A cross-country study of the effects of labour institutions on key macroeconomic variables

Raffaella Belloni

doi:10.25907/00824

Labour market regulations are considered a controversial area of public policy, with employment protection legislation being viewed as the most likely cause of poor macroeconomic performance for developed countries. One economic view supports the idea that the regulations create rigidities in the labour market, reflecting adverse effects on growth, employment, and productivity. On the other hand, labour market regulations are considered necessities to reduce the imbalance in employee/employer relationships in order to improve social stability and support aggregate demand. After many years of deregulatory advice, international organisations such as the Organisation for Economic Co-operation and Development (OECD), the World Bank and the International Monetary Fund (IMF) have recently suggested a less extreme position, however, regulation in the labour market is still viewed by a vast body of empirical literature as being harmful to macroeconomic performance. This research discusses the extent to which labour market institutions matter for macroeconomic performance and analyses how the labour market institutions are measured. This empirical research investigates the relationship between labour institutions and key macroeconomic variables by using a panel dataset from 27 OECD countries to analyse the effects of labour institutions on economic growth, unemployment, and productivity over a period of 29 years, from 1990 to 2019. The importance of the labour market indices in cross-country empirical analysis is also highlighted in this thesis. Notwithstanding the limitations of these indices and the aggregation process, they are crucial in assessing the effects of labour market institutions and, therefore, a suite of labour market indicators is critically analysed. After an overview of the main indices, the two indicators chosen for this empirical analysis, the Employment Protection Legislation Index developed by the OECD and the Labour Market Index developed by the Fraser Institute, are discussed. The findings intend to provide policymakers with a better understanding of macroeconomic performance in the face of labour market institutions. By using regression analysis, a positive relationship has been found between labour market flexibility and economic growth. Labour institutions are also found to be a determinant of unemployment, meaning that an increase in the rigidity of the labour market is associated with an increase in unemployment. Lastly, the study examines the impact of labour institutions on productivity growth. The findings fail to determine a relationship between productivity and labour market institutions; however, a robust link is found between productivity growth and foreign direct investments, meaning that the influx of foreign capital is a determinant of productivity growth. The study concludes by recommending policy measures to deregulate the labour market to promote economic growth, reduce unemployment rates, and encourage foreign direct investment to promote productivity growth. This thesis contributes to advancing the understanding of how labour market institutions affect the macroeconomic performance from country to country and, subsequently, provides insight to policymakers on which labour market framework is most suitable to foster economic growth, employment, and productivity. However, this study emphasises the importance of recognising the sensitivity of research findings to the choice of labour market indicators. Policymakers should exercise caution when generalising results from one indicator to another. They should consider the unique context and characteristics of the labour market when formulating policies. Additionally, they should assess the potential impacts of various labour market regulations and institutions in the local context to tailor policies that align with specific labour market dynamics.

A cross-country study of the effects of labour institutions on key macroeconomic variables

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