Institutional reforms have long been a central focus of the European economic policy debate, and the labor market in particular has been subject to never-definitive reforms in the past 20 years, mainly aimed at fostering wage moderation and flexible labor contracts. The employment effects of labor market institutions have been widely analyzed, but the focus on this aspect has overshadowed an equally important but scantily investigated element: their possible dynamic impact on innovation and productivity growth. This paper is a critical survey of the literature which may help shed light on this issue.
Growth theory as well as the results of the empirical growth literature teach us that the main drivers of long run productivity growth in advanced countries are innovation, research and development, human capital accumulation. Reforms which enhance labor market flexibility can in principle affect these growth drivers through different channels, but the sign of the effects on productivity growth is ambiguous. Existing empirical evidence shows that wage and numerical flexibility have negative effects on research and development, innovation and firm sponsored training, suggesting that the dynamic effects of labor flexibility are negative. This suggest that the tradeoff between labor market flexibility and productivity growth which has been detected both within many European countries and across European countries is not just a temporary, static, short run effect linked to the employment effect of flexibility enhancing reforms, but may also reflect a more worrying permanent, dynamic, long run phenomenon.
