Time-Variant Institutions: Implications for European Unemployment

The upward trend of European unemployment begs many questions, the most basic of which is why unemployment continues to climb after twenty-five years. Adverse shocks, rigid labor market institutions, and their interaction are used to explain this persistence and the differences in individual country experiences. While these models do indeed answer both questions to some extent, they assume that institutions predate the rise in unemployment, often treating them as static. By compiling extant data series and constructing my own, I find that this assumption is weak, and that the evolution of institutions is far from static. I create and estimate a new dynamic panel of 20 OECD countries with three empirical specifications, and uncover several significant results. First, the tax burden on labor appears to have a very strong and positive relationship with unemployment rates, implying that the tax structures of a country are an important indirect mechanism driving joblessness. Second, the unionization level shows a significant amplification effect; that is, high union density exacerbates adverse shocks to employment. Third, restrictions on firm hiring and firing seem to have the opposite effect - more protection reduces the impact of shocks. I also find evidence that both union/employer coordination and benefit duration affect unemployment rates significantly