Project: Institutional Complementarities
Institutional complementarities

Institutional complementarities arise in the context of second-best
arrangements to overcome market imperfections and failures,
such as the under-provision of general human capital, the lack of
insurance against aggregate risk, and short time horizons (high
discount rates) that all typically arise in a competitive environment.

Implicitly such second-best arrangements change relative prices,
but by doing so affect the outcomes on neighbouring markets as
well. My work has concentrated on the following three areas in this

Financial and labour market interactions

A firm's sequential decisions regarding its financial structure and
hiring its workforce creates interactions between institutional
arrangements on financial and labour markets. In particular, these
institutions excercise a complementary impact on:

the risk aversion of entrepreneurs and employees
their incentives to invest in specific assets
time horizon of market participants.

When discount rates are high and the time horizon low, institutions on financial markets - such as provisions that allow concentrated
ownership on stockmarkets - may help to lengthen them while at
the same time set incentives for trade unions on the labour market
to focus on employment growth rather than short-run wage gains.
Such an equilibrium proves, however, to be fragile (
paper) and
subject to institutional cycles in the presence of highly elastic
labour supply (

Investment in (firm-)specific assets - such as special human
capital, innovative outlays or specific corporate governance
structures - play an important role in determining the productivity at
the firm level. Institutional arrangements to mitigate any one of the
hold-up problems that arise due to the specific nature of these
investments will have an immediate impact on the investment
returns of all the others. Such complementary institutional solution
may, however, loose out on other dimensions - such as higher
unemployment rates that can result from trade union activity - so
that no globally optimal institutional arrangement is available in the
presence of multiple equilibria (
paper). Moreover, these multiple
peaks that arise in the economic landscape will typically react quite
differently to partial changes in the institutional set-up (structural
reforms) with considerably different outcomes (

I am currently working on a book where these ideas are developed
more fully and different avenues to financial and labour market
interactions are discussed. In particular, the different transmission
mechanisms through which complementary relations between
institutions arise are analysed more thoroughly and the question of
institutional ambiguity is brought up that helps to explain why and
how institutions - originally set up for a different purpose - may
develop complementarities (
read more in this draft chapter).

Complementarities on labour markets

Institutional complementarities can also arise among different
institutions on the same market. Different labour market
institutions, for instance, that affect both the structure of wages and
the cost of employment adjustment may increase the incentives for
firms to invest in general skills of their employees. This is in
particular the case, when collective wage bargaining systems
compress the wage structure, thereby creating a rent for firms that
invest in the skills of their workforce. Such an incentive is reinforced
when firms are constraint in their ability to fire employees by strict
employment protection legislation (EPL). Such a complementary
relationship between collective wage bargaining systems and EPL
proves, indeed, to be empirically relevant in explaining cross-
country differences in their innovation specialisation as not all
sectors are likely to benefit from such an institutional interaction to
the same extent (