Among EU countries, Spain has the highest and most stubborn unemployment rate, currently at 24%, and with an average of 19.8% for the last decade. In Discussion Paper No. 1184, Research Fellow Juan Dolado and Research Associate Juan Jimeno suggest that Spanish unemployment results from a series of adverse shocks, compounded by disinflationary policies and a system of labour market institutions which has several flaws. Their main goal is to understand the sources of these shocks and their transmission mechanism. To do so, they build a simple model consisting of three equations for aggregate supply, aggregate demand and a policy rule. Solving the model yields two equations for the unemployment rate and deviations of inflation from target inflation in terms of lagged unemployment, deviations of expected inflation from target inflation, and factor shifts in the price and wage equation. The key parameters governing the system are those associated with hysteresis, the degree of accommodation in monetary policy, the real wage resistance and nominal rigidity. Gauging reasonable values for these parameters, the authors are able to match some of the observed features

The authors find that the current state of affairs derives from an unfortunate combination of a series of events. Many inefficiencies inherited from the old autocratic system were bound to be reformed, but unfortunately the political reform coincided with the two oil price shocks. To offset the initial rise in unemployment, a neo-corporatist arrangement (social pacts) were implemented. These arrangements generally operated in favour of capital and the otherwise unemployed and against the interests of the employed (particularly skilled workers). In order to ensure the unions' participation in the agreement, the government provided much more generous welfare benefits and maintained employment protection from the past. This led to an increasing divergence between the employed and the unemployed, with the state inheriting an irreversible increase in social security outlays. In these circumstances, adverse shocks to the economy trigger undesirable adjustments. Employment destruction takes place in big chunks. In addition, more inactive people means less tax revenue, more benefits to be paid and, consequently, higher tax rates and non-wage costs. This causes further inactivity and an increase in the fiscal wedge, thereby lessening the incentive to create jobs.

Why is Spanish Unemployment So High?
Juan J Dolado and Juan F Jimeno

Discussion Paper No. 1184, May 1995 (HR)