The IMF Research Bulletin, a quarterly publication, selectively summarizes research and analytical work done by various departments at the IMF, and also provides a listing of research documents and other research-related activities, including conferences and seminars. The Bulletin is intended to serve as a summary guide to research done at the IMF on various topics, and to provide a better perspective on the analytical underpinnings of the IMF’s operational work.

Abstract

The IMF Research Bulletin, a quarterly publication, selectively summarizes research and analytical work done by various departments at the IMF, and also provides a listing of research documents and other research-related activities, including conferences and seminars. The Bulletin is intended to serve as a summary guide to research done at the IMF on various topics, and to provide a better perspective on the analytical underpinnings of the IMF’s operational work.

Martin Schindler

A flexible and dynamic labor market is central to a country’s economic growth and to most people’s economic fortunes. However, the dynamics of the labor market also expose individuals to employment and earnings risk. Not surprisingly, many countries have implemented policies to limit such risks while enhancing overall labor market performance. A large body of empirical and theoretical research at the IMF is devoted to understanding the determinants of labor market outcomes and the role played by labor market policies. This article provides a selective review of recent IMF research in this area.

Concern about unemployment ranks high on the agenda of most policymakers. As unemployment is the result of both inflows and outflows, one way to try to reduce it is to restrict inflows by making it more difficult for firms to lay off workers. However, the net effect of such a policy is ambiguous: dismissal restrictions may decrease the flow from employment into unemployment, but the reduced flexibility of firms to adjust to changing economic conditions may also diminish their incentive to create new jobs, and thus reduce the flows out of unemployment. This conceptual ambiguity is reflected in the literature. On the one hand, a study by Garibaldi and Mauro (2002) of 21 developed countries finds that a laissez-faire policy of low dismissal costs and low taxation is associated with higher net employment growth. On the other, using a calibration approach, Takizawa (2003) finds that dismissal restrictions may have increased employment in Portugal. Still, he calculates substantial welfare losses associated with dismissal restrictions because the inability of companies to lay off workers in response to adverse shocks has resulted in less productive jobs, on average.

The potentially negative effects of restricting dismissals may be mitigated if complemented by measures to increase the flow into employment. In a search model, Heijdra and Ligthart (2002) show that a combination of a subsidy for hiring and a tax on firing increases employment and, under some conditions, welfare. Similarly, in a sample of 15 industrial countries, Estevão (2003) finds that subsidies to job creation have supported employment growth. However, he notes that a partial focus on employment outcomes is ill-suited for policy evaluation because it omits the financing side. Indeed, Zhou (2005) finds that higher income tax rates may have substantially reduced employment in Belgium.

While most labor market policies attempt to influence market outcomes by changing the incentives and constraints of firms and workers, some governments try to increase employment more directly through large-scale public sector hiring. However, as noted by Demekas and Kontolemis (1999), government wage, benefit, and employment decisions, because they are not taken on a profit-maximizing basis, may have a substantial negative impact on aggregate labor market performance and unemployment. This makes government employment undesirable as a policy instrument. Focusing on countries of the Gulf Cooperation Council, Fasano and Goyal (2004) conclude that generous and easily available public sector jobs inhibit human capital accumulation and constrain competitiveness in the nonoil sector. More generally, Schiff and others (2001) note that shedding public sector labor and creating private sector jobs are key challenges facing transition economies. Brixiova and Yousef (2000) examine the appropriate pace for reducing such public sector employment in a matching model with on-the-job search.

In addition to employment issues, policymakers are also concerned about the wage structure. Some studies focus on wage inequality, which appears to have increased over time in many countries, including Poland (Keane and Prasad, 2002) and the United Kingdom (Prasad, 2002), and both within and between skill groups, pointing toward increased skill premia. An exception to this trend is Germany, where Prasad (2004) finds little change in inequality over time. Rigid relative wages, he argues, have resulted in reduced employment rates among the unskilled, rather than increased wage inequality, in the face of relative demand shifts in favor of skilled workers. Decressin and Decressin (2002) support the view that German wages are more rigid than those in the United States or the United Kingdom. The possibility of a trade-off between wage inequality and unemployment is consistent with Porter (2004), who investigates the effects of a wage compression policy in Mauritius through a calibration exercise. He finds that even relatively minor interventions have increased labor turnover and unemployment, and made the economy more susceptible to adverse productivity shocks.

“The potentially negative effects of restricting dismissals may be mitigated if complemented by measures to increase the flow into employment.”

Other studies focus on wage risk. In a theoretical model, Chami and Fischer (2000) examine the impact of private transfers, such as cross-border remittances, on domestic labor markets. They find that private transfers act as partial insurance and induce firms to shift risk to risk-averse workers, thereby reducing aggregate welfare. Rogerson and Schindler (2002) feed empirical estimates of income risk in the United States into a dynamic general equilibrium model and focus on optimal policy when insurance markets are incomplete. They find that government-sponsored severance payments dominate standard unemployment insurance systems and can deliver the first-best outcome.

Kandil and Aghdas Mirzaie (2003) explore some of the international dimensions of labor market outcomes.

According to their study, appreciation of the dollar, while negatively affecting aggregate labor market outcomes, may improve employment conditions in some sectors, particularly those with a high import share. Amiti and Pissarides (2004) consider the nexus between trade liberalization and interregional labor and firm allocation and demonstrate that trade liberalization, through reduced trade costs, may lead to increased industrial agglomeration, more interregional trade, and more efficient labor matching. Trade liberalization often is associated with fear of job losses. However, Amiti and Wei (2004) examine the issue of service outsourcing and find that although it has increased over time, many industrial countries, including the United States, are still net service importers. Using data from the United Kingdom, they also fail to find a negative relationship between service outsourcing and domestic job growth.

Finally, several studies focus on theoretical issues. Underlying many applied studies is the use of the search and matching framework with wage bargaining. One feature of this framework is that labor flows are important determinants of the wage level, which Broersma, den Butter, and Kock (2004) confirm empirically using Dutch data. Using the search framework with wage posting, Gaumont, Schindler, and Wright (2005) construct models that overturn the law of one price and generate robust equilibria with endogenous wage dispersion. Using data from the United Kingdom to study determinants of on-the-job search, Fuentes (2002) finds that on-the-job search increases with job availability and wage dispersion.

References

  • Amiti, Mary, and Christopher A. Pissarides, 2004, “Trade and Industrial Location with Heterogeneous Labor,” IMF Working Paper 04/103; also forthcoming in Journal of International Economics.

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  • Amiti, Mary, and Shang-Jin Wei, 2004, “Fear of Service Outsourcing: Is It Justified?” IMF Working Paper 04/186.

  • Brixiova, Zuzana, and Tarik Yousef, 2000, “Labor Market Adjustment in Transition Economies with On-the-Job Search,” Economics Letters, Vol. 67, No. 2, pp. 22329.

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  • Broersma, Lourens, Frank A.G. den Butter, and Udo Kock, 2004, “A Cointegration Model for Search Equilibrium Wage Formation,” IMF Working Paper 04/92; also forthcoming in Journal of Applied Economics.

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  • Chami, Ralph, and Jeffrey H. Fischer, 2000, “Do Private Income Transfers Increase Labor Market Risk?” Economics Letters, Vol. 69, No. 2, pp. 14351.

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  • Decressin, Anja, and Jörg W. Decressin, 2002, “On Sand and the Role of Grease in Labor Markets: How Does Germany Compare?” IMF Working Paper 02/164.

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  • Demekas, Dimitri G., and Zenon G. Kontolemis, 1999, “Government Employment and Wages and Labor Market Performance,” IMF Working Paper 99/55; also published in Oxford Bulletin of Economics & Statistics, 2000, Vol. 62, No. 3, pp. 391415.

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  • Estevão, Marcello, 2003, “Do Active Labor Market Policies Increase Employment?” IMF Working Paper 03/234.

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  • Fuentes, Andres, 2002, “The Determinants of On-the-Job Search: An Empirical Exploration,” IMF Working Paper 02/156.

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  • Kandil, Magda, and Ida Aghdas Mirzaie, 2003, “The Effects of Dollar Appreciation on Sectoral Labor Market Adjustments: Theory and Evidence,” The Quarterly Review of Economics and Finance, Vol. 43, No. 1, pp. 89117.

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  • Keane, Michael P., and Eswar S. Prasad, 2002, “Changes in the Structure of Earnings During the Polish Transition,” IMF Working Paper 02/135; also forthcoming in Journal of Development Economics.

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  • Porter, Nathan, 2004, “Wage Compression, Employment Restrictions and Unemployment: The Case of Mauritius,” IMF Working Paper 04/205.

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  • Prasad, Eswar S., 2002, “Wage Inequality in the United Kingdom, 1975–99,” IMF Staff Papers, Vol. 49, No. 3, pp. 33963.

  • Prasad, Eswar S., 2004, “The Unbearable Stability of the German Wage Structure: Evidence and Interpretation,” IMF Staff Papers, Vol. 51, No. 2, pp. 35485.

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  • Rogerson, Richard, and Martin Schindler, 2002, “The Welfare Costs of Worker Displacement,” Journal of Monetary Economics, Vol. 49, No. 6, pp. 121334.

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  • Schiff, Jerald, Susan George, Erik Lündback, Luc Moers, Alexandra Merlino, and Hélène Poirson, 2001, “Labor Markets in Hard-Peg Accession Countries: The Baltics and Bulgaria,” IMF Country Report 01/100.

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  • Takizawa, Hajime, 2003, “Job-Specific Investment and the Cost of Dismissal Restrictions—The Case of Portugal,” IMF Working Paper 03/75.

  • Zhou, Jianping, 2005, “Employment Effects of Reductions in Labor Taxes in a Wage Bargaining Model,” Belgium: Selected Issues, IMF Country Report 05/76, pp. 2136.

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IMF Research Bulletin, June 2005
Author: International Monetary Fund. Research Dept.