chapter  4
13 Pages

How well do the clothes fit? Priors and evidence in the debate over flexibility and labour market performance

WithRICHARD B . FREEMAN

Many economists and policy-makers believe that institutions and policies designed to protect workers have distorted labour markets in ways that impede full employment. International agencies, such as the OECD in its 1994 Jobs Study and the IMF in its 2003 analysis, proclaim that the road to full employment in advanced Europe requires reforms of those institutions and policies. But there is considerable disagreement over the evidentiary base on which this recommendation rests. Baker et al. (2004) and Baccaro and Rei (2005) have found that models which purportedly show that institutions adversely affect unemployment are non-robust to specification, measurement, and additional years of data. Blanchard and Wolfers (2000) and Ljungquist and Sargent (2004) argue that the only way to explain the increased rate of unemployment in Europe compared to the US is through the interaction of institutions and economic shocks. For its part, the OECD recognizes that the evidence is more equivocal than it first claimed.2 At the same time, Bassanini and Duval (2006; also chapter 7 of OECD, 2006) estimate that changes in tax and labour policies explain about half of the 1982-2003 changes in unemployment among countries along lines of earlier OECD pronouncements.