Institutions, Aggregate Demand and Cross-Country Employment Performance: Alternative Theoretical Perspectives and the Evidence

In New Classical and New Keynesian thinking, the cross-country pattern of unemployment reflects prevailing equilibrium rates, which in turn are mainly explained by the protective labor market institutions that produce market rigidities. While this orthodox view has framed nearly all of the research that has addressed this issue, the evidence to date is not very compelling; recent work in the Keynesian tradition suggests that more attention should be paid to capital accumulation and monetary/fiscal policy.

The central claim of this paper is that a still richer account requires embedding the Keynesian account in a comparative political economy framework to explain both levels of aggregate demand and the translation of demand to employment (and unemployment). Employment performance reflects the effectiveness of bundles of institutionalized practices related to firm strategies, labor relations, the welfare state, and macroeconomic policy. On this score the evidence is unequivocal: coherent institutional models grounded in high levels of social and political consensus can produce exceptionally low unemployment in labor markets characterized by low wage inequality and substantial income security.