IZA DP No. 957: Product Market Deregulation and Labor Market Outcomes
Recently, the interactions between product market structure and labor market outcomes have come under increased scrutiny. This paper considers the dynamic relationship between product market entry regulation and equilibrium unemployment and wages, both theoretically and quantitatively. The main elements of our model are Mortensen-Pissarides-style search and matching frictions, monopolistic competition in the goods market, multi-worker firms, individual wage bargaining and barriers to entry. We identify two main channels by which product market competition affects unemployment: the output expansion effect, by which a reduction in monopoly power is beneficial for unemployment, and a countervailing effect due to a hiring externality a la Stole and Zwiebel (1996). Quantitatively, increasing our measure of competition has a surprisingly moderate effect on equilibrium unemployment rates, but a substantial effect on equilibrium wages, indicating that product market competition does indeed have quantitatively significant effects on labor market outcomes. Competition is then linked to a specific regulatory institution, namely barriers to entry. Data on entry costs are used to compare labor market performance under two regimes: a high-regulation European regime and a low-regulation Anglo-American one. Our analysis suggests that no more than half a percentage point of European unemployment rates can be attributed to the regulation of entry.