In Defence Of Inflexible Labour Markets

It has become conventional wisdom that far-reaching labour market deregulation is the only remedy for high European unemployment. But according to Jonas Agell, writing in the February Economic Journal, this view is far too simplistic: some types of intervention in the labour market are harmless reflections of more basic social norms; and some may even serve a useful purpose in improving the workings of the economy. Agell concludes that European labour market reform that fails to distinguish between good and bad rigidities will do more harm than good. Agell notes the common message from thinktanks, organizations like the OECD and the IMF, and weekly magazines like The Economist: only if governments get rid of distortions like minimum wages, job protection laws and generous social benefits will employment resume growth. But there is, he argues, compelling counter evidence to this view:
Recent field surveys among compensation executives and managers, and experimental studies of fairness and reciprocal behaviour, strongly suggest that persistent social norms are an independent and important cause of labour market rigidity, going beyond the legal constraints emphasized in the popular debate. When these social norms of fair conduct are a binding constraint on behaviour, legal deregulation – like the abolishment of minimum wage laws, and less strict job security legislation – accomplishes nothing in terms of increased flexibility.
Judged against the theoretical yardstick of a perfectly competitive economy, hardly any of Europe''s labour market institutions make sense. But judged against the yardstick of an economy where some markets are missing or some agents are price makers, matters look rather different. These market failures explain why an unregulated labour market may lead to an inefficient outcome. Agell discusses recent theoretical work, showing that there are a number of instances when unrestricted market forces create excessive wage differentials, and that there are potential gains from institutions that promote a rigid and compressed wage structure.
The received wisdom suggests that globalization will push politicians to make labour markets flexible. But data on the relationship between labour market structure and openness in OECD show that countries that are more exposed to international trade are (on average) more likely to have high minimum wages, strict job security legislation, generous unemployment benefits and powerful unions. This suggests that these institutions can be
thought of as devices that provide workers with social insurance against the uncertainties of the international market place. To the extent that globalization leads to increased external risk, it also suggests that workers'' demand for institutions that provide income protection will increase in the future.
Agell examines whether the prospect of increased institutional involvement in the labour market is a plausible one. In the United States, labour markets have been flexible for a long time, and increased openness is unlikely to reverse this. In continental Europe, tradition and politics appear less likely to go against increased demand for income protection: the Social Chapter of the Maastricht treaty, and talk about ''Social Europe'' within the corridors of power in Brussels, bear witness to a political milieu with an inclination for interference in the market.

The UK might be a borderline case, Agell concludes. The reforms during the 1980s have given the UK labour market a quite flexible outlook. But the introduction of a national minimum wage and the Labour government''s acceptance of the labour market implications of the Social Chapter suggest that changes might be on the way.

''On the Benefits from Rigid Labour Markets: Norms, Market Failures and Social Insurance'' by Jonas Agell is published in the February 1999 issue of the Economic Journal. Agell is at Uppsala University in Sweden.