The relationship between labor market institutions and innovation in 177 European regions over the period 2000–2015.

• The impact of labor market institutions (LMIs) on regional patents is studied. • I argue that the supply-side approach is fallacious for Europe. • Stronger wage-setting institutions can foster innovation in Europe. • Wage-setting institutions offset the negative impact of employment protection legislation (EPL) on innovation. • Positive spillover effects are identified between European regions. The main goal of this paper is to investigate the relationship between labor market institutions (LMIs) and patents in 177 NUTS-1 and NUTS-2 European regions. Fixed effects models, ordinary least squares (OLS), the generalized method of moments estimation of the fixed effects (FE-GMM), multilevel modeling (MLM), and spatial models are employed. Patents are negatively correlated with EPL and union density and positively associated with wage bargaining coverage and centralization. As a result, a uniform wage that is higher than the competitive wage can enable the Schumpeterian creative destruction process, forcing firms to invest in innovation to remain in the market. Spatial analysis emphasizes that regional proximity promotes the flow of knowledge and increases the chance of innovation. Interactions also matter. Increased bargaining power and coordination, in particular, may outweigh the negative consequences of isolated EPL reforms. Thus, policies that strengthen wage-setting institutions are required in Europe to boost innovation. [ABSTRACT FROM AUTHOR]