A Schumpeterian model of investment and innovation with labor market regulation

ABSTRACT

Theoretical and empirical models provide ambiguous responses on the relationship between labor market regulation, innovation and investment. On the one hand, labor market regulation increases firms' adjustment costs and, ceteris paribus, decreases investment. But, on the other, it also stimulates firms to invest, innovate, increase productivity and profit in the long run. In this paper we present an endogenous growth model that describes the role of these opposite forces, and why a stricter labor market regulation may positively affect innovation and investment in the long run. Most of the theoretical and empirical results hold for Italy, Germany, France, and Spain.

KEYWORDS:

• Endogenous growth model
• labor market regulation
• innovation
• investment

JEL CLASSIFICATION:

• O4
• J5

Acknowledgments

This paper benefited from comments and suggestions from two anonymous referees, and participants at the international conferences and seminars: University of Rome Roma Tre, 23 June 2017; Universidad de Càdiz, 23 May 2017; European Investment Bank, Department of Economics, 16 March 2017; Annual workshop of the Italian Society of Industrial Economics and Policy held in Palermo, 9–10 February 2017; European Central Bank, Convergence and Competitiveness Division, 15 December 2016; 9th MDEF Workshop, University of Urbino, 23–25 June 2016; Workshop ‘Innovazione, crescita, lavoro’, University of Urbino, 9 March 2016. The usual disclaimers apply.

Disclosure statement

No potential conflict of interest was reported by the authors.

ORCID

Giorgio Calcagnini http://orcid.org/0000-0002-2501-4199

Germana Giombini http://orcid.org/0000-0002-1271-7389

Giuseppe Travaglini http://orcid.org/0000-0003-1943-096X

Notes

1 EPL is an index computed at the OECD that measures the procedures and costs involved in dismissing individuals or groups of workers, and the procedures involved in hiring workers on fixed-term or temporary work agency contracts.

2 A way to model z is to assume that , where measures employment protection legislation historically determined in any given economy. Any deviation of μ from , that is any change in labor regulation, also modifies the implicit cost of labor, affecting investment and innovation. Hence, in our model, labor market equilibrium is not unique, and different equilibria can characterize the long-run properties of the economy.

3 We assume that technology progress is labor augmenting. As noted by Romer (2011, p. 10): ‘This way of specifying how A enters [the production function] will imply that the ratio of capital to output eventually settles down. In practice, capital-output ratios do not show any clear upward or downward trend over extended periods’ (Blanchard 1998; Acemoglu 2003). This condition, together with other assumptions of our model, allows some scenarios to converge toward steady-state solutions.

4 We assume that investment adjustment costs only depend on labor rigidity and not on investment rigidity. This is a parsimonious way of modeling the slow adjustment of investment to labor market conditions, as it is found in a variety of models of investments with market imperfections.

5 When we obtain an indeterminate case.

6 A special case of our model occurs when and In this case the system (13(13) ) reduces toNotice that for the system is in equilibrium only for , which means that the economy is in a stationary state without economic growth.

7 The OECD statistics clarify that

a job may be regarded as temporary if it is understood by both employer and the employee that the termination of the job is determined by objective conditions such as reaching a certain date, completion of an assignment or return of another employee who has been temporarily replaced. In the case of a work contract of limited duration the condition for its termination is generally mentioned in the contract. To be included in these groups are: (a) persons with a seasonal job, (b) persons engaged by an employment agency or business and hired out to a third party for the carrying out of a ‘work mission’ (unless there is a work contract of unlimited duration with the employment agency or business), (c) persons with specific training contracts. (OECD.stat)

8 The average EPL index is the weighed average, for permanent and temporary labor positions, of the two EPL indexes (EPRC V1 and EPT V1) provided by OECD. In our calculation, the weights are given by the incidence of permanent and temporary employment on total employment. Data are provided by OECD data base.

9 In the base model presented here, VAR includes the variation of the share temporary employment for young workers, and the growth rates of capital and TFP, with a constant and one lag. We use AIC, SC and HQ tests to compute the optimal number of lags. The visual analysis of the three time series, their correlogram and the unit root tests augmented ADF and KPSS provide robust inference about the stationary property of the series. We check for autocorrelation, hoschedasticity and normality. Dummies for 1993 and 2009 allow to get BLUE statistics. The software GRETL 2016c is used to run the econometric analysis.

10 The qualitative results are similar across all alternative treatments of lags and deterministic components. The only significant difference appears when the VAR is estimated with time trends: in this case the response of investment and TFP display a shorter lasting effect.

11 Data in Tables 1–3 have the following interpretation. Define the forecast error in one of the variable as the difference between the actual value and its forecast from the moving average representation of the reduced VAR model. The error variance decomposition tells us the proportion of the fluctuations in a sequence due to its ‘own’ shocks versus shocks to the other variables. If the jth shock explains none of the forecast error variance of a single variable, at all forecast horizons, we say that the variable is exogenous. At the other extreme, if the jth shock explains all of the forecast error variance in the variable at all forecast horizons, we say that the variable is endogenous.

12 Our results are robust to alternative treatments of break, dummies and trends. In all cases, investment and technology shocks appear to be quite important for investment and innovation at all horizons, while this finding does not hold for temporary employment.

13 We estimate a trivariate reduced VAR model for temporary employment for young workers, investment, TFP growth rate, with a constant and one lag. Some dummies are used to ensure the normality of errors. Standard ADF unit root tests and KPPS test were applied to each series. The tests did reject at the 5% significance level the assumption of unit root in the growth rates of all series.