Labour market institutions and the double dividend hypothesis

Abstract

The concern over persistently high unemployment rates in Europe and the increased attention to the environment have produced the labour market double dividend hypothesis (the so called “pink” dividend¹). In a nutshell, this hypothesis suggests that governments should use an increase in the pollution tax to reduce payroll taxes. By doing so, they could kill two birds with one stone: improve the environment and expand employment (See Pearce, 1991). A similar policy has been advocated by Dreze, Malinvaud et al. (1993) and by the European Commission in a recent White Paper, and has attracted considerable academic interest. A statement that summarises current theoretical work on the “double dividend” hypothesis is that this policy is likely to be uneffective at best. Bovenberg and Van der Ploeg (1992) investigate whether a double dividend exists in a closed economy where markets are perfectly competitive and find that higher pollution taxes, combined with lower labour taxes, typically reduce employment. This result is robust to the extension of an open economy (Bovenberg and Van der Ploeg, 1993) and to the introduction of labour market rigidities (Bovenberg and Van der Ploeg, 1994) . Both Carraro, Galeotti and Gallo (1994) and Bovenberg (1994) outline the main reasons for this scepticism.² First, imposing a pollution tax on intermediate inputs increases production costs and reduces output and employment.