Labor-Market Policies in an Equilibrium Search Model

We explore to what extent differences in employment and unemployment across economies can be generated by differences in labor-market policies. We use a version of the Lucas-Prescott equilibrium search model with undirected search and endogenous labor-force participation. Minimum wages, degree of unionization, firing taxes, and unemployment benefits are introduced and their effects analyzed. When the model is calibrated to U.S. observations, it reproduces several of the elasticities of employment and unemployment with respect to changes in policies reported in the empirical literature. We find that: (1) minimum wages have small effects; (2) firing taxes have similar effects to those found in frictionless general equilibrium models; (3) unions have large and negative effects on employment, unemployment, and welfare; and (4) unemployment benefits substantially increase unemployment and reduce welfare.