Blanchard: "European Unemployment: The Evolution of Facts and Ideas"

This is a timely paper on unemployment in Europe that, with the appropriate degree of humility, asks what we do and don't know about persistently high average unemployment rates in Europe:

European Unemployment: The Evolution of Facts and Ideas, by Olivier Blanchard, NBER WP 11750, November 2005: 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. [free September Version] [free October version] See also "Explaining European Unemployment."

The paper is worth reading for more than this particular point, but given the increasing job insecurity arising from globalization and other forces, I want to highlight an important distinction Blanchard makes between protecting jobs and protecting workers:

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. ...

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 different initial outcomes. ... There is not much question, ... that the increase in unemployment led... most countries.. to changes in institutions... to limit the increase in unemployment through employment protection, and to reduce the pain of unemployment through more generous unemployment insurance. There is not much question that, since the early 1980s... 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. ...

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 ... 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. Many researchers, including myself, have tried to trace the differences to differences in shocks or institutions ... I am not sure that our explanations are much more than ex-post rationalizations. ... Nevertheless, even if one cannot pretend to have much confidence about the optimal overall architecture, much has been learned ... We know much more about the incentive aspects of unemployment insurance on search intensity and unemployment duration... We know more about the effects of decreasing social contributions on low wages ... We know more about the effects of employment protection, ... From both the macro evidence and this body of micro–economic work, 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-off 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.

This consensus underlies most recent reforms or reform proposals ... These measures are probably all desirable. If they were to be implemented, would they be enough to eliminate the European problem? I see ... reasons to worry. ... these reforms deal only with a subset of the institutions that govern the labor market. ...