Page 11 - AEI Insights 2019 - Vol. 5, Issue 1

Furuoka et al, 2019

where β is a bargaining parameter that would measure the level of strength of insider in the
e
firm, n is expected level of employment, nt-1 is the level of employment at time of the
negotiation. This employment formula indicates that some insiders who is currently working
in the firm could lose their employment during an economic recession if β is less than one.
More importantly, if the bargaining parameter is less than unity, the monetary shock will
disappear in the long-run. It means that a monetary shock would have a transitory impact on
the employment. In this case, the unemployment rates would follow a stationary process. In
the stationary process, the unemployment would have a mean-reversion tendency and in the
unit root process, the unemployment rate would not reverse to its mean value. In other words,
a higher-than-normal unemployment rate would revert to an equilibrium level. However, if the
bargaining parameter is equal to unity, a monetary shock would not disappear. In this case, the
unemployment rates would follow a unit root process (Wang, 2009). Thus, the main point of
this theoretical framework on the employment model is that the strength of the insider in the
firm will determine the labour market dynamics. In other words, the insider power could be the
main element which determines whether unemployment rate would follow the stationary
process. It means that the unemployment rate could follow a unit root process if the bargaining
parameter of the insider in the firm is equal to unity under the pure insider model. Otherwise,
2
the unemployment rate would follow the stationary process . In this context, the theoretical
model suggests that unemployment rates in Europe my follow a unit root process because of
stronger insiders’ power while the unemployment rates in Asia may follow a stationary process
due to the lack of strong insiders.

Main characteristics of labour market in Europe

There are five major characteristics of labour market in Europe. The first characteristic of
European labour market is the strong employment protection. In the European labour market,
employment protection mechanisms, such as unemployment insurance, is seen as a potential
cause of persistently high unemployment rates. It has been argued that the strong existence of
employment protection in the region can prevent the labour market from becoming flexible
enough to absorb negative shocks in the labour market. In other words, strong employment
protection would prevent wage levels from becoming lower enough to provide job
opportunities to unemployed workers during the economic crisis.

The second characteristic of European labour market is the lack of flexibility. There is an on-
going debate on the relationship between worker protection provided by labour market
institutions and the flexibility of labour market. This debate is known as the labour market
flexibility debate. Some economists who believe in the importance of flexibility argue against
employment protection. These neoclassical economists promote the importance of natural rates
of unemployment, the efficiency wage theory and the job search theory to explain the market
equilibrium of labour supply and demand. According to this school of thought, unemployment
insurance can be seen as a “social wage” which contributes to high unemployment. This line
of argument is promoted by some international organisations, such as the Organisation for
Economic Cooperation and Development (OECD) and the International Monetary Fund (IMF).
Thus, this economic thought is also known as the OECD-IMF orthodoxy for the labour market.
For example, the OECD has proposed the OECD Jobs Strategy for all its member countries.

2 This paper’s theoretical foundation is based on the employment function within the insider-outsider theory
suggested by Blanchard and Summers (1986). More recently, Gustavsson and Österholm (2007) have provided
empirical evidence to indicate a distinctive difference between unemployment and employment hysteresis.
According to them, empirical tests tend to produce mixed evidence for hysteresis in unemployment. By contrast,
unit root tests are able to produce more consistent results to support hysteresis in employment.

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