4.1 Econometric specification
Our starting point is a standard cross-country unemployment regression. Bassanini and
Duval (2006) provide a comprehensive survey of different empirical models and methods.30
Typically, researchers have estimated equations of the type
uit = λ ∙ LMRit + π ∙ Pmrit + Y ∙ gaPit + Fi + Tt + Sit + εit, (28)
where LMRit is a vector of variables describing the stance of labor market regulations
such as union density, the degree of corporatism, employment protection legislation (EPL),
and a measure that relates to the flow value of non-employment bit . It also includes a
measure of the intensity of product market regulations, pmrit , and the output gap, gapit
(calculated as the difference between actual output and the HP-filtered series). The
vector Fi collects the comprehensive set of country fixed-effects, and Tt is a vector of year
dummies while Sit includes a number of variables recording exogenous shocks (TFP, real
interest rates, terms of trade, and labor demand shocks). The construction of the latter
variables is detailed in Bassanini and Duval (2006) and is in line with common practice
in the literature. The error term εit is assumed to have the usual properties.
Bassanini and Duval (2006) do not survey a single study which would address the
possibility that the foreign rate of unemployment or foreign labor market regulations
might matter for domestic labor market outcomes.31 The existing literature has found
robust and quantitatively relevant effects on the rate of unemployment only for a very
limited number of labor market institutions. The most important is the participation tax
rate, or tax wedge (see Costain and Reiter, 2008). It consists of the sum of the average
wage tax burden and social benefits foregone when a worker switches from unemployment
into a job. It therefore measures the total fiscal burden imposed on the worker (Saez,
2002; Immervoll, Kleven, Kreiner and Saez, 2007). This will be our preferred measure
of bit. Other measures relating to the nature of wage bargaining, employment protection
legislation, or the prevalence of minimum wages receive mixed empirical support. This
is not necessarily surprising, given the ambiguity of theoretical results (see, e.g., the
discussion in Blanchard and Wolfers, 2000 ).32 Hence, in our regressions, we mostly focus
on a single labor market variable, the tax wedge (bit), but we also include additional
controls as robustness checks. A number of variables in (28) may seem endogenous; the
existing literature, however, almost always treats them as exogenous and we largely follow
this tradition as we lack natural instruments.33
30The condensed and revised version is published as Bassanini and Duval (2009).
31 A recent empirical literature studies the effects of trade openness on unemployment rates; see Dutt,
Mitra, and Ranjan (2009) and Felbermayr, Prat, and Schmerer (2009). These papers find that trade
liberalization lowers structural unemployment rates in the long run.
32Another variable that typically works well but that is very crude and not directly related to our
theoretical model is the degree of corporatism. Typically, highly corporatist countries such as Scandina-
vian countries or Austria have lower unemployment rates due to centralized bargaining and the implied
internalization of economy-wide effects of wage negotiations by the unions.
33Costain and Reiter (2008) argue that using the tax wedge rather than unemployment benefits mit-
igates endogeneity concerns. Also not that our extensive business cycle controls account for cyclical
32