The political economy of flexicurity

We document the presence of a trade-off in the labor market between the protection of jobs and the support offered to unemployed people. Different countries' locations along this trade-off represent stable politico-economic equilibria. We develop a model in which individuals determine the mix of job protection and support to the unemployed in a political environment. Agents are heterogeneous along two dimensions: employment status -- insiders and outsiders -- and skills -- low and high. Unlike previous work on the political economy of labor market institutions, we emphasize the role of job protection and unemployment benefits in the wage setting process. A key implication of the model is that flexicurity configurations with low job protection and high support to the unemployed should emerge in presence of a highly educated workforce. Panel regressions of countries' locations along this institutional tradeoff are consistent with the implications of our model.