Blanchard, O. and P.A. Diamond, “The Cyclical Behavior of Gross Labor Market Flows in the U.S. Economy,” Brookings Papers on Economic Activity (1991).
Commission of the European Communities, Growth, Competitiveness, Employment: The Challenges and Ways Forward into the 21st Century (1993).
Ortega, J., “Loss of Skill During Unemployment, Complementarities in Production, and Persistence of Shocks,” DELTA WP #93-26 (1993).
The author is a Researcher at DELTA (a joint research unit ENS-CNRS-EHESS), with a joint appointment with CERAS and ENPC, and is a Fellow of the Centre for Economic Policy Research. This paper was written while the author was visiting the International Monetary Fund Research Department. Its main theme was suggested by David T. Coe and Robert P. Ford, and it has benefitted from discussions with José De Gregorio. The views expressed in this paper are those of the author and do not necessarily reflect those of the Fund.
See the European Commission (1993) White Paper for recent policy proposals and Emerson (1989) for a cautious discussion on the welfare state and labor market reform.
Although there is also a minimum wage in the United States, as a percent of average wages it is relatively small by European standards and is now less than it was in 1950.
For an analysis of the political issues in increasing labor market flexibility, with an emphasis on complementarities, see Saint-Paul (1993).
Although, in principle, the problem could be alleviated by raising the tax rate on skilled labor, in accordance with the prescriptions of optimal second-best taxation. Another option is to specify the minimum wage as a pre-tax wage. France is trying to gradually shift toward such a system by replacing payroll taxes (which act as in Figure 1) with so-called “Contribution Sociale Généralisée” (CSSG)) which is levied upon all incomes, including the minimum wage and unemployment benefits.
This would be the case in an open economy with capital mobility where the marginal product of capital would be equal to the world rate of interest.
As emphasized by Ortega (1994), there is no canonical way of labeling workers as “skilled” or “unskilled” as long as they are not perfect substitutes.
Note that the model exhibits “fiscal increasing returns” as analyzed in Blanchard and Summers (1987): an increase in the unemployment rate lowers the tax base, which for a given target for unemployment benefits, calls for an increase in taxes, which leads to further increases in unemployment.
Given that there are only two skill levels in the economy, there is no clear-cut way to calibrate x. If one takes the number of people earning the minimum wage as a guideline, then 0.5 is too low for x, since the minimum wage will then be binding for 50 percent of the labor force. However, if one takes the proportion of workers with higher education as an alternative criterion, then 0.5 is too high.