The Misdiagnosis of Eurosclerosis

Article excerpt

For two decades, virtually every western European nation has faced high and persistent unemployment. Many Europeans now look to the United States as a model of labor market flexibility. It is argued that Europe's "rigid" policies, encumbering payrolls with benefit costs, giving workers social rights, and making them hard to fire, deters European industry from creating jobs. Conversely, it is said that America, with its lesser levels of social protection, is a job-creation machine.

The United States, however, displays rising wage inequality not mirrored in Europe. This has lead some observers to argue that labor markets on both continents share common pathologies, reflecting the common influence of slow growth, globalization, and technological change. Europe simply chooses to take its slower growth in the form of higher unemployment, while the United States has chosen more jobs but greater inequality.

It is wrong to assume a simple trade-off between social protections and labor market problems. Both the United States and Europe are experiencing problems in their labor markets. To address these problems, good policy choices will require mixing some of the best aspects of labor market flexibility with well-run activist labor market and social protection policies.

The stakes, of course, are not just economic. The high unemployment (in Europe) and rising inequality (in the United States) have social and political ramifications. They threaten a country's social cohesion. Those who have lost economically over the past few decades--either because of extended unemployment or because of falling wages--are likely to be risk-averse and prone to seek scapegoats. Various forms of rightwing violence and opposition to immigrants are on the rise in both the United States and Europe. As the gap between winners and losers widens, the sense of a common political community erodes.


Concurrent with the OPEC oil price shocks, worldwide recession and stagflation, growth faltered in the mid-1970s in both the United States and Europe. But rather than recovering in the 1980s, unemployment in many European nations got worse. Rates of long-term unemployment (the share of the unemployed out of work 12 months or more) soared to between 30 and 50 percent in many nations, while part-time employment also rose. Problems were especially severe among younger workers.

Initial attempts to explain this high unemployment focused on Europe's extensive labor market regulation and generous social assistance programs. Despite an uncertain economy, it was argued, wages stayed high because of protective legislation and rigid union rules. Employers refused to hire these highcost workers, especially since extensive severance protection made it costly or impossible to lay them off. Workers, in turn, were content to remain out of the workforce because they received generous and long-term unemployment compensation and other assistance. Those with jobs presumably had no incentive to allow flexible wages and severance rules, hence "insiders" (the employed) kept firms from adjusting in ways that would allow them to hire "outsiders" (the unemployed).

In fact, many European nations have pursued greater flexibility in their labor markets by weakening protective legislation, but with little effect on unemployment. Germany, France, the United Kingdom, and Belgium weakened their dismissal laws. Spain, the United Kingdom, and the Netherlands decentralized wage bargaining. Italy eliminated automatic wage indexation. But overall unemployment did not fall. So it is not clear that Europe's social protections are the main culprit.

From 1991 to 1993, I headed a research project sponsored by the Ford Foundation and the National Bureau of Economic Research that commissioned a group of authors from Europe and the United States to study the effect of European changes in labor market regulation and social protection on labor market flexibility. …