The theoretical model developed in Chapter 1 generates a number of empirical predictions about cross-national and intertemporal variations in the employment performance of OECD economies. This chapter tests the macro-level implications of the analysis using time series, cross-section data for OECD economies for the period 1960–1995.

Existing studies seek to explain the variation in the employment performance of advanced industrialized democracies by examining the effects of wage bargaining institutions and monetary authorities (Iversen 1998, 1999; Hall and Franzese 1998; Franzese 2002). This study qualifies their results by suggesting that the optimal wage choices of unions, and thus the equilibrium level of employment, also depend on the structure and magnitude of welfare state commitments: Unions will deliver wage moderation if a large share of social policy expenditures goes to union members, but their incentive to do so declines as the share of social policy transfers received by labor market outsiders increases. Moreover, increases in payroll and income taxes undermine the effectiveness of wage moderation in lowering unemployment. In mature welfare states, which are characterized by high levels of taxes, unions and employers effectively bargain over a small part of the total wage bill. Under these conditions, even dramatic levels of wage moderation have only a modest impact in lowering unemployment. In combination, these two factors – the increase in the number of labor market outsiders and the growth in taxes – contribute to a rise in equilibrium unemployment.