Fighting Unemployment: The Limits of Free Market Orthodoxy

By David R. Howell | Go to book overview

2
Wage Compression and the
Unemployment Crisis: Labor
Market Institutions, Skills, and
Inequality-Unemployment Tradeoffs

DAVID R. HOWELL

FRIEDRICH HUEBLER

It is the orthodox view that the persistence of high unemployment is explained by the rigidities imposed by labor market institutions such as centralized collective bargaining, legal minimum wages, employment protection laws, and unemployment benefit programs. Job creation is made less attractive for employers, whereas joblessness becomes more attractive for workers. These disincentives for employment growth may take place as direct effects of protective labor market institutions or indirectly through their effects on the wage structure—by raising wages at the bottom of the skill distribution, protective regulations and institutions price the less-skilled out of jobs. The policy response must be comprehensive labor market deregulation (OECD 1997; OECD 1999; IMF 1999; IMF 2003). This should be of particular importance in the aftermath of 1970s–80s productivity, energy price, technology, and trade shocks that are argued to have dramatically shifted the demand for labor away from the less-skilled. Because of the strong advocacy for this diagnosis and policy prescription by the Organization for Economic Cooperation and Development (OECD) and the International Monetary Fund (IMF), we refer to this widely accepted view as the “OECD-IMF orthodoxy.”

This orthodox explanation for persistent high unemployment has two distinct variants. In the first, institutions may increase unemployment by blocking downward wage flexibility (the wage compression variant). In the second, institutions can undermine employment opportunities not through their direct effects on the wage structure but through non-wage-labor costs and work incentives, since competitive forces ensure that the skill distribution will determine the wage structure (the skill dispersion variant).

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