Competitive Selection, Globalisation and the Labour Market: Welfare State and Product Market Policies

by Catia Montagna

In their WSF Working Paper GlobLabWS #4/2018 (November 2018), Hassan Molana, Catia Montagna and George E. Onwordi from project GlobLabWS consider how the interaction between welfare state and industrial policies influence the effects of (de-)globalisation on labour markets.

Interest in these reforms reflects the growing call for policies that are likely to improve an economy’s performance and enhance its ability to weather negative shocks. For instance, the OECD (2016) has recommended the implementation of reforms that can strengthen product market competition, raise workers’ participation and facilitate the finding and maintaining of jobs.

Their theoretical model is characterised by a rich menu of labour market policy instruments – including passive and active labour market policies that target hiring and firing flexibility, unemployment benefits, and public investment in employment services that affect vacancy creation and job-match efficiency.  They also consider the effects of regulations that affect business formation and the ease of entry of firms into the industry as well as the effect of corporate practices such as the share of distributed profits to shareholders.

The model is calibrated to the UK data and is used to examine the dynamic adjustment of the economy following a negative trade shock (such as that which might follow Brexit). They find increases in trade restrictions to be contractionary, resulting in lower productivity and labour market participation and higher unemployment and mismatch between the skills required by employers and those possessed by workers.

Reforms of the labour market – say in the direction of flexicurity – that  involve reductions in labour market flexibility and increases in expenditure on active labour market policies (that incentivise job creation and enhance the performance of employment services) and on unemployment insurance can make a significant difference in dampening the adverse effects of a negative trade shock.

Two key channels through which these effects take place are labour force participation and the entry of firms into industry. Contrary to conventional wisdom, an active labour market policy such as unemployment benefit (typically considered as reducing the incentive to work) acts as an activation policy that increases participation in the labour market. The expansionary effects resulting from the complementarity of policy instruments also stimulate entry of firms into the economy with an expansion of job opportunities and an increase in aggregate productivity.

The effects of product market reforms are qualitatively similar and are shown to strengthen the effects of labour market reforms when implemented alongside them.

The paper shows that policies that facilitate entry of firms into industries are important. It also highlights how corporate finance practices such the distribution of profit to shareholders are crucial in determining aggregate performance – suggesting that the growing tendency (in Anglo-Saxon countries in particular) towards a financialisation of profits might have contributed to lower productivity and to a worsening of labour market outcomes.

The complete working paper can be accessed here: