Penned by Tito Boeri and Jan van Ours, The Economics of Imperfect Labor Markets, 3rd ed., is a labor economics textbook seeking to improve our understanding of labor market institutions and how they interact with said markets. The authors define a labor market institution as “[a system] of laws, norms, or conventions resulting from a collective choice and providing constraints or incentives that alter individual choices over labor and pay.” Examples of such institutions include everything from government interventions such as minimum-wage laws to nongovernmental collective bargaining organizations such as unions.
This third edition of the book builds on the second edition by introducing changes in both content and structure. It includes two new chapters: one on self-employment regulations and another on health-related labor policies. It also merges two previous chapters (on unemployment benefits and active labor market policies) into a single chapter. The book is intended to serve either as a basis for a class focusing on labor market institutions or, more broadly, as study material for a section of a general labor economics course.
A basic model of labor supply is set out in the book’s overview. In the simplest terms, the model assumes that (1) laborers choose how many hours to work and (2) this choice is constrained by a budget of time. Laborers’ choice to work is determined by the lowest wage at which they are willing to supply labor, a wage known as the reservation wage, and their choice of time spent working is based on the counteracting income and substitution effects of the wage available. A basic model of labor demand is also built, whereby firms are assumed to be profit maximizers, with their labor demand being determined by the costs of capital and wages, along with the firms’ associated production functions. A perfect labor market equilibrium occurs at the intersection of the curves for aggregate labor supply and demand.
The difference between perfect and imperfect labor markets is the focus of the book. As defined by the authors, an imperfect market is one in which “rents [are] associated with any given job so that the total surplus of the marginal job is positive.” These rents introduce market frictions that prevent the seamless transition of laborers between jobs and alter the labor market equilibrium. It is in this environment that institutions are used to affect the reservation wage.
Following the overview, each chapter of the book examines a different institution and its effect on the equilibrium level of employment. Institutions introduce a “wedge” between the reservation wage (labor supply) and the value of a job to a firm (labor demand). These wedges have the power to create or destroy jobs. The institutions studied by chapter are minimum wages, unions and collective bargaining, antidiscrimination legislation, regulations of working hours, early retirement plans, family policies, education and training, migration policies, employment protection legislation, regulations on self-employment, unemployment benefits and active labor market policies, health-related labor policies, and payroll taxes.
Each chapter has a similar outline, beginning with a short introduction to the history of the institution being examined and proceeding with six sections. The first section focuses on measures and cross-country comparisons, detailing how the institution has been implemented in different economies. The second section provides the theory behind the institution in the context of both perfect and imperfect markets. The third section presents empirical evidence, reflecting on the conclusions of published works studying the institution. The fourth section discusses policy issues, addressing considerations relating to the institution’s implementation. The fifth and sixth sections vary in order but examine the future of the institution and its interactions with other institutions. Each chapter ends with suggestions for further reading, review questions, and a technical annex.
To illustrate this structure, the remainder of this review details the book’s last chapter, which focuses on payroll taxes. The chapter’s introduction traces the historical evolution of taxes, from temporary measures in feudal societies to permanent measures designed to support the expenditures of modern governments. The authors divide payroll taxes into two types—income taxes and social security contributions—and broadly note that payroll taxes introduce a wedge between a firm’s cost of labor and a worker’s net wage. This wedge reduces the labor market’s size by inducing workers to work fewer hours than they otherwise would. The authors point out that payroll taxes are the main vehicle for funding most of the other institutions covered in the book, and, therefore, their effect on labor markets largely depends on how other institutions are funded and used.
The chapter’s section on measures and cross-country comparisons uses a linear tax model to illustrate the tax burden experienced by workers. From this model, it is possible to derive an average tax rate and a marginal tax rate. The ratio of the marginal tax rate to the average tax rate determines if a tax system is proportional, progressive, or regressive. Adding a firm’s tax burden to a worker’s tax burden yields the tax wedge, which can be used to find the average and marginal wedges. Because tax systems are complex and cannot be summarized with a single number, the authors calculate taxes for a single worker without children at the country’s average income level. They find that, for member states of the Organisation for Economic Co-operation and Development, the total average tax wedge ranges from 7 percent in Chile to 53 percent in Belgium.
The chapter’s theory section, which reviews the literature on taxation, states that the structure of tax systems has a stronger impact on labor markets than does the level of taxation. With that in mind, the authors model a handful of tax systems, noting that taxes shift the time-budget restraint and affect the hours of labor supplied. The difference between perfect and imperfect labor markets is that unemployment in imperfect markets exists in equilibrium. In theory, taxes have the same directional effects on labor in both markets, but many of these effects depend on interactions with other institutions. For this reason, the authors discuss taxation’s interactions with unemployment benefits and how these interactions affect unemployment.
The chapter’s remaining sections discuss the reality of payroll taxes and how they are integrated into the economy. The empirical section serves as a bridge between the theory and policy sections, reviewing evidence and findings from around the world on how various tax systems affect the labor market. The policy section tackles two large questions: “How to make work pay?” and “How to pay and target beneficiaries?” The authors identify various methods countries have used to address these questions. The section on institutional interactions discusses the outcomes of combining certain tax schemes with other institutions, while the section on the future of payroll taxes sums up the institution’s purpose and the factors (e.g., technological advances) that might cause the institution to evolve.
Overall, The Economics of Imperfect Labor Markets is an excellent study resource for both students and professionals seeking a deeper understanding of labor markets. The book’s clear explanations and graphical representations of models make it an easy-to-follow read. The empirical discussions are extremely valuable because they provide real-world data to back up the theoretical claims. The authors achieve their goal of supplying a textbook that can be used as a basis for a class on labor market institutions.
United States Department of Labor
