What Causes Labor-Market Volatility? The Role of Finance and Welfare State Institutions.

Using fixed effects panel data models on a sample of 15 OECD countries over the period 1970-2007, this article explores the linkages between labor-market volatility, financial development and welfare state institutions. We analyze the interacted impact of financial development on the one hand and welfare state institutions (i.e., overall social spending) on the other hand on volatility of hours worked and volatility of wages. Our results indicate that financial development is associated with higher volatility on labor-markets. Estimates of the marginal effects show that overall social spending increasingly reduces labor-market volatility with the degree of financial development, and more specifically for low-skilled workers through compensation mechanisms. Finally, we control for potential reversed causality by running IV-GMM estimations suggesting that increasing financial development has not threatened the governments' ability to play an active role in cushioning fluctuations on labor markets.