Explaining The Rise In Unemployment In Europe Since The 1960s

A large part of the dramatic rise in unemployment in the big continental European countries since the 1960s can be explained by changes in the key labour market institutions – changes in unemployment benefit systems, increases in labour taxes, increased power of trade unions and changes in employment protection law. That is the central conclusion of a study by Professor Stephen Nickell, Dr Luca Nunziata and Wolfgang Ochel, published in the Economic Journal.

It is widely accepted that labour market rigidities are an important part of the explanation for the high levels of unemployment that are still to be found in a number of OECD countries. But acceptance is not universal. One often cited argument is that labour market rigidities cannot explain why European unemployment is so much higher than US unemployment because the institutions generating these rigidities were much the same in the 1960s as they are today and in the 1960s, unemployment was much higher in the United States than in Europe.

What are the facts? It is indeed correct that US unemployment was much higher than European unemployment in the 1960s. The picture today, however, is less clear-cut than is commonly thought. For example, in 2003, the majority of European countries (excluding those of Eastern Europe) had unemployment rates that were lower than the rate in the United States. Only the big four continental European economies – France, Germany, Italy and Spain – plus Belgium and Finland had high unemployment rates. What of the argument that the European institutions generating labour market rigidities have been more or less unchanged since the 1960s? In fact, the evidence of this research makes clear that this is simply not true.

The purpose of this study is to defend the proposition that the dramatic long-term shifts in unemployment in the OECD countries since the 1960s can be explained simply by changes in labour market institutions. The institutions concerned are the usual suspects, namely the structure of the benefit system, trade unions, labour taxes and employment protection. An alternative hypothesis is that unemployment patterns cannot be explained in this way but can be explained by the interaction between relatively stable institutions and ''shocks'', the latter being exogenous shifts in the macroeconomic environment. The idea here is that shocks drive unemployment but the scale of the unemployment consequences of any particular shock depends on the institutional structure of the economy. This sounds plausible, but to explain secular shifts in unemployment over 30-year periods, the ''shocks'' would have to last an extraordinarily long time.

Professor Nickell and his colleagues find that long-term movements in unemployment across the OECD can be explained by shifts in labour market institutions. To be more precise, changes in labour market institutions explain the majority of the rise in unemployment in European countries from the 1960s to the first half of the 1990s, the remainder being due to the deep recession ruling in the latter period.

According to the estimates in this study, of the rise in unemployment generated by institutions, around 39% is due to changes in unemployment benefit systems, 26% to increases in labour taxes, 19% to increased power of trade unions and 16% to changes in employment protection law. These are averages across the countries of Europe. There are, of course, great variations across the different countries. But interactions between average values of institutions and shocks make no significant additional contribution to the understanding of OECD unemployment changes.

''Unemployment in the OECD since the 1960s: What do we know?'' by Stephen Nickell, Luca Nunziata and Wolfgang Ochel is published in the January 2005 issue of the Economic Journal. Nickell is Professor of Economics at London School of Economics, a member of the Bank of England''s Monetary Policy Committee and former President of the Royal Economic Society; Nunziata is a research fellow at Nuffield College, Oxford; Ochel is at the Ifo Institute for Economic Research at the University of Munich