Work and pay in flexible and regulated labor markets: A generalized perspective on institutional evolution and inequality trends in Europe and the U.S.

In recent years a “unified theory” has emerged out of labor economics, which argues that a combination of “macroeconomic shocks” and flexible labor market institutions in the U.S. has produced strong upward trends in wage inequality, while these same shocks have produced high unemployment and low employment growth in Europe as a side effect of the wage stability preserved by that continent's rigid labor market institutions. This paper takes issue with the common view that inequality trends are best explained by a model of stable institutions interacting with changing macroeconomic forces. It argues that European institutions in fact have changed, and that institutional changes which were triggered by the broader macroeconomic forces have affected the form as well as the size of inequality trends. While the U.S. has experienced rising strong skill-based wage inequality, institutional change in France has produced an upward trend in the density of insecure jobs and an increased concentration of low-skill workers in insecure jobs. These results challenge the view that low employment rates is the sole mechanism through which European labor markets have absorbed asymmetric shocks to their demand for labor.