The Positive Economics of Labor Market Rigidities and Investor Protection

Abstract

This paper presents a positive model which derives the preferences of entrepreneurs, workers, and investors concerning investor and employment protection. It shows that institutional setups on capital and labor markets might be intertwined by politicoeconomic forces. Multiple politicoeconomic equilibria arise from our model. Some countries especially in continental Europe exhibit a corporatist politicoeconomic equilibrium with a substantial protection of insiders on both, capital and labor markets. The more important money is in political decision‐making, the more divided the workforce is, and the more globalized capital markets are, the more likely is a capitalist politicoeconomic equilibrium with little employment and substantial investor protection. Our prediction of a negative crosscountry relationship between different measures of labor market rigidities and of competition on capital markets receives considerable empirical support, thus being potentially important for the current debate concerning structural reforms of labor markets and of corporate governance systems.We thank two anonymous referees as well as participants of the Colloquium on Financial Markets at the Kiel Institute of World Economics, of the Workshop of the Arbeitskreis Deutscher Binnenmarkt der List‐Gesellschaft on Capital Markets, of the Economics Workshop at the University of Würzburg, and especially Norbert Berthold, Martin Hellwig, Michael Neumann, Oliver Stettes, and Eric Thode for helpful comments. The usual disclaimer of course applies.