The Quality of Labor Relations and Unemployment

There is a clear negative relation across OECD countries between measures of the quality of labor relations and unemployment. We argue that conflictual labor relations cause high unemployment, and we propose a model to think about this issue. Empirically, we use historical evidence from the 19th century to construct an instrument for current labor relations and establish causality. Theoretically, we consider an economy where asymmetric information can result in bargaining failures, inefficiencies and high unemployment in equilibrium. These inefficiencies can however be alleviated by higher trust, sustained through repeated interactions between firms and workers. We think of countries with different labor relations as playing different equilibria of the same repeated game, and we use our model to interpret cross-country and time series facts about labor relations, strikes, and unemployment in OECD countries since the early 1970s. ∗MIT and NBER, and NYU and NBER respectively. An earlier version of this paper circulated as MIT WP 04-25. Much of the empirical evidence and the model developed in this version are new. We thank Pierre Cahuc, our discussant at the IZA-PSE workshop on cultural economics. We are indebted to Youngjin Hwang for excellent research assistance.