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Full employment or a 'natural' rate of
unemployment (NAIRU)?
by
Dr Alfred Kleinknecht
Emeritus Professor of Economics
Fellow of WSI, Wirtschafts- und Sozialwissenschaftliches
Institut, Hans Bӧckler Stiftung, Düsseldorf
[email protected]
Historical Background:
After the Great Crisis (1929-1941) …
A 'Golden Age of Capitalism' (1946- ca. 1973):
• Unprecedented economic growth
• Low unemployment
• Low inflation
• Fairly stable financial markets
The Age of
Keynes!
Broad consensus:
• Manchester capitalism is passé
• Economic stability through fiscal and monetary policy
• Solid regulation of financial markets
• A decent security net
After the 'Golden Age' (1946-73) there is a
turning point around 1975-1985:
•
•
•
•
•
•
Slowdown of economic growth …
… which cannot be reversed by fiscal stimulation
Oil price shock and 'Stagflation' (stagnation + inflation)
'Dutch Disease' → plant closures and mass unemployment
Growing government debt burden
Keynesian macro-models make tough forecasting errors
All this was a fruitful breeding ground for an anti-Keynesian
counter-revolution from the right:
Supply-side economics!
Supply-side economics (1):
• Passive economic policy: no more fiscal stimulation; only
monetary policy for fighting inflation
• Striving for greater income inequality: 'Performance must
pay!'
• Deregulation of labor markets: easier firing!
• Cutting back on social security ('it makes people passive!')
• Retreat of government: deregulation, liberalization,
privatization; Hayek (Nobel Prize 1974): 'Minimal State'!
• Deregulation of financial markets: more room for financial
innovation!
• Markets are never wrong … and government is at the roots
of every problem!
Supply-side economics (2):
.
NAIRU = NonAccelerating Inflation
Rate of Unemployment
Theory of 'Natural Unemployment' → You need a sufficiently
large rate of unemployment in order to discipline labour and
prevent inflation through high wage claims
Estimated rates of NAIRU ('natural' unemployment rates):
Netherlands 4.5%; most other countries: 5-7%
If unemployment is below the NAIRU level, there is a risk of
wage-price inflation! → the ECB will intervene by raising
interest rates → restore ‘sufficient’ unemployment → strong
competition for scarce jobs assures modest wage claims …
Frame: The Euro has to be a hard and reliable currency!
Supply-side economics works (at least in one point):
Greater inequality …
Share in National Income in the US:
Of the richest 10%:
 33% in 1976
 50% in 2007
… and of the richest 1%:
 8.9% in 1976
 23.5% in 2007
Source: Atkinson, Piketty and Saez (2011)
US: Average income of the bottom 90% and of
the top 1%, 1933-2006
Keynesiaanse
periode
Supply-side
politics
Krediet
US: Domestic debt as a percentage of GDP (1950-2007)
"Household" = Consumer and mortgage debt
"Business" = Total non-financial business sector debt
"Financial" = Total financial sector debt
"Public" = total public sector debt (local and federal)
Source: US Federal Reserve
Hefboom
financieringen!
Zeepbel met
huizenprijzen
→ hogere
hypotheken
voor
consumptie
The labour market for professors in full
employment equilibrium
As professors become
cheaper, universities
buy more of them (as
with apples!)
How could we get
long-lasting (mass)
unemployment
among professors?
S = Supply of professors
Equilibrium
wage W e
As wages rise, more
people offer themselves
as professors
D= Demand for professors
Market clearing equilibrium quantity
Professors get unemployed as their wages are too
high!
Aggressive
trade
unions
raise
wages
One way to full employment:
Follow the green arrows!
S = Supply of
professors
Market
clearing
wage
D = Demand for
professors
Q
Universities
demand fewer
professors
Unemployed
professors
Supply of professors is
too high
The dominant neo-classical view:
High European unemployment is due to labour
market rigidities: the price of labour is downwardly
rigid and cannot adapt to economic shocks
Key policy targets:
 Lower minimum wages
 Lower social benefits
 More tailor-made wage contracts (de-centralization of wage
bargaining → allow for a more unequal income distribution!)
 Easier firing: change power relations on the shop floor
 Reduce the power of trade unions (= cartels that act against
the real interest of labour!)
'Liberal Market Economies' (LME) versus
'Coordinated Market Economies' (CME)
according to Hall & Soskice (2001)
LME countries:






USA
Canada
Australia
Ireland
Great Britain
New Zealand
CME ('Old Europe'):
 Most continental European
countries
 Japan
Labor market institutions in LME versus CME
LME (Anglo-Saxon):





Easy hiring and firing
Shorter stay in same firm
Modest unemployment
benefits
Weak trade unions
Wage bargaining more decentralized: income
distribution more unequal
Strong protection
of investors
CME ('Old Europe'):





Protection against firing
Longer stay in same firm
Generous unemployment
benefits
Strong trade unions
Wage bargaining more
centralized: more income
equality
Strong protection
of labor
Labor market institutions in LME versus CME:
Is there a difference in economic performance?
(incomes? job creation? Productivity growth?
GDP growth?)
Looking at some key variables …
Anglo-Saxon labour market institutions lead to modest wage growth…
Development of real wages,
1960-2004; 1960 = 100
450
Development of real wages, 1960 = 100
EU-12 excl.
Luxemburg
400
350
300
250
200
150
100
50
0
Anglo-Saxon
countries: US,
UK, Canada,
New Zealand,
Australia
Differences in real wage growth make no difference for GDP growth
Development of real GDP,
1960-2004; 1960 = 100
500
Anglo-Saxon
countries: US, UK,
Canada, New
Zealand, Australia
450
400
350
300
EU-12 excl.
Luxemburg
250
200
150
100
50
0
Year
… but it does make a difference for labour productivity growth
Development of Labour Productivity,
1960-2004; 1960 = 100
500
450
400
350
300
EU-12 excl.
Luxemburg
250
200
150
100
50
0
Anglo-Saxon countries: US,
UK, Canada, New Zealand,
Australia
… and for labour input
Anglo-Saxons create
more jobs … !
Development of labor hours
1960-2004 (1960 = 100)
200
180
Anglo-Saxon
countries: US,
UK, Canada, New
Zealand,
Australia
160
140
120
100
EU-12 excl.
Luxemburg
80
60
40
20
0
… or they have
to work longer
for the same
GDP …
Is there a causal link from wage growth to
labour productivity growth?
Traditional argument:
 Labour productivity growth → wage growth (end of story)
Alternative view:
 There is also a link: wage growth → labour productivity
growth (estimated coefficients: 0.39 ~ 0.49)
Source: R. Vergeer & A. Kleinknecht (2011): 'The impact of labor market
deregulation on productivity: A panel data analysis of 19 OECD countries
(1960-2004)', Journal of Post-Keynesian Economics, Vol. 33 (2): 371-407.
N.B. Evidence at macro-level is meanwhile confirmed by a
series of firm-level studies
Reasons for feedback from wages to labour
productivity growth:
Neoclassical theory:
 Factor substitution
 Vintage effect
 'Induced' technical change
Evolutionary theory:
 'Creative destruction' (Rehn-Meidner theorem)
Theoretical arguments about the impact of flexible
labour on labour productivity (1):


Difficult and expensive firing of redundant personnel frustrates
labour-saving process innovations (Bassanini & Ernst, 2002;
Scarpetta & Tressel, 2004)
With easier firing, shifting labour from old and declining industries
to innovative activities is easier (Nickell & Layard, 1999)
Counter arguments:
 Difficult firing gives incentives for training thus increasing
functional flexibility;
 People on the shop floor possess much of the (tacit) knowledge
required for process innovations. People threatened by easy firing
have incentives to hide knowledge relevant to labour-saving
process innovations (Lorenz, 1992, 1999)
Theoretical arguments about the impact of flexible
labour on labour productivity (2):
 Easier firing enhances the inflow of 'fresh blood' (i.e. of
people with novel ideas and networks)
 Powerful labour may appropriate rents from innovation,
thus reducing the incentive to take innovative risks
(Malcomson, 1997; Menezhes-Filho & Van Reenen, 2003;
Metcalf 2002)
↕
 Counter argument: This holds primarily for (Anglo-Saxon)
de-centralized wage bargaining and much less for
(European) centralized bargaining
Theoretical arguments about the impact of flexible
labour on labour productivity (3):
 The (latent) threat of easy firing reduces shirking (→
Counter argument: this is poor HRM policy!)
 Firms can more easily replace weak people by better
personnel (→ Counter argument: a fallacy of composition!)
Theoretical arguments about the impact of flexible
labour on labour productivity (4):
Flexible 'hire & fire' reduces loyalty and commitment:
 Greater chances that trade secrets and technological
knowledge will leak to competitors, larger positive
externalities leading to stronger under-investment in
knowledge.
 There is more need for monitoring and control. AngloSaxon countries have substantially larger management
bureaucracies which is frustrating for creative people
(Kleinknecht et al. 2006).
Share of managers in working population
(19 OECD countries, 1984-1997)
Norway
Spain
Greece
Sweden
Italy
Switzerland
Belgium
Ireland
Germany
Portugal
Japan
Denmark
Finland
Austria
Netherlands
U.K.
Australia
USA
Canada
According to De Beer
(2001), the Dutch figure
increased from 2% to 6%
during 1978-98
0
5
10
15
Managers as a percentage of the non-agrarian working population
Theoretical arguments about the impact of
flexible labour on labour productivity (5):
Given easier firing and higher labour turnover:
 Firms will reduce investments in manpower training as
pay-back periods become shorter.
 Personnel have fewer incentives to invest in firmspecific knowledge (e.g. safety instructions)
 A larger personnel turnover weakens the 'historical
memory' of organizations and the 'learning organization'.
 Easy firing of personnel will change power relations in
firms. People will less easily criticize management
decisions. Lack of critical feedback from the shop floor
can favour problematic management practices.
Theoretical arguments about the impact of
flexible labour on labour productivity (6):
Schumpeter I model (1912):
 'Entrepreneurial model': new firm foundation (e.g. in ICT,
biotechnology); inventor-entrepreneur ('Garage business').
Schumpeter II model (1942):
 'Routinized innovation model': Professionalized R&D labs in
large firms. Incremental innovations based on continuous
accumulation of (tacit) knowledge with strong path
dependencies
Impression from trade statistics:
 Anglo-Saxon countries perform better in Schumpeter I
regimes
 'Old Europe' performs better in Schumpeter II regimes
Schumpeter I Model
(‘garage business'):
Schumpeter II Model
('routinized innovation'):
Low tech firms; starters in high
tech (e.g. IT)
Larger medium-tech and high tech
firms with professional R&D labs
Many SME/young firms
Stable oligopolies
Turbulence (many new entrants;
high failure rates)
Stable hierarchy of (dominant)
innovators
Properties of knowledge base…
Spontaneously available, general
knowledge → low entry barriers
Dependence on historically
accumulated and often firmspecific (tacit) knowledge from
experience → high entry barriers!
… and appropriate labour market institutions:
Recruitment through external
labour market
Internal labour markets → wellprotected “insiders”
This table is inspired by: S. Breschi, F.Malerba & L. Orsenigo (2000): 'Technological regimes
and Schumpeterian patterns of innovation', in: Economic Journal, Vol. 110: 288-410.
Rounding up (1): Are flexible labour markets good
for labour productivity growth?
Evidence at macro and micro level:
 Flexible labour relations and wage restraint lead a to lower
growth of labour productivity and a more labour-intensive
(less capital-intensive) growth path
 Ironically, this resembles the factor-intensive growth
pattern in Eastern Europe before 1989!
 A low-productive and labour-intensive growth path is
problematic with an ageing population in Europe!
Rounding up (2): Can we create more jobs under an
LME regime (with deregulated labour markets)?
Probably 'Yes': if you succeed to bring down labor productivity
growth
A likely scenario if the NAIRU doctrine remains dominant!
But note: According to the logic of a declining demand curve
for labor, you have to create mainly lower-paid jobs i.e. create
a larger group of 'working poor'
Anglo-Saxon countries with deregulated labor markets
have higher shares of working poor ('outsiders')
Rounding up (3): Can we bring down
unemployment under an 'Old Europe' regime?
Probably 'No' (or at least doubtful) under protective 'Old
Europe' labor market institutions …
Why? High productivity growth!
Law of Verdoorn → higher growth of GDP will trigger higher
growth of GDP/working hour (= labor productivity)!
N.B: In the past, Europe had long periods of high GDP growth
in which input of working hours stagnated (or even slightly
declined) → But full employment has been achieved through
shorter working times …
A desirable Green-Left scenario (?)
… but undesirable from a NAIRU viewpoint!
200
Development of labor hours
1960-2004 (1960 = 100)
180
Anglo-Saxon
countries:
US, UK,
Canada, New
Zealand,
Australia
160
140
EU-12 excl.
Luxemburg
120
100
80
60
40
20
0
Years
Long-run growth of GDP, of GDP/labor hour and of labor hours (per
1% GDP growth)
Average Annual
GDP growth
Old
Europe
AngloSaxon
countries
1950-60
5.5
1960-73
Average annual
GDP growth per
hour worked
Growth of labor
hours per 1% GDP
growth
Old
Europe
AngloSaxon
countries
Old
Europe
AngloSaxon
countries
3.3
4.2
3.6
0.23
-0.09
5.1
4.1
5.2
2.7
-0.03
0.34
1973-80
2.7
2.4
3.0
1.1
-0.14
0.55
1981-90
2.6
3.2
2.4
1.4
0.07
0.55
1990-00
2.4
3.1
1.9
1.9
0.21
0.40
2000-04
1.3
2.5
1.1
1.6
0.15
0.35
Old Europe: EU-12 (excl. Luxemburg)
Anglo-Saxon: Australia, Canada, New Zealand, US and UK
Rounding up (4): Do Anglo-Saxon countries have
lower unemployment rates?


Yes: Nickell, Nunziata & Ochel: 'Unemployment in the OECD: What
do we know?', in: Economic Journal, Vol. 115 (2005): 1-27.
Doubts: According to our re-estimates*, their results are not
robust! → It is doubtful whether the 'flexible' countries indeed
have lower unemployment rates (in spite of their labour-intensive
growth!)
Why no lower unemployment rates?
 Anglo-Saxon countries have generous immigration policies
 In the aftermath of Reaganomics: Longer working hours
 The role of the Central Bank (NAIRU!)
*Source:
Vergeer, R. & A. Kleinknecht (2012): 'Do flexible labor markets indeed reduce
unemployment?' in Review of Social Economy, Vol. LXX (December): 451-467.
Summarizing: What are the main differences
between CME and LME?
The two regimes do not differ with respect to:
• Long run economic growth
• Unemployment rates (although LMEs create more jobs)
Where do they differ?
• LME have lower rates of labour productivity growth (value added
per labour hour); so they have to work more hours for the same
GDP - in exchange they create more jobs
• Income distribution in LME is more unequal (more working poor)
• Innovation:
– Old Europe does better in Schumpeter II industries
– LME do better on Schumpeter I industries
Summarizing: The most important barrier to full
employment: NAIRU theory
NAIRU = NonAccelerating Inflation
Rate of Unemployment
The European Central Bank has the task of assuring a
sufficiently high level of unemployment (in the name of
fighting inflation) → prevent 'too much' solidarity by
assuring strong competition for scarce jobs
Handsome frame: The Euro should be a 'hard' and
'solid' (say: investor-friendly) currency!