Evolution of European Unemployment: A Policy Analysis

1. An alternative view ”European unemployment: theevolutionof facts and ideas” Olivier Blanchard Economic Policy 21 (45):5-59

5. Placing theory in context Policy advice

6. Policy advice • Balanced growth path: The ”warranted wage” gives natural rate of unemployment • Follows technological progress • Falls (to maintain zero net profit for firms) if non-labor input prices rise • Three sources of shocks: • Oil prices (real price almost tripled from 1970-80) • Total factor productivity growth rates (more than halved) • Labour unrest • ”The increase in unemployment was explained by adverse shocks interacting with country-specific collective bargaining structures”

8. Policy advice • First half: Contractionary anti-inflationary policies gave (”temporarily”) increase in unemployment • Second half: Stable inflation buth higher unemployment, increased natural rate? • Theoretical explanations of persistence: • Capital accumulation – excessive wages -> lower employment -> lower profit rate (below user cost of capital) -> lower capital investments-> further decrease in employment. This mechanism is strengthened by contractionary policy, as nominal rigidity becomes more important to wages and real interest rates rise • Collective bargaining (insider outsider): Unemployed (especially long-term) less effective in exerting downward wage pressure than employed are in exerting upward pressure

9. Policy advice • European countries start diverging more • Still high in France, Spain, Italy • Falling in UK, Ireland, Beligium • Increasing in Germany • Still low in Austria, Norway, Portugal – with temporary upswings in Sweden and Denmark • Theory needed to account for differences: • Matching models led to new analysis of institutions, e.g.: • Employment protection reduces layoffs, strengthens workers->higher wages->longer unemployment, all in all: lower flows and higher duration, ambiguous effect on unemployment, but longer duration • Empirical work: • Differences in institutions seemed able to explain cross-country differences • Changes in institutions did not appear able to explain changes in unemployment • ”In panel data regressions of unemployment rates on institutions across 20 countries since 1960, and allowing for country and time dummies, none of the labour market institutions appeared significant”

10. Policy advice • 3 directions: • Other shocks, institutions, interactions • Example: More turbulent, globalized economy hits institutions better suited to the ”old world” • Closer look at institutions • France: Shocks believed to be temporary in 1970s led to higher unemployment insurance and better employment protection. Reversed in 80s, but in a new direction with establishment of dual labor market • ”One of the reasons why the shocks of the 1970s and 1980s have led to high unemployment in some European countries today is that they triggered a change in institutions which has been partly and poorly undone in these countries.” • Employment, capital, wages, interest rates • The theories discussed also have implications for a broader set of economic indicators

12. Policy advice