Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Past and Prospective Causes of High Unemployment

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Past and Prospective Causes of High Unemployment

Article excerpt

Twenty years ago, on the eve of the first of the great post-Bretton-Woods recessions, unemployment did not appear to be a major problem for advanced economies. Among what would later be dubbed the G7 nations, the United States had the highest unemployment rate at 5.5 percent; but very little of this unemployment was long term, and the extent of short-term unemployment could be rationalized as the inevitable and even desirable result of a dynamic economy. Western Europe had an unemployment rate that, measured on a comparable basis, was only 3 percent. Japan's unemployment rate was a trivial 1.4 percent, a performance nearly matched by West Germany's 1.6 percent. Whatever their other economic and social problems, the world's industrial nations seemed to have left fears of mass unemployment far behind.

Today, of course, unemployment is back with a vengeance. In Europe, in particular, the seemingly inexorable rise in the unemployment rate has led to the creation of a new word: Eurosclerosis (Chart 1). (Chart 1 omitted) The United States has not seen a comparable upward trend--indeed, the unemployment rate in 1989-90 was lower than in 1974, and the current recovery may already have pushed the unemployment rate into the same range (changes in the survey method, introduced this year, blur the picture slightly). However, many people on both sides of the Atlantic believe that the United States has achieved low unemployment by a sort of devil's bargain, whose price is soaring inequality and growing poverty.

The purpose of this paper is to address the big questions about OECD unemployment: Why has it risen? Will it continue to rise? What can be done to reverse the trend? These are daunting questions. Luckily, there is no need to be original. Not only has the OECD unemployment problem been the subject of massive amounts of research, many economists have coalesced around a common view of the nature of the problem.(1) This common view does not exactly represent a consensus, since there are important dissenting voices, but it is the conventional wisdom. For the most part, this paper restates that conventional wisdom.

Why is such a restatement necessary? Because while economists who think about OECD unemployment may have reached a considerable degree of agreement, educated opinion more broadly defined, and the opinion of policymakers in particular, remains far more diverse. In part, this may be because the instincts of the broader public do not accord with what the economists have to say. It may also be because the standard view is far from comforting and seems to imply some harsh choices that the public and the policymakers would rather not face. And in part, the failure of the standard economist's view to become equally standard among noneconomists may result from a failure to explain that view clearly. This last failure, at least, may be correctable.

This paper is in five parts. The first part addresses the crucial distinction between cyclical and structural movements in unemployment, aka fluctuations around and movements in the natural rate. The second part lays out the central theme of the conventional wisdom about rising unemployment in advanced economies: that high unemployment in many industrial nations is an unintended byproduct of their redistributionist welfare states, and that the problem has worsened because the attempt to promote equality has collided with market forces that are increasingly pushing the other way. The third part of the paper turns to the question of the sources of the apparent tendency toward greater earnings inequality, and in particular the relative roles of globalization and technological change. Finally, the last two parts of the paper are concerned respectively with possible policies and realistic prospects.

CYCLICAL VERSUS STRUCTURAL UNEMPLOYMENT

The starting point for most analytical discussion of unemployment trends is the hypothesis, introduced by Friedman and Phelps a generation ago, that at any given time a national economy is characterized by a "natural rate" of unemployment. …

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