Unemployment and Labor-Market Reform

Posted: 3 Feb 2000

See all articles by H. P. Gruner

H. P. Gruner

University of Mannheim - Department of Economics; Institute for the Study of Labor (IZA); Centre for Economic Policy Research (CEPR)

Date Written: July 1999

Abstract

Why do many democracies fail to reform their labor market institutions? We study the feasibility of reforms that include the compensation of the insiders for the removal of labor market regulations. In our model workers differ in their ability to perform well on a liberalized labor market. The workers' ability is unobservable for the government. This informational asymmetry generates additional costs for a government that wants to implement a compensation package together with a labor market reform. Under asymmetric information, a reformer who wants to "buy" the approval of voters has to pay them an informational rent in addition to the pure costs of compensation that would arise under symmetric information. In this setting unemployment may be constrained Pareto-efficient. Consequently, no reform, under majority voting labor market reforms, may fail politically because there exists no reform package that gets the approval of a majority of voters. Our model explains the emergence of political deadlocks where low rates of unemployment can be removed in the political process while high rates of unemployment tend to be politically stable.

JEL Classification: F70, E61, J68

Suggested Citation

Grüner, Hans Peter, Unemployment and Labor-Market Reform (July 1999). Available at SSRN: https://ssrn.com/abstract=183298

Hans Peter Grüner (Contact Author)

University of Mannheim - Department of Economics ( email )

D-68131 Mannheim
Germany

Institute for the Study of Labor (IZA)

P.O. Box 7240
Bonn, D-53072
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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