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The Role of Institutions and Policies in Creating High European Unemployment: The Evidence.” Working Paper No. 336. Annandale-on-Hudson, N.Y.: The Levy Economics Institute

By Thomas I. Palley


My thanks to Heidi Hessler for her help in compiling the data set used in this paper. All responsibility for any errors of fact and inference is mine. THE DEBATE OVER THE CAUSES OF HIGH UNEMPLOYMENT The economies of western Europe remain afflicted by high and intractable rates of unemployment, with the European Union unemployment rate standing at 8.3 % as of September 2000, while the unemployment rate in the eleven country euro zone area was 9.0%. In stark contrast, the U.S. unemployment rate touched a thirty year low of 3.9 % in September 2000. This divergence in performance has opened a great debate. One side claims that Europe's unemployment is the result of rigid sclerotic labor markets that have rendered it incapable of adjusting to technological advance and change in the international economy. Unemployment benefits are too generous and their duration too long, unions are too strong, and employee protections are such that firms are discouraged from hiring workers. This contrasts with the U.S. economy which is marked by flexible dynamic labor markets that have adjusted to these developments and used them to create new jobs. The other side claims that Europe's unemployment problem is significantly attributable to bad macroeconomic policy (Baker and Schmitt 1998; Palley 1998, 1999; Solow 1994), which has resulted from mistaken adherence to the theory of the natural rate of unemployment. This has prompted policy makers to adopt austere macroeconomic policies aimed at reducing inflation, regardless of the unemployment cost or the underlying cause of inflation. Currency market concerns have also played an adverse role. In the 1980s and 1990s the persistent threat of currency speculation induced European governments to raise rates so as to defend their currencies and guard against imported inflation. Subsequently, arrangements leading up to the introduction of the Euro aggravated the problem as countries were forced to satisfy strict fiscal convergence criteria that called for policies of austerit

Year: 2010
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