Unemployment and Inflation
Another common misperception is that there is some trade off between unemployment and inflation. Both Friedman and Phelps attacked this notion. Unemployment seems to have a “natural” (equilibrium or homeostatic) rate, which is determined by the structure of the labour market. The natural rate of unemployment is consistent with stable inflation (NAIRU – Non Accelerating Inflation Rate of Unemployment).
Making more people employable at the prevailing level of wages can lower NAIRU. This should lead to a big drop in unemployment together with a tiny increase in permanent inflation. Phelps actually sought to lower NAIRU and raise the incomes of the working poor. Stiglitz calculated that the changing demographics of the labour force and the3 competition in markets for goods and jobs reduced NAIRU by 1.5% in the USA. R. Gordon, D. Staiger and M. Watson support these findings.
It emerges, therefore, that the gap between the estimated NAIRU and the actual rate of unemployment is a good predictor of inflation.
The Rhineland Model the Poldermodel and Other European Ideas
The Anglo-Saxon variety of capitalism is intended to maximize value for shareholders (often at the expense of all others, including the workers).
The Rhineland model is capitalism with a human face. It calls for an economy of consultation among stakeholders (shareholders, management, workers, government, banks, other creditors, suppliers, etc.)
In the Netherlands there is a Social and Economic Council. Its role is advisory and it is semi-corporatist. Another institution, the Labour Foundation is a social partnership between employees and employers.
But the Netherlands succeeded in reducing its unemployment rate from 17% to less than 5% by ignoring both models and inventing the “Poldermodel”, a Third Way. Wim Duisenberg, the Dutch Banker (currently Governor of the European Central Bank), attributed this success to four elements:
Improving state finances
Pruning social security and other benefits and transfers
Flexible labour markets
Stable exchange rate.
The Dutch miracle started in 1982 with the Wassenaar Agreement in which employers’ organizations and trade unions agreed on wage moderation and job creation, mainly through decentralization of wage bargaining. The government contributed tax cuts (which served to replace forgone wage increases). This fiscal stimulus prevented a drop in demand as a result of wage moderation. Additionally, restrictions were placed on social security payments and the minimum wage. For instance, increases in wages were no longer matched by corresponding increases in minimum social benefits. Working hours, hiring, firing and collective bargaining were all opened up to labour market forces. The strict regulation of small and medium size businesses (which drove up labour costs) was relaxed. Generous social security and unemployment benefits (a disincentive to find work) were scaled back. The Netherlands did not shy from initiating public works projects, though on a much smaller scale than France, for instance. The latter financed these projects by raising taxes and by increasing its budget deficit. The result could well be a reduction in employment in the long run (the effect of taxation). In the absence of monetary instruments such as devaluation (due to the EMU), the only remedy seems to be labour market flexibility.
Such flexibility must include a substantial adjustment in sickness benefits, vacation periods, maternal leave and unemployment benefits.
The long term (more than 12 months) unemployment in Europe constitutes 40% of the total unemployment. About HALF of the entire workforce under the age of 24 is unemployed in Spain. It is about 28% in France and in Italy. Germany, Austria and Denmark escaped this fate only by instituting compulsory apprenticeship. But the young become the kernel of long-term unemployment. This is because a tug of war, a basic conflict of interests exists between the “haves” and “have-nots”. The employed wish to defend their monopoly and they form labour cartels. This is especially true in dirigiste Europe.
While in the USA, 85% of all service jobs created between 1990-5 paid more than the average salary – this was not the case in Europe. Add to this the immobility of labour in Europe and a stable geographical distribution of unemployment emerges, not ameliorated by labour mobility.
The Dutch model sought to battle all these rigidities:
The Dutch reduced social security contributions from 20% (1989) to 7.9% and they halved the income tax rate to 7% (1994).
They allowed part time workers to be paid less than full timers, doing the same job.
They abandoned sectoral central bargaining in favour of national bargaining – but more decentralized.
They cut sickness benefits, unemployment insurance (benefits) and disability insurance payments (by 10% in 1991 alone – from 80% to 70%).