Combatting Unemployment: Is Flexibility Enough?

Abstract

Our conclusions are the most important influences on unemployment come from the following (i) The longer unemployment benefits are available the longer unemployment lasts. Similarly, higher levels of benefits generate higher unemployment, with an elasticity of around one half. On the other hand active help in finding work can reduce unemployment. So more "flexibility" may need to be complemented by more intervention to provide active help. (ii) Union coverage and union power raise unemployment. But if wage bargaining is decentralised, wage bargainers have incentives to settle for more than the "going-rate", and only higher unemployment can prevent them leap-frogging. Although decentralisation makes it easier to vary relative wages, this advantage is more than offset by the extra upward pressure on the general level of wages. Thus, where union coverage is high, coordinated wage bargaining leads to lower unemployment. (iii) Conscious intervention to raise the skill levels of less able workers is an important component of any policy to combat unemployment. Pure wage flexibility may not be sufficient because it leads to growing inequality which in turn discourages labour supply from less able workers. Thus in these areas it is clear what types of reforms are needed. If well designed, such reforms might halve the level of unemployment in many countries. But there are three remedies which have been widely advocated in both OECD Jobs Study and the Delors White Paper. These are: less employment protection, lower taxes on employment, and lower working hours. Our research does not suggest that lower employment taxes or lower hours would have any long term effects; while the effects of lower employment protection would be small. (iv) Lower employment protection has two effects. It increases hiring and thus reduces long-term unemployment. But it also increases firing and thus increases short-term unemployment. The first (good) effect is almost offset by the second (bad) one. The gains from flexibility are small. (v) Employment taxes do not appear to have any long-term effect on unemployment and are borne entirely by labour. There may be some short-term effects, but it is not clear that there would be any fall in inflationary pressure if taxes on polluting products were raised at the same time as taxes on employment were lowered. (vi) Hours of work appear to have no long-term effect upon employment. Equally, if early retirement is used in order to reduce labour supply, it is necessary to reduce employment pari passu unless inflationary pressure is to increase. While flexibility hours and participation can reduce the fluctuations in unemployment over the cycle, they cannot affect its average level.