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Symposium 2008

Proposal - Points about the unemployment problem

The Challenge

Many people in the developed world are not participating in the growth of the world economy. In some countries, unemployment remains high, whereas others suffer from the problems of the working poo ...

Many people in the developed world are not participating in the growth of the world economy. In some countries, unemployment remains high, whereas others suffer from the problems of the working poor. What are the most effective policies for creating employment – particularly in well-paid, satisfying jobs – in OECD countries?

When fighting unemployment, supply-side policies and demand-side policies are highly complementary.

Supply-side policies

  1. The most “lenient” type of supply-side policy in the labor market is probably attempts to strengthen the market powers of labor-market “outsiders”, i. e. unemployed workers, individuals living on different types of social benefits, and new entrants to the labor market (including immigrants). Obvious examples of such policies are so called active labor market policies (ALMP), including retraining and employment subsidies for long-term unemployed and individuals with little appropriate skills. In countries, such as the US and the UK, where the wage dispersion is huge, and the number of working poor is large, it is natural to give the subsidies in the form of income transfers directly to low-wage workers (to encourage the them to work). By contrast, in countries with compressed wage dispersion, for instance as a result of high minimum wages, it makes more sense to subsidize wage costs for firms that hire low-skilled workers.
  2. However, such lenient types of supply policies have not always been successful. Training programs for low-skilled adult individuals have seldom contributed to many jobs. Moreover, employment subsidies, while often helping specific individuals to be hired, tend to crowed out employed workers from non-subsidized work. More “harsh” supply-side policies in the labor market may, therefore, also be required. An obvious example is a softening of job-security legislation for labor-market “insiders”, i. e. workers with well protected jobs in the formal sector of the economy. Other examples are a removal of laws that automatically extend collective wage agreements to firms without organized workers, and a softening of minimum wage legislation, in particular for young and inexperienced workers. Clearly, such policies have social and distributional disadvantages for those who already have jobs. The political difficulties are therefore obvious.

Demand-side policies

  1. But without an increase in the demand for labor, an increase in labor supply would simply raise open unemployment. For instance, higher labor supply may not automatically contribute to lower real product wages and hence this way boost the demand for labor. Moreover, if firms hire workers who earlier lived on various benefit systems, the income of these workers will only increase marginally, since the (after-tax) replacement rates in the benefit systems are often some 60-80 percent . Hence, product demand may not increase enough (as a result of new hiring) to contribute to a sufficient sustained increase in derived demand for labor. Of course, employment subsidies may help boost aggregate labor demand for a while. But Keynesian-type of demand management could also help. I refer, of course, to policies such as tax reductions, public-sector investment and public-sector consumption – as a complement to supply-side policies.
  2. In addition to short-term demand-management policies in product markets, some long-term structural reforms in product markets may also help boost employment, in particular, in a long-term perspective. For instance, incumbent firms are often protected against competition from potential entrants. One example is spontaneous anti-competitive behaviour of firms, such as cartel agreements. Another example is national and local government regulations that prevent the entry of firms. As a result, there is an insider-outsider divide also in product markets. Deregulations, designed to encourage entrepreneurship and hence the entry of firms, not least in the service sector, may therefore have long term positive effects on employment creation.

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