Labor market rigidity and productivity growth in a model of innovation-driven growth

Empirical studies investigating the relationship between productivity performance and labor market rigidity have generated a negative result. In this paper we try to provide a theoretical explanation for this empirical result. In doing so, we construct a no-shirking model of innovation-based growth and investigate the steady-state impact of a set of active labor market policies aimed at reducing labor market rigidity and knowledge mismatch generated by innovations. We find that, while enhancing job finding activity definitively improves the equilibrium growth-unemployment mix of the economy, reducing the knowledge mismatch of innovation through active measures is less effective in reducing the equilibrium unemployment and improving growth.

Research Highlights► Empirical evidence shows a negative association of LM rigidity and productivity. ► Productivity growth crucially depends on national innovation aptitudes. ► In the steady-state LMP increases innovation and decreases unemployment. ► Labor market services are more effective than active LMP in reducing unemployment. ► LMP have only a light impact on innovation and productivity growth.