Designing Labor Market Institutions

\Western Europe su®ers from too many labor market rigidities, from excessively generous unemployment insurance to high employment protection, and to high minimum wages. It is essential that countries putting in place new institutions do not commit the same mistakes." The quote is made up. But it is, I believe, a fair representation of the opinions of many experts and many organizations, from The Economist to the OECD. I am more skeptical, or at least, more open. The labor market is far from a textbook competitive market to start with. It is rife with information problems, with room for market power and for bargaining. It will not function well without proper institutions. And these institutions, from unemployment insurance to the minimum wage, came into being in response to clear market failures, from the exploitation of workers in the one{company towns in the 19th century, to the extreme su®ering of the unemployed during the Great Depression. That labor market institutions came in response to market failures surely does not imply that the institutions we have today are optimal in any sense: Their design may have been poor to start with. Circumstances and the