Labor policies and capital mobility in theory and in EMU

Abstract

Europe's Economic and Monetary Union (EMU) was characterized by large international imbalances and uneven national labor market reforms. In this paper's model, labor policies that aim to increase the welfare of capital-poor individuals within each country are in ‡uenced by …nancial integration across di¤erently capital-abundant countries. The model predicts that capital out ‡ows should be associated with labor market deregulation, as was the case in EMU, and helps interpret inequality developments and policy tensions in that experience.Very useful comments on earlier drafts are gratefully acknowledged to three referees and to workshop and seminar participants at CREST (Paris), CEGE (Goettingen), ESt (Turin), EDHEC (Nice), University of Bonn, and ECB -DG Research.JEL: F2, J08

European unemployment revisited: Shocks, institutions, integration

“…Theory associates economic integration also with institutional reforms that partly o¤set that e¤ect, and tend to decrease employment in de…cit countries (Bertola, 2017): for a capital-importing country, the politico-economic optimal employment is lower (relative to the higher laissez-faire level implied by capital in ‡ows) in more integrated …nancial market; conversely, exogenously more intense capital ‡ows imply that capital-exporting countries not only experience lower labor demand but also have stronger incentives to deregulate their labor markets. This theoretical result is consistent with the labor reform evidence generated by adoption of a common currency by some European countries, a clearly identi…ed and arguably exogenous …nancial integration shock (Bertola, 2016), and is arguably relevant to the most recent portion of the broader dataset analyzed here: if reforms increase labor market rigidity and decrease TFP in countries where capital in ‡ows reduce unemployment, the data generating process can yield a negative coe¢ cient for TFP in descriptive BW regressions that, as in Tables 4 and 5, do not control for capital in ‡ows.…”

“…To rationalize positive unemployment in the absence of shocks let market institutions be chosen, as in Bertola (2016), so as to maximize the welfare of an individual who earns the per-capita labor income and a proportion x < 1 of other per capita income. At given k d and a 1 , the relevant …rst-order condition is 5…”

“…The median voter is capital-poorer than the average individual if wealth is more unequally distributed than labor income. In democratic countries, individuals who earn less than the average non-labor income do support employment taxes and non-employment subsidies, legal or collectively bargained minimum wages, limits on weekly work hours, minimum annual holidays, and age-related employability rules (Bertola, 2016).…”

Wedges: Distribution, distortions, and market integration

“…When economic activity crosses the country's borders, however, beggar-thy-neighbor incentives also in ‡uence the politicoeconomic equilibrium policy. Bertola (2016) models labor policy motivated only by redistribution and shows that a transition from autarky to complete integration can imply reform and capital ‡ow patterns consistent with those observed in Europe's Economic and Monetary Union (EMU). In this more technical paper the laissez faire may be ine¢ cient, integration can be incomplete, and two modeling devices make it possible to obtain a richer and sharper set of results.…”

“…The …rst-order condition may alternatively and equivalently be taken with respect to speci…c policy instruments or, as in Bertola (2016), to the ! wedge.…”