Liberalization of product and labour markets: Winners and losers

 

The global financial crisis, which hit most countries in 2008, caused a severe and widespread economic downturn. Apart from the well-known over-borrowing problems, debt imbalances and excessive unemployment rate that countries in the periphery of Europe have accumulated over the last decades there is also the belief that market imperfections are equally contributing for the current problems. As a result, Cyprus, Greece, Italy, Portugal and Spain have repeatedly urged to undertake structural product and labour market reforms. Due to the existing structure in these markets the aggregate and distributional effects of the attempted reforms have been rather complex and unpredictable.

In particular important policy concerns arise: how efficient these reforms are in terms of output and employment for the EU periphery countries? Which are the distributional implications for the social groups? Do all agents profit equally or there are winners and losers? Does the public financing instrument accommodating the budget affect the efficiency of the attempted reforms? Are there different ways of public financing if a government prioritises the benefits for one social group vis a vis the other?

This paper studies the implications of higher flexibility, or liberalization, in product and labour markets. We study both efficiency and distribution implications. The vehicle is a standard dynamic general equilibrium (DGE) model that incorporates heterogeneous agents (entrepreneurs and workers) and imperfectly competitive product and labour markets. The combination of market power in the product market, and hence rent creation, with agents’ heterogeneity generates results that influence political feasibility of structural reforms. The model is solved numerically employing parameter values commonly used in the related literature and fiscal data from euro area over the recent years. Regarding efficiency, our solutions show that per capita output, as well as per capita welfare, rise when we liberalize one or both markets. Moreover, the net income of both agents rises as we move to a more competitive economy, either in one or both markets. Thus, any form of liberalization, even incomplete, is Pareto efficient. The question of course is who gains more from this. Regarding distribution, inequality rises when we liberalize the labour market only, while it falls when we liberalize the product market only or when both markets become more flexible.