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A reply to “banking crises, labor reforms, and unemployment: A comment”
Journal of Comparative Economics 43 (2015) 1142–1147
Contents lists available at ScienceDirect
Journal of Comparative Economics journal homepage: www.elsevier.com/locate/jce
A reply to “banking crises, labor reforms, and unemployment: A comment” Lorenzo E. Bernal-Verdugo a,b, Davide Furceri c,d,∗, Dominique Guillaume d a
University of Chicago, USA Bank of Mexico, Mexico c University of Palermo, Italy d International Monetary Fund, 700 19th Street, N.W., Washington, DC 20431, USA b
a r t i c l e
i n f o
Article history: Received 15 April 2015 Available online 10 November 2015 JEL classification: E29 J60 E32 D7 Keywords: Labor market Unemployment Reforms Banking crises
a b s t r a c t Bernal-Verdugo, Lorenzo E., Furceri, Davide, and Guillaume, Dominique—A reply to “banking crises, labor reforms, and unemployment: A comment” Aleksynka (2015) points to some important methodological flaws in the labor market indicators data used in Bernal-Verdugo, Furceri and Guillaume (2013) [BFG]. This paper revisits the empirical findings presented in BFG, and shows that the results and conclusions are little affected by these methodological flaws. In particular, we find that: (i) while in countries with more flexible labor markets the impact of banking crises is sharper but short-lived, in countries with more rigid labor markets the effect is initially more subdued but highly persistent; (ii) comprehensive labor market reforms have a positive impact on unemployment, albeit only in the medium term. Journal of Comparative Economics 43 (4) (2015) 1142–1147. University of Chicago, USA; Bank of Mexico, Mexico; University of Palermo, Italy; International Monetary Fund, 700 19th Street, N.W., Washington, DC 20431, USA. © 2015 Association for Comparative Economic Studies. Published by Elsevier Inc. All rights reserved.
1. Introduction Bernal-Verdugo, Furceri and Guillaume (2013) [BFG] examines the effects of banking crises on unemployment outcomes in 97 countries and the extent to which the institutional and regulatory framework of the labor market shapes these effects. The results suggest that the flexibility of labor markets directly affects not only the magnitude but also the persistence of the impact of banking crises on unemployment. BFG also assesses the impact of labor market reforms on unemployment and finds that comprehensive labor market reforms tend to reduce unemployment, albeit only after in the medium term. The labor market flexibility indicators used in BGF are taken from the Fraser Institute’s Economic Freedom of the World (EFW) database (Gwartney and Lawson, 2010), which provides a composite measure of labor market flexibility and indicators of labor market flexibility on six different policy areas: (i) minimum wage (M), (ii) hiring and firing regulation (H), (iii) centralized collective wage bargaining (C), (iv) mandated cost of hiring (MCH), (v) mandated cost of work dismissal (MCW), and (vi) conscription (CO). All indicators are standardized to a 0–10 scale, with higher values indicating a more flexible labor market. The indicators are available at a 5-year frequency from 1980 to 2000, and at a yearly frequency afterwards.
∗
Corresponding author at: International Monetary Fund, 700 19th Street, N.W., Washington, DC 20431, USA. E-mail addresses: [email protected] (L.E. Bernal-Verdugo), [email protected], [email protected] (D. Furceri), [email protected] (D. Guillaume).
http://dx.doi.org/10.1016/j.jce.2015.11.001 0147-5967/© 2015 Association for Comparative Economic Studies. Published by Elsevier Inc. All rights reserved.
L.E. Bernal-Verdugo et al. / Journal of Comparative Economics 43 (2015) 1142–1147
1143
Aleksynka (2015) points to some important methodological flaws in these data. A key question is therefore whether the results in BFG are still valid when these methodological flaws are corrected. To address this question this paper revisits the empirical findings of BFG, and shows that the results and conclusions are little affected by these methodological flaws. In particular, we find that: (i) while in countries with more flexible labor markets the impact of banking crises is sharper but short-lived, in countries with more rigid labor markets the effect is initially more subdued but highly persistent; (ii) comprehensive labor market reforms have a positive impact on unemployment, albeit only in the medium term. 2. Data flaws and corrections Aleksynka (2015) points to two main important methodological flaws in the labor market indicators data used in BFG. First, three out of the six policy indicators used in BFG have a methodological break in 2002: (i) the minimum wages sub-component is based on the World Bank’s Difficulty of Hiring index for the years 2002–2008, and on responses to the World Economic Forum Executives Survey question about the impact of minimum wages before then; (ii) the mandated cost of hiring sub-component is based on the World Bank’s Doing Business Rigidity of Hours Index for the period 2002–2008, while prior to 2002 it is based on the World Economic Forum Executive Survey question “the unemployment insurance program strikes a good balance between social protection and preserving work incentives”; (iii) the centralized collective wage bargaining sub-component after 2001 reflects the question of the World Economic Forum Executive Survey “wages in your country are set by a centralized bargaining process (=1) or up to each individual company (=7)”, while before that it measures the “share of labor force whose wages are set by centralized collective bargaining”. Second, there are flaws in the way the labor market composite indicator is computed. The composite indicator is computed as the simple average of the six policy sub-indicators. While this aggregation is common in the literature—it basically assigns equal weights to each of the sub-indicators—in several cases data for some of the components are missing and the value for the composite indicator is computed as the average of the available sub-indicators instead of being reported as a missing value. These data flaws raise questions about the validity of some of the results presented in BFG, in particular about those related to the effects of labor market reforms on unemployment. In fact, BFG estimates the impact of labor market reforms by assuming that a reform takes place when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations. Given the methodological flaws described earlier, these reforms may simply reflect breaks in the series rather than actual reforms (indeed 30 out of 52 reforms are identified to take place in 2002, the year of the break in the series). To addresses these methodological flaws we proceed in three steps. First, we compute the composite labor market indicator as the average of the sub-indicators only when data for all of the sub-components are available. Second, we identify reforms in the various policy areas only over the period in which there are no breaks in the series (that is, after 2002). Third, we consider two alternative approaches to compute comprehensive labor market reforms. In the first approach, a reform is identified when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations during the period in which there are no breaks in the series (that is, after 2002). In the second approach, a reform is identified when, for a given country at a given time, at least one reform in the six policy areas takes place.1 The next two sections revisit the empirical evidence presented in BFG using these revised data and samples. 3. Labor market flexibility and the response of unemployment to banking crises To test the impact of labor market flexibility in shaping the effect of banking crises on unemployment, BFG estimates for each year k after the onset of the crisis, the following equation:
Ui,t+k − Ui,t = αik +
l
k γ jk Ui,t− j + βk Di,t + θ Li + ϑk Di,t Li,t − Li + δ X i,t + εi,t
(1)
j=1
where Ui,t+k is the unemployment rate in country i in period t+k; Di, t is a dummy that takes value 1 for a banking crisis episode in period t in country i and zero otherwise; Li, t is a labor market indicator in country i in period t; α i represents country fixed effects that capture unobserved country-specific determinants of unemployment; and Xi, t is a vector of control variables including the initial level of unemployment, the initial annual change of the share of urban population, the initial annual change of government spending as share of GDP, and a deterministic time trend in country i in period t. Table 1 replicates Table 4 in BFG, which summarizes the effects of labor market indicators in shaping the short and medium term effects of banking crises on unemployment. In bold are highlighted the new results based on the restricted time sample for the indicators with methodological breaks, as well as for those based on the new composite labor market (computed as the average of the sub-indicators only when data for all of the sub-components are available). The results are very similar to those reported in BFG and confirm that the short-term impact of crises on unemployment is higher in countries with more flexible labor markets, while the medium-term effect is larger in countries with more rigid labor markets. This difference in 1 Annex 1 reports the episodes of comprehensive labor market reforms identified using these two approaches. The number of comprehensive labor market reforms identified in the period 2002–08 varies between 23 (first approach) and 80 (second approach).
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Table 1 Short- and medium-term effects of banking crises on unemployment: flexible vs. rigid labor markets. Composite labor market indicator (average)
Minimum wage/hiring index
Hiring and firing regulation
Centralized collective bargaining (new)
Mandated cost of hiring/hours regulation
Mandated cost of work dismissal
Conscription
2.039 (6.42)∗∗∗ 0.329 (1.49) 0.55 581
2.305 (5.36)∗∗∗ −0.126 (−0.77) 0.50 637
1.315 (4.33)∗∗∗ 0.300 (1.60)∗ 0.37 843
2.756 (5.01)∗∗∗ 0.331 (1.70)∗ 0.54 615
2.235 (6.42)∗∗∗ 0.160 (1.22) 0.51 637
2.116 (6.04) 0.149 (1.60)∗ 0.52 628
1.254 (3.36)∗∗∗ −0.028 (−0.46) 0.30 1018
−0.091 (−0.12) −0.832 (−1.61)∗ 0.90 313
−0.012 (0.96) −0.483 (−0.70) 0.89 349
−0.043 (−0.10) −0.441 (−1.87)∗ 0.76 565
−0.207 (−0.28) −0.558 (−1.86)∗ 0.84 429
0.548 (0.95) −0.474 (−0.84) 0.89 349
−1.110 (−3.12)∗∗∗ −0.402 (−6.81)∗∗∗ 0.89 343
Initial effect Crisis Crisis∗Flexibility indicator R2 N Medium-term effect Crisis Crisis∗flexibility indicator R2 N
0.179 (0.32) −0.324 (−3.16)∗∗∗ 0.64 723
Note: T-statistics based on robust clustered standard errors in parenthesis. ∗, ∗∗, ∗∗∗ denote significance at 10%, 5%, and 1%, respectively.
1 0.5 0
0
1
2
3
4
5
6
-0.5 -1 -1.5 esmate
lower limit
upper limit
Panel 2. Reforms Identified Using the Second Approach 1 0.5 0
0
1
2
3
4
5
6
-0.5 -1 -1.5 esmate
lower limit
upper limit
Fig. 1. The Effects of reforms on unemployment – OLS. Panel 1. Reforms identified using the first approach. Panel 2. Reforms identified using the second approach. Note: the solid line represents the estimated IRF; dotted lines represent 95% confidence bands. In the first approach, a reform is identified when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations during the period 2002–08. In the second approach, a reform is identified when, for a given country at a given time, at least one reform in the six policy areas takes place.
L.E. Bernal-Verdugo et al. / Journal of Comparative Economics 43 (2015) 1142–1147
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Panel 1. Minimum wage/ Hiring index 2 1 0 -1
0
1
2
3
4
5
6
-2 -3 esmate
lower limit
upper limit
Panel 2. Mandated cost of hiring/Hours regulation 2 1 0 -1
0
1
2
3
4
5
6
-2 -3 esmate
lower limit
upper limit
Fig. 2. The Effects of reforms on unemployment – OLS. Panel 1. Minimum wage/hiring index. Panel 2. Mandated cost of hiring/hours regulation. Note: the solid line represents the estimated IRF; dotted lines represent 95% confidence bands. In the first approach, a reform is identified when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations during the period 2002–08. In the second approach, a reform is identified when, for a given country at a given time, at least one reform in the six policy areas takes place.
the response is statistically significant both in the short- and in the medium-term (Table 1). Specifically, an increase of one point in the labor market flexibility composite indicator increases the short-term effect of crises on unemployment by 0.3 percentage point, but reduces the medium-term impact by about 0.8 percentage point.2 Among the sub-indicators, hiring and firing regulations and centralized collective bargaining remain the ones with the largest medium-term impact (columns III and IV). 4. Labor market reform and unemployment outcomes To estimate the dynamic impact of labor market reforms on unemployment, BFG uses the following specification:
Ui,t+k − Ui,t = αik +
l
k γ jk Ui,t− j + βk Ri,t + δ X i,t + εi,t
(2)
j=1
where Ri, t is a reform dummy that takes value 1 for the start of a reform episode in period t in country i and zero otherwise, Xi, t is a vector of control variables including the initial level of unemployment, the crisis dummy used in the previous section, and a deterministic time trend. βk measures the impact of the reform on the change in unemployment for each future period k. Fig. 1 replicates Fig. 10 in BGF, which plots the impulse-response functions (IRFs) obtained by using the least-squares dummy variable estimate of βk for k = 0, 1,…,6. The figure confirms that labor market reforms are associated with a medium-term decline in unemployment that ranges from about 0.5 (based on reforms identified using the second approach) to 1.2 percentage point (based on reforms identified using the first approach). The results are similar to those reported in BFG, which finds that reforms are associated with a decline in unemployment of about ¾ percentage point over the medium term. The results in Fig. 2 (which replicates Fig. 12 in BFG) also confirm that reforms on minimum wages (hiring index) and mandated cost of hiring (hours regulation) have a statistically significant impact on unemployment on unemployment outcomes. We have also replicated the IV results presented in BFG to address endogeneity. In particular, while potential reverse causality is addressed by estimating changes in unemployment in the years that follow a large labor market reform, it could still be the case 2 The point estimates presented in BFG suggested that an increase of one point in the labor market flexibility composite indicator increases the short-term effect of crises on unemployment by 0.4 percentage points, but reduces the medium-term impact by about 0.6 percentage points.
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Panel 1. Reforms Identified Using the First Approach 3 2 1 0 -1
0
1
2
3
4
5
6
-2 -3 -4 esmate
lower limit
upper limit
Panel 2. Reforms Identified Using the Second Approach 3 2 1 0 -1
0
1
2
3
4
5
6
-2 -3 -4 esmate
lower limit
upper limit
Fig. 3. The Effects of reforms on unemployment – IV. Panel 1. Reforms identified using the first approach. Panel 2. Reforms identified using the second approach. Note: the solid line represents the estimated IRF; dotted lines represent 95% confidence bands. In the first approach, a reform is identified when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations during the period 2002–08. In the second approach, a reform is identified when, for a given country at a given time, at least one reform in the six policy areas takes place.
that unobserved factors influencing the dynamics of unemployment over time could affect the probability of a reform. Following BFG, we instrument labor market reforms with the variables found to be significantly correlated with the probability of reforms, namely: (i) the pre-existing level of the labor market institution index; (ii) the degree of decentralization in the executive power; (iii) the length of time the chief executive’s party has been in power; and (iv) a measure of the output gap.3 The results obtained using this approach are reported in Fig. 3 (replicating Fig. 13 in BFG), and confirm the significant effect of reforms on unemployment over the medium term (the IRFs are statistically significant after five years). The results also suggest a larger effect than that shown in the baseline, which is consistent with the fact that OLS estimates of β k may be biased towards zero. In particular, the IV estimates suggest that labor market reforms may lead to a reduction in unemployment that ranges from about 1.8 (based on reforms identified using the second approach) to 2.4 percentage points over the medium term (based on reforms identified using the first approach). This effect is very similar to the one reported in BFG (2.5 percentage points).4 5. Conclusions Aleksynka (2015) points to some important methodological flaws in the labor market indicators data used in Bernal-Verdugo et al. (2013) [BFG]. This paper revisits the empirical finding presented in BFG, and show that the results and conclusions are little affected by these methodological flaws. In particular, we find that: (i) while in countries with more flexible labor markets the impact of banking crises is sharper but short-lived, in countries with more rigid labor markets the effect is initially more 3 Similarly to BFG, the test of joint significance suggests that these political variables can be considered as strongly exogenous. In particular, the Chi-square test of the null hypothesis of joint significance is 29.83, which is higher than the critical value (10) suggested by Staiger and Stock (1997) for strong instruments. 4 This result is robust to different specifications and estimates of the probability of labor market reforms, as well as to other robustness checks presented in BFG.
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subdued but highly persistent; (ii) comprehensive labor market reforms have a positive impact on unemployment, albeit only in the medium term. Appendix Table A1
Table A1 Comprehensive reform episodes. First approach
Second approach
Country
Date
Country
Date
Country
Date
Country
Date
Australia Bulgaria Burkina Faso Chile Croatia Croatia Czech Republic FYROM FYROM Georgia Hungary Italy Latvia Malawi Mali Montenegro Montenegro Pakistan Peru Portugal Romania Slovak Republic Slovenia
2005 2007 2007 2005 2003 2008 2005 2006 2008 2005 2004 2005 2006 2007 2005 2006 2008 2004 2008 2004 2007 2003 2003
Angola Argentina Armenia Australia Azerbaijan Azerbaijan Azerbaijan Bolivia Bosnia and Herzegovina Bulgaria Burkina Faso Burkina Faso Chile Chile Colombia Costa Rica Croatia Croatia Czech Republic Dominican Republic Dominican Republic Egypt El Salvador Ethiopia FYROM FYROM FYROM
2005 2007 2004 2005 2004 2005 2008 2003 2005 2007 2005 2007 2003 2005 2003 2003 2003 2008 2005 2003 2005 2003 2003 2005 2003 2005 2006
FYROM Georgia Georgia Georgia Greece Guatemala Guatemala Honduras Hong Kong SAR Hungary Indonesia Israel Italy Italy Kazakhstan Korea Kyrgyz Republic Latvia Lesotho Malawi Malaysia Mali Mauritania Mauritius Moldova Mongolia Montenegro
2008 2003 2004 2005 2006 2003 2005 2005 2002 2004 2005 2004 2003 2005 2005 2006 2005 2006 2005 2007 2003 2005 2005 2008 2005 2004 2005
Montenegro Montenegro Morocco Mozambique Oman Pakistan Panama Paraguay Peru Philippines Portugal Romania Russia Serbia Slovak Republic Slovak Republic Slovenia Spain Switzerland Tanzania Tunisia Uganda Vietnam Vietnam Zambia Zambia
2006 2008 2003 2003 2007 2004 2005 2005 2008 2005 2004 2007 2007 2005 2003 2006 2003 2004 2006 2005 2005 2006 2003 2005 2005 2006
. References Aleksynka, Mariya, 2015. Banking crises, labor reforms and unemployment: a comment. Journal of Comparative Economic (forthcoming). Bernal-Verdugo, Lorenzo E., Furceri, Davide, Guillaume, Dominique, 2013. Banking crises, labor reforms and unemployment. Journal of Comparative Economic 41, 1202–1219. Gwartney, James, Lawson, Robert, 2010. Economic Freedom of the World: 2010 Annual Report. Fraser Institute, Vancouver, BC. Staiger, J., J.H., Stock, 1997. Instrumental variable regression with weak instruments. Econometrics 56, 557–585.
Contents lists available at ScienceDirect
Journal of Comparative Economics journal homepage: www.elsevier.com/locate/jce
A reply to “banking crises, labor reforms, and unemployment: A comment” Lorenzo E. Bernal-Verdugo a,b, Davide Furceri c,d,∗, Dominique Guillaume d a
University of Chicago, USA Bank of Mexico, Mexico c University of Palermo, Italy d International Monetary Fund, 700 19th Street, N.W., Washington, DC 20431, USA b
a r t i c l e
i n f o
Article history: Received 15 April 2015 Available online 10 November 2015 JEL classification: E29 J60 E32 D7 Keywords: Labor market Unemployment Reforms Banking crises
a b s t r a c t Bernal-Verdugo, Lorenzo E., Furceri, Davide, and Guillaume, Dominique—A reply to “banking crises, labor reforms, and unemployment: A comment” Aleksynka (2015) points to some important methodological flaws in the labor market indicators data used in Bernal-Verdugo, Furceri and Guillaume (2013) [BFG]. This paper revisits the empirical findings presented in BFG, and shows that the results and conclusions are little affected by these methodological flaws. In particular, we find that: (i) while in countries with more flexible labor markets the impact of banking crises is sharper but short-lived, in countries with more rigid labor markets the effect is initially more subdued but highly persistent; (ii) comprehensive labor market reforms have a positive impact on unemployment, albeit only in the medium term. Journal of Comparative Economics 43 (4) (2015) 1142–1147. University of Chicago, USA; Bank of Mexico, Mexico; University of Palermo, Italy; International Monetary Fund, 700 19th Street, N.W., Washington, DC 20431, USA. © 2015 Association for Comparative Economic Studies. Published by Elsevier Inc. All rights reserved.
1. Introduction Bernal-Verdugo, Furceri and Guillaume (2013) [BFG] examines the effects of banking crises on unemployment outcomes in 97 countries and the extent to which the institutional and regulatory framework of the labor market shapes these effects. The results suggest that the flexibility of labor markets directly affects not only the magnitude but also the persistence of the impact of banking crises on unemployment. BFG also assesses the impact of labor market reforms on unemployment and finds that comprehensive labor market reforms tend to reduce unemployment, albeit only after in the medium term. The labor market flexibility indicators used in BGF are taken from the Fraser Institute’s Economic Freedom of the World (EFW) database (Gwartney and Lawson, 2010), which provides a composite measure of labor market flexibility and indicators of labor market flexibility on six different policy areas: (i) minimum wage (M), (ii) hiring and firing regulation (H), (iii) centralized collective wage bargaining (C), (iv) mandated cost of hiring (MCH), (v) mandated cost of work dismissal (MCW), and (vi) conscription (CO). All indicators are standardized to a 0–10 scale, with higher values indicating a more flexible labor market. The indicators are available at a 5-year frequency from 1980 to 2000, and at a yearly frequency afterwards.
∗
Corresponding author at: International Monetary Fund, 700 19th Street, N.W., Washington, DC 20431, USA. E-mail addresses: [email protected] (L.E. Bernal-Verdugo), [email protected], [email protected] (D. Furceri), [email protected] (D. Guillaume).
http://dx.doi.org/10.1016/j.jce.2015.11.001 0147-5967/© 2015 Association for Comparative Economic Studies. Published by Elsevier Inc. All rights reserved.
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1143
Aleksynka (2015) points to some important methodological flaws in these data. A key question is therefore whether the results in BFG are still valid when these methodological flaws are corrected. To address this question this paper revisits the empirical findings of BFG, and shows that the results and conclusions are little affected by these methodological flaws. In particular, we find that: (i) while in countries with more flexible labor markets the impact of banking crises is sharper but short-lived, in countries with more rigid labor markets the effect is initially more subdued but highly persistent; (ii) comprehensive labor market reforms have a positive impact on unemployment, albeit only in the medium term. 2. Data flaws and corrections Aleksynka (2015) points to two main important methodological flaws in the labor market indicators data used in BFG. First, three out of the six policy indicators used in BFG have a methodological break in 2002: (i) the minimum wages sub-component is based on the World Bank’s Difficulty of Hiring index for the years 2002–2008, and on responses to the World Economic Forum Executives Survey question about the impact of minimum wages before then; (ii) the mandated cost of hiring sub-component is based on the World Bank’s Doing Business Rigidity of Hours Index for the period 2002–2008, while prior to 2002 it is based on the World Economic Forum Executive Survey question “the unemployment insurance program strikes a good balance between social protection and preserving work incentives”; (iii) the centralized collective wage bargaining sub-component after 2001 reflects the question of the World Economic Forum Executive Survey “wages in your country are set by a centralized bargaining process (=1) or up to each individual company (=7)”, while before that it measures the “share of labor force whose wages are set by centralized collective bargaining”. Second, there are flaws in the way the labor market composite indicator is computed. The composite indicator is computed as the simple average of the six policy sub-indicators. While this aggregation is common in the literature—it basically assigns equal weights to each of the sub-indicators—in several cases data for some of the components are missing and the value for the composite indicator is computed as the average of the available sub-indicators instead of being reported as a missing value. These data flaws raise questions about the validity of some of the results presented in BFG, in particular about those related to the effects of labor market reforms on unemployment. In fact, BFG estimates the impact of labor market reforms by assuming that a reform takes place when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations. Given the methodological flaws described earlier, these reforms may simply reflect breaks in the series rather than actual reforms (indeed 30 out of 52 reforms are identified to take place in 2002, the year of the break in the series). To addresses these methodological flaws we proceed in three steps. First, we compute the composite labor market indicator as the average of the sub-indicators only when data for all of the sub-components are available. Second, we identify reforms in the various policy areas only over the period in which there are no breaks in the series (that is, after 2002). Third, we consider two alternative approaches to compute comprehensive labor market reforms. In the first approach, a reform is identified when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations during the period in which there are no breaks in the series (that is, after 2002). In the second approach, a reform is identified when, for a given country at a given time, at least one reform in the six policy areas takes place.1 The next two sections revisit the empirical evidence presented in BFG using these revised data and samples. 3. Labor market flexibility and the response of unemployment to banking crises To test the impact of labor market flexibility in shaping the effect of banking crises on unemployment, BFG estimates for each year k after the onset of the crisis, the following equation:
Ui,t+k − Ui,t = αik +
l
k γ jk Ui,t− j + βk Di,t + θ Li + ϑk Di,t Li,t − Li + δ X i,t + εi,t
(1)
j=1
where Ui,t+k is the unemployment rate in country i in period t+k; Di, t is a dummy that takes value 1 for a banking crisis episode in period t in country i and zero otherwise; Li, t is a labor market indicator in country i in period t; α i represents country fixed effects that capture unobserved country-specific determinants of unemployment; and Xi, t is a vector of control variables including the initial level of unemployment, the initial annual change of the share of urban population, the initial annual change of government spending as share of GDP, and a deterministic time trend in country i in period t. Table 1 replicates Table 4 in BFG, which summarizes the effects of labor market indicators in shaping the short and medium term effects of banking crises on unemployment. In bold are highlighted the new results based on the restricted time sample for the indicators with methodological breaks, as well as for those based on the new composite labor market (computed as the average of the sub-indicators only when data for all of the sub-components are available). The results are very similar to those reported in BFG and confirm that the short-term impact of crises on unemployment is higher in countries with more flexible labor markets, while the medium-term effect is larger in countries with more rigid labor markets. This difference in 1 Annex 1 reports the episodes of comprehensive labor market reforms identified using these two approaches. The number of comprehensive labor market reforms identified in the period 2002–08 varies between 23 (first approach) and 80 (second approach).
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Table 1 Short- and medium-term effects of banking crises on unemployment: flexible vs. rigid labor markets. Composite labor market indicator (average)
Minimum wage/hiring index
Hiring and firing regulation
Centralized collective bargaining (new)
Mandated cost of hiring/hours regulation
Mandated cost of work dismissal
Conscription
2.039 (6.42)∗∗∗ 0.329 (1.49) 0.55 581
2.305 (5.36)∗∗∗ −0.126 (−0.77) 0.50 637
1.315 (4.33)∗∗∗ 0.300 (1.60)∗ 0.37 843
2.756 (5.01)∗∗∗ 0.331 (1.70)∗ 0.54 615
2.235 (6.42)∗∗∗ 0.160 (1.22) 0.51 637
2.116 (6.04) 0.149 (1.60)∗ 0.52 628
1.254 (3.36)∗∗∗ −0.028 (−0.46) 0.30 1018
−0.091 (−0.12) −0.832 (−1.61)∗ 0.90 313
−0.012 (0.96) −0.483 (−0.70) 0.89 349
−0.043 (−0.10) −0.441 (−1.87)∗ 0.76 565
−0.207 (−0.28) −0.558 (−1.86)∗ 0.84 429
0.548 (0.95) −0.474 (−0.84) 0.89 349
−1.110 (−3.12)∗∗∗ −0.402 (−6.81)∗∗∗ 0.89 343
Initial effect Crisis Crisis∗Flexibility indicator R2 N Medium-term effect Crisis Crisis∗flexibility indicator R2 N
0.179 (0.32) −0.324 (−3.16)∗∗∗ 0.64 723
Note: T-statistics based on robust clustered standard errors in parenthesis. ∗, ∗∗, ∗∗∗ denote significance at 10%, 5%, and 1%, respectively.
1 0.5 0
0
1
2
3
4
5
6
-0.5 -1 -1.5 esmate
lower limit
upper limit
Panel 2. Reforms Identified Using the Second Approach 1 0.5 0
0
1
2
3
4
5
6
-0.5 -1 -1.5 esmate
lower limit
upper limit
Fig. 1. The Effects of reforms on unemployment – OLS. Panel 1. Reforms identified using the first approach. Panel 2. Reforms identified using the second approach. Note: the solid line represents the estimated IRF; dotted lines represent 95% confidence bands. In the first approach, a reform is identified when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations during the period 2002–08. In the second approach, a reform is identified when, for a given country at a given time, at least one reform in the six policy areas takes place.
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Panel 1. Minimum wage/ Hiring index 2 1 0 -1
0
1
2
3
4
5
6
-2 -3 esmate
lower limit
upper limit
Panel 2. Mandated cost of hiring/Hours regulation 2 1 0 -1
0
1
2
3
4
5
6
-2 -3 esmate
lower limit
upper limit
Fig. 2. The Effects of reforms on unemployment – OLS. Panel 1. Minimum wage/hiring index. Panel 2. Mandated cost of hiring/hours regulation. Note: the solid line represents the estimated IRF; dotted lines represent 95% confidence bands. In the first approach, a reform is identified when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations during the period 2002–08. In the second approach, a reform is identified when, for a given country at a given time, at least one reform in the six policy areas takes place.
the response is statistically significant both in the short- and in the medium-term (Table 1). Specifically, an increase of one point in the labor market flexibility composite indicator increases the short-term effect of crises on unemployment by 0.3 percentage point, but reduces the medium-term impact by about 0.8 percentage point.2 Among the sub-indicators, hiring and firing regulations and centralized collective bargaining remain the ones with the largest medium-term impact (columns III and IV). 4. Labor market reform and unemployment outcomes To estimate the dynamic impact of labor market reforms on unemployment, BFG uses the following specification:
Ui,t+k − Ui,t = αik +
l
k γ jk Ui,t− j + βk Ri,t + δ X i,t + εi,t
(2)
j=1
where Ri, t is a reform dummy that takes value 1 for the start of a reform episode in period t in country i and zero otherwise, Xi, t is a vector of control variables including the initial level of unemployment, the crisis dummy used in the previous section, and a deterministic time trend. βk measures the impact of the reform on the change in unemployment for each future period k. Fig. 1 replicates Fig. 10 in BGF, which plots the impulse-response functions (IRFs) obtained by using the least-squares dummy variable estimate of βk for k = 0, 1,…,6. The figure confirms that labor market reforms are associated with a medium-term decline in unemployment that ranges from about 0.5 (based on reforms identified using the second approach) to 1.2 percentage point (based on reforms identified using the first approach). The results are similar to those reported in BFG, which finds that reforms are associated with a decline in unemployment of about ¾ percentage point over the medium term. The results in Fig. 2 (which replicates Fig. 12 in BFG) also confirm that reforms on minimum wages (hiring index) and mandated cost of hiring (hours regulation) have a statistically significant impact on unemployment on unemployment outcomes. We have also replicated the IV results presented in BFG to address endogeneity. In particular, while potential reverse causality is addressed by estimating changes in unemployment in the years that follow a large labor market reform, it could still be the case 2 The point estimates presented in BFG suggested that an increase of one point in the labor market flexibility composite indicator increases the short-term effect of crises on unemployment by 0.4 percentage points, but reduces the medium-term impact by about 0.6 percentage points.
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Panel 1. Reforms Identified Using the First Approach 3 2 1 0 -1
0
1
2
3
4
5
6
-2 -3 -4 esmate
lower limit
upper limit
Panel 2. Reforms Identified Using the Second Approach 3 2 1 0 -1
0
1
2
3
4
5
6
-2 -3 -4 esmate
lower limit
upper limit
Fig. 3. The Effects of reforms on unemployment – IV. Panel 1. Reforms identified using the first approach. Panel 2. Reforms identified using the second approach. Note: the solid line represents the estimated IRF; dotted lines represent 95% confidence bands. In the first approach, a reform is identified when, for a given country at a given time, the annual change in the composite labor market flexibility indicator exceeds by two standard deviations the average annual change over all observations during the period 2002–08. In the second approach, a reform is identified when, for a given country at a given time, at least one reform in the six policy areas takes place.
that unobserved factors influencing the dynamics of unemployment over time could affect the probability of a reform. Following BFG, we instrument labor market reforms with the variables found to be significantly correlated with the probability of reforms, namely: (i) the pre-existing level of the labor market institution index; (ii) the degree of decentralization in the executive power; (iii) the length of time the chief executive’s party has been in power; and (iv) a measure of the output gap.3 The results obtained using this approach are reported in Fig. 3 (replicating Fig. 13 in BFG), and confirm the significant effect of reforms on unemployment over the medium term (the IRFs are statistically significant after five years). The results also suggest a larger effect than that shown in the baseline, which is consistent with the fact that OLS estimates of β k may be biased towards zero. In particular, the IV estimates suggest that labor market reforms may lead to a reduction in unemployment that ranges from about 1.8 (based on reforms identified using the second approach) to 2.4 percentage points over the medium term (based on reforms identified using the first approach). This effect is very similar to the one reported in BFG (2.5 percentage points).4 5. Conclusions Aleksynka (2015) points to some important methodological flaws in the labor market indicators data used in Bernal-Verdugo et al. (2013) [BFG]. This paper revisits the empirical finding presented in BFG, and show that the results and conclusions are little affected by these methodological flaws. In particular, we find that: (i) while in countries with more flexible labor markets the impact of banking crises is sharper but short-lived, in countries with more rigid labor markets the effect is initially more 3 Similarly to BFG, the test of joint significance suggests that these political variables can be considered as strongly exogenous. In particular, the Chi-square test of the null hypothesis of joint significance is 29.83, which is higher than the critical value (10) suggested by Staiger and Stock (1997) for strong instruments. 4 This result is robust to different specifications and estimates of the probability of labor market reforms, as well as to other robustness checks presented in BFG.
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subdued but highly persistent; (ii) comprehensive labor market reforms have a positive impact on unemployment, albeit only in the medium term. Appendix Table A1
Table A1 Comprehensive reform episodes. First approach
Second approach
Country
Date
Country
Date
Country
Date
Country
Date
Australia Bulgaria Burkina Faso Chile Croatia Croatia Czech Republic FYROM FYROM Georgia Hungary Italy Latvia Malawi Mali Montenegro Montenegro Pakistan Peru Portugal Romania Slovak Republic Slovenia
2005 2007 2007 2005 2003 2008 2005 2006 2008 2005 2004 2005 2006 2007 2005 2006 2008 2004 2008 2004 2007 2003 2003
Angola Argentina Armenia Australia Azerbaijan Azerbaijan Azerbaijan Bolivia Bosnia and Herzegovina Bulgaria Burkina Faso Burkina Faso Chile Chile Colombia Costa Rica Croatia Croatia Czech Republic Dominican Republic Dominican Republic Egypt El Salvador Ethiopia FYROM FYROM FYROM
2005 2007 2004 2005 2004 2005 2008 2003 2005 2007 2005 2007 2003 2005 2003 2003 2003 2008 2005 2003 2005 2003 2003 2005 2003 2005 2006
FYROM Georgia Georgia Georgia Greece Guatemala Guatemala Honduras Hong Kong SAR Hungary Indonesia Israel Italy Italy Kazakhstan Korea Kyrgyz Republic Latvia Lesotho Malawi Malaysia Mali Mauritania Mauritius Moldova Mongolia Montenegro
2008 2003 2004 2005 2006 2003 2005 2005 2002 2004 2005 2004 2003 2005 2005 2006 2005 2006 2005 2007 2003 2005 2005 2008 2005 2004 2005
Montenegro Montenegro Morocco Mozambique Oman Pakistan Panama Paraguay Peru Philippines Portugal Romania Russia Serbia Slovak Republic Slovak Republic Slovenia Spain Switzerland Tanzania Tunisia Uganda Vietnam Vietnam Zambia Zambia
2006 2008 2003 2003 2007 2004 2005 2005 2008 2005 2004 2007 2007 2005 2003 2006 2003 2004 2006 2005 2005 2006 2003 2005 2005 2006
. References Aleksynka, Mariya, 2015. Banking crises, labor reforms and unemployment: a comment. Journal of Comparative Economic (forthcoming). Bernal-Verdugo, Lorenzo E., Furceri, Davide, Guillaume, Dominique, 2013. Banking crises, labor reforms and unemployment. Journal of Comparative Economic 41, 1202–1219. Gwartney, James, Lawson, Robert, 2010. Economic Freedom of the World: 2010 Annual Report. Fraser Institute, Vancouver, BC. Staiger, J., J.H., Stock, 1997. Instrumental variable regression with weak instruments. Econometrics 56, 557–585.