Uncertainty and the Politics of Employment Protection

This paper investigates the role that idiosyncratic uncertainty plays in shaping social preferences over the degree of labor market flexibility, in a general equilibrium model of dynamic labor demand where the productivity of firms evolves over time as a Geometric Brownian motion. A key result demonstrated is that how the economy responds to shocks, i.e. unexpected changes in the drift and standard deviation of the stochastic process describing the dynamics of productivity, depends on the power of labor to extract rents and on the status quo level of firing costs. In particular, we show that when firing costs are relatively low to begin with, a transition to a rigid labor market is favored by all and only the employed workers with idiosyncratic productivity below some threshold value. A more volatile environment, and a lower rate of productivity growth, i.e. “bad times,” increase the political support for more labor market rigidity only where labor appropriates of relatively large rents. Moreover, we demonstrate that when the status quo level of firing costs is relatively high, the preservation of a rigid labor market is favored by the employed with intermediate productivity, whereas all other workers favor more flexibility. The coming of better economic conditions need not favor the demise of high firing costs in rigid high-rents economies, because “good times” cut down the support for flexibility among the least productive employed workers. The model described provides some new insights on the comparative dynamics of labor market institutions in the U.S. and in Europe over the last few decades, shedding some new light both on the reasons for the original build-up of “Eurosclerosis,” and for its the persistence up to the present day.employment protection, firing costs, productivity, political economy, rents, volatility, growth, institutional divergence

Uncertainty and the Politics of Employment Protection

This paper investigates the role that idiosyncratic uncertainty plays in shaping social preferences over the degree of labor market flexibility, in a general equilibrium model of dynamic labor demand where the productivity of firms evolves over time as a Geometric Brownian motion. A key result demonstrated is that how the economy responds to shocks, i.e. unexpected changes in the drift and standard deviation of the stochastic process describing the dynamics of productivity, depends on the power of labor to extract rents and on the status quo level of firing costs. In particular, we show that when firing costs are relatively low to begin with, a transition to a rigid labor market is favored by all and only the employed workers with idiosyncratic productivity below some threshold value. A more volatile environment, and a lower rate of productivity growth, i.e. "bad times," increase the political support for more labor market rigidity only where labor appropriates of relatively large rents. Moreover, we demonstrate that when the status quo level of firing costs is relatively high, the preservation of a rigid labor market is favored by the employed with intermediate productivity, whereas all other workers favor more flexibility. The coming of better economic conditions need not favor the demise of high firing costs in rigid high-rents economies, because "good times" cut down the support for flexibility among the least productive employed workers. The model described provides some new insights on the comparative dynamics of labor market institutions in the U.S. and in Europe over the last few decades, shedding some new light both on the reasons for the original build-up of "Eurosclerosis," and for its the persistence up to the present day.employment protection, firing costs, productivity, political economy, rents, volatility, growth, institutional divergence.

War and endogenous democracy

Many episodes of extension of franchise in the 19th and especially in the 20th century occurred during or in the aftermath of major wars. Motivated by this fact, we offer a theory of political transitions which focuses on the impact of international conflicts on domestic political institutions. We argue that mass-armies, which appeared in Europe after the French Revolution, are an effective military organization only if the conscripted citizens are willing to put effort in fighting wars, which in turn depends on the economic incentives that are provided to them. The need to provide such incentives implies that an oligarchy adopting a mass-army may voluntarily decide to promise some amount of income redistribution to its citizens, conditionally on satisfactory performance as soldiers. When the elite cannot credibly commit to provide an incentive-compatible redistribution, they may cope with the moral hazard problem of the citizens-soldiers only by relinquishing political power to them through the extension of franchise. This is because democracy always implements a highly redistributive fiscal policy, which makes fighting hard incentive-compatible for the citizens-soldiers. We show that a transition to democracy is more likely to occur when the external threat faced by an incumbent oligarchy is in some sense intermediate. A very high external threat allows the elite to make credible commitments of future income redistribution in favor of the citizens, while a limited external threat makes optimal for the elite not making any (economic or political) concession to the masses. Some historical evidence consistent with our theory is also provided

War and Endogenous Democracy

Many episodes of extension of franchise in the 19th and especially in the 20th century occurred during or in the aftermath of major wars. Motivated by this fact, we offer a theory of political transitions which focuses on the impact of international conflicts on domestic political institutions. We argue that mass-armies, which appeared in Europe after the French Revolution, are an effective military organization only if the conscripted citizens are willing to put effort in fighting wars, which in turn depends on the economic incentives that are provided to them. The need to provide such incentives, implies that an oligarchy adopting a mass-army may voluntarily decide to promise some amount of income redistribution to its citizens, conditionally on satisfactory performance as soldiers. When the elite cannot credibly commit to provide an incentive-compatible redistribution, they may cope with the moral hazard problem of the citizens-soldiers only by relinquishing political power to them through the extension of franchise. This is because democracy always implements a highly redistributive fiscal policy, which makes fighting hard incentive-compatible for the citizens-soldiers. We show that a transition to democracy is more likely to occur when the external threat faced by an incumbent oligarchy is in some sense intermediate. A very high external threat allows the elite to make credible commitments of future income redistribution in favor of the citizens, while a limited external threat makes optimal for the elite not making any (economic or political) concession to the masses. Some historical evidence consistent with our theory is also provided.Autocracy, Democracy, Wars, Redistribution.

War and Endogenous Democracy

Many episodes of extension of franchise in the 19th and especially in the 20th century occurred during or in the aftermath of major wars. Motivated by this fact, we offer a theory of political transitions which focuses on the impact of international conflicts on domestic political institutions. We argue that mass-armies, which appeared in Europe after the French Revolution, are an effective military organization only if the conscripted citizens are willing to put effort in fighting wars, which in turn depends on the economic incentives that are provided to them. The need to provide such incentives implies that an oligarchy adopting a mass-army may voluntarily decide to promise some amount of income redistribution to its citizens, conditionally on satisfactory performance as soldiers. When the elite cannot credibly commit to provide an incentive-compatible redistribution, they may cope with the moral hazard problem of the citizens-soldiers only by relinquishing political power to them through the extension of franchise. This is because democracy always implements a highly redistributive fiscal policy, which makes fighting hard incentive-compatible for the citizens-soldiers. We show that a transition to democracy is more likely to occur when the external threat faced by an incumbent oligarchy is in some sense intermediate. A very high external threat allows the elite to make credible commitments of future income redistribution in favor of the citizens, while a limited external threat makes optimal for the elite not making any (economic or political) concession to the masses. Some historical evidence consistent with our theory is also provided.autocracy, democracy, wars, redistribution

Voting as a Credible Threat

We offer a rationale for elections that take place in the shadow of power. Factions unhappy with policy can threaten violence. But when they lack common knowledge about (i) one another's rationality, and (ii) their chances of victory at arms, mutual overconfidence can precipitate civil war. We argue that elections can clarify the likely consequences of violence, and so facilitate peaceful resolution. Our theory is based on the recognition that both voting and fighting are intrinsically correlated actions: individuals who undertake the individually irrational act of voting are unusually prone the individually irrational act of voluntary combat.

Endogenous Constitutions

We present a theory of the choice of alternative democratic constitutions, a majoritarian or a consensual one, in a n unequal society. A majoritarian democracy redistributes resources from the collectivity toward relatively few people, and has a relatively small government and low level of taxation. A consensual democracy redistributes resources toward a broader spectrum of social groups but also have a larger government and a higher level of taxation. A consensual system turns out to be preferred by the society when ex ante income inequality is relatively low, while a majoritarian system is chosen when income inequality is relatively high. Moreover, we obtain that consensual democracies should be expected to be ruled more often by center-left coalitions. Finally, our model also provides a new rationale, based on the endogeneity of the political system, of the positive or absent (rather than negative) association between equality and redistribution transpiring from the cross-sectional evidence of developed countries presented in some recent studies. Some historical and empirical evidence supporting our results is provided.Endogenous Constitutions; Consensual Democracy; Majoritarian Democracy; Inequality; Heterogeneity; Redistribution

An Economic Theory of Constitutional Choice

Verfassung, Wahlsystem, Politische Partei, Einkommensverteilung, Constitution, Electoral system, Political party, Income distribution

War and endogenous democracy.

Many episodes of extension of franchise in the 19th and especially in the 20th century occurred during or in the aftermath of major wars. Motivated by this fact, we offer a theory of political transitions which focuses on the impact of international conflicts on domestic political institutions. We argue that mass-armies, which appeared in Europe after the French Revolution, are an effective military organization only if the conscripted citizens are willing to put effort in fighting wars, which in turn depends on the economic incentives that are provided to them. The need to provide such incentives, implies that an oligarchy adopting a mass-army may voluntarily decide to promise some amount of income redistribution to its citizens, conditionally on satisfactory performance as soldiers. When the elite cannot credibly commit to provide an incentive-compatible redistribution, they may cope with the moral hazard problem of the citizens-soldiers only by relinquishing political power to them through the extension of franchise. This is because democracy always implements a highly redistributive fiscal policy, which makes fighting hard incentive-compatible for the citizens-soldiers. We show that a transition to democracy is more likely to occur when the external threat faced by an incumbent oligarchy is in some sense intermediate. A very high external threat allows the elite to make credible commitments of future income redistribution in favor of the citizens, while a limited external threat makes optimal for the elite not making any (economic or political) concession to the masses. Some historical evidence consistent with our theory is also provided.Autocracy, Democracy, Wars, Redistribution