Given that every sensible analysis of an economy is based upon a coherent and self-contained theory, it is surprising how rarely the predictive powers of macroeconomic theories are explored before the theories are used as the basis for policy formulation. The reasoning is, if policy is based upon theory and the theory proves to be appropriate, policy must also be appropriate. In Discussion Paper No. 1081, Programme Director Dennis Snower assesses the significance of four unemployment policy approaches by examining the ability of their underlying theories to predict five well-known stylized facts. The approaches are: a) the laissez-faire policy stance, based on neoclassical theories of voluntary unemployment (natural rate theory); b) demand management policies, resting upon Keynesian views; c) supply side policies to raise labour productivity; and d) structural policies based upon institutional and contractual concepts.

The stylized facts use to test the predictions of these theories are: 1) unemployment rates usually display a high degree of serial correlation; 2) unemployment durations are longer in Europe than in the US; 3) US labour and product market activity levels move more in tandem than European levels; 4) European variations of unemployment rates are more pronounced across than within business cycles - this is much less significant for the US and Japan; and 5) in the mid-1970s, European average unemployment rates overtook US rates. Snower admits that his criterion is highly simplistic because unemployment arises from several different causes operating simultaneously. Nevertheless, he maintains that his paper can be a useful preliminary guide to the potential significance of unemployment policies.

Evaluating Unemployment Theories: What do the Underlying Theories Tell Us
Dennis J Snower

Discussion Paper No. 1081, December 1994 (HR)