Effects of Labor Market Regulation on Employment and Working Hours in a Labor Search Model

The past 30 years have witnessed lower employment rates and lower hours worked per worker, and thus lower hours worked per person, in Europe relative to the US. European countries have more regulated labor market then the US. This paper envisages the role the labor market regulation plays on the long-term difference in hours worked per person in Europe relative to the US. We study the issue in a neoclassical-growth and labor-search model. We find that our model has a unique steady state. Moreover, we analytically solve the effects of labor market regulation, represented by higher unemployment compensation and labor’s bargaining shares, on the employment and hours worked per worker. Finally, using the US as a benchmark, we translate higher unemployment compensation and labor’s bargaining shares in Europe into the data and quantify our model. We find that a more regulated labor market can lead to sizable differences in hours worked per person between Europe and the US, with the decomposition into employment and hours worked per worker being close to the data.