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At a lunchtime meeting on 24 February, Dennis Snower argued that most current theories of unemployment do not fit the facts. Snower is Professor of Economics at Birkbeck College, London, and Co-Director of CEPR's Human Resources programme. His remarks were based on his CEPR Discussion Paper No. 883, `Why People Don't Find Work', which reports research carried out under the auspices of CEPR's research programme on `The UK Labour Market: Microeconomic Imperfections and Institutional Features', supported by a grant from the UK Department of Employment. The views expressed by Professor Snower were his own, however, not those of the Employment Department nor of CEPR, which takes no institutional policy positions.Snower first noted that unemployment is associated with illness, family problems and loss of self-esteem, so it is therefore curious that so many Europeans apparently choose to remain unemployed. The major waves of unemployment are much longer than business cycles and the long-term unemployed who have not worked for more than a year now account for some 50% of Europe's total. Over the past 30 years, most European labour markets have stagnated long after product markets have recovered, which contrasts sharply with US experience. Also, unemployment has for the most part afflicted unskilled rather than skilled workers. Snower maintained that current academic theories can provide only partial explanations of why people do not find work. He first dismissed theories proposing that the unemployed don't really want to work and that unemployment policy therefore wastes taxpayers' money. Those based on deviations around a `natural rate' of unemployment that depends on an economy's structural characteristics cannot account for the its growth throughout the 1980s, which have witnessed a decline in union density, no improvement in welfare provision and substantial labour market deregulation. Theories of intertemporal substitution, in which workers expect real wages to rise in the future and choose more leisure now, cannot account for unemployment's upward trend since the mid-1970s; and they enjoy no convincing support from the available empirical evidence relating hours worked to real interest rates or real wages. He then turned to theories based on imperfect information. `Search' theories relate the costs faced by workers in seeking suitable jobs to measures of labour market turbulence, but no such measures correspond to the secular rise in the level of unemployment. `Efficiency wage' theories, in which firms' imperfect information about workers' productivities provides them with incentives to maintain wages above the levels required to ensure full employment, shed little light on the rise of EU unemployment over the past two decades, the stronger employment performance of the US and Japan, or why skilled workers suffer less than the unskilled, whose performance is more easily monitored. Theories based on the role of labour unions have not performed well over time; the UK has witnessed a substantial decline in union density together with rising unemployment over the 1980s. Bruno and Sachs's attribution of European unemployment to supply-side shocks under rigid real wages tells only part of the story; real oil prices fell steadily in the 1980s while unemployment continued to rise. Keynesian models of a vicious cycle of deficient demand in labour and product markets cannot account for their behaviour in the early 1980s: European product demand started to pick up in 1982, but employment showed no improvement until 1986 in the UK and even later elsewhere. Finally, `insider-outsider' theory, in which labour turnover costs discourage hiring and firing, may account for some short-term employment fluctuations but only its dynamic variants can deal with its behaviour in a prolonged recession. Snower stressed that theories that do not fit the facts are unreliable guides to policy. In particular, improved dissemination of information about job opportunities is unlikely to have a big impact on European unemployment, while Keynesian demand management policies are unlikely to be effective unless labour turnover costs are low, as for example after a large-scale shake-out of labour-hoarding. He called for reform of unemployment benefit systems that discourage work, which is a particularly serious problem among unskilled men and single mothers in the UK, and he proposed that existing benefits to the long-term unemployed should be redirected to provide subsidies to firms willing to hire them. |