An alternative view

”European unemployment: the evolution of facts and ideas”

Olivier BlanchardEconomic Policy 21 (45):5-59

Policy advice

Placing theory in context

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”

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

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”

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

Policy advice