I. ANALYSING UNEMPLOYMENT: A RESEARCH PROGRAM

There are many kinds of unemployment. An average economist should be able to enumerate at least a dozen without forward notice. This embarrassing abundance of definitions gives a clear indication of the trouble we have pinning unemployment down.

Unemployment is generally considered to be an undesirable quantity in a market economy. Although not all of it. Part of it is unavoidable and even considered necessary for an efficient matching of jobs and workers. In this sense one could define —although this would not be easy— an optimal quantity of unemployment taking into account the institutions and stochastics of the labour market. Unemployment under and above this optimum would be inefficient. The next question is: can one avoid too much or too little unemployment through policy measures at reasonable costs? There is no definite answer to that. A lot of heated discussion in macroeconomics focusses on this subject.

Conceptually, unemployment may originate in various types of (temporary) imbalances on the labour market. Five types of origins are broadly to be distinguished (given the real wage level and the volume of labour supply):

Uk: unemployment originating in very short term — seasonal — fluctuations in economic activity;

Ul: unemployment originating in the underutilization of the existing physical production capacity;

Um: unemployment originating in a shortage of new investment, that fails to compensate for the loss of employment due to the ongoing scrapping of older vintages of production capacity. Two dimensions can be distinguished (a) production capacity may increase too slowly and (b) the new capacity may be too capital intensive to guarantee the absorption (utilization) of the (given) labour force;

Un: unemployment due to labour market imperfections leading to real mismatches of supply and demand. Market imperfections, in turn, originate in the behavioural reactions of workers and employers to incomplete information and in the fact that adjustments are seldom immediate and necessarily take time (see de Neubourg 1985a for details);

INTRODUCTION

Until 1975, unemployment in the UK had remained below the 1 million mark for over 30 years. Between 1979 and 1982 it rose from under 1.5 million to over 3 million and has remained there ever since. The 1980s have certainly been a disaster as far as unemployment is concerned and a question of paramount importance to policymakers is whether the government can do anything to reduce unemployment significantly in the foreseeable future. The answer to this question depends on the causes of unemployment and whether these causes can be affected by government action. Unfortunately, the causes of current unemployment are not clearly understood and there is a startling lack of consensus amongst policymakers and their economic advisers over what can (or should) be done to tackle the unemployment problem.

One of the issues about which there is substantial disagreement amongst economists is whether unemployment is currently high because of a deficiency in the aggregate demand for goods, or whether it is high for other reasons. These other reasons include : the existence of disincentives to take jobs because unemployment benefit is too high relative to net takehome pay ; a serious mismatch between labour demand and labour supply ; excessively high real wages relative to labour productivity; the sudden structural collapse of large sections of UK manufacturing industry; and a combination of these factors.

1. INTRODUCTION

Observing wage formation, at least in Norway during recent years, you cannot miss the unions increased emphasis on relative wages in the wage negotiations. This focus might be motivated by tactical reasons. Relatively decreasing wages is often a good argument, at least as far as support from the public opinion is concerned. On the other hand, people’s appreciation of their situation (here wages) does often depends on the situation of “groups with which we naturally compare ourselves”.

The economics of trade unions is a rapidly expanding area. Oswald (1985) and Pencavel (1985) have given surveys of the last years’ literature. So far, little attention has been paid to the existence of different sectors and trade unions in the economy. A multisectoral framework may imply interdependence between the wage claims of the different unions. When the unions care about relative wages, there will be implications for the wage formation process. In an economy with more than one union there might exist links between wage claims of different trade unions. There are roughly three main ways in which the interdependence takes place. First, the wage claims of one union may affect the demand for workers who are members of the other unions.

1. INTRODUCTION

Like in most European countries, unemployment in Holland has increased considerably in the past ten, fifteen years. This phenomenon is of major concern and warrants explanation. This paper sets out to explain employment and unemployment in a small open economy with powerful trade unions. It provides a framework in which various essential features of a small open economy, like Holland, are imbedded. World trade is a dominating factor on the demand side, whereas unions and long-run labour supply are dominating factors on the supply side. The various instruments the government has available (tax rates, levels of benefits, investment subsidies, public sector expenditure and employment) affect both sides of the economy. The investment behaviour of firms is an important link between present and future.

The formal framework developed in this paper consists of a model with a well developed supply side and a demand side. The supply side is built around rums engaged in monopolistic competition. This provides a role for demand. The firms take the wage rates and aggregate demand as given when deciding on their labour demand and investment decisions.

SECTION 1 : INTRODUCTION

An endemically high rate of unemployment has always been one of the most pressing problems facing policy makers in Ireland. Since 1980 the unemployment rate has risen inexorably, as illustrated in Figure 1. Furthermore, on the basis of the most recent medium-term projections to 1990 (Bacon (1986)), the unemployment rate is set to continue to rise, albeit at a much slower rate, to over 18 per cent of the labour force. This more recent rise in unemployment is, of course, a phenomenon not confined to Ireland, but shared, in one form or another, by many other European economies.

All political groups in Ireland place great emphasis on their policies to alleviate unemployment. The extent of direct state intervention in the Irish labour market can be seen clearly from Figure 2. Employment in the sheltered marketed services sector grew over the period 1973-83 by 18.4 percent (56900), while employment in the non-market sector (public administration and other non-marketed services) grew by 40.2 percent (68700). While industrial employment remained relatively stagnant, displaying cyclical highs in 1974 and 1980, agricultural employment declined steadily. Over the same period, the labour force grew by 17.7 percent (196900) and migration abroad, having declined from a net outflow of about 60000 per annum in 1959 to a zero net flow by 1970, became a net inflow during the years of 1973-78, but has returned to a net outflow since 1983 (Figure 3).

I. INTRODUCTION

Unemployment in Europe has risen during the 70s and early 80s to double digit rates, rates which are not considered likely to fall much in the remaining years of the 80s. This is so in enough countries to encourage some to speak of a ‘European disease’. Those of us who live in Britain have long been familiar with the ‘British disease’, as have the Dutch with their ‘Dutch disease’ (supposedly related to North Sea energy resources). This paper suggests that these earlier national ailments are precursors of the general European one to which attention has more recently been drawn — notably by Professor Giersch who has spoken of a ‘market sclerosis’ in Europe, especially in the labour market (Giersch, 1985). (Also see OECD (1985, p. 38)).

However, in spite of this provocative general opening we wish to focus in this paper on West Germany, and thus to highlight a specific case of what may well be a general phenomenon. Our motivation is fourfold: to widen the analysis of the possible disease to a country in which there is wide interest; to stimulate other European researchers to work along the lines of analysis portrayed here; to follow up the echoes sounded in the comments of authoritative national students (e.g. Giersch, op. cit., and de Grauwe, Fratianni and Nabli, 1985), and finally, to utilize a full macroeconomic model of the Federal Replublic of Germany in this direction of research.

This paper represents an attempt to construct a simple classical model of the aggregate labour market from which it is nevertheless possible to draw certain Keynesian conclusions about the desirability of intervention, in the form of a conventional counter-cyclical fiscal policy, in order to maintain full employment. The starting point of the paper is the observation, based on recent studies of the simulation properties of two macroeconomic models of the United Kingdom, (Brooks et al [1983], Peterson [1984]), that it appears to be possible to devise policies which start from current levels of output, employment and inflation and which represent an unambiguous improvement in all welfare indicators. Such policies have become known as «free lunches», apparently after the habit of 19th century American barkeepers in providing their customers with free, but thirst provoking, food in order to stimulate sales of drink : similar incentives are offered by Nevada casino proprietors. In these contexts the catch is obvious, but in the case of expansionary macroeconomic policies there is scope for more controversy.

INTRODUCTION

With an election year in France and in the Netherlands, a national collective convention in Belgium and high unemployment rates in most European countries, an economic reflection on the effectiveness and efficiency of the pursued job creation policies is certainly meaningful.

The main purpose of the job creation policies, as conceived in most European countries, is the promotion of an effective and fair fine tuning of supply and demand of labor.

The instruments traditionally used, can be divided into five categories, namely :

1. Wage-cost subsidies

2. Educational and vocational measures

3. Direct job creation measures

4. Reduction of labor supply

5. Promotion of entrepreneurship.