European countries are diverse nations offering different traits, policy directions and macro-economic positions. However, there is a general trend for European countries to have higher unemployment in comparison to the USA. This essay will attempt to explain the different courses of unemployment, the possible macroeconomic reasons for high unemployment, the significance, if any, of labour market rigidity as a course of high unemployment and if labour market reform can offer an effective solution. It will also briefly consider the validity of high rates in employment as a policy preference. In order to achieve these goals it will be necessary to analyse the differing stands of classical and Keynesian theory and to examine their relevance to the ‘real world’.

Primarily it is important that we consider what is meant by unemployment and the different forms that it take. Although it may seem rather simplistic to consider the meaning of unemployment, in economic terms it is a rather specific thing: ‘ those of working age who are without work, but who are available for work at current wage rates’ (’Economics Sloman, John Fifth edition Prentice Hall 2003). It is important to note, therefore, that we can not consider the problem of European unemployment to be one of people being unable to work, as inherently these will not be counted. Secondarily we must consider if Europe does in fact have an unemployment problem. If we examine the statistics then we can clearly see that whilst from 1964-2001 US unemployment has moved from 4.6% to 5.5% European union average unemployment has risen from 2.7% to 9.7%. This clearly suggests that there is an issue with unemployment in Europe. If we are to consider if labour market rigidity is a cause of this unemployment then we must consider the possible theoretical causes of this unemployment. The courses of unemployment may we broadly categorised as follows: disequilibrium unemployment and equilibrium employment. Disequilibrium employment occurs when labour supply and labour demand are not in equilibrium, this can occur in two main circumstance, ‘real-wage unemployment’ where the wage is held at an artificially high level, thus creating a decrease in demand for labour, and demand deficient or cyclical unemployment, which follows the business cycle and is a result of decreased demand. Equilibrium (natural) unemployment is the level of unemployment that would be expected even if demand for jobs is equal to supply. He types of unemployment are known as frictional, where people have left one job and are searching for another with potentially great pay or better conditions and structural unemployment, where there is a change in the pattern of demand or a change in the technology used in a company. Regional and seasonal unemployment are also significant, however they should not effect the long-term national unemployment statistics which are our concern. If Labour market rigidity is having an adverse effect on European labour markets then it should be effecting ‘disequilibrium’ employment. Therefore we must firstly consider what labour market rigidity may entail, how this can effect unemployment, and if equilibrium employment unemployment, or other factors could be coursing higher unemployment.

Let us consider what is meant by labour market rigidity. For the purposes of this essay we shall consider labour market rigidity to be the speed that an economy recovers from a ’shock’ in labour. Therefore if there is disequilibrium in the labour market, the time it takes for equilibrium to be restored. As we see in Figure 1.1 at wage one (w1) equilibrium wage price is met. Therefore supply of labour has met demand and we should expect one ‘natural’ unemployment. However, what happens if the wage goes above the equilibrium to ‘W2′. Well, we would expect there to be a ’supply surplus’ in labour and therefore unemployment. Classical economists would expect wage rates to drop therefore, and the unemployment to be removed. However, there can be a problem with so called ’stickiness’ in wages decreasing. Keynes believed that companies were reluctant to reduce wages for several reasons: artificial maintenance of a higher wage via national minimum wages, trade union power, ‘collective bargaining’, the ‘insider issue’ . Trade unions, the ‘insider issue’ and collective bargaining can all influence the tendency of companies to lower employees wages, therefore increasing employment and reducing the unemployment issue.

Although rigidity may seem to primarily effect ‘disequilibrium’ employment, it can also influence equilibrium employment. Legislation may well influence people’s choices to hire/fire employees, or how long unemployed people search for jobs. As we see in figure 1.2 people will have a tendency to ‘hold out’ for a higher paid job if they are unemployed for a set period of time. This will no doubt be increased with more generous unemployment benefits. Europe also offer more legislation on workers rights, with greater legislation on working hours, grievance procedures and dismissal rights. This is likely to increase staff turnover costs, and subsequently make employers less likely to hire/fire employees when necessary to achieve equilibrium. The ease of movement from one job to another may also increase the structural unemployment.

So, we have seen that unemployment can be coursed by a lack of flexibility in labour markets, however we must now consider if Europe offers greater degrees of inflexibility that countries like the UK, and what the alternative effects on unemployment might be. Europe offers greater average unionisation in comparison to the UK. Sweden’s unionisation rates are 83%, Finland’s 72%, Austria’s 46% compared to the UK’s 39% ( Source OECD Employment outlook 1994, chart 5.1 and tables 5.7 and 5.8). Levels of collective bargaining are also higher in most European countries with Austria tapping the tables with 98%, Belgium with 90% and the UK with only 47% ( Source OECD Employment outlook 1994, chart 5.1 and tables 5.7 and 5.8). We can also see that the UK experience less ‘labour disputes’ than several European countries, having only 70 between 1989-1993 in comparison to 4470 in Greece (source D.Bird (1994 table 1). The UK also has no compulsory restrictions on working hours, however most European nations now have some working hour restriction. To substantiate the claim that European nations offer a greater ’safety net’ against unemployment we can also note that spending on ‘ social protection’ in Sweden represents 32.4% of GDP, 25.45 in Germany, but just 21.4% in the UK (source OECD employment Outlook). WE can also note that benefits such as paid holidays and bank holidays are greater in many European countries.

We have noted that Europe has greater labour market rigidity and that this can effect the levels of employment. However, to consider it’s probable effect on unemployment level we must consider other possible factors. Structural unemployment, demographic transition, participation, capital and technology may also influence unemployment. Europe has seen a greater decrease in primary industry in comparison in the USA and this is likely to have had an influence in unemployment. As there is a lag time when people move from one type of job, coal mining for example, to another , telesales for example, there is likely to be a period of time where they are training/adapting when there is a higher rate of unemployment. As in Europe there is a notable decrease in primary industry, and an increase in the service industry one might expect a degree of unemployment. Other structural issues may well be seen in the unification of Germany, this created a high level of unemployment as the previously socialist state of east Germany reformed to a liberal economic state. This effect is still coursing problems for Germany and, as a pillar of European economic power this must influence other nations. The demographic transition model predicts that ’stage 5′ will see a degreasing of fertility rates and an increasing in the retired population. In some European nations like Italy this effect is great than in America or the UK, and ‘participation’ rates between the ages of 55-64 are notable less, with 64.3% in the UK and only 32.9% in Italy (source OECD employment outlook 1995 table J,K and B). Another issue that may well been investment in capita. There is some degree of evidence to suggest that European economies suffered from capital shortages ‘there was an apparent capital shortfall of 14% in France…34% in Germany’ (European Labour markets analysis and policy Adnett nick, Longman 1996). A capital shortage could have lead to hysteresis and prolonged unemployment. Technological change is also a possible cause of short-term unemployment, although there is little evidence to support the long-term loss of jobs of technological change, or that Europe differs significantly from the UK or US.

The effect of ‘liberalising’ markets, and de-regulating the labour market depend on the degree to which rigidity of the Labour market effects unemployment. As we have seen there are many complicated factors influencing the rate of unemployment, therefore it is not possible to give an exact figure of unemployment coursed by lack of flexibility. However, it would seem that there could well be potential benefits to increased labour market flexibility as the market would be able to more effectively equalise The UK experience would certainly seem to suggest that there could be some benefit. However, Keynesian economic theories suggest that the wage rate are, to some degree inherently inflexible and this would lead to questions about the value of increased deregulation of labour markets. Hysteresis makes it even more difficult to know the effect of macro- economic policy. The introduction of Labour market reforms will probably not solve all Europe’s unemployment problems, however it may well have a positive impact and therefore have intrinsic value.

European countries are diverse in their economies, but have a degree of similarity. They have certainly suffered from higher unemployment in comparison in the UK and USA. They also appear to have less market flexibility. It would seem, therefore, that there is a good case for cutting down on market regulation. However, there are many other factors that might effect unemployment, such as structural, capital, and demographic factors. Therefore we should not expect complete results from such reforms, or fast results, owing to hysteresis. As always, the degree to which economics believe Labour market reforms could benefit Europe depends to a large degree on their theoretical stand point, with classical economists like Says and Friedman suggesting a large effect, whereas Keynes suggesting that the effect would be limited. IT is also worth noting that, Although Europe has a higher level of unemployment, they also boast a higher level of productivity in comparison to the UK, and in many cases a higher standard of living. So Employment may well not be the be all and end all of economic strength.

‘Economics’, Sloman, John Fifth edition Pearson education limited 2003
‘Labour Markets in Transition Balancing flexibility and security’ Cazes, Sandrine Nesporova Alena
‘Labour Markets in Modern Europe ‘ Edited by Addison John Dryden Press1997
‘European Labour Market’ Adnett, Nick, Longman 1996
http://www.unece.org/press/pr2001/01gen07e.htm
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http://www.britac.ac.uk/pubs/src/keynes97/text1.html