Differences In Unemployment Benefits Explain The Contrast Between European Unemployment And American Wage Inequality And Poverty

Continental European labour markets have experienced a large rise in unemployment over the past quarter of a century while the United States and, to a lesser extent, the UK have seen a significant increase in wage inequality and poverty. Writing in the latest issue of the Economic JournalRamon Marimon and Fabrizio Zilibotti explain that these two phenomena are deeply interlinked and originate from the same change in the world economic environment. They attribute the different responses of the Anglo-American and continental labour markets to fundamental differences in labour market institutions, particularly in their systems of unemployment insurance.

A central element of these researchers'' theory is that unemployment benefits provide a search subsidy, giving the unemployed time to find not just a job but the ''right job'' – one that is suitable to the characteristics of the searching unemployed worker. Unemployed workers without a safety net might accept unsuitable jobs and form a class of working poor. But when the safety net is too high, workers become too selective, rejecting matches that would have been socially efficient to accept.

Marimon and Zilibotti argue that the nature of technological change in the last twenty years has enhanced the importance of this mechanism. To illustrate their point, they construct a model of two fictitious economies, equal in every way but for the generosity of their unemployment benefits. Initially, the two economies have fairly similar unemployment rates – a situation corresponding to the mid-1970s. Then, the researchers simulate the response of these fictitious economies as they are hit by a common, unexpected technological shock.

Both fictitious economies end up in long-run outcomes resembling those of the US and European economies in the 1990s: the unemployment rate increases sharply in the economy with the more generous unemployment insurance (from 5% to 11%), as does the average duration of unemployment spells; while both indicators remain approximately constant in the other (with unemployment at about 4%). Consistent with the facts, the growth of productivity per worker is much higher in the economy with unemployment benefits. And wage inequality increases in the economy without benefits, whereas it remains practically unchanged in the one with benefits.

On the basis of their results, the researchers question the widespread view that the virtuous performance of the US labour market in keeping unemployment low should indicate unambiguously to European governments the way to fight unemployment. They conclude that there are no easy recipes for returning European unemployment to the levels of the Golden Age of the 1960s without causing other difficult problems.

It might be necessary and advisable to reform the European welfare state, they suggest. But the social cost of the reforms should be carefully understood in order to implement social policies in favour of the losers. Without this awareness, the reforms may encounter strong social resistance, threatening their viability. In these researchers'' simulated economies, for example, it turns out that in the 1970s, a majority of workers would have been opposed to dismantling the unemployment benefits system, even if they could have rationally foreseen that preserving the status quo would have led to increasing unemployment and higher taxes.

''Unemployment versus Mismatch of Talents: Reconsidering Unemployment Benefits'' by Ramon Marimon and Fabrizio Zilibotti is published in the April 1999 issue of the Economic Journal. Both authors are attached to the Universitat Pompeu Fabra; Marimon is based at the European University Institute in Florence; Zilibotti at the Institute for International Economic Studies in Stockholm.