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Labor Market Rigidities, Financial Integration, and International Risk Sharing in the OECD

This paper examines the impact of labor market rigidities and financial integration on international risk sharing in the OECD. The findings suggest that financial integration has a limited impact on risk sharing, while stricter labor market regulations increase cross-country correlations. The paper raises questions about the exact channels of risk sharing and the cost-benefit analysis of labor market regulations.

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Labor Market Rigidities, Financial Integration, and International Risk Sharing in the OECD

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  1. Comments on:Labor Market Rigidities, Financial Integration and InternationalRisk Sharing in the OECD by Jarko Fidrmuc, Neil Foster and Johann Scharler

  2. There is a theory which states that if ever anyone discovers exactly what the Universe is for and why it is here, it will instantly disappear and be replaced by something even more bizarre and inexplicable.There is another theory which states that this has already happened. Douglas Adams

  3. What it is not about • Paper claims to deal with the consumption correlation puzzle, • but, rather it accepts the empirical fact of low correlation, without endorsing a a particular solution for it.

  4. And what it really is about • Testing whether risk sharing can be achieved. • Empirical examination of the two determinants of risk sharing: • Degree of international financial integration (bilateral FDI flows). • Labor market rigidities.

  5. Main Findings • Financial integration is found to have a limited impact on international risk sharing • But facilitates output correlation – reducing the need to insure against idiosyncratic risk • Stricter labor market regulations increase the cross-country correlations: • profits may be easier to diversify • strong labor market regulations makes future income more predictable (collateral)

  6. General comments • Extensive exercise • New contributions to the empirical literature • The impact of labor market institutions • Still, some questions remain without answers • What are the exact channels?

  7. FDI flows as measure of risk sharing • Authors consider them superior to portfolio investment as a measure of financial flows • more closely related to long-term development • less susceptible to speculative flows • However, markets for equity more likely subject to frictions and market incompleteness than markets for bonds or loans,due to moral hazard and enforceability (Artis and Hoffman, 2004).

  8. World FDI vs. Debt and Equity stocks (USD trillion) Sources: UNCTAD and IMF CPIS

  9. What role for labor market rigidities? • Estimated impact a bit surprising! • Some theoretical papers predict adverse impact on international consumption correlations (Krznar, 2007). • Positive coefficient rather adds to the puzzle than provide a resolution.

  10. More strict labor market legislation • Making owners of the capital more to invest abroad - butit does not show in the FDI flows?! • Possible misspecification - investment probably not likely into other tightly regulated country. • Distancein EPL more important for FDI flows than average level of regulation!

  11. EPL effects (II) • More stringent EPL for temporary workers does not provide more security, but rather tougher conditions for application of contracts • E.g. successive contracts, duration, allowed cases • Extent of temporary employment interplay of different regulations.

  12. EPL and temporary employment (OECD)

  13. Why theory is important? • If employment protection indeed improves the international sharing of consumption risk, what are the exact channels? • Whether the risk sharing makes sense? • What if cost of labor market regulation exceed benefits of risk sharing? • Would it be cheaper to insure income through unemployment benefits?

  14. To conclude • Impact of labor market regulation on risk sharing important finding • supposed to be reflected in financial flows – should be examined further • Financial integration facilitates consumption correlation in EU • Seems to resolve the puzzle, but why?

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