation bias. The externality arises because of the centralized nature of monetary policy and the decentralized nature of labor-market policy. 60. This is again an externality problem. A large union in any one member country imposes a negative externality on other countries by demanding higher real wages resulting in higher domestic unemployment. The externality is felt in higher rates of inflation in the other countries. Similarly, there is an external benefit to wage moderation by a large, national union. 61. Data on labor-market institutions and regulations was drawn from Nickell and Layard (1998). 62. Structural stability was investigated by estimating the following linearized version of equation (10) (using the estimated global shocks as hard data), which also includes a domestic inflation shock to assess the level of nominal-price rigidity (see Layard et al. 1991 and Phelps 1994): Duit = f1i + f 2i uit-1 + f3iD + f4i Dp + eit where f2 measures the persistence of unemployment, f3 the sensitivity to global shocks, and f4 the sensitivity to nominal shocks. Among core-EMS countries, Chow tests of a break in 1980 were significant at 5 percent levels for Germany and the Netherlands and at 15 percent levels for Austria. 63. The indicator was defined as: reform = -( 0.08*D( repl. ratio) + 0.98*D( ben. duration) + 0.02*D( union dens.) - 1.45*D( union coord.)) 2.53). Product-market regulation could not be included because it is only observed for one period.

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Comments Olivier Blanchard

This is an extremely informative book on a difficult issue. It has two main strengths. It is intellectually honest; it is not a pamphlet about the evils of economic rigidities, but a balanced review of the theoretical arguments, together with a careful examination of the empirical evidence. It shows the power of OECD resources at work: the new set of indexes for goods market distortions represents a gigantic amount of work. It is not something that an individual researcher could have constructed alone. It proves useful here, and will prove useful to other researchers in the future. For both reasons, this book may well become a standard reference on what we know about product-market rigidities and labor-market performance. The study suggests that, while product-market liberalization is desirable on many grounds, one should not expect miracles in the labor market. One wishes for a stronger bottom line, but I suspect the authors have reached the right conclusion and for a simple reason: if the goal is to improve labor-market performance, then the first set of institutions one should look at is labor market, not product-market, institutions. For example, were we to fully eliminate state-provided unemployment insurance—something I do not condone—I am confident that the equilibrium rate of unemployment would substantially decrease in Europe. No product-market reform is likely to have, even remotely, effects of this magnitude. This is not to say that product-market reforms or financial market reforms do not matter. They matter enormously, but they surely matter much more for output and productivity than for unemployment. Most of the focus of this book is on the steady-state effects of productmarket regulations on the labor market. This is obviously the right first step. I think the dynamic effects, however, the effects on the path of employment and unemployment of product-market liberalization, are

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likely to be very important and that we have a number of clues as to what might happen. 1 Product-Market Restrictions: Causes and Effects A few years ago, I participated in a McKinsey study of differences in productivity across France, Germany, Japan, and the United States, by sector (McKinsey 1997). It gave me a much better idea of how productmarket restrictions affect an industry, and, by implication, a much better idea of what the effects of product-market liberalization may be. The first part of this book involves using detailed industry information together with PPP adjustment for prices to do productivity comparisons across the four countries. Figure C.1 gives a summary of the results. On average, for the six sectors the study focused on, labor productivity in both France and Germany was equal to 80 percent of labor productivity in the United States. In the automobile industry, labor productivity in France was only 55 percent of best practice (in West Germany France

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Figure C.1 Summary of the economic performance analysis at the industry case level, 1994/95

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this case, Japan rather than the United States), and labor productivity in Germany only 70 percent of best practice. The second part of this book involves trying to identify the sources of these productivity differences for each sector. Figure C.2 gives a summary of the conclusions for the automobile industry. The conceptual approach followed by McKinsey proceeds in three steps: look first at external factors, from macroeconomic policy, to product, labor, and financial-market regulations; then look at the impact of these external factors on industry dynamics, from the degree of competition to exposure to best practice; and finally, go to the organization of production and the implications for productivity. In the case of the automobile industry, the conclusions were very clear. Much of the lag behind best practice was due to a lack of competition, due in particular to protection from foreign (especially Japanese) competition. This lack of competition had two main effects on industry performance: 1. Higher rents, in the form of higher markups (irrelevant for productivity, but very relevant when we think about product-market reform). Important

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• Fiscal and macroeconomic environments • Product market – Competition/concentration rules – Trade/FDI barriers – Product regulations – Other industries/up- and downstream • Labor market – Labor rules/unionism – Relative labor cost • Capital market – Corporate govemance/government ownership – Relative cost of capital/inermediation

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1 Explaining > 10 percentage points of the overall productivity differences 2 Explaining 3–10 percentage points of the overall productivity differences 3 Explaining 0–3 percentage points of the overall productivity differences 4 Financial pressure (resulting from product regulations) offsetting lack of pressure from owners (In France) Sourese : MMcKinsey

Figure C.2 Causality for productivity differences—automotive

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2. Lower productivity, coming from a lack of exposure to best practice. This was the main source of differences between what had happened to the U.S. industry and what had happened in Europe. Faced with increased competition, the U.S. automobile industry had gone through crisis and resurrection, but the European industry had not. The study identified three specific shortcomings of the European automobile industry: (1) a poor organization of tasks, that is too many workers; (2) a poor design and use of economies of scale; and (3) inefficient relations with suppliers. What are the implications here? Were France and Germany to allow for more competition in the automobile market, the effects, the book suggestes, would be twofold. First, as emphasized by Nicoletti et al., there would be a large decrease in rents. Second, there would be a potentially large effect on productivity and output. Let me now generalize from the automobile industry to the economy as a whole and ask the question: If deregulation led to lower rents and higher productivity, what would be the dynamic effects on unemployment? 2 Deregulation, Productivity, and Unemployment Let us start with productivity. If deregulation were to lead to a productivity boom—or more accurately, to higher productivity growth for some time—what would be the likely effects on unemployment? The answer from both theory and empirical evidence is fairly clear. In the long run, the higher level of productivity should have roughly no effect on the unemployment rate. This is probably one of the best established facts in macroeconomics: the steady increase in productivity over time has not led either to a steady increase or decrease in the unemployment rate (it has been associated with a steady decrease in the number of hours worked, but there is little in common between the determinants of unemployment and the determinants of the laborleisure choice). Because of this long-run neutrality proposition, the study by Nicoletti et al. does not focus on the implications of productivity gains on unemployment, and in the long run, this is clearly right. The empirical evidence also suggests, however, that the long run may be very long in this case, and the dynamics are important. If it takes some time for higher productivity growth to be reflected in an increase in wage demands, equilibrium unemployment will be lower

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for some time. The evidence suggests that, higher productivity growth leads to lower unemployment for some time: Looking at unemployment and TFP growth across time suggests that high TFP growth after WWII was associated with low unemployment, while lower TFP growth from the mid-1970s was associated with an increase in unemployment. The proximate cause appears to be that, as TFP growth decreased, real wage growth took some time to adjust to this new reality, leading to an increase in labor costs and to higher unemployment. (This statement is based on the empirical work in Blanchard 1998.) •

Looking across European countries, one can read the Irish miracle as an example of what higher TFP growth can accomplish. Since the mid-1980s, largely under the influence of FDI, TFP growth has been high in Ireland. As real-wage growth has lagged behind, labor costs have dropped and unemployment has steadily decreased. The Irish experience is largely idiosyncratic: labor mobility between Ireland and England has limited wage growth in Ireland to be roughly the same as in the United Kingdom where TFP growth was lower. This effect would not be present in an economy without such labor mobility, but it is still relevant. To the extent that product-market deregulation leads to higher productivity growth for some time, it is likely to lead to lower unemployment for some time as well. This is good news. •

3 Deregulation, Rents, and Unemployment Let us ask the same question about rents as we did for productivity. If deregulation were to lead to a reduction in rents, what would be the likely effects on unemployment? The answer is much less clear than in the case of productivity. It depends on what happened to the rents, on who captures them, firms or workers. If firms kept the rents, then their elimination is likely to do some good, both in the short and the long run. This is the case the book mainly focuses on when it looks at the effect of a decrease in the markup brought forth by higher competitive pressure. A decrease in the markup in effect increases the real wage paid by firms (by reducing the price of goods relative to the nominal wage). This is likely to lead to a decrease in unemployment, at least for some time.

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It may be that the rents were captured, however, by the workers. Such capture can take many forms: higher wages in sectors with higher monopoly power, or similar wages, but various degrees of excess employment—labor hoarding. There is plenty of evidence that both forms are present in practice. If this is the case, then the effects of product-market liberalization on unemployment may be quite different. Take for example the case of labor hoarding. Suppose that productmarket deregulation leads to higher competitive pressure, which in turn forces firms to eliminate labor hoarding. In the short run, the elimination of labor hoarding means higher layoffs and so an increase in unemployment. Other things being equal, the reduction in labor hoarding means higher profits. This may in turn lead to more capital accumulation and more employment over time. The bottom line is that the reduction of rents may lead to higher unemployment for some time. This is bad news. Why do I insist on this case? Because I believe it is not a hypothetical case but rather something we have observed for some time in Europe. 4 The Last Fifteen Years: Capital Shares and Unemployment Figures C.3 and C.4 show the evolution of two central macroeconomic variables in France, Germany, and Italy since 1970. The variable plotted in figure C.3, the unemployment rate, is familiar. And so is its evolution, the steady increase in unemployment since 1970. Much less attention has been paid to the variable plotted in figure C.4, namely the capital share in the business sector of the economy. Note the evolution: a drop in the share in the 1970s, but a much larger increase since then. In all three countries, the share stands at a historical high—at least in recorded statistical history. For example, the capital share in France stands in 1999 at more than 10 percentage points above its 1981 level, an enormous swing by historical standards. There are many ways to interpret the evolution of the capital share, but my interpretation of the evolution of the capital share is that the increase in the capital share reflects in large part a decrease in labor hoarding by firms since the early or mid-1980s. Blanchard 1998 presents the full argument, but the intuition behind this interpretation is straightforward. By definition, reducing labor hoarding means decreasing employment at a given wage; this clearly generates unemployment,

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Figure C.4 Unemployment rates in France, Germany, and Italy

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at least initially. Decreasing employment at a given wage also implies a reduction in the wage bill and thus a reduction in the labor share— equivalently an increase in the capital share. Thus, a decrease in labor hoarding can explain both why unemployment has remained high since 1985 (when a number of other factors should have led to a decline), and why the capital share has increased so much since then as well. This decrease in labor hoarding—if indeed this is the right interpretation of what has happened—may not have been due to productmarket deregulation. It may have come instead from a decline in the bargaining power of unions for any number of reasons, from changes in labor-market institutions, and so forth. It may be a portent, however, of what will happen as a result of product-market regulation, namely more unemployment for some time. Another empirical observation may be relevant here. Since 1985, the unemployment rate in southern Italy has jumped from 12 to 22 percent, while the overall unemployment rate remained roughly constant. While one can think of a number of factors, one major factor appears to be considerable reduction in subsidies to firms in southern Italy (in the process of transition from national subsidies to EU based “structural programs”). This is a clear warning that, as desirable as reductions in subsidies may be, they may well come at the cost of higher unemployment, for quite some time. To summarize: product-market restrictions, and by implication, product-market liberalization have major effects on rents and productivity. Some of the effects of liberalization (higher productivity, lower markups) may lead to lower unemployment for some time; some of these effects (decrease in rents going to workers, decrease in labor hoarding) may instead increase unemployment for some time. What I have done in my comments is to attempt to identify the mechanisms. One could wish to sign the net effect, but this would require having more knowledge than most of us have at this point. References Blanchard, O. 1998. “Revisiting European Unemployment, Capital Accumulation and Factor Prices.” NBER working paper, no. 6566. McKinsey Global Institute. 1997. Removing Barriers to Growth and Employment in France and Germany. McKinsey.

Comments André Sapir

During the past twenty-five years, the EU, the United States, and the world economy in general have undergone important shocks and changes. Most economists appear to agree that, compared with the United States, Europe has displayed little aptitude to respond to the new set of economic circumstances. One of the manifestations of this inadequate response is the unemployment problem afflicting European society, which is generally viewed as a result of sclerotic labor markets. Labor markets are far from being alone in their failure to respond appropriately to changes confronted by Europe. Other markets also suffer from sclerosis. In general, it is probably fair to claim that most product and factor markets in Europe are less responsive to changes than in the United States. This situation translates into a significant difference of per capita GDP (measured in PPP) between the two sides of the Atlantic. During the thirty years after WWII Europe was able to catch up with the United States, but the gap between the two continents has remained nearly constant since the late 1970s and it has even increased during the 1990s. Today, per capita GDP in the United States is 45 percent above the EU15 level, which suggests that structural deficiencies remain important in the EU. The gap in per capita GDP between the EU and the United States relates to problems in both product and labor markets. Deficiencies in product markets probably explain why labor productivity in the United States was, in 1997, 20 percent higher than in the EU15, whereas deficiencies in labor markets are probably responsible for the fact that the U.S. employment rate is about 10 percentage points higher than in the EU. The study by Nicoletti et al. deserves to be commended for enlarging the scope of investigation of Europe’s problem beyond the traditional analysis of labor markets and into the difficult realm of product

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markets. The only market that is not covered by their study is the financial market. As readers will recall, the single market program (SMP) (“Europe 1992”) was designed to improve the functioning of product and financial markets by removing barriers to free circulation inside the EU. It did not address directly, however, the functioning of labor markets. A few years ago, the EC attempted to make an economic evaluation of the SMP.1 We were able to provide a measure of the extent of product-market integration based on price comparisons, but this measure was only partially adequate. Nicoletti et al. use two measures of product-market integration: one based on price comparisons as in the EC work and the other based on product-market regulation. Price comparisons are useful, but they need to be supplemented by studies about the behavior of prices such as those by Engel and Rogers.2 One such study was undertaken recently by Natalie Chen, who adopts a two-stage research strategy.3 In the first stage, Chen uses monthly observations for domestic output price indices for NACE three-digit sectors. Chen tests mean reversion toward PPP by sector for five countries (Belgium, France, Italy, the Netherlands, and Spain) relative to Germany. Her findings indicate that prices behave differently across countries (mean reversion generally occurs for Belgium, France, and the Netherlands, but not for Italy and Spain) and across sectors. In the second stage, she estimates probit equations for the probability of mean reversion based on the results of stage one. Chen’s findings indicate that this probability is influenced by country variables (exchange rate volatility and distance) and sectoral variables (nontariff barriers, product differentiation, and market concentration). The main contribution of the study by Nicoletti et al. lies in the construction and analysis of an indicator of product-market regulation. This opens an extremely fruitful line of research. Precisely because of its importance, I want to underline two major problems that I see with this indicator. First of all, the indicator of product-market regulation focuses almost entirely on the country dimension, excluding the sectoral dimension. This is regrettable because, contrary to labor markets where the country dimension clearly dominates, product markets exhibit a very strong sectoral dimension. The other problem with the indicator lies in its focus on government regulation, whereas barriers to competition in product markets can also arise from the behavior of firms, which again relates to the sectoral industrial organization.

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Leaving aside these considerations, I want to turn to the indicator itself as a measure of product-market regulation. How should we go about testing whether the indicator provides a reliable measure of the extent of product-market regulation? In the case of labor-market regulation, the reliability of the indicator previously constructed by the OECD could easily be verified with the help of a simple indicator of labor-market performance, such as the employment or unemployment rate. By analogy, an appropriate indicator of product-market performance could be labor productivity for OECD countries with similar factor endowments. Using labor productivity as a check, the indicator of product-market regulation devised by Nicoletti et al. appears to perform well when comparing the United States with the average for the EU. The results are far from satisfactory, however, for intra-EU comparisons. Here are two examples. Italy ranks near the top and the United Kingdom ranks at the bottom on the product-market regulation scale, whereas the former outperforms the latter in labor productivity. The same holds true for Belgium, which ranks second in regulation, and the Netherlands, which ranks near the bottom of the scale. Despite a certain degree of skepticism about the indicator itself, I not only accept but share the key assumption of the study, namely that product-market competition interacts with labor-market regulation to affect employment performance. The authors offer a great deal of (weak) econometric evidence in support of their assumption, however, they are commendably forthright about the shortcomings of their results. The authors also seek to evaluate the likely impact of economic and monetary union (EMU) on product-market competition and labormarket regulation. The study rightly argues that in theory EMU could either increase or decrease labor-market regulation, hence, the question is essentially an empirical one. To provide empirical evidence on the link between EMU and labormarket regulation, the authors attempt to draw lessons from the European monetary system (EMS). Unfortunately, the EMS is a poor proxy for EMU. The latter consists of two channels in the context of the issues raised in the study: a macroeconomic channel operating through the strong expectation of price stability, and a microeconomic channel operating through increased competition in financial and product markets. Both channels are relevant, but the authors choose to concentrate on the macroeconomic one, which is probably the least powerful

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of the two channels as far as the potential impact on labor-market regulation is concerned. Greater competition in financial and product markets induced by EMU is likely to translate into greater competition and lower regulation in labor markets, at least initially, a tendency that labor would want resist. Since the labor market is essentially a political market mediated by governments, the issue of the effect of EMU on labormarket regulation boils down to the reaction of governments to the expected pressure. Governments in all EMU member countries are deeply committed to the success of EMU. Most have come to realize that the smooth functioning of monetary union requires the implementation of structural reforms designed to improve the functioning of all EU markets, including labor markets. This awareness has led to the so-called Cardiff process, whereby the European Council (EC) asked for closer monitoring on and coordination of structural reforms.4 The system of peer pressure established by the Cardiff process has already borne fruits. Indeed, the 1999 broad guidelines of the economic policies of the member states and the EC adopted by the council on recommendation by the commission include, for the first time, country- and marketspecific suggestions for structural reforms. Lastly, I want to address the issue as to whether increased competition in product and factor markets and lower regulation of labor markets at national levels may lead to renewed efforts toward social regulation at the EC level. Throughout the history of European integration, there has been a debate about the relationship between liberalization and social protection. On the one hand, optimists have claimed that liberalization “naturally” leads to harmonization through convergence of economic conditions. On the other, pessimists have asserted that harmonization is required prior to or in conjunction with liberalization so as to avoid social dumping or a race to the bottom in social protection. As long as European economic integration generated rapidly increasing incomes and low unemployment, optimists were vindicated. With the slowdown in income growth and rising unemployment since the late 1970s, however, pessimists have become louder in Europe.5 This suggests that the prospect for EMU to promote EU social regulation will depend upon the effect of EMU on income and employment.

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Notes 1. European Commission, “Economic Evaluation of the Internal Market,” European Economy, Reports and Studies 4, 1996. 2. See, for instance, C. Engel and J. Rogers, “How Wide is the Border,” American Economic Review 68, 1996. 3. N. Chen, “The Behavior of Relative Prices in the European Union: A Sectoral Analysis,” ECARE, Université Libre de Bruxelles, mimeo, 1999. 4. See “Economic and Structural Reform in the EU (Cardiff II),” A report by the European Commission, 1999. 5. See A. Sapir, “The Harmonization of Social Policies: Lessons from European Integration,” in J. Bhagwati and R. Hudec (eds.), Fair Trade and Harmonization, Cambridge: MIT Press, 1996.

Conclusions: Is There a Role for Supranational Institutions? Tito Boeri

The two studies presented in this book shed light on the complex institutional transformations taking place in Europe and on their likely effects on the labor market. They also provide important background material for policy, and in some areas formulate explicit policy recommendations. In the first part, desirable features of social policies in a united Europe are identified and supported by sound theoretical arguments. In the second part, the benefits deriving from a furthering of product and labor market liberalization are pointed out in a carefully documented and balanced way. A key issue raised concerns who should lead Europe from here to there, which level of government should be in charge of the institutional transformations going on, and who should direct regulatory changes to reach the long-term objectives set by the authors. The main issue is to which extent national authorities and/or EU-level decisionmaking should be governing this process. An apparent tension exists between the two studies in this respect, which is important to point out, as it may otherwise mislead the reader. The research by Giuseppe Bertola, Juan Jimeno, Ramon Marimon, and Christopher Pissarides (Bertola et al. henceforth) suggests that important results can be achieved without necessarily strengthening EU institutions. The policy prescriptions developed in the first part of this book are indeed all compatible with EU institutions, which lack politically accountable executive power at the central level and are subject to strong unanimity requirements in central decisions. In principle, even without reforming European institutions, it is possible to implement the first proposal made by Bertola et al., namely to harmonize programs of social assistance of last resort. Clearly, such programs should entail limited international redistribution, as large cross-country transfers would require strong EU institutions in charge

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of running income-of-last-resort schemes. The other prescriptions of Bertola et al. involve some EU-level policy coordination, which can be achieved possibly without stronger supranational authorities. In the field of social insurance, in particular, it is recommended that mandatory minimum contribution rates be coordinated at the EU level, leaving to national entities the task of designing such schemes. The EU should make sure, however, that social-insurance schemes can be financed in a sustainable way by contributions to preserve appropriate labor-mobility incentives. All other social-policy interventions, according to Bertola et al., should be left to local decision-makers and fully financed at the local level to accommodate the wide heterogeneity of preferences and economic means within the EU. The Luxembourg process is criticized in this study insofar as it aims at imposing specific models on necessarily country-specific labor-market policy strategies and reform trajectories. The second study, by Nicoletti, Haffner, Nickell, Scarpetta, and Zoega, does not address explicitly the issue of supranational authorities. A key message of this study, however, is that while the benefits from liberalizing product and labor markets can be substantial, there is no guarantee that EMU and, more broadly, the furthering of the European economic integration process, will deliver environments with less product-market restrictions and, above all, less employment protection. Nicoletti et al. argue and show, based on the rich body of empirical evidence they assembled, that restrictive product- and labormarket regulations are closely interlinked. Environments more prone to restrict competition in the product markets also tend to offer more protection to labor-market insiders and vice versa. Nicoletti et al. suggest that regulatory reforms should go hand-in-hand in product and labor markets. Simultaneity in regulatory reforms of product and labor markets can win resistance to change and makes it more likely that liberalization exerts positive effects on employment. As regulatory reforms lead to better outcomes, the authors conclude, there is a potential role to be played by the European institutions, both in coordinating national reforms and in setting the framework for Europe-wide policy actions. Although the EC has a mandate and executive powers in the area of product-market regulations—and the EC has indeed played a key role, according to their study, in dismantling regulations that were unfriendly to competition—it has no powers in the field of labor-market regulations. Hence, from these facts and arguments one may be tempted to draw the conclusion that supranational authorities

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prerogatives should be strengthened on labor-market regulation front, at least to match those prevailing in the field of product-market reforms. In the first part of the book, we have a study on social policy— making a strong case in defense of relatively large, albeit more efficient than in the current European landscape, social welfare systems—that does not advocate stronger supranational powers. In the second part of the book, we have a study illustrating the benefits deriving from more competitive markets, which provides arguments for stronger EU institutions. How can this contrast be? It is because the two studies put the debate on a new footing. We are at least one step ahead of the traditional dichotomy between, on the hand, advocates of social protection and, on the other hand, apprentice liberals. There is also no distinction between optimists and pessimists of European integration, the historical divide recalled by André Sapir in his comments. There is no room for ideological statements in this book, as acknowledged by all the discussants. This is an important achievement in its own right, as all too often caricature prevails over reasoning when these highly sensitive topics are addressed, even when scientists, rather than politicians, are at work. The tensions between the two parts of this book are also much less marked than it may appear at first sight. The stronger supranational prerogatives in the field of labor-market policy that should match the EC powers on product-market regulations are much more in the spirit of negative integration than in the logic of positive integration. Supranational powers are needed to dismantle existing protections rather than to introduce brand new EU-wide regulations. If the Luxembourg process was only an exercise in which the EC simply pushes through reforms of employment protection legislation and restrictions to regional and cross-country labor mobility, I believe that Bertola et al. would be much less critical of this exercise. They would also be more sympathetic with the spirit of the EC employment guidelines if these were confined, in their “positive” interference with national policies for employment, to circulating information on best practices, making full use of the policy experiments going on in Europe, and persuading governments to follow some policies that proved successful elsewhere. In the first part of this book it is clearly stated that full advantage should be taken of wide experimentation, ensuring the availability of information as to the character and effectiveness of social policies. The issue is that the Luxembourg process currently goes much beyond this; for

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example, it defines thresholds to be reached by active labor-market policy intakes in all countries of the EU no matter what their labormarket conditions and characteristics of the unemployment pool look like. One of the key reasons why it is risky to rely on supranational powers in this field is that institutional features are very closely interconnected. The linkages between product- and labor-market restrictions, documented by Nicoletti et al., are matched by the country clusters and institutional trade-offs (e.g., less unemployment insurance more employment protection) characterized in the first part. They are also described in Olivier Blanchard’s insightful remarks. These institutional linkages imply that reforms need to be comprehensive to be successful. Comprehensive reforms, however, should necessarily work on country-specific institutional clusters. The fact that the policy recommendations developed in this book do not challenge the broad character of EU institutions means that they can be implemented rather quickly. We may have different views as to whether in the long run the EU will and should have an elected executive providing democratic consensus to more ambitious EU social policies. It would be dangerous, however, to postpone the reforms of social policy in the EU to a necessarily long-run institutional rebuilding process. Policy review exercises carried out at the EU-level, for example, in the context of the Cardiff process, as well as multilateral surveillance by international organizations on the implementation of structural reforms can appreciate institutional differences across EU countries and be respectful of national specificity. As acknowledged by three senior economists, however, with longstanding experience in this field, who intervened at the Genoa conference—David Coe (IMF), John Martin (OECD), and Georg Fischer (EC)—peer reviews and multilateral surveillance exercises can do little to bind governments to push through reforms. The pressure of national lobbies defending productand labor-market restrictions is much stronger than the persuasion profusely dispensed in the context of these policy review processes. These may have some impact on national policies only when they are used for screening purposes, for instance, in the context of negotiations with countries that want to join the EU. In this case, the desire to please the EC may be sufficiently strong to stimulate candidate countries to take the steps that are advocated in these multilateral surveillance exercises. It is much more difficult for policy reviews to have some impact on

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national policies for the countries that are already members. This does not mean, however, that it is not worth trying. The problem with having EU-level decision-making under majority rule in charge of the structural reforms discussed in this book is in the pressures to harmonize institutions. Social Europe is so heterogeneous—and social policies so strongly interlinked with redistributional policies—that majority voting may result in some countries being always in the minority. The problem lies not in the fact of having someone from the outside pushing national governments to act. Quite the opposite is true: as stressed by Gøsta Esping-Andersen in his stimulating comments, external pressures have played and can play a very important role in legitimizing reforms undertaken by governments facing powerful lobbies that oppose reforms. If external pressures for reform cannot be too strong, there is no alternative other than trying to identify ways to reduce the opposition of internal pressure groups. There ought to be reasons why small EU members have often been most successful in undertaking fundamental reforms of employment and social protection without meeting strong political opposition. There must be some explanation for unions and employers associations resisting reforms more in some countries than in others. These issues were not discussed in this book, which is focused on long-term outcomes rather on politically feasible reform trajectories. Further work carried out by the Fondazione Rodolfo Debenedetti will try to address these important dimensions of labor-market and social-policy reform in Europe.

Appendix: Taking Stock of Social Policy Reforms in Europe Fondazione Rodolfo Debenedetti

Figure A.1 Reforms of Employment Protection Legislation (EPL) in Europe (1986–1997)

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Table A.1 Reforms of Employment Protection Legislation (EPL) in Europe (1986–1997) Austria

1993: The employment security law is introduced, written justifications to the labor office and compulsory contributions to older-worker retraining programs may be required in the event of the lay-off of workers over 50 years old. The employment contract adjustment law came into force. It stipulates that when a company is taken over, the existing employment contracts have to be taken over too. This does not apply if the sale is the result of bankruptcy proceedings. 1996: To promote the recruitment of older workers and to prevent layoffs a “plus/minus” system was introduced on 1 April 1996. It specifies that employers have to pay only half of the employer’s unemployment benefit contribution if they take on an employee over 50 years of age. If they take on someone over 55, this contribution is waived entirely. If an employer lays off an employee of over age 50 who has been working for the company for ten years or more, on the other hand, he/she has to pay a special unemployment contribution until the employee in question reaches the age of 55 (for women) or 60 (for men).

Belgium

1994: Notice periods for high-income white-collars made subject to negotiation (permanent workers). A new type of contract came into force (“emploi-tremplin”), it is possible for a specific category of workers (aged less then 30 years and with less than six months of experience) to interrupt the employment relation on the basis of a shorter notice period (one month in case of dismissal or one week in case of voluntary separation).

Denmark

1990: Temporary work agencies (TWA) were deregulated. 1994: Notice period extended. A new law (AFLM 1/6/’94, no.414) extends the notice period in very large establishments making half the workforce redundant.

Finland

1996: Employers’ notice period is shortened. For workers with tenure of less than one year the notice period is halved; it is reduced from two months to one month.

France

1986: Administrative authorization for individual dismissal for economic reasons is abolished. Administrative authorization was previously required only for collective dismissals of more than nine employees. From July 1986 to 31 December 1986 (3/7/1986 nr.86–797). The list limiting the circumstances in which the use of fixed-term contract is allowed is abolished. The use of “intermittent” work contract (containing provisions for temporary interruptions), is authorised. Ordinance 11/8/’86. 1986: The employers must state the ground of the individual dismissals in writing. Law 30/12/1986 no. 86–1320. 1989: Individual dismissals for reasons not related to the person, (but depending from modification of the employment contract as a result of economic difficulties), must be notified in a letter including the grounds of the dismissals. Statuary requirements that collective redundancies are accompanied by “social plans” (early retirement schemes, retraining contract). Law 2/8/1989, nr.¢89–549.

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Table A.1 (continued) 1990: The list limiting the circumstances in which the use of fixed-term contracts and temporary staff is permissible is restored. (law 12/7/’90 nr.¢90). 1992: The law (29/7/92) established that all separations (i.e., resignations or the refusal of a radical modification of the employment contract) due to economic reasons are subject to the regulation concerning dismissals for economic reason. 1993: Statutory requirements are introduced concerning the contents of social plans (if there is no social plan or the measures proposed are inadequate, the redundancies will be considered null). Law 27/1/1993 nr.¢93–12. In 1995 the cour de cassation will interpret the 1993 legislation restrictively. Germany

1993: Notice period for blue-collar workers extended and aligned with those of white-collar workers. 1994: TWA and private employment services are allowed. 1996: The employment threshold at which EPLs applies, is increased from five to ten employees (on a full basis) per firm. A law comes into force liberalizing employment conditions. Legal conditions covering dismissals are relaxed. 1997: Exemption from general dismissal law widened; social criteria for dismissals relaxed.

Greece

1990: A new law replaces compulsory arbitration of labor disputes related to dismissals with special boards responsible for the creation of a group of independent mediators and arbitrators. Three independent professors sit on the board in addition to three employers’ and three union representative as well as one ministry of Labour official and a chairman elected by the rest. 1991: Liberalisation of collective agreement.

Ireland

1991: A law increases job security for part-timers, ensuring, at the same time, that they qualify for a wide range of benefits. 1993: Amendment to the unfair dismissal act introduces compulsory reinstatement of an employee unfairly dismissed. 1994: Employment (information) act came into effect. This act requires an employer to provide employees with a written statement of the contract conditions, including the length of the notice period required in case of dismissals.

Italy

1987: Fixed term contracts can be used more widely, if allowed by sectoral collective agreements. Increased the age limit of apprenticeship, among artisans, to 29 years of age. Reorganization of employment offices. Law 28/2/1987 nr.¢56. 1989: The employment threshold guarantees in cases of dismissal on disciplinary ground extended to small firms (with less than sixteen employees).

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Table A.1 (continued) 1990: Compulsory reinstatement and/or compensation in case of unfair dismissal is extended, to employers of noncommercial organizations employing more than fifteen employees in the same production unit and those employees in enterprises with more than sixty employees in total. Law 11/5/1990. 1991: A law regulates collective redundancies, establishing standards related to notice and consultation. Law 23/7/1991 nr.¢223. Reinstatement for the lack of dismissal communication in written form. 1997: In case of violation of fixed-term contracts legal discipline, a new act limited the drastic sanction (conversion of fixed-term contract into an open-ended one) only to serious cases. TWAs were legalized. The law has stated that the training contract can be extended, from two to years in the south of Italy in case of a change into a permanent contract. The law has established that the term of apprenticeship contract can vary in all sectors. Luxembourg

1993: Legislation concerning collective dismissals tightened. 1994: The government presents a new package of measures to preserve employment, including a reorganization of the Public Employment Service. 1997: Measures to encourage recruiting more people on fixed-term contracts. Reform of the public employment service (PES). The emphasis is on improving communication among the PES, enterprises, and job seekers. The obligation for employers to notify all vacancies to the PES.

Netherlands

1989: Dismissals that result from bankruptcy of companies no longer need authorization by the public employment office (PES). 1991: The official employment service was overhauled by the provision of employment act. This entailed a number of steps to decentralize the service and involve employer organizations and trade unions both in its operation on policy formation. The ban on private recruitment agencies for permanent employment was lifted; they are now allowed to operate alongside the official service. They need a license from the Ministry of Labor to operate. 1994: Implementation of the EU directive on proof of an employment contract (91/533/ec art 653 civil code). This requires employers to provide every employee with the basic terms on the conditions of their employment in writing no later than one month after their employment commences. (See Ireland, 1994—harmonization of national law to EU directives). 1995: The government decides to ease dismissal procedures. According to the new rules, an employer can dismiss an employee at the same time or even before asking permission from the director of the Public Employment Office.

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Table A.1 (continued) Portugal

1989: Several restrictions on layoffs’ legislation are phased out. The length of the decision process was reduced and administrative redtape revoked. At the same time, legislation governing dismissals was deeply changed; individual dismissals due to failure to adapt were reintroduced; the list of circumstances that can be considered cause for individual dismissal due to economic reasons are broadened. 1989: Part-time employees have the same contractual rights as fulltime employees. They have the same basic employment rights such as the right to claim for unfair dismissal. Art. 648 civil code. 1991: Firing restrictions eased. Through a wider range of admissible lay-offs. 1996: The government, the employers’ associations (AIP), and the trade unions sign a strategic social pact. Wider use of atypical work term contracts is allowed. In the public sector, fixed term contracts can, under special circumstances, be extended two more times beyond normal requirements before being automatically transformed into a permanent contract. Incentives for using temporary employment agencies, stronger sanctions against firms employing children or false independent workers.

Spain

1994: Individual dismissals eased: zero days of notice required when length of service is below fifteen days for blue-collar workers or below one month for white-collar workers. Thereafter (only for objective dismissal) one month when length of service is below one year, two months when length of service is between one and two years, and three months for two or more years’ service. Collective redundancies: the firms can initiate a collective dismissal if the dismissal affects to 10 or 30 percent of workers, depending on the size of the firms. The legally acceptable causes for collective dismissals have been expanded to include production and organizational causes. Law 19/5/1994 nr.¢11. 1994: TWA legalized, increased restrictions on fixed-term contracts. 1997: The reform has extended the causes that may give rise to an individual dismissal. It includes the possibility of staff adjustments with a view to overcoming problems related to a lack of competitiveness. Decree 17/5/1997 nr.¢8. 1997: Payment for unfair dismissal is reduced to thirty-three days per year of seniority for new permanent contracts of employment (aimed at young and disadvantaged workers), with a maximum of twentyfour months wages. Decree 17/5/1997 nr.¢8. 1992: The government wage guarantee in the case of employers’ bankruptcy is lowered.

Sweden

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Table A.1 (continued) 1996: Local union may freely agree on recruitment and dismissal provisions, economic sanctions in case of breach of the rules are to be adapted to the enterprise’s ability to pay. Refocusing of the activities of employment offices. From administering ALMPs toward their traditional role of improving the matching between unemployed and vacancies. Formulation of individual plans reflecting the job-seekers qualifications. A reassessment of balance between EPL and the enterprise adaptability attempts to bring out an agreement between social partners on further changes in this framework. United Kingdom

1993 Trial period extended from one to two years.

Figure A.2 Reforms of nonemployment benefits in Europe (1986–1997)

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Table A.2 Reforms of Nonemployment Benefits in Europe (1986–1997) Austria

1989: An amendment to the Unemployment Law approved; entry conditions for youth and long-term unemployed are improved. 1993: The definition of “suitable job-offer” is tightened. • Early retirement for employees over age 55 is introduced. 1995: Weeks of work necessary to requalify for Unemployment Insurance in the case of repeated spells of unemployment are reduced from twenty-six to twenty weeks. • The special preretirement benefit (Sonderunterstützung), higher than the normal Unemployment Benefit and available from the age of 54 for women and from the age of 59 for men is abolished. • Entitlement for Unemployment Benefits and special help for longterm unemployed is restricted. • Unemployment benefits for those on high incomes cut and the minimum age for support of older unemployed in a few special sectors is raised. 1996: Incentives for early retirement in the public sector are phased out. • The qualifying period for Unemployment Benefits is increased from twenty-six to twenty-eight months and the earnings history for the calculation of benefits is increased from six to twelve months. • A “bonus-malus” system is introduced to encourage employment of older workers and to discourage their dismissal. • Number of months of contributions necessary for early retirement is increased from 420 to 450 and early retirement for older workers on account of long-term unemployment is phased out. 1997: The unemployed made eligible for continued receipt of Unemployment Benefits even if they accept temporary employment. • For early retirees the earnings base from which pension entitlements are computed is increased by three years to the eighteen “best years” of a person’s work history, to be phased in between 2003 and 2020. • The eligibility conditions for early retirement on account of reduced capability to work are sharpened by extending the required contribution period within the previous 180 months from 36 months to 72 months and requiring a spell of reduced capability to work of at least twenty weeks to qualify for the pension. To be enforced from 1998 onward.

Belgium

1986: Certain categories of the unemployed are excluded from benefits because of a new method of calculation of Unemployment Benefits. 1988: The Unemployment Benefits replacement rate is lowered markedly with the December tax reform. 1990: An agreement between the employers’ federation and trade unions is stipulated; Unemployment Benefits for people between 50 and 55 years of age are increased. 1992: A fiscal package on Unemployment Insurance is approved: • Temporary unemployment schemes and part-time unemployment are made less financially attractive.

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Table A.2 (continued) • The number of daily unemployment benefit payments that can be combined with part-time employment is limited to a maximum of 13 per month; the maximum wage at which it is possible to cumulate benefits and wages is reduced. • Monitoring of the availability of unemployed to take up “suitable job offers” is increased. • Minimum age for early retirement is increased from 55 to 56. 1993: The “global plan” is approved in November; eligibility for Unemployment Benefits is tightened and linked more closely to work by, inter alia, extending the period during which school-leavers are not entitled to Unemployment Benefits. 1996: Conditions under which older unemployed are exempted from job search are eased. • Stronger incentives for people interrupting unemployment are introduced (interruption de chômage). • Rules governing the exclusion from the unemployment schemes on grounds of abnormally long periods of unemployment are tightened. Denmark

1987: Unemployment Benefits and retirement payments are significantly increased. • Rules diminishing Unemployment Benefits after a certain period of unemployment are abolished. 1991: Budgetary outlays for Unemployment Benefits are reduced. • Compensation for the first twenty-five hours of unemployment is abolished. 1991: Eligibility conditions and rules on refusing suitable job offers are tightened. 1994: A comprehensive Labor Market Reform is approved by the Parliament. • The maximum duration of unemployment insurance benefits is limited to seven years. • The Unemployment Benefits period is split in two (four plus three years) with full-time activation through job offers, training, and education compulsory in the second period. • The possibility of renewing entitlements to Unemployment Benefits by participation in active programs is abolished. • Policy implementation is decentralized to regional labor market authorities. 1996: Another Labor Market Reform is approved. • Eligibility criteria for access to Unemployment Benefits are tightened (fifty-two instead of twenty-six weeks necessary to qualify). • The minimum age for access to Unemployment Benefits is raised from 17 to 19 years of age. • The maximum duration of Unemployment Benefits is lowered to five years.

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Table A.2 (continued) Finland

1993: The government’s employment commitment imposed by the Employment Act of 1988 is removed. • The benefit period in the basic flat-rate of Unemployment Assistance scheme is limited. • Unemployment assistance eligibility requirements and duration brought in line with those of the Unemployment Insurance earningsrelated supplementary benefit. 1995: The Employment Program is approved in September. • Unemployment Insurance recipients required to work for at least ten months to requalify for benefits. • The benefit level at which Unemployment Insurance participants requalify is linked to the compensation received during the ten-month period rather than to the pre-unemployment earnings before unemployment. • The automatic extension of Unemployment Insurance benefits for those over 55 years old is reduced from five years to three. 1997: The period of prior employment for entitlement to the earningsrelated unemployment benefit is extended from six to ten months, and the basis for earnings-related daily allowances to be calculated from the date when the employment requirement is fulfilled; new allowances will be at least 80 percent of the previous allowances. • Incentives for earning additional income while benefiting from unemployment insurance are improved. • The period of unemployment benefit for the long-term unemployed over 53 years of age is shortened by two years. • People between 20 and 24 years old with no vocational training are no longer entitled to labor market support if, without any acceptable reason, they refuse a suitable job offer or a slot in a training course. • Unemployed persons are allowed to make short, occasional trips abroad without loosing the right to daily unemployment benefit if there is advance notice of the trip and they can be immediately contacted during the trip and are able to accept work offered within a few weeks. • Long-term unemployed persons who have been active in the labor market in paid employment or as entrepreneurs for at least twelve years and registered as unemployed job seekers with the employment office for at least twelve of the preceding twenty-four months have the right to daily unemployment benefits or to Labor Market Support benefits during a period of voluntary training aimed at promoting professional skills for a period not to exceed two years. • The possibility to be reintegrated into unemployment compensation rolls after having been on subsidized employment is tightened. • Reduction in benefit level for renewal of unemployment insurance is adopted. • New benefit rules are implemented to discourage entry into early retirement.

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Table A.2 (continued) • The “education guarantee,” a special in-school benefit at a level equal to the Unemployment Assistance scheme that was previously available only to unemployed workers out of work for at least six of the previous eighteen months, is “opened-up” to all unemployed workers. France

1992: A downward sliding scale for benefit payments (allocation unique dégressive) is agreed upon. 1993: Benefits cut by reducing their duration, which now varies according to the age and the length of prior affiliation to the unemployment insurance system.

Germany

1990: Eastern Germany Unemployment Insurance merged with the western German Labor Office. • The two previous GDR social security institutions—the social security insurance for employees and the state social insurance system—are collapsed into one organization “the Social Insurance of the GDR”. • Early retirement schemes for employees over 57 years old are introduced. 1991: Early retirement schemes are extended to employees over 55 years old. 1994: Most of the payments of benefits under unemployment insurance and labor-market policy are reduced by 3 percentage points. 1995: Several changes to unemployment insurance are implemented to halt the trend towards early retirement through the use of generous unemployment insurance provisions for older workers. • The duration of UI in case of unjustified dismissals is limited to twenty-four months. • The duration of unemployment (UI) benefits is linked to the amount of redundancy payments. 1996: A gradual withdrawal of early retirement provisions is agreed upon. 1997: Redundancy payments (abfindungen) now generally credited against unemployment insurance benefits up to a fixed limit. • The minimum age for receiving unemployment benefits for more than a year is raised by three years. • Abolition of the possibility of refusing job offers on the grounds that they do not correspond to the vocational qualification of the unemployed; offers must be accepted during the first three months of unemployment if the wage offer is within 20 percent of the previous wage and this discount rate is 30 percent in the following three months; from the seventh month job offers must be accepted if the net income is greater than unemployment benefits. • Tighter controls of the eligibility criteria are introduced. • Abolition of the possibility of renewal of the right to Unemployment Insurance through participation to training courses. • The age of early retirement for women and for the unemployed with a long contribution record are raised, effective in the year 2000.

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Table A.2 (continued) Greece

1990: The duration of unemployment benefits is raised from seven to twelve months. • The system of employment incentives and unemployment benefits consolidated (a system of multiple-use voucher is introduced to allow the unemployed to choose to apply the money value of the voucher to either training, a wage subsidy, or unemployment benefits). • Early retirement schemes are introduced for older unemployed workers. 1996: Unemployment Benefits set at a flat rate of Dr 2,710 per day plus 10 percent for each family member (reduction in generosity on account of increasing financial deficits of the agency responsible for distributing unemployment benefits).

Ireland

1987: The earnings-related component of the Unemployment Benefits is reduced to 12 percent for new applicants. • Earnings-related benefits are halved. 1988: Social insurance is extended to farmers and the self-employed. 1991: Social insurance coverage is extended to part-time workers. 1994: The earnings-related supplement to unemployment benefits, which was payable for one year, is phased out. • Unemployment benefits are made taxable. • Unemployment benefits for the long-term unemployed are raised by more than the rate of inflation, but less than in the previous years. • Unemployment assistance is sharply increased to equalize the payments under the two systems. 1995: Unemployment benefits replacement rates are reduced while cutting taxes on the low paid and providing full indexation of benefits to prices. 1996: The rise of unemployment benefits kept below the increase in average earnings. • The universal child benefit is increased by 7 percent while the child dependant allowance paid to unemployed parents is left unchanged, thus making employment relatively more attractive. • Long-term unemployed who start working are allowed to retain the dependent allowance for three months and their free medical card for three years instead of two.

Italy

1988: The daily Ordinary Unemployment Benefit is raised to 8 percent of the average wage. 1991: The Wage Supplementation Fund (cassa integrazione guadagni, CIG), for workers put on short-time or zero-time work is reformed. • Time-limits put on the duration of the benefits. • Special Wage Supplementation Fund (cassa integrazione guadagni straordinaria, CIGS), is replaced by a generous “mobility allowance” paid to employees laid off in the context of “mass layoffs.” • Ordinary Wage Supplementation Fund (cassa integrazione guadagni ordinaria, CIGO) subjects to a ceiling after six months.

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Table A.2 (continued) 1993: New entitlements to early retirement are frozen. • The “ordinary” unemployment benefit replacement rates are raised to 30 percent of previous earnings. 1994: A plan to cushion the effects of rising unemployment is approved. • The unemployment allowance is increased. • Benefits paid by the Wage Supplementation Fund are extended to small and medium-sized enterprises. • The coverage of Special Unemployment Benefits is extended to construction workers with at least three years of job seniority on solidarity contracts and mobility lists. • Early retirement benefits are extended to workers in the steel industry, to workers in large enterprises, and for employees of Alitalia. • Income support provided by the Wage Supplementation Fund (cassa integrazione guadagni) is extended to include banks, trade, and public utilities. Netherlands

1987: The two key parts of the previous Unemployment Benefits scheme (WW, unemployment insurance and WWW, unemployment assistance) are combined and eligibility requirements are tightened. • The maximum duration of benefits is more closely linked to the age and length of the contribution period. • The revision of the Social Security System Act is enacted to reduce the incentive to obtain a disability pension rather than an unemployment benefit. • Criteria governing access to disability pensions are tightened. • Claimants who are less than 80 percent disabled will receive a prorated disability pension supplemented by an unemployment related component declining over time. • The total benefit will decline over time as the unemployment related portion of the benefit falls, with a maximum benefit period of five years. • Eligibility requirements for unemployment benefits are tightened: workers are obliged to accept an appropriate job even outside their geographical region. 1990: The minimum wage and social benefits are again linked to wage growth after the nominal freeze decided in 1983. 1991: The obligation of the PES to inform the institutions in charge of unemployment benefits of insufficient job search efforts by benefit claimants introduced with the new PES Law of January; sanctions for refusing a suitable job offer increased: refusal now entails a complete and permanent loss of unemployment benefits. • A new Social Insurance Organization Act is approved: the implementation of social security laws concerning unemployment, sickness, and disability schemes is now entrusted to a tripartite national public body to assure a better balance between administrative costs and the quality of implementation and to make the implementation effectively independent of the social partners.

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Table A.2 (continued) 1991: Social security benefits and the minimum wage are raised by 1.27 percent. • Social security benefits and the minimum wage are increased by 1.7 percent. 1992: The link between the minimum wage and social benefits is no longer automatic: the government is no longer obliged to respect the full linkage if the dependency level (the ratio of full-time equivalent beneficiaries to full-time employed persons) exceeds a reference level. 1995: The indexation of the legal minimum wage and social security benefit to the contractual wage is restored for 1996. 1996: Local authorities are given more responsibility in the implementation of income-support legislation with the General Social Assistance Act, which stresses also the Activation obligation (anyone who receives income support, except for single parents with children under five years of age, must in principle be available for work). • Eligibility to Unemployment Benefits after voluntary quits is removed. • Penalties for violating the rules on unemployment benefits are made mandatory and are no longer applied discretionally by the administration. Portugal

1987: First-time job-seekers are entitled to compensation subject to certain conditions. 1988: Unemployment benefits regulations are revised: minimum qualifying contribution period is reduced and age henceforth taken into account in determining the period of receipt. 1994: A fundamental reform of the social security scheme for selfemployed workers came into effect; the contribution rate is scheduled to reach parity with the overall rate for dependent employment by 1999.

Spain

1992: A decree to redress fiscal slippage approved by the government: the minimum contribution period for eligibility is raised from six to twelve months. • The duration is reduced by about one third. • Lump-sum Unemployment Insurance schemes offering lump-sum payments are phased out. • The system of minimum unemployment assistance allowances is reformed: it now provides those who have worked for at least three months but are not eligible to unemployment insurance with 75 percent of the minimum wage. • The amount is reduced by over 10 percent. • The unemployed are no longer allowed to take up the unemployment insurance payment in a single installment to start a new business as a self-employed worker. 1993: Unemployment benefits amounts are lowered. 1994: Unemployment benefits become subject both to income taxes and social security contributions, even if the tax regime is more generous than for wage income.

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Appendix

Table A.2 (continued) 1995: The special unemployment subsidy for temporary farm workers in Andalucia and Extremadura, the empleo rural, is reformed in February. • Eligibility requirements are lowered (the minimum days worked in a year to qualify for benefits reduced from sixty to forty). • Entitlements are increased for youths and older workers (entitlements of unmarried youths under 20 years old raised from one and one-half days of benefit per day of contribution to two and onequarter days, while those of youths between age 20 and 25 receive three days benefit). Sweden

1986: Training participation is considered equivalent to work for benefit eligibility purposes. 1987: An unemployed person approaching benefits exhaustion is given the right to receive a job offer of a duration that would renew his entitlements. 1993: The Unemployment Insurance replacement rate is reduced from 90 to 80 percent. • A five-day waiting period is introduced in the unemployment insurance. • The unemployed are entitled to a slot in a training course that could be used for requalification. • Compensation in the relief work scheme is reduced by 10 percent. • Rules for early retirement are tightened. • The public employment service monopoly of formal job brokerages is abolished. 1994: Membership of unemployment insurance funds made mandatory. • The possibility of acquiring indefinite benefit periods through participation in labor-market measures is abandoned. • The youth practice labor-market scheme is phased out. 1995: The replacement rate is reduced from 80 to 75 percent. • Sanctions for not complying with the job availability criteria for unemployment benefits are tightened. 1996: Replacement rates in social security schemes are lowered from 80 to 75 percent. • The Employment Bill is put forward by the government. • Length of spells on unemployment insurance to be limited (an upper limit of three years is introduced). • The replacement rate to be increased to 80 percent. • The qualifying period to be increased from five to nine months. 1997: The Employment Bill repealed before it entered into force and the revised proposal forwarded in March: • The qualifying period is increased from five to six months (it had been proposed nine months). • The proposal for an upper limit of the duration is dropped. • The underlying structure of the unemployment benefit is changed; the benefit now consists of an earnings-related part and a flat-rate component.

Appendix

273

Table A.2 (continued) • The maximum Unemployment Insurance (earning-related component) benefit raised. • The possibility of requalifying for benefits through participation subsidized jobs is no longer available. United Kingdom

1987: Further limitations are placed on unemployment benefit claims. 1988: Unemployment Benefit replacement rates are reduced by increasing waiting periods for eligibility. The earnings-related supplement to the basic unemployment allowance is abolished. • Entitlement to benefit is calculated on net rather than gross earnings. 1989: Unemployment Insurance replacement rates are reduced, especially for short-term unemployed by lengthening minimum waiting period for eligibility. • Rules on refusing a job offer are tightened. 1996: Unemployment Benefit is replaced by the Job-Seekers’ Allowance. • The duration of the Job-Seekers Allowance is halved (from twelve to six months). • The replacement rate of the Job-Seeker Allowance is lowered. • The Income-Support scheme is replaced by the means-tested component of the JSA as a safety net with a marginal withdrawal rate of 100 percent.

Figure A.3 Reforms of pension systems in Europe (1986–1997)

274 Appendix

Appendix

275

Table A.3 Reforms of Pension Systems in Europe (1986–1997) Austria

1988: The rate of compulsory social security contributions to public pension to be increased by 0.5 of a percentage point to 9.5 percent as of 1 January 1989. 1989: The rate of compulsory contribution to the public-sector pension fund is raised by 0.25 of a percentage point to 9.75 percent. 1990: The law regulating private pension funds and enterprise pension systems is enacted: • Pensions to be increased 5 percent as of 1 January 1991. • Minimum pensions for singles to be raised to Sch 6,000 (Sch 8,000 for couples). 1993: An amendment to the general social security law came into effect: • Pensions entitlements will require at least twenty-five years of contributions into the system with four years’ credit given for time off for raising children. • The basis for calculation of benefits will be the fifteen highestearning years. • A job can be held while drawing on a normal old-age pension, although with earnings above Sch 7,000 per month the pension is reduced. 1995: Compulsory social security contributions to public pension for civil servants are raised by 1.5 points. 1997: The pension reform is approved: • Over the entire contribution period, pension rights are accumulated at a uniform rate of 2 percent of the calculation base for each year of insurance. For each year of early retirement the above mentioned percentage is reduced by 2 percentage points up to a maximum of 15 percent or 10 percentage points. The law will take effect in 2000. • The criteria for taking a part-time pension have been relaxed about the required reduction of hours of work. • Pension claims brought from raising children are increased. The law will be enhanced as of January 2000. • Individuals nursing family members who give up employment can still be covered by the pension insurance under related favorable conditions. • A new form of part-time pension is introduced, requiring a shorter contribution period. • The degree of self-financing—as opposed to financing out of the government budget—in the pension insurance for self-employed and for farmers is increased by Sch 250 million annually. Valid from 1998 onwards. • The pension base for civil servants is changed from the last salary to the same base as the general pension system. Phased in between 2003 and 2020.

276

Appendix

Table A.3 (continued) • Pensions for civil servants to be annually adjusted applying the adjustment factor of the general pension system. • Social security coverage extended to occasional jobs. Belgium

1986: The self-employed and wage earners are no longer allowed to draw their pension before the age of 60, and the pension age is set at 65 for both men and women. 1987: A general reform of old age, invalidity, and survivors’ pensions is approved. • A single insurance scheme covering manual and nonmanual workers, shopkeepers and tradesmen, industrialists, farmers and professionals is introduced. • A 7 percent increase in all private sector pensions is approved. • A five-stage increase in the guaranteed minimum pension is agreed upon. 1990: The government decides to increase employees’ pensions from 1 to 3 percent, according to the retirement date, effective October 1st. This measure will cost BF 1.3 billion in 1990 and BF 5.3 billion for a full year. 1991: Compulsory employer’s and employees’ social security contributions are slightly increased. 1994: A global plan is approved to redress the financial position of the social security system: • A new method of calculating pensions with a longer base period is introduced. Pensions for men and women are harmonized; the pension regime for women will be brought in line with that of men by the year 2009. 1997: Pensionable age for women will be gradually increased and aligned with those of men (65 years of age). The minimum working period for early retirement will be gradually increased to thirty-five years by the year 2005.

Denmark

1987: In the budget for 1988 significant increases in public old-age pension are approved. 1991: Pensions provisions are reduced in the budget for 1992. 1996: Amendments to occupational and individual pension savings are adopted by the parliament to allow, inter alia, pensions rights to be transferred between jobs.

Finland

1989: The minimum age for entitlement to an unemployment pension (early retirement) to be raised gradually from 55 to 60 years of age and other eligibility requirements are tightened. 1991: Private-sector employers’ contribution rates to social security are temporarily reduced by 1 percent. • Public-sector rates are set at 3.4 and 5 percent. 1992: Employers’ national pension contributions are lowered to 2.4 percent in the private sector and to 3.95 percent in the public sector.

Appendix

277

Table A.3 (continued) • Individuals’ national pension insurance contribution rate is increased by 1.5 percentage points to 2.2 and to 3.7 percent of annual taxable income exceeding Mk 80,000. 1993: Several measures are adopted with the aim of bringing the pension rules in the public sector in line with those in the private sector: • The retirement age for public-sector workers is raised from 63 to 65 years of age, the same as in the private sector. • The annual accrual factor for public-sector workers is reduced from 2.2 to 1.5 of the pensionable age. These adjustments initially applied to newly recruited civil servants since 1995 and will affect all civil servants age 55 or below. • A change in the index for the pensionable wage to take account of reductions in purchasing power of active workers with the introduction of employees’ pension contribution applied (previously only the employers paid such contributions). 1994: The minimum age for early disability retirement is raised from 55 to 58 yeas and the accrual factor of workers in the 60 to 65 years age bracket is raised from 1.5 to 2.5 percent (effectively lifting their pension by 1 percent of the pensionable wage for every additional year of work) • A change in the method of computing the pensionable wage of older workers is introduced: earnings after the age of 55 disregarded if they would lead to a reduced pension level. • To encourage part-time employment of older workers, the required minimum retirement age for part-timers is lowered from 60 to 58 years. • Pensionable wage and postretirement benefits are not indexed for inflation in 1994. 1995: A fixed increase of 1.5 percent per year of nominal pensions replaces the automatic indexation mechanism. • Pension benefits cut by 4.5 percent to reflect the fall in earnings of employees caused by the increase in employment pension and unemployment insurance contributions. • A reform of the employment pension scheme for the private sector is agreed upon by the central labor-market organization. The pension rules are revised, with the benefit calculated on the basis of earnings in the last ten years instead of the last four. The new rules will be introduced gradually, starting on 1 January 1996. 1996: The accrual factors for early retired and disabled workers are reduced from 1.5 to 1.2 percent for those age 50 to 60 years and from 1.5 to 0.8 percent for the remaining five years until regular retirement. • The annual adjustment of postretirement benefits of people age 65 and above is based on 80 and 20 percent weights of the CPI and the earnings index, respectively, a measure that tends to reduce the level of pension benefits relative to the overall earnings.

278

Appendix

Table A.3 (continued) • The flat-rate component of the national pensions to be abolished by the end of the decade. France

1991: Introduction of a new tax—the contribution sociale généralisée—at a flat rate of 1 percent on all incomes. • Employee retirement-pension contribution rates cut by 1 point plus a flat FF 42 per month. 1993: A reform of the “régime général” is decided in July: • The amount of pension is related more closely to the basis on which contributions are calculated (the best-paid twenty-five years instead of the ten best-paid). • The period of contribution is increased. • Pension is indexed to prices instead of (net or gross) wages; nevertheless in case of rapid increases of net wages (high productivity growth), some occasional and discretionary reindexation could be introduced (clause de rendez-vous). • Leaving at the age of 60 will still be possible, but to benefit from the full rate pensioners will face minimum-contribution period conditions that will become progressively tighter, from 37.5 to 40 years for people leaving in 2003. • Noncontributory pension rights are transferred to a solidarity fund financed out of taxes to reinforce the insurance character of the system. 1994: An agreement between the social partners on balancing the pension scheme for managerial staff (Association générale des institutions des retraités cadres—AGIRC) is reached: • Pensions are frozen in 1994. • A pensioners’ solidarity contribution is introduced. • A timetable for raising the compulsory rate of employer and employee contributions is set. • Pensions of farmers are raised by 10 percent. 1995: Old-age and disability pensions are raised by 1.2 percent. • Employers’ contributions to the pension scheme for local authority employees are raised by 3.8 percent. 1996: Old-age and disability pensions are raised by 2.1 percent. • An agreement between the social partners is reached concerning the balancing of the complementary pension system (ARRCO and AGIRC) until 2005.

Germany

1987: The contribution rate to the pension insurance funds is lowered from 19.2 to 18.7 percent of eligible income; the contribution to the Federal Labor Office is raised from 4.0 to 4.3 percent. 1991: Social security contributions are increased by 2.5 percentage points. 1992: A reform proposal put forward and agreed upon by the government: • The de facto net-wage adjustment principle for pensions is formally adopted (the average pension is indexed to the average net wage).

Appendix

279

Table A.3 (continued) • The retirement age is gradually increased from 60 years for women and 63 years for men to a uniform retirement age of 65 years (starting in 2001 and completed in 2012 for women and 2006 for men). This implies the abolition of the present flexible retirement-age scheme; early retirement may still be obtained with a reduction in pension levels, while pension benefits for those working after the age of 65 are increased. • For contributions between 1973 and 1992, multiples (used in computing the individual relative contribution position) below 75 percent are multiplied by 1.5 up to the maximum of 75 percent, effectively reducing the redistribution for workers with income position below 50 percent. • Contributions to the pension system during periods where contributors are receiving income-support payments paid by the unemployment insurance fund are to be increased. • Contribution-free years of higher education are reduced. • Pensions for low-income earners are to be upgraded. • Age 65 is set as the pivotal age for benefit computations; for each year of earlier retirement up to five years and under certain conditions, benefits will be reduced by 3.6 percentage points in addition to the effect of few service years. Rewards for later retirement were also introduced: the pension is increased by 6 percent for each year of retirement postponed. • The possibility of partial retirement is introduced: all rules and regulations apply in proportion. • In the new Länder old-age pensions are raised by 11.65 percent and legislation on pensions extended to the new Länder. 1993: Old-age benefits are increased by 3.86 percent in Western Germany and by 14.24 percent in Eastern Germany. 1994: Contributions to pension insurance funds are increased by 1.7 percent. 1995: The contribution rate for the public-pension insurance fund is decreased from 19.2 to 18.6 percent. • In the new Länder old-age benefits are increased by a nominal 2.78 percent. Due to the introduction of the sickness insurance, the effective rise is 2.23 percent. 1996: The pension contribution rate is increased from 18.6 to 19.2 percent. 1997: Contribution rates for the pension insurance are increased from 19.2 to 20.3 percent of the wage base. • The accrual of pension rights that are not based on contributions is restricted. • The pension level for immigrants is reduced. The 1999 pension reform law is passed: • A phased decline in the average replacement rate from 1999 is introduced. • Higher transfers from the federal budget to the pension system are agreed upon.

280

Appendix

Table A.3 (continued) • Eligibility criteria for invalidity pensions are tightened. • Pension claims for contribution free periods of child raising are increased. Greece

1990: A pension reform law is approved: • For the private sector, the minimum contribution period giving right to a minimum pension at age 65 is lengthened from thirteen and a half years to fifteen years and the minimum pension is increased by 1 percent for each additional year of contribution above fifteen years. In addition to the minimum retirement age, the “35 year” rule will be gradually raised from 58 to 60 by 2002, for men only. • For the public sector a minimum contribution period of twentyfive years is introduced, which mainly affects women who could previously retire after fifteen years’ service and at the age of 42 years. • Civil servants recruited after 1990 will have to pay a contribution rate of 5.75 (civil servants recruited before will continue to be exempt from pension contributions and other public-sector employees to pay minimal rates, less than 3 percent on average). • Contribution rates for private-sector employees will be gradually raised by 3 percentage points, two-thirds of which will be met by employers. • The ceiling for calculating contribution rates is raised. • For the public sector a minimum pensionable age is introduced for those hired after end–1982 (age 60 for men and 58 for women) which will be gradually raised to those applied in the private sector. • For all pensioners an overall limit is placed on the total value of all pensions per individual pensioner equivalent to four times the 1991 per capita GDP; for all funds but applying mostly to the broader public sector and professionals, the replacement rate of new retirees will be capped for primary pensions at 80 percent and for supplementary pensions at 20 percent of the applicable salary base. • The criteria for defining occupations as “hazardous” are tightened. • Eligibility to invalidity pensions is tightened; the minimum degree of invalidity required to receive a pension is raised from 35 to 50 percent and checks on past decisions enforced. 1992: A new pension reform law is adopted: • In the public sector the minimum employment period required to retire without an age limit is extended from 32.5 to 35 years; for people who have worked for more than 25 years but less than 35 the minimum age is raised from 60.5 to 65 and a back-loaded pension formula is introduced to provide a greater incentive to retire later.

Appendix

281

Table A.3 (continued) • All civil servants will pay a contribution to the pensions system raising from 3 percent in 1993 to 6.7 in 1995; for all other public employees the rate is 22 percent for employers and 11 percent for employees. • Private-sector employers’ contributions are increased from 12.5 to 13.3 percent; employees’ contributions are raised from 5.8 to 6.7 percent. • For the self-employed, where contributions are based on a set of voluntarily chosen income classes, the lower classes are eliminated and the earnings base for contributions is gradually raised. • Pensions in the private sector are no longer indexed to changes in the blue-collar minimum wage but adjusted in line with civil servant pensions that are adjusted according to the government inflation objective. • The replacement rate for private-sector pensions is lowered from 80 to 70 percent of the previous earnings. • The minimum age to be eligible for non-insured people is lowered from 68 to 65 years and the benefit made more generous. 1996: A new means-tested old-age pension supplement is introduced. Ireland

1990: A law comes into force establishing a pension commission, guarantees on pension rights, a minimum regime of capitalization, diffusion of information, and equal treatment for men and women. The objective of the law is to build a clear framework for the improvement of private pension funds and to simplify the general rules of pension programs. • The Pension Commission, a group of 14 people, is appointed to regulate and control the development of private pension funds and to inform the Minister of Social Affairs about all issues on pension programs. • The new law states that pension rights must be transferred and reevaluated when a job change occurs. A complete information on pension schemes must be assured.

Italy

1988: Compulsory contributions to public pension are raised and pension ceilings for senior executives are raised. 1988: Pension rights are to be calculated on the basis of ten years (instead of five). 1992: New law introduced on pension programs: • Retirement age of 65 for men and 60 for women by the year 2002. • Calculation of old-age pension; earnings-based, reference earnings = whole career with adjustment of past earnings for inflation and 1 percent real growth. Yield coefficient harmonized at 2 percent. • Eligibility for old-age pensions will require at least twenty years of contributions by the year 2000.

282

Appendix

Table A.3 (continued) • Indexation of pensions: based on price inflation with scope for additional indexation to real earnings. • Contribution rate: 26.5 percent for private employees, 15 percent for the self-employed. Seniority pensions: • Eligibility gradually raised to thirty-five years of contributions for all workers. Private pension funds: • Introduced with 15 percent withholding tax on funds deposited. 1993: Freeze on seniority pensions. 1994: Budget law: Seniority pensions: • Cuts to the benefits received by public workers retiring with less than thirty-five years of contributions. 1995: Budget law: • Retirement age of 65 for men and 60 for women by the year 2000. • Indexation of pensions: 1995 indexation delayed until January 1996. • Private pension funds: 15 percent withholding tax suspended. 1995: New law on pension programs. • Retirement age: flexible from 57 to 65 for both men and women. • New formula to calculate old-age pension, “prorata” is introduced: those with less than 18 years of contribution at the time of reform will enter the contribution system; capitalization of contributions based on nominal GDP growth; the coefficient converting cumulative contributions into annual pensions is based on residual life expectancy, plus adjustment to real GDP growth (1.5 percent). • Eligibility to social pensions requires at least five years of contributions, subject to the condition that pension is at least 20 percent higher than old-age assistance; indexation of pensions to price inflation. • Contribution rate: 32 percent for employees; 20 percent for the self-employed. Seniority pensions: • Eligibility is raised to forty years of contributions, or thirty-five years of contributions plus an age of 57. • Private pension funds: earnings ceiling for participation in public system, to favor the creation of private funds; fiscal incentives for contributions paid. Netherlands

1987: Continuation of nominal freeze of social security benefits. 1988: The freeze of social security benefits in nominal terms is continued. 1990: Contributions for the AOW (old age pensions), AWW (widows and orphans pensions), schemes are included in the personal income tax system.

Appendix

283

Table A.3 (continued) 1991: Social security benefits are raised by 1.27 percent. 1991: The government submits a set of policy proposals relating to retirement pensions to Parliament. It includes a proposal to base pensions on the average wage during the career instead of the last earned wage. Moreover, it contains a proposal to improve pension rights for two-earner couples relative to single-earner couples. 1993: The government eases investment rules for the General Government Pension Fund (ABP), allowing it to invest up to 10 percent of its funds abroad. 1995: The early retirement system will be transformed from a payas-you-go system to a funded system. 1996: The Pension Fund for Civil Servants is privatized. 1997: The budget is presented including an increase in social security contributions. Portugal

1987: Old-age and disability pension provisions are increased from 1 December. General scheme pensions are increased by 1 to 23 percent and noncontributory pensions (farmers) by 14.7 percent. This decision implies additional expenditure of Esc. 34 billion (0.6 percent of GDP). 1988: Pensionable age is lowered from 62 to 60 years. 1989: The government increases retirement and invalidity pensions paid by the social security scheme. 1990: Invalidity pensions and retirement pensions are increased by 17 percent in average. 1991: Retirement provisions are increased by 15 percent on average. 1993: Reforms on pension formula: • The basis to calculate old-age pension will be fifteen (rather than ten) years, and the accrual rate will be reduced from 2.2 to 2 percent. • A gradual rise in the retirement age for women from 62 in 1993 to 65 years by 1999. • An increase in the contribution period required for full pension. • A reduction in the contribution rate paid by employers of 0.75 percentage points, offset by a rise in VAT rates of 1 point, receipts of which are marked for social security.

Spain

1990: Unions and the government agree on an increase in pensions averaging 10 percent and on a full compensation (to civil servants and pensioners) for the overshooting 1989 inflation target. 1993: The minimum legal pensions for 1994 are raised by 3.5 percent and the latter will be revised if actual inflation exceeds 3.5 percent. 1997: In July the Parliament approved legislation introducing several reform to pension system: • Gradual extension of the basis to calculate pensions from the last eight years of contributions to the last fifteen years.

284

Appendix

Table A.3 (continued) • Unification of the different contribution ceilings at the level of the highest one. • Reduction of front-loaded accumulation of pension rights, which provides incentives to retire early by having an accumulation rate that diminishes in relation to the years of contributions. Sweden

1987: Semiretirement pensions are increased from 50 to 65 percent of the loss of earned income. 1992: The pensionable age is raised from 65 to 66 years and public pensions are reduced with effect from January 1993. 1994: The age limit for part-time retirement is raised from 60 to 61 years. The replacement rate is lowered from 65 to 55 percent. 1994: The tax on private pension schemes is increased.

United Kingdom

1987: New tax regime for personal pensions is introduced. Employees will be able to contract-out of the SERPS (State Earnings Related Pension) by joining an individual pension scheme to which the State Department will pay a minimum contribution. 1988: Pensionable age for women is increased to 65 years from 60. 1989: Employers allowed to set up “top-up” pension schemes for their employees, with no limits on benefits but without special tax relief. A (price-indexed) limit is placed on pensions paid from taxapproved schemes, based on earnings of £60,000 a year. Annual contribution limit for a personal pension scheme increased in line with earnings and subject to an overall cash limit (based on the earnings limit). 1995: Pension Act: it provides a raising the state pension age for females from 60 to 65 years, starting in 2010 with those born in April 1950 and completing the transition in 2020 with those born in April 1955. • Introduction of a new private-pension scheme.

Marginal Radical

Marginal Radical

Nonemployment Benefits

Public Pensions

15

6 1

6 0

2 0

22

8 2 6 1

5 0

70

10

0

5 13

0

5 0 4

3 0 5

4 0

0 2

23 5 18

13 6

68

2

2 28

24

0

12

GDP growth >1.5%

198

9

69 9 67

36 8

Total per rows

Source: Fondazione Rodolfo Debenedetti. Note: In the case of Employment Protection Legislations, radical reforms are those modifying the rights of permanent workers, while marginal reforms simply introduce new contractual forms holding a lower degree of employment protection (as the “atypical” contracts), they don’t modify the rights of insiders. In the case of nonemployment benefits, marginal reforms are those adjusting the amount of the subsidy by less than 10 percent, or introducing a limited change in the duration of benefits, while radical reforms are those introducing changes on the whole structure of the system and discrete changes in the generosity of subsidies. In the case of public pensions, marginal reforms are those partially adjusting the system, while radical reforms arise from an intervention in the whole structure of the system and discrete changes in the generosity of provisions or introduction of alternative pension schemes.

Total per columns

Marginal Radical

Employment Protection Legislation

GDP growth 0–1.5%

GDP growth 1.5%

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