Imperfect labor market and convergence: theory and evidence for some OECD countries

In this paper, we show the existence of a negative relationship between long run growth and labor market imperfections both theoretically and empirically. We consider a "monopolistic union" imperfect labor market in a neoclassical growth framework and show that labor market rigidity, captured by the mark-up over the reservation wage, does lower the growth rate along the transitional path. For policy purposes, this result implies that removing labor market imperfections in Europe is important not only for reducing unemployment but also for fostering output growth. In this respect, the traditional evaluation of these policies has greatly been underestimated for their beneficial effects on output growth. We verify empirically the convergence relationship implied by the model on a panel of 18 OECD countries using both traditional cross-countries growth regression and the system GMM estimator proposed by Arellano and Bover (1995) and Blundell and Bond (1998). The data support the basic implications of our model. In particular, the standard proxies for mark-up, the unemployment replacement ratio and union density, result to affect the long run growth rate negatively. We also analyze the relationship between growth and an alternative mark-up proxy based on Bean's (1994a) insight: the ratio of per worker wage on per capita consumption. A negative and significant relationship between output growth rate and this mark-up proxy is found. (C) 2003 Society of Policy Modeling. Published by Elsevier Inc. All rights reserved.