Endogenous Labor Market Rigidities and Family Ties

Much has been written about institutional differences between European and North American labor markets, and about their role in determining the large and persistent differences between the unemployment rates in Europe and US over the last fifteen-twenty years. The objective of this paper is to answer the question: why have these differences in labor market flexibility emerged and why do they persist? First, evidence is presented showing that, in countries with high employment protection policies, credit market imperfections are more severe and young people live longer in the family. Then a general equilibrium, overlapping generations model is developed to explicitly capture the relationship between degree of employment protection, family structure and credit market imperfections. In this context, the endogenous response of the family structure to credit market imperfections, gives rise to conditions in which differences in labor market rigidities emerge as the outcome of a dynamic and repeated bargaining process between generations. ––––––––––––––––––––— * I would like to thank Andrew Atkeson, Raquel Fernandez, Patrick Kehoe, Fabrizio Perri, Victor Rios-Rull, Richard Rogerson, Randall Wright and seminar participants at the SED meetings in Sardinia and at Penn for helpful comments and suggestions. All remaining errors are mine.