Policies to reduce the long-run level of unemployment follow two broad approaches: `supply-side' policies stimulate long-run productivity growth through measures such as training provision or tax credits to encourage investment, while `structural' policies reduce the persistence of unemployment by reducing hiring and firing costs, making wages more responsive to unemployment, and improving the functioning of government employment services. In Discussion Paper No. 958, Programme Director Dennis Snower considers the effects of long-run productivity changes and persistence on unemployment to show that policies of the two types may be substitutes, at least in part, in the sense that increased use of one may reduce the effectiveness of the other.

Snower extends a simple model of the labour market based on an expectations-augmented Phillips curve to incorporate `persistence' the dependence in part of current wages and prices on previous unemployment levels. In this framework, increasing the responsiveness of prices and wages to current market conditions reduces persistence and makes the long-run unemployment rate less susceptible to changes in trend productivity growth, so growth-promoting policies are correspondingly less effective in reducing unemployment. Snower reports that estimating time-series models of the unemployment rate for 14 OECD countries during 1952-88 yields results that broadly confirm his model's predictions. Those countries in which unemployment persistence is high, such as France and the UK, are those in which the unemployment rate responds most strongly to changes in productivity growth. In countries with low unemployment persistence, such as Japan, Norway and Sweden, the responsiveness of unemployment to productivity growth is much weaker. Snower concludes that these findings may account for the observation that countries with very different labour market structures can have similar unemployment rates, whether high or low, if some have concentrated on increasing the responsiveness of labour markets while others have focused on increasing their productivity. These results suggest that the UK could successfully pursue policies to reduce unemployment persistence with relatively little effort on the productivity side.

Unemployment Persistence and the Unemployment-Productivity Relation
Dennis J Snower

Discussion Paper No. 958, July 1994 (HR)