The Latest Word on High European Unemployment

Olivier Blanchard's latest on European unemployment:

Olivier Blanchard (2005), European Unemployment: The Evolution of Facts and Ideas (Cambridge: NBER Working Paper No. 11750): Abstract: In the 1970s, European unemployment started increasing. It increased further in the 1980s, to reach a plateau in the 1990s. It is still high today, although the average unemployment rate hides a high degree of heterogeneity across countries. The focus of researchers and policy makers was initially on the role of shocks. As unemployment remained high, the focus has progressively shifted to institutions. This paper reviews the interaction of facts and theories, and gives a tentative assessment of what we know and what we still do not know.

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6 Do We Know Enough to Give Advice?

At the end of this tour, one may ask whether we know enough to give advice to policy makers about how to reduce unemployment. I believe we do—-with the proper degree of humility. In this last section, I summarize what I think we know and we do not know.

6.1 A General Story Line

Going back over the last thirty years, there is little question that the initial increase in unemployment in Europe was primarily due to adverse and largely common shocks, from oil price increases to the slowdown in productivity growth. There is not much question that different institutions led to di®erent initial outcomes. Whether collective bargaining led to a decrease in the growth of bargained wages, whether inflation could be used to reduce real wage growth, all played a central role in determining the size of the increase in unemployment.... [T]he increase in unemployment led, in most countries, to changes in institutions as most governments tried to limit the increase in unemployment through employment protection, and to reduce the pain of unemployment through more generous unemployment insurance.... [S]ince the early 1980s, because of financial pressure and intellectual arguments, most governments have partly reversed the initial change in institutions. But this reversal has been partial, and sometimes perverse. The different paths chosen may well explain the differences in unemployment rates across European countries today.... The role of shocks and the interaction with collective bargaining emphasized by initial theories, the role of capital accumulation and insider effects emphasized by the theories focusing on persistence, the role of specific institutions clarified by flow-bargaining models, all explain important aspects of the evolution of European unemployment.

6.2 Which Institutions?

It is one thing to say that labor market institutions matter, and another to know exactly which ones and how. Humility is needed here, and there is no better reminder than the comparison between Portugal and Spain. Both experienced revolutions and wage explosions in the 1970s (the Portuguese labor share reached 100% in the mid 1970s...); both have, at least on the surface, rather similar institutions, including high employment protection. Yet, Spanish unemployment has been very high, exceeding 20% in the mid–1990s, whereas Portuguese unemployment has remained low, with a high of 8.6% in the mid–1980s, and a decrease thereafter.... [T]he history of the last thirty years is a series of love affairs with sometimes sad endings, first with Germany and German–like institutions—-until unemployment started increasing there in the 1990s... -—then with the United Kingdom and the Thatcher–Blair reforms, then with Ireland and the Netherlands and the role of national agreements, and now with the Scandinavian countries, especially Denmark, and its concept of “flexisecurity”....

We know much more about the incentive aspects of unemployment insurance on search intensity and unemployment duration, be it the length and time shape of unemployment benefits, or the form of conditionality or training programs.... We know more about the effects of decreasing social contributions on low wages.... We know more about the effects of employment protection, and the effects on the labor market of introducing temporary contracts at the margin while keeping employment protection the same for most workers.... [A] large consensus-—right or wrong—-has emerged: It holds that modern economies need to constantly reallocate resources, including labor, from old to new products, from bad to good firms. At the same time, workers value security and insurance against major adverse professional events, job loss in particular. While there is a trade-of between efficiency and insurance, the experience of the successful European countries suggests it need not be very steep. What is important in essence is to protect workers, not jobs. This means providing unemployment insurance, generous in level, but conditional on the willingness of the unemployed to train for and accept jobs if available. This means employment protection, but in the form of financial costs to firms to make them internalize the social costs of unemployment, including unemployment insurance, rather than through a complex administrative and judicial process. This means dealing with the need to decrease the cost of low skilled labor through lower social contributions paid by firms at the low wage end, and the need to make work attractive to low skill workers through a negative income tax rather than a minimum wage.

These measures are probably all desirable. If they were to be implemented, would they be enough to eliminate the European problem? I see at least two reasons to worry.

6.3 Collective Bargaining and Trust

The first worry is that these reforms deal only with a subset of the institutions that govern the labor market. An early theme of the research on European unemployment was the importance of collective bargaining. And it is a fact that some of the successful countries, the Scandinavian countries in particular, have very different structures of collective bargaining from, say, France or Italy, with much more of an emphasis on national, trilateral, discussions and negotiations between unions, business representatives, and the state.

This raises two questions. First whether countries such as France or Italy need to also modify the structure of collective bargaining. Second whether, even if they did, the results would be the same as in Sweden or Denmark.... [V]arious measures of trust, from strike intensity in the 1960s to survey measures of trust between firms and workers, [can] explain a substantial fraction of differences in unemployment across European countries. Even if these findings reflect causality from lack of trust to unemployment, it is just a start. The question is whether trust can be created....

6.4 Low Inflation, the Natural and the Actual Rate of Unemployment

Since 2000, European unemployment has been associated with roughly constant inflation. This would suggest that the current high unemployment rate reflects a high natural unemployment rate, rather than a large deviation of the actual unemployment rate above the natural rate. This is indeed the assumption which justifies the focus on inflation by the European Central Bank: Maintaining constant inflation is then equivalent to maintaining unemployment close to its natural rate; this natural rate can only be reduced by labor market reforms, and this is not the responsability of the central bank.

One may however question this assumption. Inflation in the EU15 is now running under 2%, and close to 0% in countries such as Germany. At these low inflation rates, it is not implausible that nominal rigidities matter more, that workers for example are reluctant to accept nominal wage cuts—-a hypothesis explored, for example, by Akerlof et al (1996). In such an environment, it may be that an unemployment rate above the natural rate may lead to low rather than declining inflation. Put another way, it may be that, in fact, an expansion of demand might decrease unemployment without leading to steadily higher inflation. The experience of Spain, where unemployment has steadily decreased without major labor market reforms and without an increase in inflation, can be read in this light.

Another, conceptually different, argument for a more expansionary monetary policy, is that institutional reforms encounter less opposition when economies are growing and unemployment is decreasing.... This argument is an old one (Blanchard et al (1985) already argued for such a “two-handed” approach in Europe) but is still relevant today. One issue however is whether, in fact, growth and the decrease in unemployment do not alleviate the political need for reform, and thus delay rather than encourage reforms. The experience of the late 1990s in Europe, where a cyclical expansion often delayed reforms, is not reassuring in that respect. Developing this last point would take us to the political economy of labor market reform, and this should be the topic of another survey.

Comments

[liberal]

"6 Do We Know Enough to Give Advice?"

Probably not, if "increase taxes on land, and decrease taxes on labor, capital, and consumption" isn't part of the advice.

[anne]

The unemployment difference between Spain and Portugal is intriguing, the cause not at all clear. Curiously the Spanish housing boom has had less of an employment effect than I would have expected, though I would much like to find a sustained housing expansion in Germany. Also, as background, the Spanish stock market has been far more robust than Portugal's for more than a decade. Spanish financial companies by the way are increasingly significant not just in South America but in Europe.

[anne]

Though I do not properly understand what is happening in France, along with European unemployment there obviously needs to be a questioning of the extent of social and economic isolation or alienation of population groups. What is happening is France must be carefully considered from differing sociological perspectives.

What is ethnicity in Europe, what is class in Europe, how are immigrant households faring, adults and children, what does integration in Europe mean? I have the sense that there is a general satisfaction with life in Europe beyond economist's worries. Who then is satisfied? Who not, and why more precisely?

[anne]

What of the integration of African immigrants in Spain and Portugal? Is integration more significant for adults and children? Is there similar tension as in France, as in the Netherlands? What of Spanish unemployment and immigrant communities? Even if there are reasonably common unemployment levels among different ethnic groups in France or in Spain, is the employment at all comparable? Questions I wish to have answered.

Statistics with an ethnic breakdown for France are difficult to come by. For the French ethnicity is of no account, citizenship everything, still, is this mythology?

[A. Zarkov]

One of my friends works for a software consulting company with a number of international offices. This company decided to close its Paris office, but they had made a job offer to someone before the decision. In France you can terminate an employee for any reason during the first six months of employment. After that, it’s virtually impossible to fire anyone. Their lawyer advised the company to withdraw the offer. The applicant sued and won a year’s pay. They might have been better off letting him work one day and then laying him off. I’m not surprised jobs are hard to come by in France. An employer makes a big commitment.

[Pancho Villa]

The Latest Word on High European Unemployment...is complexity: i.e. 'The state of being complex; intricacy; entanglement.'

[derrida derider]

"most governments tried to limit the increase in unemployment through employment protection, and to reduce the pain of unemployment through more generous unemployment insurance"

And this absolutely bedevilled the econometrics of these issues. I spent a lot of the mid 1990s pointing out to anyone who would listen that all those time series studies got the causality wrong when they claimed high European unemployment was due to an expansion of the welfare state. The (highly influential) 1994 OECD Jobs Study was a particularly bad offender here.

Yeah, unfortunately nature is often messy - moocausal explanations of the malaise in european labour markets are just wrong.

[derrida derider]

Oh, and BTW Blanchard's paper is a great discussion of the issues for non-specialists - make time for it if you want to get a feel for both Europe's malaise and for where labour economics is at.

[typekey pseudonym]

Not having read Blanchard's whole paper, I cannot say that this is the best line, but it's snarkiness suggests it must be pretty close:

Let me start with two caveats. I have not tried to be encyclopedic. And, because the editors unwisely encouraged me to do so, I have certainly focused too much on my own research -- one of the results being a Stiglitz-like bibliography.

[Isabel]

Anne, maybe you can get some information in this paper:

Structural Unemployment: Spain versus Portugal
Olivier Blanchard, Juan F. Jimeno
American Economic Review, Vol. 85, No. 2, Papers and Proceedings of the Hundredth and Seventh Annual Meeting of the American Economic Association Washington, DC, January 6-8, 1995 (May, 1995) , pp. 212-218

Maybe you can find it online or have access to it in any other way and then tell us something about it? I, for one, would be very grateful, because I'm intrigued, too.

About immigration, all I know, anectodically, is that it's very different in Portugal and Spain. Portugal has a fairly large African immigration from the ex-colonies (mostly legal, I think) and, more recently, of Eastern European countries (Ukrania, Moldova, Romania), both legal and ilegal. Spain has immigration from the latin american countries (Portugal also has some from Brasil), and North African immigration (much of it ilegal) to the labor intensive agriculture in the south, with a lot of arrowing stories similar to the US-Mexican border, or even worse because they include lots of capsized boats and drownings. It is probably possible to find official statistics on nationality, at least in respect to legal immigration, but certainly not on ethnicity (or religion!).

Incidentally, Olivier Blanchard has another article comparing the labor market in Portugal and the US, that have very similar unemployment rates with a very different structure, apparently. By the way, I've always heard that the comparisons between the US and most European countries are not correct because they are comparing two very different definitons of employment. With the more comparable parameter, the US unemployment rate would be roughly double or the European one cut in half. Is that true, Anne?

[wkwillis]

European unemployment is not a problem. European unemployment is a policy.
Now the interesting thing is if the Sarkozy types in France win their arguments about the way to handle the high unemployment rates among immigrant's children.
Deporting the illegals and limiting legal immigration will be costly to France in general, but very beneficial to the immigrant's children who are rioting now. Doubling their wages and decreasing the price of housing will cause major changes in their cost/benefit ratios for education and employment.
Now if only they got rid of welfare in favor of workfare so the young men could get married...But even Sarkozy can't do something that radical.

[anne]

Thanks Isabel, I am reading and thinking through differences in employment structure in Spain and Portugal. Spanish levels of inflation were considerably higher than Portugese levels earlu in the 1990s, and Spain adopted austerity programs to limit inflation at the cost of higher unemployment. But, why the lingering unemployment difference with Portugal? Can a decade of lower interest rates in Portugal have explained the remaining difference?

As you point our most European countries have far stricter official definitions of unemployment than America, so our levels and lengths of unemployment would be considerably higher were we to adopt a French or German or Danish definition.

[VJ]

I haven't looked at it lately, but as of a couple years ago, if the U.S. calculated unemployment in the same manner as Europe does (the "augmented" jobless rate), the Unemployment Rates would not be all that different.

[meno]

hmmm.

Here in New Zealand unemployment has hit a record low of 3.8%. I think that's the lowest in the OECD.

Our GDP growth has run at approx 4% for the last 5 years, we've got inflation creeping up from 2% towards the top of our Reserve Bank's desired band at just over 3%, and our govt's been running a surplus for the last decade. Meanwhile our interest rates are the highest in the Western world and I'm damned if I can figure out why.

We have high 'european' taxes by US standards, a fully functional social welfare system included good unemployment insurance, etc, etc.

It's very also hard to fire a worker here unless you've strong evidence they've done Very Bad Things.

So I'm unsympathetic to claims that these things undermine high employment (or high economic growth).

[But, unlike France, it's very easy to make people redundant here if their position really has gone away (not just been renamed). Which means businesses can take a punt on hiring a few more employees, and shrink back down if necessary]

[scottynx]

Meno writes:
[We have high 'european' taxes by US standards, a fully functional social welfare system included good unemployment insurance, etc, etc.

It's very also hard to fire a worker here unless you've strong evidence they've done Very Bad Things.

So I'm unsympathetic to claims that these things undermine high employment (or high economic growth).]

Meno, unlike France, in the very recent past New Zealand undertook some very important economic reforms. This may help explain New Zealand's superior economic performance

[...in 1990, the right-of-center National government took up the reform baton with steep cuts in welfare programs and the most radical shake-up of labor law outside Margaret Thatcher’s Britain.]

and..

[The economic impact of the Douglas/Richardson reforms was far-reaching. Government subsidies to industry and agriculture fell from 16 percent of government spending to just 4 percent. This was achieved especially through the drastic reduction of farm subsidies, which fell from NZ$1.2 billion (about $670 million U.S. at current exchange rates) in 1983 to NZ$206 million (about $115 million U.S. ) in 1990. New Zealand remains the only developed country to have scrapped farm support, a political achievement all the greater given that agriculture is New Zealand’s largest sector. The move also revealed the malign economics of farm welfare and the benefits of injecting market economics into agriculture. Since abolition, agriculture has increased its share of New Zealand GDP, and total factor productivity growth (labor and capital) averaged 6.3 percent a year for the first nine years of the reforms.2

Tax reform gave New Zealand one of the flattest tax structures in the developed world. The top rate of income tax was halved from 66 percent to 33 percent. Tight control of government spending under Ruth Richardson reduced government spending (excluding debt service), which had peaked at just under 40 percent of GDP, to 35 percent — and trending down to 30 percent if the reform momentum had been maintained. Together with higher growth, the liberalization of the labor market and welfare reform to encourage active job-seeking by the unemployed resulted in rapid job creation. Minority groups particularly benefited from the improved performance of the labor market. Unemployment among the indigenous Maori and Pacific Island people dropped by 10 percentage points. In 1995, Maori had an employment growth rate double that of non-Maori.]
Market Reform: Lessons from New Zealand
by Rupert Darwell
http://www.policyreview.org/apr03/darwall.html

[Sandwichman]

"if the U.S. calculated unemployment in the same manner as Europe does... the Unemployment Rates would not be all that different."

Not exactly. Very little difference in the unemployment rates is due to different methodology of collecting and reporting statistics. The real difference between Europe and US lies in what those statistics mean. There is virtually no relationship between the unemployment rates and an index of labor market well-being that also includes such things as disposable income, human capital investment, income inequality, job insecurity. Unemployed Europeans are better off than many employed Americans.

[anne]

Meno and Scotty Nx,

The sketches of New Zealand's economy were quite valuable, and I certainly hope you will often refer back to New Zealand. More international comparison will be useful.

[anne]

Sandwichman,

Agreed, in part. Benefits for the unemployed through the European Union countries are more supportive than here, but the calculation of unemployment rates varies by country and in countries such as France and Germany the definition of unemployment is more strict than here.

[James Galbraith]

For a paper that Olivier Blanchard does not cite, consider this effort by Enrique Garcilazo and myself, published in the Banca Nazionale del Lavoro Quarterly Review in 2004. Using a new data set, we completely undercut arguments linking European unemployment to the national labor market institutions of large countries.

To get the paper, click on the link at my name below.

Title: Inequality, Unemployment and the Policy of Europe, 1984-2000

Abstract:

This paper reconsiders the problem of unemployment in Europe at multiple geographic levels and through time from 1984 to 2000. We employ a panel structure that permits us to separate regional, national and continental influences on European unemployment. Important local effects include the economic growth rate, relative wealth or poverty, and the proportion of young people in the labor force. As part of this analysis, we assess the relationship between pay inequality and unemployment in Europe, following the insight of Harris and Todaro (1970) that pay inequalities influence job search. With our own panel of inequality measures derived from Eurostat’s REGIO data set, we find that higher pay inequality in Europe is associated with more, not less, unemployment, and the effect is stronger for women and young workers. There are modest country fixed effects for the UK and Spain, but large effects are found only for small countries. These are all negative, a fact that may be due partly to large past emigration in some cases, and partly to strategic wage bargaining in others. Apart from this, distinctive effects at the national level are few, perhaps indicating that national labor market institutions are not the decisive factor in the determination of European unemployment. Changes in the European macro-environment are picked up by time fixed effects, and these show a striking pan-European rise in unemployment immediately following the introduction of the Maastricht Treaty, though with some encouraging recovery late in the decade.

[anne]

Excellent, you are a gem. This paper is just what was wanted. And, and, and I dearly love your parents :)

[Gar Lipow]

Just as an alternative explanation: Europe has also had a "tight" money policy - high interest rates compared to U.S. How sure are you that that has nothing to do with higher unemployement there?

[anne]

Gar

Agreed; I have long argued that the Euro bank has kept short term interest rates needlessly high. Worrying about a real estate boom in Ireland or Spain, at the expense of Germany, when inflation is well controlled and there is certainly slack in the labor market makes slight sense. An experiment with lower rates long seemed warranted.

[anne]

http://economistsview.typepad.com/economistsview/2005/11/is_high_europea.html#comment-11222671

November 15, 2005

Is High European Unemployment Due to Labor Market Rigidities?
By Mark Thoma

Recently, a paper by Olivier Blanchard on European Unemployment was posted here and at Brad DeLong's. This paper by James K. Galbraith and Enrique Garcilazo, which arrived through comments (thanks anne) provides countervailing evidence to the claim that high and persistent unemployment rates in Europe are the result of labor market rigidities arising from policies at the national level. Instead, the paper finds that a large amount of the excess unemployment in Europe can be explained by changes common across countries since the Union such as the policies of the European Central Bank and the convergence criteria for the Euro:

Unemployment, Inequality and the Policy of Europe: 1984-2000, by James K. Galbraith and Enrique Garcilazo, UTIP WP 25: Abstract: This paper reconsiders the problem of unemployment in Europe ... We employ a panel structure that permits us to separate regional, national and continental influences on European unemployment. Important local effects include the economic growth rate, relative wealth or poverty, and the proportion of young people in the labor force. ... [W]e find that higher pay inequality in Europe is associated with more, not less, unemployment, and the effect is stronger for women and young workers. ... [D]istinctive effects at the national level are few, perhaps indicating that national labor market institutions are not the decisive factor in the determination of European unemployment. Changes in the European macro-environment are picked up by time fixed effects, and these show a striking pan-European rise in unemployment immediately following the introduction of the Maastricht Treaty, though with some encouraging recovery late in the decade.

I. Introduction ...[T]he literature on unemployment in Europe tends to concentrate on national characteristics and national unemployment rates. The predisposition is to blame unemployment on labor market “rigidities” -- and then to search for particular culprits, generally in the fields of national unemployment insurance, job protections, and wage compression. Periodic movements to reform national labor markets sweep aside the careful qualifications found in empirical work such as Nickell (1997) and Blanchard and Wolfers (1999), and presuppose that greater wage flexibility is the established cure for European unemployment. ... In a recent paper, Baker, Glyn, Howell and Schmitt (2002) provide a comprehensive review of the national-institutions approach to explaining European unemployment. They find only one robust result, namely that coordinated collective bargaining and (perhaps) union density are associated with less unemployment in Europe. Of course, this interesting finding is inconsistent with the rigidities framework. ...

In this paper, we try a different approach. Instead of the nation, our smallest unit of analysis is the region. ... We specify just four regional “labor market” variables that, we find, account significantly for the variation in regional unemployment rates. ... We identify two regional factors that influence the demand for labor. First is the strength of economic growth at any given time – an obvious determinant of construction and investment jobs, and a consequence of the local effects of macroeconomic policies and regional fiscal assistance. The second is a measure ... of the average wage rate of the region relative to the average for Europe as a whole. Our thinking is that regions with higher average wages should tend to have stronger tax bases, more public employment, and also more open (and therefore taxed) employment in services. On the supply side, we also identify two factors. The first is the relative size of the population of very young workers – an obvious measure of the difficult-to-employ. The second is a measure of the inequality of the wage structure. To acquire this measure, we construct, for the first time, a panel of European inequalities at the regional level, comparable both across countries and through time.

Our hypothesis that regional pay inequalities should be placed on the supply side of the labor market is an innovation. ... [I]n this analysis we take the regional wage structure as a datum facing individual workers. We consider that this datum affects how long they choose to search for employment. The greater the differential between high and low-paid jobs in the local setting, the longer a rational person will hold out for one of the better jobs, accepting unemployment if necessary. This theoretical position is well-known in neoclassical development economics, ... The general concept, that inequality creates an incentive to search, has not been applied to Europe or to any developed-country setting so far as we know. But there is no compelling reason why it should not be. In practice, we find that pay inequality is a strong determinant especially of cross-sectional variation in European unemployment, ...

The time effects are striking for all population groups. They show a sharp rise in unemployment common to all regions beginning in 1993. This is an interesting break-point in view of the introduction of the Maastricht Treaty on European Union at the start of that year. The effect continues through the 1990s, and suggests that a substantial part of European excess unemployment – generally between two and three percentage points–reflects policy conducted at the European level since the Union. In this regard, the monetary policy of the European Central Bank and the convergence criteria for the Euro come to mind as leading suspects.

[anne]

James Galbraith is a gem, and this paper deserves to be far more broadly considered. I do think often of the Galbraiths :) Europe needs to further emphasize education, though the subsidies are superb, and at least experiment with the employment effect of lower interest rates. But, the finding of Galbraith and Garcilazo are thoroughly intriguing and almost certainly would be further supported in New Zealand and likely Australia.

[anne]

Galbraith's work becomes especially compelling when looking at the extent to which New Zealand was able to address and sharply lower unemployment as it expressly addressed the lack of integration of the Maori. Compare this with relative integration of Africans in Portugal as compared to Spain or France. Then too, there was East Germany which was a signal problem for Germany and as such for the European Union.

[anne]

What is remarkable about Galbraith's research is the extent to which thought to labor is given in framing questions as opposed to the overwhelming thought to companies otherwise given. As such the research can be interestingly revealing.

[Fred]

Can anyone comment on the effect on relative unemployment rates of the disproportionately large prison population in the United States vis a vis Europe?