Cross - sectional wage and employment rigidities vs . aggregate employment

When studying real-life market outcomes and evaluating policy interventions, economists like to refer to a hypothetical situation where intertemporal and insurance markets are perfect and complete. In reality, of course, laissez faire economic interactions can hardly supply insurance against the risk of becoming or remaining unemployed, because moral hazard and adverse selection stand in the way of such potential contractual arrangements. Workers would not try as hard to avoid unemployment and find new jobs if they were covered against the negative consequences of the event and, by purchasing insurance at a given market price. And workers who know their unemployed risk is particularly high would make the scheme unprofitable for insurance providers and/or unattractive to workers with average risk. Hence, one can understand why collective action would try and remedy the ex-post inequitable or " unfair " labour market treatment of workers who, lacking insurance, become or remain unemployed despite their best efforts. Indeed, regulation and legislation aimed at protecting workers from " unfair " labour market shocks have a long history (see, e.g., Hepple, 1986), and one that largely proceeds apace with the development of modern industrial modes of production. The industrial revolution led to increasingly impersonal economic interactions, and reduced the role of informal insurance arrangements at the family or village level at the same time as it concentrated economic power in the hands of employers. Thus, it is hardly surprising that national policymaking authorities (notably in Bismarck's Germany, but also in most other Continental European countries) would introduce legislation and regulation aimed at protecting workers from the health, unemployment, and old-age hazards of their trade; and it is even less surprising that workers would try and organise so as to offset the bargaining power of their employers. Provision of insurance in the presence of asymmetric information unavoidably decreases productive efficiency. Information problems, in fact, plague not only private contracts but also public intervention in both its efficiency-seeking and equity-seeking dimensions. Workers have no less incentive to decrease their job-seeking effort when covered by social rather than private insurance, and protection from " unfair " developments unavoidably decreases the labour market's speed of adjustment. Such efficiency losses are not easily affordable for developing countries, but are not a major concern for rich and more stable societies. Hence, it is not surprising that Europe's unprecedented fast and stable growth after World War II would, by the late 1960s and …