Political Instability and Labour Market Institutions

This paper investigates the relationship between political instability and labour market institutions. We develop a theoretical model in which political instability creates incentives for a government to introduce labour market regulation in the economy. The distortionary effect of regulation on unemployment effectively puts a constraint on the design of fiscal and public policies. We empirically investigate these predictions using panel data for 21 OECD countries for the period 1985–2006. Our results are consistent with the view that political instability is associated with more regulated labour markets, lower labour taxation, and lower unemployment benefit replacement rates.