sou · H3B353en · 2015-06-04 00:00:00 — These conditionalities include various elements ranging from control/enforcement of job search and availability criteria to enhancement of qualifications to improve job finding rates.82 To see the implications of these conditionalities consider the limiting case of a participation requirement for receiving unemployment benefits. Assume for the sake of argument that programme participation does not affect qualifications but only serves as an availability test. Participation in such a programme increases the opportunity costs of receiving benefits, which reduces both adverse selection problems and the moral hazard problem in individual search activities by lowering the net gains from claiming benefits. As an illustration of how the trade-off between employment (efficiency) and inequality (equity) can be affected by such conditionalities consider a simple search model of the labour market (and Svarer, 2014). In this setting unemployment benefits distort search incentives, and if benefits are financed by general taxation, there is a standard common pool or moral hazard problem. Higher benefits (replacement rates) will lower the gain from working and lead to less search and thus reduce employment. Including a workfare element into the scheme implies higher opportunity costs from claiming benefits, which makes unemployed search more for the basic reason that employment becomes more attractive for given benefit levels. Therefore such conditionalities serve to maintain incentives in the labour market and thus support high employment rates despite a high level of income insurance (replacement rate). search incentives can thus be strengthened either by a benefit cut or by strengthening of workfare elements. This is illustrated in Figure 6.4 showing combinations of the replacement rate and the workfare requirement (measured in terms of the time requirement relative to 82 and Tonin (2014) show that an earned income tax works in much the same way to boost employment, and it may also strengthen educational incentives. Risk sharing and economic performance Bilaga 4 till LU15 normal working hours) delivering the same employment rate (see and Svarer (2013)).83 Figure 6.4 The role of the replacement rate and workfare conditionalities in a basic search framework Note: Workfare requirement is measured as the time requirement relative to normal working hours. The figure is based on model and simulations in and Svarer (2014). The important point of this example is that incentives can be strengthened without necessarily deteriorating the level of support offered by the social safety net.84 Economic deprivation is not necessary to create incentives! This can also be interpreted in the sense that there is a complementarity between replacement rates and workfare requirements, or that the total package matters. From a policy perspective the important lesson is that incentives in the 83In the model the benefit scheme is associated with possible participation in a workfare programme. The programme has two dimensions, the likelihood or share or unemployed being asked to participate in the programme (the extensive ) and the work requirement (the intensive ). The intensive is measured as the time requirement relative to normal working hours, see and Svarer (2014). 84Scandinavian countries are characterised by centralized labour markets and a strong tradition for seeking cooperative solutions (tripartite settlements). In relation to the common pool property of the welfare state this is particularly important. Union leaders will not formulate an agenda where they ask for tax increases to finance a more extended welfare state and at the same time ask for wage increases to compensate for the implied tax increases. In short, centralized wage setters take the effect of their actions on the public budget into account (the common pool problem is internalized) (see e.g. Summers et al. (1993)). The labour market institutions are also important for wage setting and employment, see e.g. and Moene (2013). Bilaga 4 till LU15 Risk sharing and economic performance labour market can be maintained without retrenchment of the social safety net, cf. The point is not to deny the incentive problems arising from an extended social safety net. There are many examples of policy designs which have caused large drops in employment rates (including the early retirement scheme in , and sickness pay in ). The point is that the solution to these problems is not necessarily retrenchment of the social safety net, but design changes which via conditionalities and screening mechanisms reduce the incentive problems. Thereby incentives can be maintained without increasing income disparities. Designing labour market policies involves a number of concerns. Such activities are costly (direct costs of labour market policies amount to 1.3 percent of GDP in and 2.1 percent in in 2012)85, and the shift in the trade-off between incentives and insurance is thus not obtained for free. Two aspects are particularly important, namely timing and programme types. Frontloading of workfare requirements will strengthen incentives the most, but it will also be very costly, and it would entail a large deadweight loss from programme participation for many who in any case would find a job after a short unemployment spell. This is particularly so in a labour market with a high incidence of short-term unemployment spells. , workfare requirement should be imposed after some duration of an unemployment spell. The group of unemployed is heterogeneous, spanning from some who have the qualifications and experience making them readily employable to some who lack these characteristics (e.g. due to long-term unemployment) and therefore find it very difficult to get a job. For the former group, help with job search may be sufficient, while for the latter more specific programmes may be needed to specifically address the constraints lowering their job finding rate. In some cases, it may be easy to identify these constraints (e.g. if the unemployed lacks specific skills), while in others it may be more difficult and also depend on market conditions (qualifications become obsolete due to structural changes). In the latter case, avoidance of deadweight 85 Data from , the measure is total public expenditures on labour market policies. The (unweighted) average is about of GDP. Risk sharing and economic performance Bilaga 4 till LU15 losses gives an argument for making workfare programmes duration dependent. 6.5Flexibility and adjustment in the labour market Social insurance may have structural effects of importance for flexibility and adjustment, in particular in the labour market. Discussions on various aspects of social insurance or institutional set-up often take a partial perspective focusing on only one aspect, disregarding system wide implications or policy complementarities. This may be misleading. Risk in the labour market in the form of wage and employment variations is an indisputable fact. Various institutional arrangements have implications for risk sharing and diversification, but they do not make risk disappear. It is thus important to pay explicit attention to the complementarity/substitution between different institutional arrangements. A crucial question in the labour market is how to share risk between employers and employees. The precise sharing is reflected in the contract between the two parties. If workers are going to bear more risk, it may affect their labour supply or the wage (cf. above), and similarly if the risk rests on employers, they may want more flexible hiring rules or lower labour costs. Two alternative risk sharing arrangements are unemployment insurance and employment protection legislation. The former insures against income loss in case of job loss, the latter protects those holding a job from becoming jobless. There is thus a fundamental difference in terms of insuring incomes or jobs. Unemployment insurance is by definition a collective risk sharing device.86 A primary advantage is the pooling of risk, which can be an advantage for both employers and employees. The downside is the moral hazard problems which can arise both with employers (temporary lay-offs) and employees (job search, reservation wages). 86 In both and the system has voluntary membership (contribution based, but tax subsidized), which raises adverse selection issues. Do individuals with low risk aversion or low perceived unemployment risk staying outside the system? Bilaga 4 till LU15 Risk sharing and economic performance Employment protection makes job loss less likely for those holding a job. It also implies less job turnover, which may be conducive to on-the-job training and investments, but it reduces worker reallocation across firms and sectors. Moreover, it may create a dual labour market (temporary and permanent contracts) where insiders are well protected but outsiders are in a difficult position (especially labour market entry for youth). The institutional set-up also has a political side. Technological progress and globalization are associated with general welfare gains. However, the process has both winners and losers. To reap the gains it is important that resources can be reallocated between uses. If there are impediments, the adjustment process will run less smoothly and the gains will be smaller. It is well established that general productivity gains are associated with structural changes, cf. The aggregate gains may in this way cause individual costs and this may induce opposition against such adjustment. This opposition may show up as less political support for e.g. globalization or contractual arrangements which protect individuals from carrying the costs associated with the changes. Various institutional set-ups thus have different implications for risk sharing (and Tirole, 2010). There is some empirical evidence pointing to a substitution between unemployment insurance and employment protection legislation (EPL); i.e. countries with more generous unemployment insurance have less strict EPL, and vice versa, see Buti et al. (1998) and Boeri et al. (2003). The reasoning above may suggest that a collective risk sharing arrangement via social insurance is more conducive to labour market flexibility, labour reallocation and productivity. There are two sources of empirical evidence on this. Part of the empirical literature assessing the incentive effects of unemployment insurance has also questioned the effect this may have on job match quality. The basic point is that while more generous unemployment insurance tends to lengthen the duration of unemployment spells, it may also improve the quality of job matches. With heterogeneity in the labour market it takes time and costs to locate a good match. Longer benefit duration may thus work in the direction of improving job match quality either in terms of higher wages or job stability. Risk sharing and economic performance Bilaga 4 till LU15 measurement and identification issues are involved in empirical attempts to assess job match quality. There is evidence showing that a more generous unemployment insurance scheme is associated with high job match quality (see e.g. Centeno and Novo (2006) and Tatsiramos (2009) ), although there are also studies pointing to absence or even a negative effect (see e.g. Degen and Lalive (2013) and van Ours and Vodopivec (2008)) Another branch of the literature has considered the role of worker reallocation and employment protection legislation. The evidence shows the following (for a survey see and Scarpetta (2012)): –Labour reallocation is associated with productivity gains. Reallocation of labour across firms and sectors is associated with productivity gains, see e.g. Parrotta og Pozzoli (2012). –Gross job flows depend on labour market policies and institutions. Both cross-country studies and country-specific studies find empirical evidence that strict EPL is associated with lower job flows, and that unemployment generosity is associated with higher gross flows (see e.g. and Scarpetta (2012) and (2012)). –The direct effect of EPL on productivity is less clear. Crosscountry studies do not find evidence in support of any effects, but country-studies find some effect, see the survey in and Scarpetta (2012). In assessment of various institutions it is thus important to take into account what the alternatives will be. A recent literature levy a critique on traditional analyses for having a too one-sided focus on identifying the optimal institutional setting87, see e.g. Nuun and Trefler (2013). There is no specific institutional setting which is optimal. The reason is that various institutional arrangements have 87 Acemoglu et al. (2013) argue that the Scandinavian countries hold a particular situation in an asymmetric global equilibrium, where some countries have more inequality to induce entrepreneurship and innovation and thus driving productivity. Other countries will freeride on technological developments and have less inequality. Although income is lower, welfare is higher for those “follower”-countries. Since the global equilibrium is asymmetric, it is not possible for all countries to be followers. Empirical evidence is not overwhelming in support of this hypothesis. The Nordic countries have large public investments in education and R&D, and it is not clear that they are free-riders. Bilaga 4 till LU15 Risk sharing and economic performance pros and cons, which may be a source of comparative advantage. Countries with flexible employment protection legislation and generous unemployment insurance may have a comparative advantage in industries with substantial short-term variation in demand and thus production, while countries with more strict employment protection legislation and less generous unemployment insurance may have a comparative advantage in production of commodities with less variability. As an example of this Cuñat and (2012) find in a cross-country study empirical support that countries with more flexible labour markets have a higher degree of specialization in sectors more frequently exposed to sector-specific shocks. This may be interpreted in the sense that the nature of shocks or needs for adjustment to some extent is endogenous, meaning that countries specialize in the activities for which their particular institutional setting has a comparative advantage. This type of research is still in its infancy, but it is highly suggestive of why different institutional settings (welfare regimes) survive. The hallmark of the Nordic model is that it delivers a high living standard and a fairly equal distribution of income. This encapsulates the overarching objectives of the model. The specific means by which to achieve them differ across time and the Nordic countries. Despite a large public sector and thus tax burdens, income is high and employment rates are high. In economic jargon, the efficiency costs of achieving egalitarian outcomes have been muted. The design of welfare arrangements is important in this respect. While taxes seen in isolation do distort incentives, the overall effects cannot be seen independently of what taxes are financing. In the Nordic countries expenditures are front-loaded over the lifecycle (of larger importance for young and old), and they have a large share of so-called or productive expenditures both of which serve to support employment and production. The social safety net cushions various types of events and shocks which can happen through life, but can be conducive to adjustment and flexibility. The design of transfers with strong employment conditionalities (workfare) is important in balancing concerns for distribution and insurance with incentives. The Nordic model is not crisis free, and deep economic crises are part of the history of the Nordic countries. Despite the turbulence, the model has proven resilient and stands out in international comparisons as an example of how to reconcile social objectives with a well-functioning economy. Accordingly, the Nordic countries rank in the top in most international league tables comparing country performance. Part of this is a strong legacy ingrained in institutions and policies constituting a social and political capital also making it possible to implement far reaching reforms in due time to ensure Bilaga 4 till LU15 the viability of the model. A prime example of this is reforms of pension systems so as to address the ageing problem. The recurrent reforms also point to a dynamic interpretation of the Nordic model; the specific policy instruments employed at a given point in time do not define the model, but the overall package and objectives do. In a forward-looking perspective the Nordic countries face a number of challenges. Most of these are global, but the quest is to find solutions in accordance with the principles of the Nordic model. It is beyond this paper to discuss these challenges, but a few remarks are in order. Ageing is an important example of a global challenge, and some adjustments inevitably have to be made. While politically important (and difficult), it is not requiring fundamental changes in the model. The specific policy response can be discussed, but reforms of pension systems (including retirement ages) to address the problems can not in any meaningful way be categorised as retrenchment of the welfare state. If people live longer, some adjustment has to be made. Globalization is not a new phenomenon for the Nordic countries, and the constraint to remain competitive is deeply ingrained in policies. Globalization in combination with technological changes affects labour markets, inducing changes in the structure of labour demand. In particular the skill bias reducing the demand for low skilled labour is important from a distributional perspective. This brings the importance of the level and distribution of human capital to the fore as important not only for overall income or wealth but also for its distribution. Globalization also puts tax financing under pressure via tax base mobility and potentially larger distortionary effects of taxes due to easier scope to relocate employment and production. This may require changes in the tax structure. It is worth reminding that there is some scope since the Nordic countries raise a relatively small share of tax revenue from e.g. property taxation. Increased migration flows (including migrant workers) is an implication of globalization which potentially challenges the universality principle by introducing selection mechanisms if immigrants tend on average to be net-beneficiaries and emigrants to be net contributors. This may raise questions on entitlement conditions to welfare arrangements. Bilaga 4 till LU15 Finally, the welfare state is continuously facing new needs and demands. Society is changing, and it is accordingly to be expected that welfare arrangements are changed. 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