We document the presence of a trade-off between unemployment benefits (UB) and
employment protection legislation (EPL) in the provision of insurance against labour market
risk. The mix of quantity restrictions and price regulations adopted by the various countries
would seem to correspond to a stable politico-economic equilibrium. We develop a model in
which voters are required to cast a ballot over the strictness of EPL and over the generosity
of UB. Agents are heterogeneous along two dimensions: employment status — there are
insiders and outsiders — and skills — low and high skills. We show that if there exists a
majority of low-skill insiders, the voting game has a politico-economic equilibrium with low UB
and high EPL; otherwise, the equilibrium features high UB and low EPL. Another testable
implication of the model is that a larger share of elderly workers increases the demand for
EPL. Panel data on institutions and on the age and educational structures of the populations
are broadly in line with our results. We also find that those favouring EPL over UB in a public
opinion poll carried in 2001 in Italy have precisely the same characteristics predicted by our
model.
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