Can the insider–outsider theory explain unemployment hysteresis in OECD countries?

Abstract

Abstract Insider–outsider theory is often used as a basis for explaining the hysteretic behaviour of unemployment. Despite this, there is no empirical evidence about the validity of this theory on explaining the persistence of unemployment. This article addresses this gap, using various labour market proxies of insiders’ power for the OECD countries over 1960–2013 and employing panel unit root tests that exploit the information contained in these proxies. The results show that although the unemployment rate exhibits a pronounced hysteretic behaviour in OECD countries, this behaviour is reversed once we account for the insider–outsider proxies. Our findings thus validate the role of the insider–outsider theory as a key source of unemployment hysteresis.