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Wednesday, July 27, 2011

Labor Market Rigidities and Unemployment

Murat Tasci and Mary Zenker have written an interesting Economic Commentary for the Cleveland Fed, looking at the relationship between labor market rigidities and the response of unemployment rates during the recent recession.  They focused on OECD countries.  What they found, using the OECD index of "Overall Strictness of Employment Protection" as their measure of labor market rigidity, is this:  In the OECD, countries with more strict employment protection experienced smaller increases in their unemployment rates during the "Great Recession", while countries with less strict employment protection (notably the U.S.) experieced larger increases in unemplyment rates.  However, in non-recessionary periods, countries with less strict employment protection tended to have lower unemployment rates than did countries with more strict employment protection.

For example, the unemployment rate in the U.S. (least strict protection) rose by more than 4 percentage points during the recessions, while in France (4th most restrictive) saw an unemployment rate increase of less than 2 percentage points.  Both had total GDP declines during the recession of about 4% to 4.5%.  However, the unemployment rate in France was consistently 2 - 3 percentage points higher than in the US from the trough of the previous recession (in 2001).

What I find interesting, but unable to do much with (because finding the relevant data for France, or other countries, is apparently more difficult than it is for the U.S.), is that Tasci & Zenker say nothing about the labor market rigidity often cited as a major contributor to flexibility in labor markets--wage rigidity (or its converse, wage flexibility).  We would expect countries with more flexible wages to display smaller increases in unemployment during recessions (although our expectations about average levels of the unemployment rate are less clear).  So what can we say about wage flexibility?

All I can (easily) find are quarterly data for the U.S. on "Usual Median Weekly Wages" in current dollars (at  And, relative to trend, U.S. wages appear both to be reasonably flexible (the mean percentage point change in actual relative to trend for the 1979 to 2011 period is 2.2 percentage points.  And this is quarterly data, not annual data.  Furthermore, wages do not appear to behave particularly counter-cyclically (in the U.S.), so this does not appear to be a source of added flexibility for the U.S. economy.  (Real wage flexibility apears roughly similar to nominal wage flexibility, with an absolute mean quarterly deviation from trend of 2.4 percentage points.  Again, the pattern does not appear to be counter-cyclical.)

Ignoring wage flexibility seems to me to be a clear (and unforced) error, but one that I cannot easily try to adjust for.


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