Labor market regulation, the diversity of knowledge and skill, and national innovation performance

The diversity of knowledge and skill is an important element of a national system of innovation. We propose a theory of how certain labor market institutions affect diversity, and through that route affect levels of innovation. Specifically, unemployment protection (UP) encourages diversity by reducing the risk burden of a broad range of learning, or human capital investment; for that reason, UP fosters innovation. Employment protection (EP) reduces the risk burden of a much narrower range of learning; for this reason, it will not enhance diversity to the extent UP does, and it may actually depress overall diversity and innovation. Our approach differs from previous research on labor market insurance and skill formation, much of which has dealt with a distinction between general and specific skills, and which has treated the effects of UP and EP as similar. Estimating the effects of UP and EP on patenting for 25 OECD countries over 24 years, we find a positive effect from UP, a negative effect from EP, and evidence that the UP effect is mediated by diversity of skill.