Should-Read: Tolga Aksoy and Paolo Manasse: The hysteresis-resilience trade-off in unemployment

Should-Read: A very interesting take on the comparative structure of European labor markets. I should ask my ex-roommate Robert Waldmann what he thinks about this: Tolga Aksoy and Paolo Manasse: The hysteresis-resilience trade-off in unemployment: “We focus on… resilience: the impact of output shocks on the unemployment gap (the lower the impact, the higher resilience)…

…hysteresis: the persistence of unemployment. We find that reforms that liberalised labour and product markets tended to reduce both hysteresis and resilience…. We can estimate the speed of adjustment of the rate of unemployment toward long-run equilibrium. The regression coefficient of the output gap measures the short-run elasticity of the unemployment gap to the output gap. The smaller the absolute value of this parameter (beta) is, the more resilient the country’s unemployment rate. Similarly, the coefficient of the lagged unemployment gap (alpha) measures the persistence of the unemployment response. The closer the parameter to unity, the more persistent the effects of a shock…. A trade-off: labour markets that display more hysteresis (high alpha), are characterised by more resilience (low beta)….

We may conjecture that high resilience and high hysteresis, as in Italy, exemplifies a ‘rigid’ labour market, in which high firing and hiring costs (Bentolila and Bertola 1990) and strict employment protection legislation prevent firms from cutting employment in downturns, at least in the short run, also raising the unemployment persistence in the long run. We may also imagine that low resilience and low persistence, as in Spain, represents ‘flexible’ markets….

A more regulated product market and a more centralised wage bargaining system are associated with a lower impact of output on unemployment. Also, a more regulated product market and more centralised bargaining system are associated with more persistent unemployment. Finally, we find that a more restrictive employment protection legislation is associated with higher hysteresis, but not significant ‘protection’ effects against output shocks….

Did the structural reforms hastily introduced by southern European countries during the crisis worsen their unemployment outlook? The short answer is “yes, but…”. The effects were relatively small, and quickly reversed….

Our findings are consistent with the view that labour and product market reforms speed up the recovery from recession and so yield long-run benefits. But we also find that reforms have tended to make the labour markets less resilient to shocks. This second effect, though small, prevails initially. Therefore caution should be used in implementing labour market reforms during large recessions and fiscal adjustments…