Canada and the "OECD Hypothesis": Does Labour Market Inflexibility Explain Canada's High Level of Unemployment?

One of the most remarkable features of international economic performance in the last decade has been the employment performance of the United States. While unemployment rates in almost all other developed countries remain high by postwar standards, the U.S. unemployment rate has fallen to levels not seen in decades. Even more spectacular than the decline in unemployment is the increase in the fraction of the U.S. population employed, which has exceeded that in almost all developed countries. A phenomenon of such magnitude of course calls out for an explanation. Probably more than any other single factor, some form of “labour market inflexibility” has recently been blamed for the high unemployment rates outside the United States. In a number of forums, including the policy recommendations of the Organization for Economic Cooperation and Development (OECD), “rigid” labour markets, with considerable government and/or union involvement in wage-setting, and considerable restrictions on firms’ abilities to adjust the size of their work forces, are commonly seen as more prone to unemployment and less conducive to employment growth than more flexible ones. The purpose of this paper is to provide a critical assessment of the popular notion that differences in labour market “flexibility” explain the recent differences in employment and unemployment rates between the U.S. and other developed countries. In addressing this issue I shall focus particular attention on a comparison between two countries, the United States and Canada. On the surface, the recent experience of these two countries would appear to support the hypothesis, with the more “rigid” country --Canada, where unions have much more influence on the wage-setting process and employment protection is stronger-- experiencing much worse unemployment performance since the early 1980's. Indeed the proximity of the countries and their similarity along other dimensions may yield an ideal comparison for assessing the labour market flexibility hypothesis.