Labour Market Institutions and Unemployment Volatility: Evidence from OECD Countries

Abstract

Using publicly available data for a group of 20 OECD countries, we find that the cyclical volatility of the unemployment rate exhibits substantial cross-country and time variation. We then investigate empirically whether labour market institutions can account for this observed heterogeneity and find that the impact of various institutions on cyclical unemployment dynamics is quantitatively strong and statistically significant. The hypothesis that labour market institutions could increase the volatility of unemployment by reducing match surplus is not supported by the data. In fact, unemployment benefits, taxation and employment protection appear to reduce the volatility of unemployment rates. In addition, we find that the precise nature of union bargaining has important implications for cyclical unemployment dynamics, with union coverage and density having large and offsetting effects. Finally, we provide evidence suggesting that interactions between shocks and institutions matter for cyclical unemployment fluctuations. However, institutions only account for about one quarter of the explained variation, which implies that they are important but they are not the entire story.