1
DOES THE WELFARE STATE HURT EMPLOYMENT?
An earlier version of the paper was presented at the Annual Meeting of the American
Political Science Association, San Francisco, CA, August 2001. For help and
suggestions, I am extremely grateful to Peter Hall, Torben Iversen, Fritz Scharpf, David
Soskice, and Anne Wren.
2
The question about the adverse impact of taxes on the employment performance
of a political economy has emerged as a critical issue on the agenda of policy reform in
most European economies. The publication of various policy white papers as well as the
introduction of numerous policy changes testify to the importance of this issue in recent
years1. For example, both left- and right-wing governments in France have attempted to
address the persistent levels of unemployment, by introducing more than 40 policy
measures that have lowered the social charges of employers and exempted a number of
firms from social security contributions to various branches of the French welfare state2.
During recent years, the Belgian and Dutch governments have enacted a number of
policies reducing payroll taxes of employers in both the manufacturing and service
sector3. The current red-green coalition government in Germany is considering a number
of broad reforms in the mode of financing of social insurance – involving a partial shift to
taxes that are not employment-based – such as ecological taxes – as well as various
1
For example of these policy debates, see for example, Conseil Supérieur de l’Emploi, ed., 1996,
L’allègement des charges sociales sur les bas salaries. Rapport au premier ministre, Paris: La
documentation française; European Commission, ed., 1995, Employment in Europe, Bruxelles: European
Commission.
2
For an overview of these policy developments, see Bourguignon, François and Bureau, Dominique, ed.,
1999, L’architecture des prélèvements en France: Etat des lieux et voies de réforme, Paris: La
Documentation Française; De Foucauld, Jean-Baptiste, 1995, Le Financement de la Protection Sociale,
Paris: La Documentation Française; Dehez, Pierre and Fitoussi, Jean-Paul, 1992, Revenu minimum,
allocations-chomage et subventions a l’emploi: un modèle macroéconomique simple, Document de travail
Nr. 92-07, Observatoire Français de Conjonctures Economiques, Paris: OFCE.; Piketty, Thomas, 1998
L’impact des incitations financiers au travail sur les comportements individuals: une estimation pour le cas
français, Economie et Prévision, Nr. 132- 133, pp. 1- 35; Assouline, Mireille, et. al., 1998, L’impact
macro-économique d’une baisse des cotisations sur les bas salaries, Travail et emploi, Nr. 73, pp. 41- 65.
3
See Investing in People and Jobs: Belgium’s 1999 Action Plan prepared in accordance with European
Employment Guidelines and The Netherlands’ National Employment Action Plan, 1999, Brussels:
European Commission.
3
proposals to direct fiscal transfers to low-earning employees and exempt employers from
social security contributions4. Finally, tax reforms (in exchange for wage restraint) are an
important issue on the agenda of new ‘social pacts’ in Europe.5
Most of these reforms respond to a growing political perception that the high
levels of income and payroll taxes are one of the general causes of economic malaise
experienced by European economies during recent decades. As Fritz Scharpf concludes
in a recent study, “a considerable range of perfectly decent jobs, which in the absence of
payroll taxes would be commercially viable, are eliminated from the private labor market
of continental welfare states”.6 During recent years, many social democratic governments
have begun to share the policy diagnosis that high non-wage labor costs are inimical to
employment expansion and overall economic competitiveness7. This stands in sharp
discontinuity to traditional social democratic economic policy, which has attempted to
reconcile full employment and a redistributive welfare state.
4
On these policy debates in the German context, see, for example, Schelkle, Waltraud, 2000, Subsidizing
low earnings. German Debates and US Experiences, Vierteljahresheft für Wirtschaftsforschung, 69, 1, 116; Bofinger, Peter, Fasshauer, Stephan, 1998, Reduzierung der Sozialabgaben statt Kombilohn,
Wirtschaftsdienst, 78, 9, 519- 528; Wanger, Gert, 1999, Soziale Sicherung im Spannungsfeld von
Demokratie und Arbeitsmarkt, in Nübler, Irmgard, Trabold, Harald, eds., Herausforderungen an die
Wirtschaftspolitik an der Schwelle zum 21. Jahrhundert, Berlin: Sigma, pp. 77- 91.
5
On the development of these new social pacts, see Regini, Marino. 2000. Between Deregulation and
Social Pacts: The Responses of European Economies to Globalization, Politics and Society, 28: 1, pp. 533; Fajertag, Giuseppe and Pochet, Philip, eds., Social Pacts in Europe, Brussels: European Trade Union
Institute; Hassel, Anke, 1999. Bündnisse für Arbeit: Nationale Handlungsfähigkeit im europäischen
Regimewettbewerb, Discussion Paper, Max Planck Institute for the Study of Societies, Cologne.
6
See Scharpf, Fritz. 1999. Governing in Europe. How effective? How Democratic? Oxford: Oxford
University Press, p. 142; see also Scharpf, Fritz. 1997. Employment and the Welfare State: A Continental
Dilemma, Discussion Paper: Max Planck Institute for the Study of Societies, Koln.
7
For the importance of policy considerations pertaining to the financing of social insurance for current
social democratic governments, see for example, Julian Le Grand, 1999, New Approaches to the Welfare
State, in Gamble, Andrew and Wright, Tony, eds., 1999, The New Social Democracy, Oxford: Blackwell
Publishers, pp. 142- 150.
4
The goal of this paper is to provide a theoretical framework modeling the
employment consequences of the growth of the welfare state. The analysis seeks to
uncover the key institutional and political variables affecting the sensitivity of
employment to taxation. What is the effect of the growth of taxes and social policy
commitments on the employment performance of various political economies? Does it
vary across countries – in other words, do salient cross-national institutional differences,
such as differences in labor market institutions – affect the magnitude of the impact of
taxes on employment? What is the importance of the economic choices made by unions,
in this new political context of heightened austerity and retrenchment?
To analyze these policy questions, this paper will develop a model exploring the
impact of the growth of the welfare state on the wage demands of trade unions and on the
level of unemployment in different economies. The results of the model can be
summarized as follows. By explicitly modeling unions concern for social policy, I show
how the optimal strategy of trade unions is to deliver wage restraint in exchange for
social policy expansion (given a particular mix of social policy transfers and services).
This proposition formalizes an insight of many corporatist studies that have highlighted
the crucial role played by incomes policies in sustaining the simultaneous pursuit of
welfare state expansion and employment expansion during the golden age period8.
Moreover, I show how the structure of labor market institutions – more specifically the
level of centralization of the wage bargaining authority – affects the magnitude of the
8
For a formulation of these arguments, see Cameron, David, 1984, Social Democracy, Corporatism and the
representation of economic interests in advanced capitalist societies, in John H. Goldthorpe, ed., Order and
Conflict in Contemporary Capitalism, New York: Oxford University Press, pp. 143- 178; EspingAndersen, Gosta. 1990, Three Worlds of Welfare Capitalism, Princeton: Princeton University Press,
(Chapter 5: Distribution Regimes in the power structure), pp. 105- 143; for a recent comprehensive
overview of these themes see Hicks, Alexander. 1999. Social Democracy and Welfare Capitalism. A
century of income security politics, Ithaca: Cornell University Press.
5
employment effects resulting from the wage restraint of trade unions. Building on the
theoretical propositions advanced by Calmfors and Driffill and further refined by other
scholars of corporatism, the model predicts a parabolic relationship between the level of
centralization of the wage bargaining authority and the level of unemployment. Thus,
economies with institutions of wage bargaining centralized at the sectoral-level have the
worst employment performance. Next, I show how demographic and fiscal developments
have strained this political exchange, undermining the ability of trade unions to deliver
wage restraint. A series of developments that characterize the economic climate of two
recent decades – such as population aging and the rise in the number of labor market
outsiders – have contributed to a rise in the level of taxes. These developments have
simultaneously raised the costs of social policy to unions (and employers) and have also
reduced the share of social policy benefits received by union members, weakening thus
the ability of unions to deliver wage restraint. Thus, while welfare states have become
more overburdened, the ability of trade unions to deliver the wage restraint necessary to
restore high levels of employment has declined. The model suggests that the process of
welfare state maturation has undermined the political exchange between unions and
governments premised on wage moderation in exchange for social policy expansion.
Thus, while welfare state expansion and the pursuit of full employment were compatible
policy goals during the first decades of the postwar period, demographic and fiscal
developments have undermined this policy compatibility.
This article is divided into three sections. The following section situates the
analysis developed in this paper within recent theoretical debates in the study of
advanced industrialized economies. Section 3 develops a model of the employment
6
consequences of the welfare state. In section 4, I test the main implications of the model
using OECD data for the period 1960- 1995. A final section of the paper discusses
implications of the model for future research on labor market developments in advanced
industrialized economies.
2. MODELS OF WAGE BARGAINING, MACROECONOMIC POLICY AND
THE WELFARE STATE: TOWARDS A NEW THEORETICAL SYNTHESIS.
The model developed in this paper builds on recent theoretical developments in
the study of economic policy-making in advanced industrialized democracies. This
section will briefly review the main theoretical and empirical findings of this new
research agenda and will situate the contribution of this paper within the existing
literature9. I also seek to demonstrate that, while existing models have been rather
successful in explaining the impact of existing institutions on cross-national differences
in the level of unemployment, they have been less successful in explaining temporal
changes in the level of unemployment in different political economies.
The building block for my analysis is the influential economic model studying the
relationship between wage bargaining institutions and macroeconomic performance
developed by Lars Calmfors and John Drifill10. Building on Mancur Olson’s theory of
9
For similar comprehensive reviews of these recent theoretical developments, see Thelen, Kathleen. 2000.
New Directions in the study of labor in the advanced industrial countries, Draft Paper for the APSA project
on the ‘State of the Discipline’ edited by Ira Katznelson and Helen Milner, Hall, Peter and Soskice, David.,
An Introduction to Varieties of Capitalism, in Hall, Peter and Soskice, David, Varieties of Capitalism: The
Foundations of Comparative Institutional Advantage, Oxford: Oxford University Press.
7
collective action, Calmfors and Drifill’s model posits a “hump-shaped” relationship
between the centralization of wage bargaining and the level of unemployment. This
“hump-shaped” relationship is the consequence of two effects: the monopoly effect
(resulting from an increase in union power) and the ability of large wage setters to
internalize some of the negative labor market consequences of their wage demands.
According to Calmfors and Drifill, when labor markets are extremely decentralized,
individual companies compete in product markets which are characterized by a high
elasticity of substitution among goods. In these environments, the trade-off between
unemployment and wage increases faced by trade unions is extremely steep, as a wage
settlements that exceeds the wage-rate paid by a competitor within the same industry
contribute to a steep employment decline of a firm. The consequence is a high level of
wage restraint and a low level of unemployment in economies in which wage bargaining
takes place at the firm level (decentralized labor markets). An increase in the level of
centralization of wage bargaining system – which generally takes the form of an increase
in intra-sectoral centralization of wage bargaining – is associated with a decline in the
elasticity of substitution of among the goods produced by the firms that are subject to
unified wage demands of trade unions. This economic and institutional environment
increases the incentives of trade unions for wage militancy. Calmfors and Driffill posit
that the level of wage militancy is higher in economies with intermediate-level
centralization of wage bargaining as compared to economies with decentralized labor
markets. However, if a further increase in the level of centralization of wage bargaining –
from industry-level to economy-level centralization—creates incentives for trade unions
10
Calmfors, Lars and Driffill, John. 1988. Bargaining structure, corporatism and economic performance.
Economic Policy, 6, 1, 14-61.
8
to “internalize” some of the consequences of militancy. Thus, Calmfors and Driffill
predict wage moderation and lower levels of unemployment in economies with highly
centralized institutions of wage bargaining compared to intermediately-centralized wage
bargaining systems. Figure 1 presents the relationship between the structure of labor
market institutions and the level of unemployment hypothesized by the Calmfors and
Drifill model.
FIGURE 1
During recent years, a number of studies have developed a theoretical and
empirical challenge of this model11. These studies critique the Calmfors and Drifill model
for failing to take into account the importance of monetary policy in the determination of
the level of inflation and unemployment. In a number of papers, David Soskice and
Torben Iversen have returned to the original question about the impact of labor market
centralization on unemployment posed by the Calmfors and Drifill model. Soskice and
Iversen depart from Calmfors and Driffill by introducing an additional parameter
modeling the degree of ‘accommodation’ of a monetary policy. Monetary
accommodation is defined as the overall responsiveness of the government to the
11
For representative examples of research that attempt to model the interaction between the corporatist
literature on wage bargaining and the literature on macroeconomic policy, see Scharpf, Fritz. 1991. Crisis
and Choice in European Social Democracy, Ithaca: Cornell University Press; Hall, Peter A. and Franzese,
Robert. 1998. Mixed Signals: Central Bank Independence, Coordinated Wage Bargaining and European
Monetary Union, International Organization, 52, 3, 505- 535; Iversen, Torben, 1998, Wage Bargaining,
Central Bank Independence and the Real Effects of Money, International Organization, 52, 3, 469- 504;
Iversen, Torben, 1999. Contested Economic Institutions: The Politics of Macroeconomics and Wage
Bargaining in Advanced Democracies, Cambridge: Cambridge University Press; Soskice, David and
Iversen, Torben. 2000. the non-neutrality of money with large price or wage setters, Quarterly Journal of
Economics, 115, 1, 1-20.
9
increases in the aggregate price level. In the Soskice and Iversen framework, a central
bank that is completely accommodating sets the real money supply equal to the price
level, whereas in the case of a totally ‘non-accomodating’ monetary policy, the money
supply is entirely independent of changes in the prices level.
The important finding of the Iversen and Soskice model is that in nonatomistic
labor markets, monetary policy has a real impact on unemployment. Moreover, they
show that the impact of monetary policy on unemployment is conditional upon the
centralization of the wage bargaining system. The predictions for cross-national
differences in the level of unemployment of the Soskice and Iversen model are in
agreement with the Calmfors and Driffill model only for the case of an ‘accomodating’
macroeconomic policy regime. In this case, both models predict that the employment
performance of economies characterized by intermediately centralized wage bargaining
systems is inferior to the performance of economies in which wage bargaining is either
extremely centralized or extremely decentralized. The predictions differ, however, in the
case of a ‘non-accomodating’ macroeconomic policy. Soskice and Iversen argue that a
‘non-accomodating’ monetary policy can in part deter some of the wage militancy of
trade unions. As Iversen argues, “if the monetary authority is non-accomodating, higher
wages can no longer be externalized to the same extent and this will deter militant union
behaviour. The collective action problem facing unions in intermediately centralized
systems – which can lead to excessive wage demands and unemployment – is thus
‘solved’ (or at least dissipated) by an agent that is deliberately non-accomodating to
union objectives. This crucial (and perhaps surprising) result is overlooked in all existing
models of union behaviour (such as Calmfors and Driffill’s application of Olson’s theory)
10
because they fail to consider the conditioning effects of monetary policies on interunion
interactions”12.
[SEE FIGURE 2]
Figure 2 summarizes the predictions about cross-national variation in the
employment performance of European economies of various specifications of the Soskice
and Iversen model. Common to all different specifications of the model is that the change
in the macroeconomic policy orientation from monetary ‘accommodation’ to monetary
‘non-accommodation’ results in a decline in the level of unemployment. Iversen and
Soskice (2000) predict that the increase in the centralization of wage bargaining should
enhance the positive employment effects of monetary non-accomodation13. Thus, the
lowest levels of unemployment should be encountered in economies in which the
monetary policy regime is non-accommodating and the wage-bargaining system is highly
centralized. In Contested Economic Institutions, Iversen introduces an additional
assumption about unions’ concerns for wage equality14. Iversen argues that these
12
Iversen, Torben, 1998, op. cit., pp. 48- 49.
13
See Soskice, David and Iversen, Torben. 2000. The Nonneutrality of Monetary Policy with large price or
wage setters, Quarterly Journal of Economics, 265- 284.
14
More specifically, Iversen assumes that the objective function of trade unions can be written as
−
U i = α ( wi − π ) − (1 − α )U i U − β (r i − r e ) 2 . Iversen, 1999, op. cit., pp. 38- 39. In this equation,
wi denotes the percentage nominal wage increase, π the percentage increase in consumer prices, U i is the
−
i
unemployment rate among the trade union members in sector i , U is the average unemployment rate, r is
e
the ideally sought wage ratio between low-wage and high wage workers and r is the actual wage ratio
expected from a particular wage settlement. The parameters α and β denote the weights attached by trade
unions to different policy objectives, such as the objective of an increase in the level of real wages (first
11
concerns for wage equality have a negative impact on employment in economies with
highly centralized systems of wage bargaining. This is graphically represented in Figure
2 by the upward slope of the predicted employment for the case of the nonaccommodating monetary policy.
The most striking aspect about the empirical predictions of Iversen’s model is the
fact that it is totally at odds with the recent employment trends in European economies.
Two implications of the model seem to be contradicted by recent labor market
developments. First, the model seems unable to predict why unemployment has risen so
dramatically in Europe during the recent two decades. Between 1960 and 1975, the
average-level of European unemployment was 2.6 percent. Average unemployment rose
to 8 percent between 1976 and 1995. However, the empirical predictions of the Iversen
model go in the opposite direction! Since the increase in monetary non-accomodation
shifts the curve predicting unemployment downwards, European unemployment should
have declined between 1975 and 1995. Secondly, Iversen’s model remains unable to
account for cross-national differences in the employment performance of European
economies under conditions of monetary non-accomodation. While the model predicts
that economies with highly centralized institutions of wage bargaining (Scandinavia)
should perform worse than economies with sectoral-level wage bargaining (Belgium,
Netherlands, Germany), the data suggest the opposite. For the period between 1976 and
1995, average unemployment rates in Scandinavian economies were 4.8 %, but 9.4 % in
countries of the European community. If anything, these empirical data seem to confirm
term of the utility) and the objective of wage equality (third term). This specification of the objective
function of trade unions implies that unions’ utility will increase as the level of real wages ( wi − π )
increases, but that it will decline as the level of unemployment increases. Furthermore, an increase in
differences between the “anticipated” and de facto level of wage incquality ( r − r ) also leads to a
decline in the utility of unions. Ibid., p. 39.
i
e
12
the original Calmfors and Drifill hypothesis about the “hump-shaped” relationship
between centralization of wage bargaining and unemployment.
This suggests that additional economic and political factors (that were not
included in the analysis of Iversen and Soskice) counteracted the employment effects of
an increase in monetary non-accommodation. The model developed in this paper suggests
that the steady rise in the level of payroll and income taxes can account for the
deterioration in the employment performance of European political economies during the
last two decades. The growth in the level of taxes has been the consequence of two
developments. First, both demographic developments (such as population aging) and
labor market changes (such as the development of early retirement policies) have
increased the share in the population receiving social policy transfers, worsening the
employment-dependency ratio of many European systems of social protection. Secondly,
the explicit commitment to deficit reduction by many European governments during
recent years has shifted a larger part of the burden of financing existing welfare state
commitments to the tax system. Thus, to understand the recent steady rise of
unemployment, we need to bring in the welfare state into existing models of
macroecomic policy-making and explore the employment consequences of different
systems of social protection.
Both the Calmfors and Drifill model and the Soskice and Iversen framework serve
as the building blocks of the analysis developed in this paper. I build in additional
complexity to these models, by incorporating institutional and policy characteristics of
the welfare state into the analysis. More specifically, I focus on differences in the mode
of financing different welfare state commitments and on differences in the structure of
13
social policy benefits (the mix between social policy transfers and social services). This
allows me to examine cross-national variation in the impact of the growth of the size of
the welfare state on the level of employment in different political economies and to study
the interaction between different labor market arrangements and different social policy
arrangements.
3. THE MODEL
This paper will use the standard set-up of the of the Calmfors and Drifill model15
and will also incorporate the differences in the monetary policy regime modeled by
Iversen and Soskice. The game has the following policy stages. Governments choose the
level of taxes (τ ), the level of deficit ( D ), and the macroeconomic policy orientation of
an economy ( β ). Unions move next, announcing their wage demands. In contrast to the
existing models of wage bargaining, I will assume that social policies are a crucial
objective for trade unions (see below on the details of how social policy demands enter
the utility of trade unions). Employers move next. After accepting the wage demands of
trade unions, employers will choose the level of prices for the products in their sector. In
a final stage of the game consumers will determine demand, based on the level of prices
and on the elasticity of substitution among goods. In equilibrium, the level of demand
will determine the level of employment of the economy.
15
For an analysis of similar questions, using a Nash bargaining framework, see Isabela Mares. 1999.
Payroll taxes and unemployment, Paper Presented at the Annual Meeting of the American Political Science
Association, Washington DC.
14
The economy consists of I sectors, with J firms in each sector. The model
assumes there are N unions in the economy. Denoting by n the total labor force, the
number of members in each union is
n
, in other words the assumption is that either the
N
entire workforce is fully unionized or that unions’ contracts are binding even for those
workers that are not union members. (This assumption is standard in the literature and
follows Calmfors and Driffill). The cross-national variation in the institutional set-up of
the wage bargaining system is modeled as a variation in the level of centralization of the
bargaining authority. Building on the Calmfors and Driffill model, I introduce a
distinction between decentralized, intermediately centralized and fully centralized wage
bargaining systems. The above parameters I (the number of sectors) and J (the number of
firms in each sector) distinguish among these cases as follows. The case of a totally
decentralized political economy can be characterized as an economy in which both I and
J are high. An intra-sectoral centralization of wage bargaining can be modeled as a
decline in J. Thus in economies with intermediate centralization, wage determination is in
the hands of sectoral-level trade unions. Finally, in an economy with national-level
institutions of wage bargaining, both J and I take very low values. The limit case of this
process of inter-sectoral centralization of wage bargaining is the case in which one union
determines the level of wages of all firms in the economy. This distinction between intrasectoral and inter-sectoral centralization of the institutions of wage bargaining will allow
me to model more systematically the mechanisms by which wages determined in one
sector affect the level of employment in other sectors.
FIGURE 3
15
I will assume a linear technology, i.e.
xij = αaij
(1)
Throughout this paper, the double index ij denotes the j-th firm in sector i. In equation 1,
xij denotes the demand for goods produced by firm j in sector i , aij is the level of
employment of firm j in sector i and α is a productivity factor, assumed to be constant
across all sectors.
I will make the standard microeconomic assumption that consumers have a twolevel constant-elasticity of substitution (CES) utility function. [Mas Colell, Chapter 3]. In
other words,
I
J
i =1
j =1
σ −1 σ ρ −1 ρ
σ −1 ρ
ρ −1
σ
ij
U = (∑ (∑ x
C
)
)
(2)
In equation 2, xij denotes the consumption of good ij . σ denotes the elasticity of
substitution among goods created within one sector (assumed to be the same for all
sectors). In contrast, ρ is the elasticity of substitution among sectors. A very natural
assumption is that σ > ρ , in other words goods produced in one sector are closer
substitutes to each other than goods produced in different sectors. To have a well-posed
maximization problem for the firms, I will assume that σ , ρ > 1 . Consumers’ utility
16
function is constructed through a two-step aggregation process: first, goods produced in
sector i are combined into a CES basket in the form
J
(∑ xij
σ −1
σ
σ
) σ −1
j =1
This consumption basket can be thought of as an “aggregate” or “synthetic” good
produced in sector i . At a second stage, these “aggregate” goods produced by each sector
are combined into a basked according to the CES rule. Consumers maximize their utility,
U C subject to the budget constraint
I
J
∑∑ p x
i =1 j =1
ij ij
=E
(3),
where pij is the price of good j in sector i and E is the “total spending” in the economy.
When choosing the level of prices for the goods produced in their sector,
employers will maximize total revenue minus labor costs. Equation 4 below represents
the utility of employers, U iE
U iE = pi xi − wi (1 + τ E )ai
(4)
In this equation, pi and xi denote the prices and demand, respectively, for the good
produced in sector i , wi are the total wages paid by employers and ai is the level of
employment in this sector. Given equation 1, the level of employment is found by
17
dividing the demand for the goods in this sector by the productivity factor, i.e. aij =
xij
.
α
The model makes the following assumptions about the structure of taxes that are
necessary to finance social policy transfers and services. Social policy expenditures are
financed by two broad categories of revenues, income taxes (paid by union members) and
payroll taxes (paid by unions and employers). The model does not take into account the
importance of corporate taxes. The empirical justification for this assumption is the
modest role played by corporate taxes in the financing of social policy expenditures in
OECD countries. I will further assume that the ratio of payroll taxes paid by capital and
labor is fixed and that the share of payroll taxes financed by unions and employers is ½ of
the level of payroll taxes. Summarizing these assumptions and denoting by τ P the payroll
taxes, τ I the income taxes and τ U and τ E the total share of taxes paid by unions and
employers, respectively, equation 5 expresses the assumptions of the model about the
distribution of the burden of financing the welfare state among capital and labor.
τE =
τP
2
τU = τ i +
τP
2
(5)
Before analyzing the maximization problem faced by trade unions, it is important
to lay out the assumptions about the structure of social policy benefits made in this
model. Building on an important distinction introduced by the comparative literature on
social protection, the model distinguishes among “social services” such as education,
publicly provided child-care and “social transfers” – which include unemployment
benefits, pensions and disability benefits. The parameter S denotes the level of services
18
financed by the government. To simplify computations, I will assume that the level of
generosity is the same across all major welfare state transfer programs and I will denote
this generosity by b.
Roughly, we can divide the population of an economy in two major groups:
workers that are currently employed or seeking employment and the “inactive”
population. Let n denote union members that are currently employed or that are seeking
employment. In contrast, the parameter m will denote the non-active share of the
population. This part of the population – which is sizeable in many European economies
– comprises in addition to pensioners, early retirees and women who choose not to enter
the labor market. The total population is thus m + n, the active labor force rate is
n
.
m+n
The parameter π denotes the “dependency ratio” of the economy (and will be used in the
presentation of some of the comparative statics results of the analysis). Thus, π =
m
.
n
Summarizing the above discussion, equation 6 expresses the budget constraint
equation determining the balance between total social policy expenditures and taxreceipts. The left-hand side of this equation comprises the three main categories of
welfare state expenditures, transfers to the non-active population (bm) unemployment
benefits to union members that are out-of work and social services. These expenditures
can be financed either through a deficit (denoted by D) or through taxes.
I
J
bm + b∑∑ (
i =1 j =1
I
J
n
− aij ) + S = (τ U + τ E )∑∑ aij wij + D
N
i =1 j =1
(6)
19
We can now finally characterize the utility function of trade unions. In contrast to
the existing economic literature on wage bargaining, I will assume that social policy
considerations play an important role in the overall demands of trade unions. The model
thus, formalizes an important observation of political scientists and sociologists.
According to these studies, at the basis of the expansion of most welfare states in
advanced industrialized democracies was a political exchange between unions and
governments, in which unions exercised wage restraint in exchange for the expansion of
social policy programs.
To model this political exchange, I will assume that the objective function of trade
union comprises not only wages but also social policy transfers to union members as well
as social services (S). In this model, the level of publicly provided social services is
endogenously determined. I will assume that in equation 6, the level of services (S) is
I
J
chosen after the existing transfers to union members ( b∑∑ (
i =1 j =1
n
− aij ) and to the nonN
active population are financed. Another reformulation of this assumption is that passive
social policy expenditures are “already committed”, due to their entitlement-based
character, while services are more ‘discretionary’ in nature. I assume that services are
divided equally among all members of the population. Given that each union has a total
of
n
members and that the total size of the population is m+n, it follows that the social
N
services received by the individual union are
1 n
S . This implies that the ability of
IJ n + m
trade unions to internalize the provision of services and collectively exercise wage
restraint is influenced by the degree of centralization of the labor movement (IJ) and by
20
the share of active labor force participants of the total population. The higher the number
of trade unions in the economy (N) and the higher the share of the population (m)
receiving social policy transfers (c), the lower is the ability of trade unions to internalize
the provision of services.
Equation 7 expresses the utility of trade unions. As discussed above, the key
assumption of this model is that there are three broad objectives that enter the calculation
of the trade unions: the net (i.e. after tax) level of wages, the passive transfers for union
members and the level of public services available to union members.
U ijU = (1 − τ U ) wij aij +
14243
NET .WAGES
n
( − aij )b
IJ4243
1
TRANFERS .TO .UNION . MEMBERS
+
1 n
S
+
IJ
m
n
14243
(7)
SOCIAL. SERVICES
Since unions care about the real level of wages and social policy benefits, it is
important to divide the net utility derived by union members by the aggregate price level
in the economy. Following Soskice and Iversen, I will assume that the aggregate price
level of the economy is a function of the degree of the accommodation of the monetary
authority16. Let the parameter β denote the level of monetary non-accommodation. The
parameter β takes values between 0 and 1. In the case of a totally non-accomodating
monetary regime, β = 1 ; β decreases as the level of ‘monetary non-accommodation’
16
I follow both the assumption of Iversen and Soskice 1999, p. 5. To make the comparison of the results
easier, I use the same notation.
21
decreases17. Dividing by the aggregate price level of the economy, the utility of trade
unions becomes
U ijU =
(1 − τ U ) wij aij
Pβ
n
1 n
− aij )b
S
n
+ IJ β
+ IJ m +
P
Pβ
(
(7*)
From equation 6 (the tax balance equation), we can derive the level of services
available in the economy as
I
J
I
J
S = (τ U + τ E )∑∑ aij wij + b∑∑ aij − b(m + n) + D
i =1 j =1
(8).
i =1 j =1
We are now ready to find the solutions to this game. Given the assumption about
the utility of the consumers made in equation 2, the aggregate price-level of the economy
can be defined as the weighted average of the prices of sectors i. Thus, if the price-level
in sector i is
1− β
Iversen and Soskice reformulate this assumption as follows. Assume M = P
where M is the
nominal money supply, P is the aggregate price level and β is the parameter measuring the degree to
which the Central Bank follows a non-accomodating policy rule. “If the central bank it completely
accommodating, the Central Bank fixes the real money supply by setting M equal to the price level,
whereas if the central bank is completely non-accommodating, it fixes the nominal money supply and sets
M equal to unity”. Ibid., p. 5. In other words, in the case of nonaccomodating monetary policy ( β = 1 ),
the money supply is independent of the price level, while in the case of accommodating monetary policy
( β = 0 ), the money supply is set equal to the price level.
17
22
1
J
Pi = (∑ pij1−σ )1−σ
j =1
the aggregate price-level of the economy becomes
I
1
1− ρ 1− ρ
P = (∑ Pi
)
(9)
i =1
It follows, that the optimal choices of consumers are
xij =
E Pi − ρ pij −σ
( ) ( )
NP P
Pi
(10)
Substituting equation 9 into the utility function of employers, maximization with
respect to pi yields
pij =
σ
(1 + τ E ) wij
(σ − 1)α
(11)
By substituting equation 10 into equation 8, we can determine the price-level in
the economy and the level of demand for the goods produced by firm j in sector i .
1
P=
σ (1 + τ E ) I J
(∑∑ wij1−σ )1−σ
(σ − 1)α i =1 j =1
(12)
23
E (σ − 1)α
xij =
σ (1 + τ E )
wij−σ
I
J
∑∑ w
(13)
1−σ
ij
i =1 j =1
Since the level of employment for firm j in sector i is equal to
E (σ − 1)
aij =
σ (1 + τ E )
wij−σ
I
J
∑∑ w
i =1 j =1
xij
, it follows that
α
(14)
1−σ
ij
We are now ready to compute the optimal wage demands of trade unions. After
rearranging terms, the utility of the trade union setting wages in sector i becomes
U iU =
1
n
1 n
[(1 − τ U )aij wij + ( − ai )b +
S]
β
P
IJ
IJ m + n
(15)
Since the wage demands of trade unions are conditional upon the level of services
provided by the government, we need to substitute equation 6 (which express the level of
services provided by the government) into equation 15. As a result of this substitution
(and after rearranging some terms), unions’ utility becomes:
24
U ijU =
+
1
1 n
1 n
[(1 − τ U +
(τ U + τ E ))aij wij + (−b + b
)aij
β
P
IJ m + n
IJ m + n
1 n
1 n
1 n
(τ U + τ E ) ∑ akl wkl + b
ak , +
D]
∑
IJ m + n
IJ m + n k ,l ≠i , j
IJ m + n
k ,l ≠i , j
The ratio
(16)
n
can be expressed in terms of the dependency ratio π as
m+n
n
1
=
, so the utility function can be rewritten as
m + n 1+π
U ijU =
+
1
1 1
1 1
[(1 − τ U +
(τ U + τ E )aij wij + (−b + b
)aij +
β
P
IJ 1 + π
IJ 1 + π
1 1
IJ 1 + π
∑a
k ,l ≠ i , j
kl
wkl + b
1 1
IJ 1 + π
∑a
k ,l ≠i , j
kl
+
1 1
D
IJ 1 + π
(16’)
The next step is to maximize 15 with respect to the wage demands wij . For
reasons of analytical tractability, I will restrict to symmetric equilibria, i.e. equilibria in
which w1∗ = w2∗ = ... = wN∗ = w SYM . The complete derivation of the equilibrium wage is
presented in the appendix. After a series of computations, we obtain
Proposition 1: In a symmetric equilibrium, the total level of employment is given
by
25
*
a SYM
=
E (σ − 1)
bσ
π 1−τU
1
1 D σ
]
+
(β +
)
1+ π 1+τ E 1+ π.
IJ E σ − 1
π
I ( J − 1)σ + ( I − 1) ρ + (1 + β )
1+π.
[ I ( J − 1)σ − J ) + ( I − 1) ρ + 1 + β
(17).
The optimal wage demand of trade unions is given by
*
wSYM
=b
I ( J − 1)σ + ( I − 1) ρ + (1 + β )
[ I (( J − 1)σ − J ) + ( I − 1) ρ + 1 + β
π
1+π
π
1 D σ 1+τE
](1 − τ U ) + ( β +
)
IJ E σ − 1 1 + π
1+π
(18)
Before exploring the implications of the results, it is important to go back to the
assumption by which this model differs from existing models of wage bargaining. The
main difference lies in the assumption about the utility of trade unions. Existing models
assume that unions care about wages (Iversen and Soskice)18 or wages and
unemployment benefits for union members that are out-of-work (Calmfors and Driffill).
In contrast, this paper assumes that social policy considerations are an important
component of the utility of trade unions. Thus, in addition to wages and social policy
benefits for their members, the objective function of trade unions used in this model
comprises a third component – denoting unions’ concern for social policy. More
formally, the difference between this model and the Calmfors and Drifill model can be
18
α
α
For example, Iversen and Soskice assume that the union in sector i is U i = wi ⋅ ei , where wi is the
average wage for the union members in this sector and ei is the employment rate in sector i . See Iversen
and Soskice, 1999, Monetary Integration, Partisanship and Macroeconomic Policy, Paper presented at the
Annual Meeting of the APSA, p. 7.
26
written as follows. The utility of a trade union which cares only about wages and
unemployment benefits can be written as:
U ij = (
(1 − τ U ) wij
P
β
+(
n − aij
IJP β
)b
In contrast, this paper assumes that
(1 − τ U ) wij aij
+
U ijU = (
P β44
1442
3
NET .WAGES
n − aij
(
)b
β
IJP
14
24
3
TRANFERS .TO .UNION . MEMBERS
+
1 n
S
β
IJ 42
m + n43
P
1
4
4
SOCIAL. SERVICES
How does this additional assumption about the utility of trade unions affect the
predictions about the level of unemployment? To answer this question, we need to study
the impact of the additional term in the utility of trade unions on wages (and then
employment). We begin by rewriting the utility of unions (after substituting the “social
services component” of the utility function)
U ij =
(1 − τ U )aij wij − baij
β
1444P
2444
3
U1
+
I
J
I
J
1 n
1
[(
a
w
)]
+
b
aij + D
∑∑ ij ij ∑∑
IJ m + n P β i =1 j =1
i =1 j =1
1444444442444444443
U2
27
In the equation above, I have decomposed the utility of trade unions into “wages
and unemployment benefits) (U 1 ) and “benefits derived from the public provision of
social services” (U 2 )19. We can show that
Proposition 2:
dU 2
< 0 . The wage demands of unions that internalize concerns
dwi
about the provision of social services are lower than the wage demands of unions that
care only about the real wages and unemployment benefits of their members.
The result formalizes an observation of the “neo-corporatist” literature, which has
argued that an important political exchange between unions and governments has
underpinned welfare state expansion during the first decades of the postwar period20. In
exchange for the expansion of social programs (the expansion of the social wage), unions
delivered wage restraint. The institutional structure of the wage bargaining system affects
the employment consequences of this collective wage restraint: the employment is
highest in economies with the most centralized levels of wage bargaining. (
dU 2SYM
dw1
increases as N decreases). Note also that in the limit case of extremely decentralized
labor markets (if N is very large) unions’ preoccupation with social policy has no impact
on the equilibrium level of employment. In this case, the Calmfors Driffill model and the
19
Strictly speaking, benefits from income are U 1 +
public provision of social services are U 2 −
20
nb
, while the benefits derived by the union from the
NP
nb
.
NP
For a formulation of these arguments by ‘corporatist scholars’, see footnote XX.
28
model of this paper yield the same predictions for the equilibrium level of employment.
Summarizing these results, Figure 4 contrasts the employment predictions of this model
and Camlfors and Driffill.
[FIGURE 4]
We are now ready to explore some of the implications of the equilibrium results
of proposition 1. Why has the employment performance of European economies
deteriorated so strongly during recent decades? What factors explain cross-national
variation in the levels of unemployment? To answer these questions, we will study the
impact on employment of the various parameters of the model: the structure of labor
market institutions (centralization of wage bargaining authority), the macro-economic
policy orientation of a government and the structure of welfare state commitments. We
can further disaggregate the latter term and explore the effects of (a) a rise in the level of
taxes, (b) an increase in the number of pensioners and (c) a commitment to deficit
reduction and fiscal austerity.
The model yields the following comparative statics results:
Proposition 3:
da *
< 0 . Inter-sectoral centralization of wage bargaining promotes wage
(a)
dI
restraint and higher employment.
29
da *
< 0 . An increase in the level of taxes hurts employment.
(b)
∂τ
(c)
da *
< 0 . An increase in the number of labor market outsiders hurts
dπ
employment.
(d)
da *
> 0 An increase in deficit spending contributes to higher employment.
dD
(e)
da *
> 0 . An increase in monetary non-accommodation promotes
dβ
employment.
Proposition 3 identifies several causes accounting for the deterioration of the
employment performance of European economies. In this model, the rise in the level of
unemployment is a consequence of the inability of trade unions to deliver wage restraint,
given a social policy mix characterized by high taxes and high level of social policy
expenditures devoted to labor market outsiders. In other words, the process of welfare
state maturation gradually undermines the political exchange among trade unions based
on wage restraint in exchange for social policy expansion. To explore how changes in the
size and the policy mix of the welfare state contribute to an increase in the real wage
demands of trade unions consider again the budget constraint equation (equation 6) and
the equation specifying the utility of trade unions (equation 7). Let me begin by exploring
the simultaneous impact of worsening demographic developments and of an increase in
the size of labor market outsiders. Both developments are modeled as an increase in the
parameter m and, thus, to an increase in the first term of equation 6 (which denotes
passive welfare state expenditures). Assume at first that the government does not
30
counterbalance this increase in expenditures by an increase in the level of taxes or an
increase in deficits. The consequence of an increase in social policy commitments
devoted to labor market outsiders is a decline in the level of social policy expenditures
devoted to the public provision of social services. In other words, a mix in the
composition of social policy commitments takes place. According to equation 7, this
decline in the level of publicly provided social services contributes to a reduction in the
term U 2 in the utility of trade unions and thus to an increase in the real wage demands of
trade unions.
Let us also examine the impact of changes affecting the level of taxes and in the
mode of financing of welfare state commitments. If the government holds the level of
social policy expenditures constant, a reduction in the level of deficit will lead to an
increase in the level of taxes. Moving to equation 7, we see that higher taxes reduce the
net wages of union members. Thus, given higher levels of taxes, the rational strategy of
trade unions is to demand higher levels of wages. This implies that the growth in the level
of tax burden necessary to finance existing social policy commitments undermines the
ability of trade unions to deliver wage restrain, leading to a rise in the level of
unemployment. The virtuous cycle between wage restraint and commitment to social
policy expansion is more difficult to sustain in “mature” welfare states.
FIGURE 5
The above analysis explains the downward shift in the equilibrium level of
employment represented in Figure 5. These factors account for the steady deterioration of
31
the employment performance of European economies between the “Golden Age’ period
and recent decades21. The analysis generates a number of predictions about cross-national
differences in the level of employment, given similar level of taxes, deficits and policy
mixes of transfers and social services. Here the model predicts that the level of structure
of labor market institutions continues to exert a positive impact on the equilibrium level
of employment. The model implies that intra-sectoral centralization of wage bargaining
continues to exert a positive impact on the level of employment (
da *
< 0 ). Holding all
dI
other parameters of the model constant, employment in economies with highly
centralized institutions of wage bargaining will be significantly higher than employment
in economies with industry-level centralization of wage bargaining. As in the Calmfors
Driffill model, the Olsonian logic accounts for this result: large and encompassing trade
union associations are better able to internalize some of the consequences of wage
militancy and exercise wage restraint.
4. A CROSS-NATIONAL ANALYSIS
The model developed in this paper yields implications about cross-national and
temporal differences in the employment performance of advanced industrialized
economies. I now turn to a test of the macro-level hypotheses for unemployment, using
21
Note that an increase in the level of monetary nonaccomodation contributes to an increase in
employment, i.e.
da *
> 0 . This finding is consistent with Iversen and Soskice (1999, 2000).
dβ
32
time-series data for 14 OECD economies, covering the period between 1960-199522. In
related papers, I test the implications of the model for the strategic behavior and wage
demands of trade unions.
One of the critical results of the paper suggests that the magnitude of the impact
of the tax burden on the level of unemployment depends on the structure of the wage
bargaining system. The predictions of the model, summarized in Figure 5 imply a
parabolic relationship between the level of centralization of the wage bargaining
authority and the level of unemployment. In other words, the structure of corporatist
institutions of wage bargaining has a decisive impact in explaining differences in the
level of unemployment across European economies.
To test these propositions we can, fortunately, rely on an extensive empirical
literature measuring cross-national differences in the structure of labor market
institutions. While disagreement continues to exist about the relative importance of
employers’ associations in facilitating the coordination of wage demands across firms or
sectors or about classification of particular countries, such as France (characterized by a
weak labor movement and de facto firm-level wage bargaining, but by an a large and
significant public sector)23, nevertheless, a significant consensus seems to exist about the
encountered cross-national variation in the structure of corporatist institutions. Recent
22
The countries included in my analysis are Austria, Belgium, Canada, Denmark, Finland, France,
Germany, Italy, Japan, Netherlands, Norway, Sweden, Switzerland, the United Kingdom and the United
States. For each country, the time-series data is grouped into 9 four-year intervals.
23
Most English-speaking studies classify France as a case of an economy with ‘decentralized’ labor market
institutions. This paper follows this approach. It is important to point out that a large number of French
industrial relations scholars disagree. See, for example, Boyer, Robert. 1994.Wage reforms imposed by the
state: some paradoxes in French incomes policies, In Dore, Ronald, Boyer, Robert and Mars, Zoe, eds., The
Return to Incomes Policy, London: Pinter, pp. 47- 70.
33
research has generated increasingly sophisticated measure that capture cross-national
differences in the level of centralization of wage bargaining authority, the concentration
of union membership and the level of union density.
The measure of the centralization of wage bargaining system used in this paper
averages four of the most widely-used indexes of the literature developed by Schmitter24,
Cameron25, Calmfors and Driffill26 and Iversen27. Schmitter’s ‘corporatism score’
measures both the organizational centralization and the associational monopoly of the
labor movement. While the first term is a measure of the level of the wage bargaining
authority, the second term captures the number and importance of competing unions and
each level of bargaining, or what Golden refers to as ‘union monopoly’.28 Cameron
aggregates three institutional characteristics of the labor movement: “the power of the
labor confederation in collective bargaining” (a proxy for the locus of decision making
authority), the “organizational unity of labor” (a measure of union monopoly) and an
average measure of union density29. A similar approach is used by Iversen whose
measure of centralization sums the share of workers covered by a trade union at each
24
Schmitter, Philippe. 1981. Interest intermediation and regime governability in contemporary Western
Europe and North America, in Berger, Suzanne, ed., Organizing Interests in Western Europe: Pluralism,
Corporatism and the transformation of politics, Cambridge: Cambridge University Press, pp. 287- 327.
25
Cameron, David. 1984. Social Democracy, Corporatism, Labor Quiescence and the representation of
economic interests in advanced capitalist society, in Goldthorpe, John H. ed., Order and Conflict in
Contemporary Capitalism, Oxford: Oxford University Press, pp. 143- 178.
26
Calmfors and Driffill, op. cit.
27
Iversen, 1999, op. cit.
28
Golden, Miriam. 1993. The dynamics of trade unionism and national economic performance, American
Political Science Review, 87, 2, 439- 454.
29
Cameron, op. cit., p. 165.
34
bargaining level30. Finally, Calmfors and Drifill’s index measures both the level of
bargaining and degree of coordination within organizations on both the union and the
employer side31. Table 1 presents a rank-ordering of individual countries according to
their degree of centralization of labor market institutions and averages the four indexes.
TABLE 1
I begin by displaying some simple cross-tabulations, which describe some of the
patterns in the data. Table 2 presents data on the employment performance of economies
featuring different levels of coordination of the wage bargaining system. The countries
with decentralized labor markets have an average centralization score higher than 10 and
include Canada, UK, the US, France and Switzerland. Countries with a centralization
score lower than 2.5 (Austria, Sweden and Norway) are ranked as highly centralized. The
remaining 6 cases (Belgium, Denmark, Finland, Germany, Italy and the Netherlands) are
classified as intermediately centralized32. The figures in Table 2 provide initial support of
the hypotheses of the model. The employment performance of economies with
intermediately centralized institutions of wage bargaining in inferior to the performance
of economies with either extremely centralized or extremely decentralized labor market
institutions. While the long-term unemployment has risen in all economies, it is, again,
economies with intermediately centralized institutions of wage bargaining that have
30
Iversen, 1999, op. cit., pp. 51- 57.
31
Calmfors and Driffill, 1988, op. cit., p. 52-53.
32
Denmark and Finland are, of course, borderline cases. For an discussion of the “organizational
fragmentation and the conflictual labour relations” in Finland, see Ebbinghaus, Bernhard and Visser, Jelle.
2000. Trade unions in Western Europe since 1945, p. 201.
35
experienced the strongest deterioration of their economic performance. Average levels of
unemployment rose by 1.676 percent in economies with highly centralized labor markets,
by around 4 percent in economies with firm-level wage bargaining and by 5.3266 percent
in intermediately-centralized cases.
TABLE 2
Next, I test of the implications of the model based on pooled cross-sectional timeseries analysis. Following a recent approach to this type of analysis, I use ordinary leastsquares (OLS) regression with lagged dependent variables and panel-corrected standard
errors to take account of potential problems of heteroskedasticity in the data33. Omitting
all controls, the basic regression model estimating the impact of the degree of
centralization of the wage bargaining system and of existing welfare-state commitments
on the level of unemployment is
U i ,t = ai + b1U i ,t −1 + b2Ci ,t + b3Ci2,t + b4WELFEFFi ,t + b5 MONETNONACCi ,t + b5ε i ,t
where U i,t is the unemployment rate for country i at period t , C i,t is the index
measuring the level of centralization of the wage bargaining system, WELFEFFi,t is a
measure of the welfare state effort of a government, MONETNONACC i ,t a measure of
33
Beck, Nathaniel and Katz, Jonathan. 1995. What to do (and not to do) with time-series cross-section data,
American Political Science Review, 89, 3, 634- 647.
36
the monetary nonaccomodation and ε i,t is an error term. The predictions about the impact
of the structure of wage bargaining systems of the level of unemployment imply that the
signs of the coefficients b2 and b3 should be + and - , respectively.
In addition to the corporatism index described above, the parameters of the model
have been operationalized as follows. I have used both tax-based and expenditure-based
measures to evaluate the employment consequences associated with the growth and
maturation of the welfare state (WELFEFF). To capture the impact of the income and
payroll taxes (Ti.t ), I have relied on the measures of “effective average rates” developed
by Mendoza et al34. The time series used in this paper updates Mendoza’s average labor
tax rates series and has been developed (and generously provided) by Tom Cusack. The
model predicts a positive effect of this variable on the level of unemployment. A second
measure of the welfare effort is total government transfers (GOVTRANSF). This measure
computes expenditures on pensions, unemployment, family benefits and so on and was
computed by Huber, Ragin and Stephens, using OECD Historical Statistics.35 An increase
in government transfers is expected to contribute to a rise in unemployment. As a test of
the impact of demographic developments, the variable PENS measures the population
over 65 as a percentage of the total population and has been computed by using OECD
labor force statistics data.
34
For the methodology in developing this measure, see Mendoza et. al., “Effective Tax Rates”, Journal of
Monetary Economics, vol. 34, 1994 and NBER paper 4684.
35
See Evelyne Huber, Charles Ragin and John D. Stephens, 1997. Comparative Welfare State Data Set,
Northwestern University and University of North Carolina.
37
The variable MONETNONACC operationalizes the degree of monetary
nonaccomodation of the government (parameter β of the model). I have relied on
Iversen’s measure of the degree of conservatism monetary policy regime36. This measure
is computed as follows. First, Iversen averaged the 3 most widely used indexes
measuring the degree of central bank independence (developed by Cukierman, Bade and
Parkin and Grilli, Masciandaro and Tabellini, respectively)37. These indexes pay
particular attention to (a) the insulation of central bankers from political influence, (b) the
policy goals of the central bank as well as (c) the type of policy instruments used by the
central bank and their degree of power over these policy instruments. However, as
Iversen points out, “central bank independence is neither a necessary, nor a sufficient
condition for commitment to a conservative monetary policy. When the bank is
dependent, a credible commitment to a nonaccomodating policy may be achieved through
alternative institutional avenues, such as membership in international monetary
institutions or it may come about as a result of persistent policies by governments that are
sufficiently secure in power to create a reputation for toughness. Conversely, when the
bank is independent, policy intentions may be defeated through a combination of
expansionary fiscal policies, exhortation and political threats”38. To overcome this
problem, Iversen multiplies the legal index of central bank independence with a measure
of the relative currency appreciation. (The relative currency appreciation is itself a good
36
For the development of this measure, see Iversen, 1999, op. cit., pp. 57- 60.
37
See Cukiermann, Alex. 1992. Central Bank Strategy, Credibility and Independence, Cambridge: MIT
Press; Grilli, Victorio, Masciandaro, Donato and Tabellini, Guido, 1991, Political and Monetary
Institutions and Public Financial Policies in the industrialized countries, Economic Policy, 13, 42- 92. Bade,
Robin and Parkin, Michael. 1982. Central Bank laws and Inflation – A Comparative Analysis, manuscript
quoted in Iversen 1999.
38
Iversen, 1999. op. cit., p. 58.
38
proxy of the degree of commitment of the government to anti-inflationary policies). The
values of the Iversen’s hard currency index for the countries in the sample are presented
in Table 4.
I have added broad range of control variables to the analysis. To test the impact of
globalization on changes in the employment performance of different economies, I have
relied on three measuring trade flows and financial openness. OPEN is a measure of the
trade exposure of an economy and is computed as the sum of exports and imports as a
percentage of GDP. I relied on the IMF International Financial Statistics Yearbook to
compute the openness measure. CAPFLOWS is a measure of cross-border capital flows
as a percentage of GDP and was computed using IMF Financial Statistics Data. Finally, I
have included a variable measuring the liberalization of financial markets.
FINLIBERALIZ is an index measuring the legal restrictions on cross-country capital
flows, computed by Quinn and Inclan. High values on this index denote the absence of
government restrictions on capital mobility. Thus, one predicts a negative relationship
between this variable and the level of unemployment.
Two additional political variables have been added as control measures. The first
variable LEFTCAB is a measure of the percentage of cabinet seats held by left-wing
parties. Finally, COGRAVITY is a measure of the ‘center of gravity of the government’
computed by multiplying the share of seats of parties in government with an expert
ranking of their ideological position. The scale ranks from 1 (parties on the extreme right)
to 5 (parties on the extreme left). Thus, high values on this variable denote a strong
presence of more extreme left-wing parties in the government.
39
TABLES 3 and 4
Tables 3 and 4 display the results of the statistical analysis. The regression results
using the tax measures as a proxy of welfare state effort are reported in Table 3. Table 4
reports the results using transfer expenditures as independent variable. We find a positive
(and significant) effect of the level of taxes and of the level of transfer expenditures on
the level of unemployment. These results confirm the argument of the paper that the rise
in the level of payroll taxes and the increase in the magnitude of social policy transfers
(modeled in the paper as an increase in the term bm in equation 6) are the cause of the
deterioration of the employment performance experienced by European economies
during recent decades. Secondly, we find that monetary nonaccomodation has a strong
negative effect on the level of unemployment. This finding confirms key proposition of
Soskice and Iversen and is in general agreement with similar empirical results of Iversen.
The test of the impact of the structure of wage bargaining institutions on the level
of unemployment strongly confirms the hypothesis that economies with centralized
systems of wage bargaining deliver higher levels of wage restraint and thus lower levels
of unemployment. The coefficient of the term measuring the strength of corporatist
institutions has the predicted sign (and is statistically significant from zero). Not all
models support however, the hypothesis suggesting a parabolic relationship between the
level of centralization of the wage bargaining system and the level of unemployment.
While the sign of the coefficient of the quadratic term measuring the structure of the
wage bargaining system is negative (confirming thus the predictions of the model), the
term is not always statistically significant.
40
In substantive terms, the results of the benchmark model reported in the first
column of Tables 3 and 4 can be interpreted as follows. An increase in the level of taxes
by one standard deviation contributes to an increase in the level of unemployment by
0.65 percent. To estimate the employment impact of a centralization of the wage
bargaining system assume now that a country such as Netherlands (with a 6.75 score on
the corporatism index) were to centralize its wage bargaining system by one standard
deviation on our measure of corporatism (4.15). As a result of this change, the Dutch
system of wage bargaining would resemble Austria or Sweden (both countries have an
average centralization score of 2.5). The predicted employment effect of this institutional
change would be a 1.1 percent decrease in the level of unemployment.
The results of the benchmark model reported in the first column of Tables 3 and 4
are robust to the introduction of additional control variables and across multiple
specifications39. I first control for the effect of various changes in the level of exposure to
capital and trade flows. (The results are reported in the fourth column of Tables 3 and
second column of Table 4). None of the globalization measures is statistically significant
from 0. In addition, I control for the effect of demographic developments and the
participation of left-wing parties in government. Left wing-governments contribute to
lower levels of unemployment. I test for the effect of another political variable measuring
the center of gravity of a government, but this variable does not seem to have a
significant effect on the level of unemployment. (Column 3 in Tables 3 and 4).
These empirical findings support the propositions advanced in this paper. The
level of centralization of the wage bargaining system strongly accounts for the variation
39
The results are robust to the introduction of country-dummies. Results of these analyses are available
from the author.
41
in the employment performance of European economies. The growth in the level of taxes
has partially undermined the ability for wage restraint of unions in economies with
centralized institutions of wage bargaining and has thus contributed to the rise in the level
of unemployment experienced by these economies.
42
CONCLUSION
During the last two decades, the literature examining cross-national differences in
the structure of labor market institutions has generated important insights for the
understanding of variation in economic performance across advanced industrialized
democracies. The formalization of the Olsonian logic of collective action has allowed
these studies to specify the incentives for wage moderation of large wage bargaining
actors and to account for the low levels of unemployment and superior employment
performance of economies with centralized institutions of wage bargaining during the
first decades of the postwar period. During recent years, important theoretical
developments have added new dimensions of institutional complexity to earlier models,
by specifying the strategic interaction between wage bargaining actors and monetary
authorities. Yet while this literature has been especially successful in explaining crossnational differences in economic performance in the period until the first oil shock, it is
less successful in accounting for the deterioration of the employment performance of
European economies during recent decades. The most significant limitation of this
literature is its inability to specify the factors that have undermined the capacity for wage
moderation of unions in economies with corporatist institutions of wage bargaining and
that account for the rise in unemployment in European economies during recent decades.
To address these empirical questions this paper has developed a model exploring
the interaction between labor market institutions and the policies of the welfare state. The
crucial insight of the paper is that the wage demands of trade unions are affected by the
43
structure of welfare state commitments. We show that the rational strategy of trade unions
is to deliver wage restraint in exchange for the expansion of social policy commitments if
a sizeable part of these transfers affect union members and if the magnitude of the net
benefits derived by unions from the provision of social policy transfers and services
exceeds labor’s share of the tax burden necessary to finance these commitments. This
argument, stressing the importance of social policy as a source of wage moderation
formalizes a number of existing observations formulated by students of the welfare state.
However, we show that the strategy of wage moderation is no longer ‘self-enforcing’ in a
policy environment characterized by high levels of taxes and sizeable social policy
commitments devoted to labor market outsiders. In this case, the costs imposed on social
policy of unions exceed the benefits derived by unions from the provision of social
services. Thus, the process of welfare state growth and maturation undermines the earlier
political exchange on which welfare state expansion was premised during the first
decades of the postwar period.
This paper points towards two directions of social policy reform that could
attenuate the negative impact of the welfare state on the employment performance of
European economies. The aim of these reforms is to restore the ability of unions to
generate wage restraint in exchange for the provision of social policy benefits. First,
future reforms need to reduce the size of labor market outsiders. It is important that
welfare states counteract the fiscal and employment consequences of unfavorable
demographic developments. Policies that aim to improve the employment performance of
occupational groups situated at the demographic extremes of the labor market – by
stopping the trend towards early retirement or by improving the skill mix of younger
44
workers and, thus, reducing youth unemployment – could, simultaneously, lower the
fiscal burden of declining labor force participation rates. Secondly, the paper points to the
importance of reforms of the mode of financing of social insurance. These reforms would
not only reduce the non-wage labor costs of employers but also increase the ability of
unions to deliver wage restraint.
45
FIGURE 1
PREDICTIONS OF CALMFORS AND DRIFILL MODEL ABOUT THE
RELATIONSHIP BETWEEN CENTRALIZATION OF WAGE BARGAINING AND
UNEMPLOYMENT
Unemployment
Centralization of wage bargaining
46
FIGURE 2
IVERSEN’S PREDICTIONS ABOUT THE
RELATIONSHIP BETWEEN CENTRALIZATION OF WAGE BARGAINING,
MONETARY NON-ACOMMODATION AND UNEMPLOYMENT
Unemployment
Accommodating
macroeconomic regime
Nonaccommodating
macroeconomic regime
and egalitarian wage policy
Nonaccomodating
Macroeconomic
regime
Without egalitarian
Wage policy
Centralization of wage
bargaining
47
FIGURE 3
MODELLING THE DEGREE OF CENTRALIZATION OF WAGE BARGAINING
SYSTEM
Number of firms and sectors participating in the wage-setting process
Large J………………………….Small J………………………………Small J
Large I………………………….Large I………………………………Small I
degree of centralization
Firm
.level
..........
..........
...Sector
− Level...................................Economy − level
1
44
44
4
42
444
444
3
144444444244444444
3
int ra −sec toral .centralization.of . wage −b arg aining − sytem
int er sec toral .centralization.of . wage −b arg aining
Degree of centralization of wage bargaining system
48
FIGURE 4
RELATIONSHIP BETWEEN EMPLOYMENT AND CENTRALIZATION OF WAGE
BARGAINING SYSTEM UNDER DIFFERENT ASSUMPTIONS ABOUT THE
UTILITY OF TRADE UNIONS
Equilibrium employment (a*)
Predicted level of employment if unions “care”
about social transfers and social services, in
addition to wages
Effects of social policies on wage restraint.
Magnitude is higher in more centralized systems
of wage bargaining
Employment under the assumptions of the CalmforsDrifill model (if unions maximize real wages and
unemployment benefits of union members)
Level of Centralization of wage bargaining system
Firm-level wb…………Industry-level wb…………………………………Economy-level wb
49
FIGURE 5
PREDICTED LEVEL OF EMPLOYMENT AS A FUNCTION OF
(a) CENTRALIZATION OF THE WAGE BARGAINING SYSTEM,
(b) DEGREE OF ACCOMODATION OF MONETARY REGIME,
(c) NUMBER OF LABOR MARKET OUTSIDERS
(d) SIZE OF BUDGET DEFICIT.
equilibrium employment (a*)
Equilibrium employment as a function of
centralization of wage bargaining system
if
(a) number of labor market
outsiders is small
(b) level of monetary
nonaccomodation is high
(c) fiscal deficit is large
m increases
D decreases
β decreases
Equilibrium employment as a function of
centralization of wage bargaining system if
(a) number of labor market outsiders is large
(b) level of monetary nonaccomodation is
low
(c) fiscal deficit is small
centralization of wage bargaining system
50
TABLE 1
Corporatism Index
(VARIABLE CWB)
Schmitter
(1981)
Austria
Belgium
Canada
Denmark
Finland
France
Germany
Italy
Norway
Netherlands
Sweden
Switzerland
UK
USA
1
7
11
4
4
12
8
15
2
6
4
9
14
11
Cameron
(1984)
3
4
12
6
5
15
8
11
2
7
1
10
9
13
CalmforsDriffill
(1988)
1
8
14
4
5
9
6
11
2
7
3
13
10
15
Iversen
(1999)
5
8
14
3
4
13
7
11
1
6
2
10
12
15
Average
2.5
6.75
12.75
4.25
4.5
12.25
7.25
12
1.75
6.5
2.5
10.5
11.25
13.5
Source: Schmitter, Philippe, 1981, p. 284; Cameron, David, 1984, p. 165, Calmfors and
Driffill, 1988, pp. 52- 53, Iversen, Torben. 1999, p. 56.
51
TABLE 2
Average levels of unemployment in OECD economies under alternative wage bargaining
arrangements and social policy arrangements
LEVEL OF UNEMPLOYMENT
Centralization of Wage Bargaining System
Period
Decentralized
Intermediately
Highly
Centralized
Centralized
1960-1975
3.04
3.135
1.49
1976-1995
6.986
8.4616
3.166
Highly Centralized countries: Austria, Norway, Sweden (Centralization score <2.5);
Intermediately Centralized countries: Belgium, Denmark, Finland, Germany, Italy, Netherlands.
Decentralized Cases: UK, US, France and Switzerland (Centralization score > 10)
Source: OECD.
52
TABLE 3
OLS Estimates of the effects of wage bargaining institutions and taxes on
unemployment
(Pooled Cross-Sectional Time Series 1960-1995 with Panel Corrected Standard Errors)
Regression Estimates and Standard Errors
Variables
Predicted
Sign
CONSTANT
UNEM i ,t −1
Model 1
Model 2
Model 3
Model 4
-1.3092
(1.001)
0.7938***
(0.116)
-1.050
(1.447)
0.762***
(0.112)
-1.8718
(1.782)
0.778***
(0.111)
-1.454
1.395
0.731***
(0.121)
CWBi ,t
+
0.6081*
(0.324)
0.463
(0.319)
0.5113*
(0.313)
0.459*
(0.279)
2
i ,t
CWB
-
-0.0319*
(0.018)
-0.023
(0.017)
-0.025
(0.017)
-0.224
(0.015)
MONNONACC i ,t
-
-3.8696**
(1.662)
-4.075*
(1.598)
-4.188**
(1.645)
-4.167**
(2.039)
TAXRATE i ,t
+
0.0706***
(0.025)
0.0612**
(0.022)
0.063***
(0.021)
0.0544**
(0.020)
0.0097
(0.095)
0.007
(0.005)
PENS i ,t
+
0.0527
(0.106)
OPEN i ,t
-
0.0716
(0.005)
0.100
(0.117)
0.2096
(0.017)
FINLIBERALIZ i ,t
OFINM i ,t
LEFTCABi ,t
-0.010*
(0.006)
-
0.222
(0.376)
COGRAVITYi ,t
N
0.015
(0.007)
108
0.757
Adj.R 2
Note: ***p<0.01; ** p<0.05; *p<0.1
108
108
108
0.7652
0.760
0.7674
53
TABLE 4
OLS Estimates of the effects of wage bargaining institutions and government transfers
on unemployment
Regression Estimates and Standard Errors
Variables
Predicted
Sign
Model 1
Model 2
Model 3
Model 4
-0.7543
(1.128)
0.7325***
(0.103)
-2.496
(1.697)
0.7208***
(0.104)
0.5361
(1.721)
0.7106***
(0.101)
-0.6814
(1.970)
0.7189***
(0.103)
+
0.4705**
(0.236)
0.5214**
(0.242)
0.4621*
(0.252)
0.4983**
(0.249)
CWB
-
-0.0234
(0.014)
-0.0279*
(0.015)
-0.2654*
(0.015)
-0.0277*
(0.015)
MONNONACC i ,t
-
-4.3193***
(1.5355)
-3.6682**
(1.7046)
-3.7346**
(1.645)
-3.782**
(1.695)
GOVTRANSFi ,t
+
0.1775***
(0.059)
0.1811***
(0.0511)
0.1874***
(0.050)
0.1846***
(0.051)
CAPFLOWS i ,t
-
0.0162
(0.015)
0.0143
(0.015)
0.0152
(0.015)
FINLIBERALIZ i ,t
-0.0295
(0.125)
-0.0365
(0.133)
-0.0402
(0.127)
OPEN i ,t
-0.013
(0.0110)
-0.0136
(0.010)
-0.0134
(0.010)
CONSTANT
UNEM i ,t −1
CWBi ,t
2
i ,t
-
-0.0089
(0.006)
LEFTCABi ,t
0.2524
(0.373)
COGRAVITYi ,t
N
110
110
110
110
Adj.R 2
0.789
0.7928
0.7972
0.7936
Note: ***p<0.01; ** p<0.05; *p<0.1
54
TABLE 5
Country Averages
CWB
MON
UNEMPL
TAXRATE
OPEN
OLD
LEFTCA
COGRAV
Austria
2.5
.52
2.4
38.14
65.9
14.3
67.9
2.4
Belgium
6.75
.47
7.4
40.10
108.1
13.9
30.6
2.9
Canada
12.75
.35
7.6
23.4
48.4
9.3
Denmark
4.25
.42
6.1
33.55
63.2
13.6
52.3
2.9
Finland
4.5
.38
5.0
28.8
52.5
10.9
37.4
2.7
France
12.25
.39
5.4
39.36
37.3
13.2
27.5
3.5
Germany
7.25
.60
4.4
36.95
51.5
14.1
34.2
3.2
Italy
12
.29
7.9
34.5
38.2
12.2
14.2
2.8
Norway
1.75
.40
2.4
38.55
81.9
14.1
66.3
2.5
Netherl
6.5
.54
5.3
47.1
98.2
11.2
17.9
3
Sweden
2.5
.29
2.4
47.65
55.8
15.4
72.5
2.3
Switzerl
10.5
.67
0.7
29.1
66.6
12.8
29.3
3.4
UK
11.25
.15
6.4
25.7
48.9
14.1
30.1
3.4
USA
13.5
.47
6.1
27.2
15.9
10.9
Mean
7.78
0.44
4.77
33.22
57.04
12.58
32.11
3.06
St.Dev.
4.15
0.147
3.48
9.12
26.43
2.51
33.96
0.643
3.4
3.6
55
REFERENCES
Alesina, A. and R. Perotti.1997. The Welfare State and Competitiveness, American
Economic Review, 87: 5, 921- 939.
Calmfors, L. and J. Drifill. 1988. “Bargaining Structure, Corporatism and
Macroeconomic Performance, Economic Policy, 6: 1, 14-61.
Daveri, Francesco and Tabellini, Guido. 1997. Unemployment, Growth and Taxation in
Industrial Countries, Discussion Paper 122, IGIER, Universita die Bocconi.
Ebbinghaus, B. and A. Hassel. 1999. Striking Deals: Concertation in the Reform of
Continental European Welfare States, Journal of European Public Policy, 7(1): 44-62.
Glyn, Andrew. Ed., 1999. Social Democracy in Neoliberal Times. The Left and Economic
Policy since 1980. Oxford: Oxford University Press.
Hall, P. and R. Franzese. 1998. Central Bank Independence, Coordinated Wage
Bargaining and European Monetary Union, International Organization 52(2): 505-535.
Hicks, Alexander. 2000. Social Democracy and Welfare Capitalism. A century of income
security politics, Ithaca: Cornell University Press.
Iversen, Torben. 1999. Contested Economic Institutions. The Politics of Macroeconomics
and wage bargaining in advanced democracies, Cambridge: Cambridge University Press.
Pochet, Philip. Ed., 1999. Monetary Union and Collective Bargaining in Europe.
Bruxelles: Presses Interuniversitaires Europeennes.
Regini, Marino. 2000. “Between Deregulation and Social Pacts, Politics and Society
28(1): 5-33.
Scharpf, Frtiz. 1991. Crisis and Choice in European Social Democracy. Ithaca, Cornell
University Press.
Scharpf, F. 1998. Governing in Europe: How effective? How Democratic? Oxford,
Oxford University Press.
Soskice, David. 1990. “Wage Determination: The Changing Role of Institutions in
Advanced Industrialized Countries.” Oxford Review of Economic Policy, 6(4): 36-61.
Soskice, D. and T. Iversen. 2000. “The Nonneutrality of Money with large price or wage
setters.” Quarterly Journal of Economics, 115(1): 1-20.
56
Summers, L., J. Gruber, et al. 1993. “Taxation and Structure of Labor Markets: The Case
of Corporatism.” Quarterly Journal of Economics 108(2): 385- 411.
Visser, J. and A. Hemerjick. 1997. A Dutch Miracle: Job Growth, Welfare Reform and
Corporatism in the Netherlands. Amsterdam, Amsterdam University Press.
Wallerstein, M. 1999. Wage-setting institutions and pay inequality in advanced industrial
societies, American Journal of Political Science, 43(3): 649-680.