Labor Markets and Unemployment Rates: — A Cross Country Analysis Application 1 Labor Markets and Unemployment Rates: — A Cross Country Analysis

1. Cross-Country Variations in Unemployment Rates

Cross Country Variations in Unemployment Rates During the last decade, the major European economies, Australia, and Canada have persistently experienced double-digit unemployment rates. In recent years, the unemployment rate of the European Union has been about twice that of the United States.

The Standardized Unemployment Rates of Nine Major Industrial Economies: 1986-1998 Australia Canada Japan United States European Union France Germany Italy Spain United Kingdom 7.3 9.6 8.4 10.0 2.5 1986–90 3.0 5.9 9.2 10.4 9.7 11.6 8.0 10.6 18.9 20.9 9.0 8.7 1991–98 Source: OECD, OECD Economic Outlook, Dec. 1998.

2. The Structure of Labor Markets in Europe

Unionization and Centralized Wage Setting Compared to U.S. and Japan, centralized wage setting through collective bargaining is much more common in Europe and Australia. When used in large and diverse labor markets, a centralized wage-setting process will push wage rates above market levels in various regions and skill categories. This will tend to cause higher rates of unemployment.

Share of Employees Whose Wages are Set by Collective Bargaining: 1980 & 1995 Unionized Workers As a Share of Non-farm % of Employees with Wages Labor Force: 1995 Set by Collective Bargaining 1980 Low-Unemployment Countries 1995 28 24 Japan 21 26 16 United States 18 High-Unemployment Countries 88 35 Australia 80 37 38 Canada 36 85 9 France 95 91 29 Germany 92 39 Italy 85 82 76 19 Spain 78 34 United Kingdom 70 47 Sources: OECD, Employment Outlook (July 1994), Table 5.7; OECD, Employment Outlook (July 1997), Table 3.3; and OECD, Country Surveys (various issues).

Regulation of Employee Dismissal Regulations limiting the dismissal of employees are more restrictive in Europe. Regulations that make it more costly to dismiss workers will also make employers more reluctant to hire employees. Restrictive dismissal regulations will lead to sluggish employment growth and high rates of unemployment, particularly for youthful workers seeking to enter the work force.

Restrictiveness of Dismissals: The Average Months of Mandated Severance Pay and Notification for a No-Fault Dismissal: Mid 1990s Average Months of Mandated Severance Pay and Notification: 0.5 0.0 1.5 0.6 2.1* 1.4 11.6* 5.2* 3.6 Low-Unemployment Countries Japan United States High-Unemployment Countries Australia Canada France Germany Italy Spain United Kingdom *Indicates that firms must obtain government approval to layoff workers when reducing the size of their labor force. Source: OECD, OECD Jobs Study: Evidence and Explanations, 1994, Part II, Table 6.5; and OECD, Country Surveys (various issues).

Impact of Unemployment Benefits and Payroll Taxes High unemployment benefits will reduce the opportunity cost of job search, and thereby cause more lengthy spells of unemployment. Unemployment benefits are more generous in Europe than the U.S. and Japan.

Average Replacement Rate of Unemployment Benefits: 1980, 1995, & 1995 Low-Unemployment Countries 9 Japan 10 1980 10 1990 15 United States 11 1995 12 High-Unemployment Countries 22 Australia 26 27 25 Canada 28 27 30 France 37 38 29 Germany 28 26 1 Italy 3 20 28 Spain 33 32 24 United Kingdom 18 18 Sources: OECD, Employment Outlook (July 1994), Table 5.7; OECD, Employment Outlook (July 1997), Table 3.3; and OECD, Country Surveys (various issues).

Summary: Compared to the United States and Japan, the labor markets of Europe, Australia, and Canada are characterized by: centralized wage-setting processes, more restrictive dismissal regulations, and high unemployment benefits. There is reason to believe that these policies have contributed to the high unemployment rates of these economies.

3. United Kingdom & New Zealand: Case Studies on the Impact of Structural Changes in Labor Markets

United Kingdom & New Zealand: Case Studies on the Impact of Structural Changes in Labor Markets : Recent reforms in the United Kingdom and New Zealand have increased the competitiveness of labor markets. The rates of unemployment in both countries have declined and are now significantly lower than the rates of countries that follow more restrictive labor market practices.

Questions for Thought: 1. Suppose that legislation was passed requiring all employers in the United States to pay workers that were dismissed one week of severance pay for every year they were employed by the firm. What impact would this have on: (a) the dismissal rate of employee, (b) the productivity of employees, and, (c) the unemployment rate of youthful workers? 2. Do you think that the U.S. should moved toward the European labor market model characterized by more extensive collective bargaining, greater government regulation, and more generous unemployment benefits? Why or why not?

End Application 1