Konjunkturelle Arbeitslosigkeit, Lohnrigidität, Vereinigte Staaten, EU-Staaten, Vergleich, Cyclical unemployment, Wage rigidity, United States, EU countries, Comparison

Henri Sneessens

Olivier Pierrard

English

Research Papers in Economics

CESifo Forum 1/2004 19
Focus
AGGREGATE UNEMPLOYMENT
AND RELATIVE WAGE
RIGIDITIES
OLIVIER PIERRARD AND
HENRI R. SNEESSENS*
T
he contrast between the United States and the
EU countries in terms of unemployment is well
known. It is summarised in Figure 1. In the United
States there is no trend (if any, it is negative) over the
period 1959–2002, although the unemployment rate
remained abnormally high during the 1980s and early
1990s. In Europe, we start in the early 1960s with low
unemployment rates (around 2 to 3 percent in France,
Germany and the UK, that is, approximately half the
US unemployment rate at the same period). In the
1970s, unemployment starts increasing in all coun-
tries. Substantial intra-EU differences are, however,
observed after 1985.The unemployment rate remains
high in a majority of countries (more than 8 percent
in France and Germany, for instance), while it is on a
decreasing path in some others (mainly the United
Kingdom and the Netherlands).
The rules governing the labour market (the so-called
“labour market institutions”) are, of course, quite
different in the United States compared to most EU
countries: limited social security provisions (espe-
cially unemployment insurance), wage formation,
etc.. However, most economists agree today that
such institutional differences alone cannot explain
the differences summarised in Figure 1. Many
European countries were already enjoying well-
developed welfare systems in the late 1960s, well
before the rise in unemployment.It is also difficult to
explain US-EU differences by country-specific
shocks. Most economic shocks (oil shocks, disinfla-
tion, introduction of new technologies, etc.) were
common to all countries. Against this background,
the consensus view is that the observed variety of
outcomes can only be explained by the interaction
between specific institutional setups and common
shocks. Despite the difficulty of measuring “institu-
tions” and “shocks”, empirical work has accumulat-
ed convincing evidence supporting that point of
view.1The main challenge,however,is to uncover the
mechanisms at work, so as to be able to derive the
right policy implications and design appropriate
institutional setups.
Labour market institutions
Our understanding of the interactions between insti-
tutions and shocks and their implications for unem-
ployment has been improved by
the use of general equilibrium
models incorporating job cre-
ation and destruction, search
and wage formation behaviours.
Three institutional aspects have
been particularly emphasised in
the literature: unemployment
benefits, employment protection
and wage rigidities (in the form
of minimum wages, e.g.).
Unemployment benefits affect
the equilibrium outcome by
Figure 1
* IRES, Department of Economics
Université catholique de Louvain.
1 See for instance Blanchard-Wolfers
(2000), Bertola, Blau and Kahn (2001).changing the unemployed job
seeker’s search and bargaining
behaviour.The effect on equilib-
rium employment is clearly neg-
ative. The quantitative effects
obtained by simulating general
equilibrium models are in line
with those reported in the
empirical literature: the elastici-
ty of expected unemployment
duration with respect to benefits
is generally in the range of 0.2 to
1.0; and an increase of ten per-
centage points in the replace-
ment ratio increases the equilib-
rium unemployment rate by one
to two percentage points.2
Employment protection legislation is known to have
a priori an ambiguous effect: it decreases the job
destruction rate, but has simultaneously a negative
impact on the job creation rate. When all wages are
adjusted by free bargaining between employers and
employees, the net outcome seems to be a lower
unemployment rate.With rigid wages, the results are
reversed, albeit quantitatively small.3 Imposing a
minimum wage constraint turns out to have a strong
negative impact on employment through a higher
job destruction rate.This result is again confirmed by
empirical literature.4
The role of these three institutional variables has
been further examined in Joseph, Pierrard and
Sneessens (2004). They consider an economy where
firms are hit by firm-specific (idiosyncratic) produc-
tivity shocks. Wages are negotiated at the firm level,
but can never fall below a minimum wage determined
at the aggregate level (by a minimum wage law e.g.).
Employment protection is introduced as a firing tax.
Unemployed workers receive unconditional unem-
ployment compensation.As expected, the wage rigid-
ity reinforces the negative employment effects of
employment protection. The key result, however, is
the dominant role played by relative wage rigidity.
Numerical simulations suggest that, among the three
institutional variables considered in the model, it is
the wage rigidity associated with the least productive
jobs that explains most of the differences between
US-type and EU-type economies, both in terms of
equilibrium unemployment rates and of the cyclical
properties of job creation and destruction.
Low-skilled unemployment
It is not enough to take into account firms’ hetero-
geneity. Workers are heterogeneous, too. There is
ample empirical evidence that biased technological
change (combined with organizational changes) has
had a negative impact on the demand for low-skilled
workers.Microeconometric studies also show that the
probability to exit unemployment is much lower for
low-skilled workers. Figure 2 reproduces the differ-
ence between the low-skilled and the aggregate
unemployment rates in the four countries already
considered in Figure 1.It is in France and in Germany
that the low-skilled unemployment problem seems
most acute. More recent data, reported in Puhani
(2003), suggest that the low-skilled unemployment
problem has further increased in Germany during the
1990s. Figure 3 compares the real minimum wages in
the United States and in France over the last three or
four decades. The trends go in opposite directions:
downward trend in the United States,upward trend in
France. Standard wage dispersion indicators (D5/D1
ratios) suggest that throughout the 1980s and the
1990s wage dispersion has been increasing in the
United States and in the United Kingdom, stable or
decreasing in France and Germany respectively. This
suggests that the low-skilled unemployment problem
may be related to relative wage rigidities in the face of
relative demand changes.
Although this last conclusion is widely accepted,
there is much controversy about the contribution of
CESifo Forum 1/2004 20
Focus
Wage regidity in
least productive jobs
explains most of the
US–EU differences 
in unemployment
Figure 2
2 See for instance Layard, Nickel and Jackman (1991), Holmlund
(1998).
3 See Garibaldi (1998), Cahuc and Zylberberg (1999).
4 See for instance Kramarz and Philippon (2001) for an empirical
evidence on French micro data.CESifo Forum 1/2004 21
Focus
Is low-skill 
unemployment 
related to changes
in relative supplies, 
to crowding-out?
the low-skilled unemployment problem to aggregate
unemployment.If relative demand changes were the
main cause of low-skilled unemployment, one
should simultaneously have observed a decrease in
high-skilled unemployment,with a resulting ambigu-
ous effect on total unemployment.Some people thus
argue that the rise in low-skilled unemployment is
much more related to the change in relative supplies
rather than to the change in relative demands. With
more and more high-skilled job seekers, low-skilled
workers are crowded out of their traditional labour
market segment (the so-called “job competition” or
“crowding-out”effect).Empirical investigations cor-
relating aggregate unemployment to a variety of
institutional variables and to a measure of the
change in net relative demands for skilled workers
often suggest a limited (albeit significant) effect. A
correct evaluation is, however, made difficult by the
lack of long-run time series data on relative wages,
relative labour force and employment changes, and
on crowding-out effects.
Biased technological change
and job competition
Calibrated general equilibrium
models offer an interesting
alternative analytical tool. In
Pierrard-Sneessens (2003), we
construct a model with two
types of jobs (“simple” and
“complex”) and two types of
workers (low-skilled and high-
skilled), so as to be able to dis-
cuss both biased technological
change and job competition
issues.This representation of the
working of the economy in-
cludes frictions and search be-
haviours in the labour market.
The model is calibrated on
Belgian data (Belgium is a fairly
typical EU country in terms of
aggregate unemployment per-
formance,wage dispersion,labor
market institutions, etc.). The
numerical parameter values are
either based on the available
empirical evidence chosen so as
to reproduce the situation ob-
served in the mid-1990s,in terms
of unemployment rates, job
destruction rates,unemployment
exit rates, etc.We next introduce two changes: (i) an
increase in the proportion of high-skilled workers in
the labour force; (ii) a biased technological change
stimulating the relative demand for high-skilled
workers. The net outcome is a “net biased techno-
logical change”unfavourable to low-skilled workers.
These two changes are meant to reproduce the
changes observed from the mid-1970s till the mid-
1990s. Information on labour force composition
changes comes from labour surveys; information on
biased technological change comes from the esti-
mates of a production function.
The results of this simulation exercise are repro-
duced in Table 1 for two variants of the same sce-
nario,respectively fixed vs.flexible wages.The “fixed
relative wage” variant reproduces the observed situ-
ation: relative wages did remain unchanged over the
whole period.With this constraint on relative wages,
our representation of the working of the economy
Figure 3
Table 1
Simulating the effects of a net biased technological change
 
net
skill bias u
h u
l w
 l/w
 h
crowding
out
  Actual data (Belgium)
  1996 values     6.8%      20.1% 67% n.a.
  1977–96 +0.28 +2.1 +13.3 +0.0 n.a.
  Model with rigid wages
  1977–96 +0.28 +2.7 +10.1 +0.0 +6.5
  Model with flexible wages
  1977–96 +0.28 +0.4   +2.4 -15.5 +7.2
Sources: Pierrard and Sneessens (2003). u
h: high-skilled unemployment rate;
u
l: low-skilled unemployment rate; w
h: high-skilled wage; w
l: low-skilled wage.
Low-skilled: at most lower secondary education. High-skilled: at least upper
secondary education.reproduces quite well the unemployment changes
observed in Belgium: the high-skilled rate increases
by around 2.5 percentage points, the low-skilled
unemployment rate increases by more than 10 per-
centage points. The “flexible wage” variant mimics
quite well (from a qualitative point of view) the situ-
ation observed in countries like the United States or
even the United Kingdom: the rise in aggregate
unemployment is moderate, the relative wage of
low-skilled workers decreases,but still the difference
between the low-skilled and the high-skilled unem-
ployment rates increases. The role played by job
competition seems crucial.Although the proportion
of “simple jobs” occupied by “over-qualified” high-
skilled workers remains limited (around 6 to 7 per-
cent, which is well below the most often quoted esti-
mates of “crowding-out”), job competition con-
tributes significantly to the deterioration of the low-
skilled worker’s employment perspectives.
The conclusion seems to be the existence of a trade-
off between wage inequalities and unemployment:
low wage inequalities are associated with high unem-
ployment (typically in European economies) and
high wage inequalities are associated with high levels
of employment (typically in Anglo-Saxon countries).
Policy implications
Should we choose between income inequality and
unemployment? Table 2 reproduces the outcomes of
three policy scenarios. The results are based on
numerical simulations of a general equilibrium
model similar to the one discussed before.The refer-
ence situation is the one prevailing in 1996 (first row
of Table 1). The first policy considered is simply a
drastic reduction in the replacement ratio (50 per-
cent cut). The effects are those one would expect: a
significant reduction in the unemployment rates
(10 percentage points for the low-skilled worker
group).The cost of this increased economic efficien-
cy is a drastic increase in income inequality.The rel-
ative wage of the low-skilled worker decreases by
6.2 percent; the average consumption of low-skilled
workers decreases by 10 percent, while that of high-
skilled workers increases by 5 percent.That is,labour
market conditions (relative labour productivities,
relative labour supplies) are such that the economic
efficiency gains benefit only one category of worker
and is detrimental to the other,in absolute as well as
in relative levels.
The second policy scenario considered is a 15 per-
cent tax cut on low-skilled wages, financed by a tax
on high wages (5 percent) so as to keep the govern-
ment budget in equilibrium. This policy stimulates
the demand for low-skilled workers (the low-skilled
unemployment rate decreases by 6.6 percentage
points), while leaving high-skilled employment
almost unchanged. Both unemployment and wage
inequality are reduced, but the welfare of high-
skilled workers deteriorates.
The last policy scenario combines the previous two:
a drastic cut in the unemployment replacement ratio
and simultaneously a subsidy to low-skilled employ-
ment. The effects on unemployment rates are more
favourable than in each of the previous two scenar-
ios. This time though, the improved economic effi-
ciency benefits both categories of workers.
Conclusions
We emphasised the role of relative wage rigidities in
explaining the differences between the United States
and a “typical EU economy”. Simulating general
equilibrium models does suggest that relative wage
rigidities are one of the key institutional features
explaining both the changes observed in several EU
countries over the last decades and the contrast with
the US economy.Our conclusion is thus that to stim-
ulate employment one should change the “institu-
tions” of the labour market so as to allow more
(downward) flexibility of wage costs. Simply reduc-
ing the generosity of the unemployment benefit sys-
tem contributes to that objective, but is does so by
CESifo Forum 1/2004 22
Focus
Combining cuts in
the replacement
ratio and subsidies
to low-skilled work-
ers would reduce
unemployment 
without increasing
inequality
Table 2
Policy design, unemployment rate and income inequalities
consumption
u
h u
l W
 l/w
 h high skill low skill
  50% replacement ratio reduction –1.3 -10.0 –6.2% +5.0% –10.1%
  15% low-wage subsidy –0.4 –6.6 +7.1% –0.8% +7.4%
  Combining the two policies –1.5 –12.4 +3.2% +2.2% +0.7%CESifo Forum 1/2004 23
Focus
exacerbating income inequality. Combining this pol-
icy with wage tax cuts targeted at low-skilled work-
ers amplifies the positive employment effects and
avoids the income inequality problem. Such a policy
combination can be beneficial for both groups of
workers.
Distinguishing two groups of workers (high-skilled
and low-skilled), of course, fails to account for the
huge heterogeneity observed in actual economies.
Designing an optimal policy package is thus not that
simple. Our discussion, however, illustrates why
unemployment figures alone may be grossly inap-
propriate policy performance indicators. Labour
market reform proposals will be more successfully
and efficiently implemented if they benefit the poor-
est workers as well as the wealthiest.
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The European Labour Markets - Aggregate Unemployment and Relative Wage Rigidities

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