|
Unemployment
Persistence A CEPR
conference on 'Unemployment Persistence and the Long Run: Re-Evaluating
the Natural Rate' was held in Vigo, Spain on 30 November/1 December
1997. The organizers were Dennis
Snower (Birkbeck College, London and CEPR), Brian
Henry (London Business School) and Jenni
Greenslade (London Business School). The objective of the conference
was to examine the observed movements in European unemployment and to
assess the degree to which these movements could be explained by changes
in labour-market equilibria, as opposed to dynamic unemployment
processes. The
conference brought together a group of academics from Europe and North
America with interests in the analysis of high levels of unemployment to
examine radically different approaches to unemployment. Policy
implications were also considered, as was the question of whether a new
policy agenda was required to combat the high European unemployment
levels. The deliberations continued the theme developed in a previous
conference and workshops, but extended the debate to look in depth at
developments across Europe and North America. Stephen Nickell (University of Oxford) presented 'Unemployment:
questions and some answers'. In almost every OECD country, unemployment
was lower in the decades following the Second World War than in any
other period of comparable length. The paper set out to consider why
this was so, and to ask what factors had caused the enormous variations
in cross-country unemployment rates. Nickell offered some tentative
answers to the second question and some speculation about the first. The paper set
out a general dynamic model in which the long-run solution for
unemployment depended upon industrial turbulence, the replacement ratio,
the terms of trade, the skills mismatch, the mark-up, the tax wedge and
the real interest rate. This relationship comfortably explained the
four-fold rise in unemployment from the early/mid-1960s to the late
1980s/early 1990s. There remained, however, a feeling of
dissatisfaction, since it was hard to tell a seven-variable story
simply, and because the variables that were really needed – for
example, those close to capturing exogenous shifts in search
effectiveness – were not observed. On the reasons for the rise in
unemployment, Nickell suggested that, by the 1980s, either employers
found it far harder to get the workers they wanted from the unemployed
pool, or the unemployed were much less enamoured of the work on offer.
The problem was to provide a persuasive empirical analysis of these
apparently large shifts in behaviour. Dennis Snower emphasised the
importance of lagged dynamic effects, arguing that the outcome depended
upon the extent of nominal inertia. Robert
Gordon (Northwestern University, CEPR and NBER) suggested that a
cross-sectional estimation be conducted to analyse the impact across
countries. Brian Henry (London Business School) presented 'Dynamic adjustments
versus the natural rate: A story of UK unemployment', written with Dennis
Snower (Birkbeck College, London and CEPR). This paper challenged
the standard account of UK unemployment, namely that the major swings in
unemployment over the last 25 years were due predominantly to movements
in the underlying empirical 'natural rate of unemployment' (NRU). The
authors' explanation of the medium-term movements of unemployment was
that the trajectory of unemployment through time reflected the
cumulation of labour-market 'impulses' and their associated streams of
'dynamic' responses, with each shock followed by a prolonged adjustment
process. Their paper thus sought to refocus analysis of the labour
market away from exclusive attention to equilibria and towards the
dynamic movements between them. They contended that, because these
movements took place over long periods of real time, they were important
objects of analytical attention. The analysis
suggested that an important part of the movement of UK unemployment was
due to the interaction between structural shifts in exogenous variables
(such as the real oil price and the interest rate), and mutually
reinforcing lagged labour-market responses operating on employment, wage
determination, labour supply and capital accumulation. In contrast to
the conventional interpretation, the authors argued that the UK's NRU
had been reasonably stable through time, whereas the major unemployment
swings had arisen from the cumulation of one-off shocks and their
associated dynamic repercussions. Discussion centred on the nature of
shocks that might yield a transitory, but possibly prolonged, effect. Edmund
Phelps (Columbia University) gave examples of many such shocks,
including EMU and real interest rates. David
Rose (QED Solutions, Ontario) pointed out that separating the
equilibrium level and the dynamic path was a difficult empirical task. Robert Gordon (Northwestern University, CEPR and NBER) presented his
paper 'Price, wage and unemployment dynamics in the recent experience of
the United States'. The paper provided a unified framework in which
inflation depended on inertia, demand and supply. The benign behaviour
of inflation and unemployment in the United States in the mid-1990s was
interpreted as the direct converse of the positively correlated 'twin
peaks' of US inflation and unemployment in the mid-1970s and early
1980s. The decade between 1973 and 1982 was dominated by the
macroeconomic effects of the adverse food and energy price shocks, which
were largely reversed in 1982–86. Gordon's interpretation of the
'Cinderella' economy of the mid-1990s was that three beneficial supply
shocks had combined to create 'twin valleys' of inflation and
unemployment. These shocks were: (1) acceleration in the rate of
computer price deflation; (2) reduction in the relative price inflation
of medical care; and (3) measurement improvements which had reduced
measured inflation relative to true inflation. The estimation of wage
equations indicated that the same factors that had held down price
inflation had also held down wage inflation. There was thus no need to
appeal to factors specific to labour markets to explain why wage
inflation had been so well behaved in recent years. The author explained
that a period of outstanding economic performance was only the first
step in guiding policy-makers; also needed was a prediction of the
future behaviour of the special factors. Dennis
Snower questioned whether the extent of the changes in computer and
medical care prices and in the measurement of prices accounted fully for
the movement in the Phillips Curve, and whether the exchange rate might
also have an important role to play. The paper by Edmund Phelps (Columbia University), entitled 'Lessons in
natural-rate dynamics' built upon previous work on the dynamic model of
the natural rate, such as the author's 1994 book. In this paper,
attention was paid to these medium-run dynamics, with all frictions
stripped away in order to focus on what Phelps believed was the crucial
driving force behind the equilibrium motion of unemployment in an open
economy, namely the accumulation of private assets net of liabilities
– private wealth. Thus the Phelps-Winter customer was banished in this
model. Only physical capital that was frictionless, costless and
instantaneously transportable in and out of the country was permitted.
The turnover-training model of wages and unemployment, as rebuilt by
Hoon and Phelps, was used. For simplicity, however, the hiring/training
cost of each new employee was taken to be constant, rather than an
increasing function of the hire rate. In the equilibrium case, with
these simplifications, the unemployment rate jumped on to its
equilibrium path and, in the future, the equilibrium rate was driven by
the evolution of the private wealth of the representative worker. Robert Gordon questioned why US unemployment was currently low,
given that stock market wealth was high. The flow of the benefits from
wealth, rather than the current market value of workers' homes and
durables, was more relevant. Another participant questioned why wealth
dynamics should affect the movement in unemployment given that the
unemployed hold only a small fraction of the average national wealth per
head. 'A comparison
of inequalities across French and US labour markets', presented by Daniel Cohen (CEPREMAP, Paris, and CEPR) provided a theoretical
comparison of the bargaining power of French and American workers and an
investigation of the channels through which they were affected. Using
(the log of) wage inequality as a criterion, Cohen found that the United
States was a much more inegalitarian society, with a coefficient of
variation about 60% higher than the French coefficient. Taking the
computed value functions as a criterion, the US was still more
inegalitarian, but by a margin of only 15%. This difference was not
uniform across various segments of the labour force: French labour
markets were more inegalitarian along the age axis, whereas US labour
markets were more inegalitarian along the diploma axis. The author
found that, for all segments of the labour market, job turnover was the
dominant feature, always explaining more than 80% of the discrepancy
between the welfare of an employed and an unemployed worker. A
difference arose only in the segment of workers with no diplomas, in
which the bargaining power of French workers was about 20% higher. For
all the other segments, there was no difference in the
wage-determination process in the two countries. Job turnover, rather
than lack of wage flexibility, therefore appeared to be the critical
discrepancy. Henri Sneessens,
(IRES, Université Catholique de Louvain and Faculté Libre des Sciences
Economiques, Lille) initiated discussion on the possibility that
bargaining power might be underestimated. Attention also focused on the
issue of job tenure, with more job-to-job turnover taking place in the
United States, where it was quicker for workers to be rehired. Stephen
Nickell questioned whether differences in France could be overstated
because of higher employment protection in that country. David Rose (QED Solutions, Ontario) presented 'Inflation and
unemployment in Europe and North America: Asymmetry versus hysteresis',
written with Hamid Faruqee
(International Monetary Fund) and Douglas
Laxton (International Monetary Fund). A model and methodology for
simultaneous estimation of the Phillips Curve and the Non-Accelerating
Inflationary Rate of Unemployment (NAIRU) was specified in a small
system of equations, and was applied to the data for seven countries in
Europe and North America. The authors found that a model with modest
asymmetry in the Phillips Curve fitted the data better than a linear
alternative in most cases. They also found that this model could explain
part of the rise in the NAIRU in many countries over the past few
decades as a macro phenomenon, related to the increased volatility of
the business cycle. The model
with asymmetry had some interesting policy implications. Interpreting
the NAIRU as the 'equilibrium' unemployment rate consistent with stable
inflation, the authors noted that this value must lie above DNAIRU
(deterministic NAIRU), namely the value that would be obtained in a
world without shocks. The difference between these values, which they
dubbed the a-shift, depended, among other things, on the degree of
asymmetry and the degree of volatility in the macro cycle. Their
estimates suggested that the a-shift had been growing through the sample
in most countries, but may now be falling in countries where
stabilization policies have been more successful in establishing both
credibility in the stable-inflation monetary policy, and a new direction
with respect to fiscal policy. Dennis
Snower questioned whether stochastic variations around a non-linear
short-run Phillips Curve implied a non-vertical long-run Phillips Curve.
David Mayes (Bank of Finland) asked whether the convexity of the
curve had changed, to which David Rose replied that there was some
empirical evidence of increased convexity. Marika Karanassou (Queen Mary and Westfield College) presented
'Surprising properties of the natural-rate hypothesis', written with Dennis Snower. The paper examined whether it was possible to find a
unique empirical estimate of the natural rate of unemployment,
representing the rate towards which unemployment is tending. In the
standard, single-equation models of natural-rate theory, such a unique
rate was simply the unemployment rate at which unemployment adjustment
dynamics have worked themselves out. The authors argued, however, that
single-equation models were at best an encapsulated summary of the
unemployment behaviour that emerged from a multi-equation labour-market
system containing labour demand and labour supply equations. For an
empirical model of the UK labour market, they computed various estimates
of the long-run unemployment rate and found that these differed
substantially from one another. Since each of the estimates was equally
compelling as a potential reference point towards which the actual
unemployment rate could move, the search for a unique, empirically
assessable natural rate of unemployment consequently must be abandoned.
Rather than viewing unemployment dynamics in terms of movements towards
an identifiable reference point, it might be more useful to focus
instead on labour-market shocks and the lagged behavioural adjustments
to them. Given that each shock affected the labour market by feeding
through a network of lagged adjustment processes, unemployment movements
may then be viewed as a cumulation of past shocks and their associated
dynamic sequence of labour-market responses. Stephen
Nickell suggested that, since capital accumulation and working
populations evolved at different rates across countries and time
periods, unemployment may be independent of these factors. Dennis Snower
considered that this depended upon the time frame, and that long-run
restrictions should not be imposed in the medium run. Gylfi Zoega (Birkbeck College, London) presented 'Education and the
natural rate of unemployment'. Written with Michael Orszag (Birkbeck College, London) and Edmund Phelps (Columbia University), this paper used Phelps's 1994
turnover-training model to predict differences in the rate of
unemployment across education groups. There were two types of labour
which differed in their level of education. The authors found that the
rate of unemployment in each group depended on the rates of autonomous
inflow into and out of employment, the responsiveness of hires and quits
to changes in the rate of unemployment and the unemployment-benefits
replacement ratio. Unemployment among the less educated was higher for
three reasons. First, the less educated faced a higher
unemployment-benefit replacement ratio since their wages were lower, and
hence they were more prone to quit and less likely to accept jobs.
Second, the less educated could perform fewer tasks in the firm and
hence were more often turned down for jobs. In turn, this reduced the
rate of inflow into employment and raised the group's unemployment rate.
Third, the less educated may be more prone to quit because of a variety
of social problems affecting those in the lower levels of the education
distribution disproportionately. Within the
context of the model, the recent deterioration in the relative
unemployment/wage rate of the less educated could be attributed to the
information revolution which had made firms more selective when hiring
from the pool of less educated workers, rather than relying on biased
technological change in the traditional sense of affecting the ratio of
marginal products. There was some discussion about the impact of the
minimum wage on the outcome. Furthermore, such a model potentially
allowed for a large role for longer-run unemployment dynamics via
education. The authors believed that education provided part of the
explanation for the rise in unemployment. Torben M Andersen (Aarhus University and CEPR) presented a paper
entitled 'Persistency in the Danish labour market', written with Svend
Hylleberg (Aarhus University). The aim of the paper was to identify
different sources of persistency in employment adjustment. Based on a
dynamic labour-market model, an explicit distinction was made between
real and nominal (prices and wages) propagation mechanisms. The
theoretical analysis provided the basis for an empirical analysis of
wages, prices and employment for the manufacturing sector in Denmark
from 1973 to 1993. The authors found that nominal rigidities prevailed
in the short run and that nominal propagation mechanisms played a larger
role than real propagation mechanisms. As the half-life of temporary
shocks was about 11 quarters, it followed that endogenous propagation
mechanisms were important, although they could not fully explain the
observed persistency. The finding
that nominal adjustment failures had a larger effect than real
adjustment failures had several important implications. First, it might
be misleading to base measures of the structural unemployment rate on
recently observed unemployment rates. Second, policies directed towards
making the labour market more flexible, and so reducing inertia in the
adjustment process, should focus more on the incentives underlying wage
and price formation than on employment adjustment. Finally, given
substantial inertia – particularly nominal inertia – there is a role
not only for general demand management policies in smoothing employment,
but also for monetary policies in speeding up the adjustment process. Simon
Burgess (University of Bristol and CEPR) commented that it might be
interesting to consider the effects of linear symmetric adjustment
mechanisms. Edmund Phelps
questioned whether some persistence in real shocks was needed. It was
also suggested that it would be important to evaluate the relative
importance of the real and nominal adjustments. 'Labour
supply, the natural rate and the welfare state in the Netherlands: the
wrong institutions at a wrong point in time' was presented by Coen
N Teulings (University of Amsterdam and Ministry of Social Affairs,
The Netherlands) and written with Lourens
Broersma and Jan Koeman
(both Ministry of Social Affairs, The Netherlands). This paper analysed
the causes of the Dutch miracle. Low wage increases in the Netherlands,
by comparison with the rest of Europe, were the main factor explaining
the fast employment growth. Two factors might explain the lag in wage
growth: the 1982 Wassenaar agreement between trade unions and employers;
or the realignments in the welfare state. A small
macroeconomic model for the Dutch economy was estimated to analyse these
issues. The residuals of the wage equation were not systematically
negative for the post-1982 period. These residuals did have a large
impact on the employment history, however. There was a clear effect
resulting from the generosity of the welfare state, but the data did not
allow the magnitude of this effect to be established precisely. The
impacts on the Dutch economy of the oil price shock and the social
experiment of more generous welfare benefits were felt during much the
same period (1975–84) and so it was difficult to disentangle their
effects. Stephen Nickell
pointed out that the Netherlands had the highest productivity in the
world. He commented that if wages grew in line with productivity, then
unemployment would appear constant in the model. The next
paper, 'Duration distributions and unemployment dynamics', was presented
by Michael Orszag (Birkbeck College, London). Economic policy
frequently relied on constructs which related changes in unemployment,
away from its natural rate, to other variables, such as growth rates
(Okun's Law) or inflation (the Phillips Curve). Such constructs ignore
the distribution of unemployment. In Orszag's view, this was misleading
for economic policy because distributional issues – such as the number
of long-term unemployed – had implications for both growth and
inflation. Beginning
with a general Markov chain model, Orszag derived a continuum model of
employment and unemployment, the steady states of which had
distributions corresponding to those used in the microeconometrics of
transitions. These steady states differed considerably from traditional
natural-rate theories in which only the aggregate unemployment rate
settled down to its steady-state level. The author demonstrated the use
of the model in calculating steady-state unemployment rates for
comparison with natural-rate theories. He also analysed convergence to
steady-state equilibrium and discussed possible extensions. Simon
Burgess suggested that the flows into and out of unemployment, with
their associated probabilities, be included in the model, and Stephen Nickell commented that it would be beneficial to include
wages. 'Unemployment
persistence' was presented by Alison
Booth (University of Essex and CEPR) and written with Wiji Arulampalam (University of Warwick) and Mark Taylor (University of Essex). They estimated dynamic panel-data
models of unemployment incidence, in order to disentangle the effects of
unobserved individual heterogeneity and true state-dependence. They also
controlled for the 'initial conditions' problem that arose when the
start of the observation period did not coincide with the start of the
stochastic process generating individuals' unemployment experiences.
These problems could be properly addressed only with panel data, such as
the new British Household Panel Survey. If there was no state-dependence
in the incidence of unemployment, then short-run policies to reduce
unemployment would have no effect on the natural rate. If there was true
state-dependence, however, then policies that reduced the incidence of
short-run unemployment would have longer-run effects by reducing the
natural rate. The authors
estimated their models for a sample of men for the period 1991–5. They
found strong evidence of state-dependence, especially for more mature
men (defined as those aged 25 and over in 1991). This finding was
consistent with the 'scarring' theory of unemployment, which suggested
that individuals' previous unemployment experiences had implications for
their future labour-market behaviour. Some discussion, initiated by Daniel
Cohen, concerned a possible sample-selection problem. Alison Booth
confirmed that if a person became employed, he/she would remain in the
sample, but that the data did not take into account a person who may
have changed jobs several times during the survey period. Juan Dolado (Universidad Carlos III, Madrid, and CEPR) presented
'Hysteresis and the sources of shocks: A cross-country analysis',
written with Manuel Balmeseda
(CEMFI, Madrid) and David López-Salido
(Banco de España). Their paper used long-run identifying restrictions
on a three-variable system, containing output growth, real-wage growth
and the unemployment rate, to isolate three 'structural' shocks which
drove business-cycle fluctuations in a sample of 16 OECD countries
during 1950–94. These shocks were interpreted variously as
aggregate-demand, productivity and labour-supply disturbances. Two
competing hypotheses were assumed for the stochastic behaviour of the
unemployment rate: trend stationary, or integrated of order one. The authors
found that the observed dynamic adjustment of the variables in response
to structural shocks was much more consistent with the implications of a
model with full hysteresis in unemployment than with models of partial
hysteresis. In particular, aggregate demand and productivity had almost
mirror-imaged positive/negative cumulated effects on output and
unemployment, while labour-supply shocks tended to increase
unemployment, and productivity shocks were most important in explaining
fluctuations in real wages. The authors also concluded that productivity
and aggregate-demand shocks explained most of the fluctuation in real
output, the former being particularly important in the Anglo-Saxon and
Scandinavian economies. Most remarkable, however, was the contribution
of aggregate-demand shocks to the forecast error variance decomposition
for unemployment for a large subset of countries, comprising the
above-mentioned economies and some central European economies. Some
discussion took place about the assumption of modelling unemployment as
an I(1) process. Although this may be a good approximation for the
economies and sample periods used, in the long run it would be an I(0)
process; it was possible, however, that unemployment over a specific
period might be interpreted as being I(0), but with a mean shift. Henri R Sneessens (IRES, Université Catholique de Louvain and
Faculté Libre des Sciences Economiques, Lille) presented 'Demand-supply
interactions and unemployment dynamics: is there path dependency? The
case of Belgium, 1955–1994', which was written with Fatemeh Shadman-Mehta (IRES, Université Catholique de Louvain). The
fact that the proportion of capacity-constrained firms in European
economies had remained fairly small suggested that capacity shortages
could not be the direct and single cause of unemployment persistence.
Inferring from this observation that low investment rates played no role
in explaining the persistence of high unemployment rates, however, may
fail to take into account the relationship between demand expectations,
capital accumulation and real rigidities. The authors'
objective was to show how a continuum of excess-supply equilibria could
be obtained in models with real rigidities, similar to those
traditionally used to analyse the determinants of equilibrium
unemployment (the NAIRU), provided the effect of a 'capital gap' on wage
formation and the relationship between capital accumulation and demand
expectations were explicitly taken into account. Such a persistence
mechanism might explain why current unemployment rates seemed to depend
so much on past history, and why there was not a simple explanation that
applied equally well to all European countries. The authors estimated an
econometric model using post-war Belgian data, with special emphasis on
the effects of the 1982–7 wage controls. They estimated the model
using Johansen's maximum likelihood approach, thus imposing as few a priori structural restrictions as possible. Their results
suggested path-dependency and were thus compatible with the implications
of their theoretical model. Dennis
Snower questioned whether there was a sales constraint, implying
wage and price inertia, to which Sneessens replied that the model
implicitly contained menu costs, and hence nominal inertia. Giorgio Brunello (Università degli Studi di Udine) presented
'Regional Disparities and the Italian NAIRU', written with Claudio Lupi (Instituto di Stidi per la Programmazione Economica
(ISPE), Roma). In this paper, the authors estimated the Italian NAIRU
using annual data for the period 1951–96. They found evidence that
aggregate wage-setting in Italy depended only on the rate of
unemployment prevailing in the northern and central areas of the
country. Southern unemployment did not affect wage pressure. There was
evidence of a co-integrating relationship between unemployment in the
northern and central areas, the tax wedge, the real interest rate and a
measure of union power. The NAIRU
estimates were not very precise, and the width of the 95% confidence
interval was close to two percentage points. The NAIRU had remained more
or less constant in the past ten years, in association with a reduction
in union power and in the real interest rate, which was almost
completely compensated for by the increase in the tax wedge. However,
aggregate equilibrium unemployment had increased by 8 percentage points
and actual unemployment had increased by 15.2%. These numbers suggested
that both regional-mismatch and demand factors had been important in the
increase of Italian unemployment since the early 1980s. Dennis
Snower suggested that if the mismatch was roughly measured by the
difference between average and northern unemployment (and therefore
between southern and northern unemployment), then changes in mismatch
could be regarded as exogenous. If this were the case, the model could
be extended to endogenise southern unemployment. Hector Sala-Lorda (Universitat Autonoma de Barcelona) presented his
paper on 'The natural rate and lagged adjustment processes in Spain'.
The paper represented a first attempt at using Chain Reaction theory to
analyse the Spanish labour market. The objective was to understand how
much the dynamic effects of different kinds of shocks could explain
unemployment in Spain. The analysis was done via two different types of
exercises. First, Sala-Lorda used unemployment persistence and imperfect
responsiveness measures to evaluate the degree of persistence of the
effects of temporary and permanent shocks on unemployment. Second, he
estimated which part of the unemployment trajectory could be explained
by lagged adjustment processes and which by the impulses of growing
exogenous variables. When analysing the contribution of lagged
adjustment processes to the change in unemployment, he found that the
dynamics of the system accounted for one-half of this change. The
interplay between the succession of impulses and the dynamic responses
may have been explained by the medium-run unemployment changes. Sala-Lorda
suggested that these results showed that Chain Reaction theory provided
a useful framework for analysing the causes of unemployment and thus for
deriving an appropriate design of unemployment policy. Juan
Dolado suggested that, rather than looking at the entire business
cycle, it might be beneficial to consider the peak and the trough of the
cycle separately. Dennis Snower
thought it might be desirable to ensure that there was a reasonably
close fit between the Spanish unemployment 'story', factors such as the
1978 tax reform, the introduction of fixed-term labour-market contracts
in 1984 and the empirical analysis. 'Structural
unemployment and the NAIRU in Austria: theoretical considerations and
empirical results' was presented by Andreas-Ulrich
Schuh (Ministry of Finance, Vienna) and written with Karl Pichelmann (Institute for Advanced Studies, Vienna). Their
paper gave a brief survey of the main theoretical and empirical issues
surrounding the NAIRU concept. According to modern labour-market
literature, NAIRU was defined as the rate of unemployment at which
inflation stabilizes in the absence of any wage-price surprises.
Conventional thinking about the equilibrium unemployment rate assumed
that, in the long run, the NAIRU is determined solely by supply-side
factors in the labour market. The authors showed that quite complex
adjustment dynamics may arise even in simple log-linear wage-price
models. Furthermore, they surveyed a number of hysteresis mechanisms
which could lead to permanent shifts of equilibrium unemployment over
time, implying that a unique long-run NAIRU may not even exist. In addition
to these theoretical issues, the authors referred to two serious
problems which might arise with empirical applications of the NAIRU
concept. First, various empirical studies suggested that the results
depended highly on model specifications. Second, a considerable amount
of statistical imprecision was inherent in the results obtained from
empirical estimates. For these reasons, they argued, policy conclusions
drawn from the NAIRU concept must be judged with the utmost care,
particularly in the many countries in which a number of labour-market
measures, as well as monetary policies, were based on the concept. Dennis Snower questioned how important the static natural rate of
unemployment, as well as the lagged adjustment processes, were in
accounting for the observed movements in unemployment. David Mayes (Bank of Finland) presented 'Unemployment in a small
open economy: Finland and New Zealand', written with Jouko Vilmunen (Bank of Finland). This paper sought to make a
contribution to the understanding of the causes of unemployment and its
successful reduction by exploring the examples of two rather different
small open economies, Finland and New Zealand. They hoped to shed light
on three key issues: (1) the degree to which unemployment had been the
result of slow adjustment to large external shocks; (2) the degree to
which differences in labour-market structures could lead to different
responses to shocks; and (3) the importance of the exchange rate and the
external sector in resolving the problem. For Finland,
the bulk of the short-run adjustment to a shock to the long-run
unemployment relationship fell on unemployment. The speed of adjustment
of unemployment was also quite fast, whereas the response of real wages
was perhaps surprisingly small: unemployment would adjust at the speed
of 0.34 percentage points per six months to a unit shock, while the
adjustment speed of real wages was as low as 0.01 percentage points per
six months. In the case of New Zealand, the evidence was more difficult
to interpret because of some uncertainty about the parameter estimates.
Terms of trade, however, appeared to be an important adjustment channel
to shocks to the long-run equilibrium in the New Zealand economy. On the
relevance of productivity growth in New Zealand, which was raised in
discussion, Mayes pointed out that, although it may be the case that the
actual outcome for the service sector was more favourable than the
impression given by the official statistics, there were many new jobs in
lower productivity areas. Unlike many other countries, however, these
jobs were not generally of a part-time nature. The final
paper, 'Unemployment persistence in a small open labour market: The
Irish case', was presented by Brendan
Walsh (University College Dublin). The question underlying the paper
was whether the behaviour of the Irish unemployment rate since the 1960s
was best understood in terms of the lagged adjustment of a stable
equilibrium unemployment rate (NAIRU) to shocks, or in terms of
variation over time in the equilibrium rate of unemployment. Walsh
presented evidence from a variety of sources to demonstrate that the
relevance of the NAIRU concept was not easily established under Irish
conditions. The price-inflationary process was generally agreed to
reflect the influence of world inflation, transmitted through the
exchange rate. Although domestic inflationary pressures, emanating from
wage costs, had been shown to play a minor role in Irish price
inflation, it had proved difficult to establish a link between these
pressures and the rate of unemployment. Alternative approaches to defining an 'equilibrium' rate of unemployment had drawn on the relationship between Irish and UK unemployment. A stable relationship appeared to have existed between these two variables until the mid-1970s. Although it subsequently broke down, this link now appeared to have been re-established, but with a significant negative trend in the gap between the two rates. This was attributed to favourable developments in the Irish economy, notably the steady improvement in competitiveness, changes in the wage-bargaining process and reforms in the social welfare system. It remained to be seen how rapidly and how far the Irish unemployment rate would fall in response to further rapid economic growth. |