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Tuesday, November 15, 2005

Is High European Unemployment Due to Labor Market Rigidities?

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.

    Posted by on Tuesday, November 15, 2005 at 12:09 AM in Academic Papers, Economics, Unemployment | Permalink  TrackBack (0)  Comments (4)

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