Political instability and labour market institutions

- Political instability influences the level of labour market institutions.
- We provide both a theoretical and an empirical analysis using OECD aggregate data.
- Political instability favours labour regulations that constrain labour taxes.
- Political instability also induces a lower unemployment benefit replacement rate.

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.