Unemployment
Growth effects

Conventional macroeconomic theory predicts that growth depends on exogenous, labour-augmenting technical progress and that the `natural' rate of unemployment depends on labour market institutions. Recent theoretical work suggests that an increase in productivity growth raises the present value of profits from new job creation and hence reduces unemployment (`capitalization') and that productivity growth through the replacement of low-productivity jobs by high-productivity jobs elsewhere in the economy raises unemployment (`reallocation'). Causality may also run from unemployment to growth if high or prolonged unemployment reduces learning-by-doing or the pool of savings available for investment.

In Discussion Paper No. 723, Research Fellow Charles Bean and Christopher Pissarides develop a simple overlapping generations endogenous growth model, with unemployment due to frictions in the labour market, but without `capitalization' or `reallocation'. The model shows that unemployment and growth need not be inversely related since they are now jointly determined endogenous variables. For example, an increase in workers' bargaining strength that reduces employment may increase growth by redistributing income to those with higher propensities to save. An increase in the propensity to consume will reduce growth and leave unemployment unchanged, which is at variance with some Keynesian models in which accelerator effects on investment also raise future output.

Bean and Pissarides adopt a `New Keynesian' approach by introducing a separate imperfectly competitive consumption goods sector, rather than an accelerator effect. They find that an increased propensity to consume raises not only consumption, but also employment and output through the effect of a deeper market on competition and the price mark-up. If this effect is strong enough, total savings and investment will also increase and hence raise the growth rate.

Unemployment, Consumption and Growth
Charles Bean and Christopher Pissarides

Discussion Paper No. 723, October 1992 (IM)