DP803 | On the Political Economy of Labour Market Flexibility


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This paper starts from the observation that despite their very high levels of unemployment, major European countries have devoted few resources to reducing it. This suggests that there is little political concern about high unemployment. I develop a model where the government tries to increase employment by increasing labour market flexibility, and where any reform must pass majority voting. It is shown that the employed will block a complete reform of the labour market. A two-tier system will eventually generate consensus over the reform, however. In the long run, when the two-tier system prevails, political support gradually builds up in favour of further increases in flexibility. This creates a time-consistency problem, however, putting bounds on the reform that can be implemented <MI>ex ante<D>. The model may generate complementarities between the economic system and the political system and lead to multiple equilibria. I also review various pieces of evidence, which lend support to the hypotheses brought up in the paper.