Speakers at a panel discussion on 8 July examined the causes of Europe's high and persistent unemployment and considered possible policies to reduce it. The meeting formed part of CEPR's research programmes on `Labour Market Imperfections', supported by a grant from the UK Department of Employment, and `Product Market Integration, Labour Market Imperfections and European Competitiveness', supported by a grant from the Commission of the European Communities under its Human Capital and Mobility programme. The views expressed by the speakers were their own, not those of the above institutions nor of CEPR, which takes no institutional policy positions.

Dennis Snower (Birkbeck College, London, and CEPR) noted that European policy-makers are increasingly viewing high and persistent unemployment as a symptom of economic old age. Labour market institutions are becoming ossified, as high payroll taxes and other rigidities are combining to remove incentives to invest in skills and training and dampen market reactions to changes in the composition of demand. There is now widespread agreement that measures to promote flexibility are now essential to release the forces of free enterprise and increase labour markets' responsiveness to changes in supply and demand.

Snower maintained, however, that this `solution' may not be enough, since it may only replace Europe's unemployment problem with America's low-wage employment problem: the large numbers of unskilled `working poor'. Unemployment is concentrated in low-skill groups and free enterprise creates insufficient incentives for workers or employers to invest in training. This is because the social returns from such training exceed their private returns to the extent that firms can `poach' workers that have been trained by others, while the tight credit constraints the unemployed face also discourage them from investing in the acquisition of skills. Both problems apply with particular severity to the long-term unemployed, who additionally risk falling into a `low-skill, bad-job trap': if firms respond to the deficient skills of the unemployed by creating low-skill vacancies, their relative abundance will further reduce the unemployed's incentives to acquire skills.

Jonathan Haskel (Queen Mary and Westfield College, London, and CEPR) focused on the causes and consequences of skill shortages in the UK and examined their relationship with unemployment. During 1979-91, 14% of UK firms reported shortages of skilled labour, compared with an average level of 5% for the European Union as a whole. The available evidence suggests that such shortages arise from external factors over which firms have little control, such as poor quality and quantity of available labour, rather than the wages and conditions they offer to potential employees. Comparisons of the performance of UK plants with those using similar capital equipment elsewhere and inter-industry survey data both indicate that the UK's poor skills base is reducing its productivity. Inter-industry data suggest that skill shortages also increase upward pressure on wages, which has damaging consequences for both inflation and unemployment.

Gilles Saint-Paul (Département et Laboratoire d'Economie Théorique et Appliquée, Paris, and CEPR) adopted a political perspective to identify the sources of labour market rigidities and possible policies to remove them. Not all policies are politically feasible and the choice of which are implemented in practice reflects the outcome of political conflict rather than academic discussion. Even when the overall level of unemployment is high, the unemployed are a poorly organized minority, whom politicians have few incentives to please. Policies to reduce unemployment therefore require the support of the employed. This rises with their own exposure to unemployment, which is greater in more mobile societies with lower firing costs. If the initial rigidities of this type are very large, however, the economy may remain stuck in a `high unemployment trap'.

Saint-Paul noted that many European countries had increased labour market flexibility by developing two-tier employment structures that allow the creation of many `temporary' jobs without changing the terms of existing labour contracts, which is essential to secure support for reform from the employed. He contrasted the substantial steps taken to promote labour market flexibility in the UK with the recent French public reaction of rioting against quite modest proposals to reduce youth unemployment by deregulating minimum wages of young workers. A high unemployment rate is quite compatible with general political indifference to it, especially if it reflects a low rate of job finding rather than a high rate of job loss. In the latter case, the employed will be more willing to support reform, which may account for Spain's recent success in implementing substantial labour market deregulation.

Samuel Bentolila (Centro de Estudios Monetarios y Financieros, Madrid) first noted that the proportion of workers with fixed-term contracts in EU countries had risen substantially, from 4% in 1983 to 10% in 1991, and it is highest in Spain, where such `temporary' contracts now account for one-third of total employment. This has enabled firms to increase employment flexibility considerably at the margin, while leaving the core of permanent employees unaffected. Increasing flexibility by creating such a two-tier labour market may have damaging effects, however, if the permanent employees or `insiders' come to dominate wage-setting and disregard the interests of unemployed `outsiders'. If an increase in the number of workers on temporary contracts serves to protect the insiders from competition in labour markets, a rise in the proportion of temporary employment may increase permanent employees' ability to extract profits.

Bentolila reported that the results of his empirical study (with Juan Dolado) of a sample of some 1200 Spanish manufacturing firms during 1985-8 confirmed the importance of such effects. Each percentage point rise in the share of temporary employment could raise the wages of permanent employees by as much as one-third of one percent. Results obtained from sectoral data for Denmark, France, West Germany and the UK were less clear-cut but also consistent with their hypothesis, and they suggested that such `insider effects' are generated by temporary rather than part-time employment and are stronger in countries whose legislation governing the adjustment of permanent employment is relatively strict. These perverse effects of increased flexibility at the margin are initially masked, because the wages and firing costs associated with temporary workers are lower so average labour costs initially fall. This stimulates employment while unit labour costs are falling, but this process soon ends once the proportion of temporary workers stabilizes, and unit labour costs begin to rise again, as they have done in Spain since 1991.