Labor Market Flexibility and the Impact of the Financial Crisis

Abstract

The recent financial crisis, which originated in the US, has also hit the rest of the world. However, the impact of the crisis on economic activity varies widely across countries, reflecting differences in exposure and vulnerability to financial crises, heterogeneity in macroeconomic structures, and differences in policy responses (Berkmen et al., 2009). A few recent studies have examined the impact of the global financial crisis on output identifying factors that may explain cross-country differences in the impact of the financial crisis. For instance, Berkmen et al. (2009) find that countries with more leveraged domestic financial systems and more rapid growth in lending to the private sector tended to suffer more from the crisis, while countries exporting advanced manufacturing goods were more affected than those exporting food. Also countries with pegged exchange-rate regimes fared significantly worse than countries with a more flexible exchange rate regime. 1 Up to now, there is no study examining the relationship between labor market flexibility and the impact of the financial crisis on output. 2 This paper examines for 56 countries over the period of 2007 until the first quarter of 2010 whether cross-country differences in the impact of the financial crisis on the loss of output and the duration of the crisis are related to differences in labor market flexibility. We measure the output loss by the decrease of real GDP from peak to through. Likewise, the duration of the crisis is the length of the period between the peak and the through of real GDP. Employing a cross-country model that includes control variables such as trade and capital market

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