Why Europeans Stay On The Dole

Wage prospects lag high benefits

Of all the problems facing European economies, that of high and persistent unemployment looms as the most intractable. By contrast, joblessness in the U.S. is not only at a seven-year low but is running at less than half of Europe's double-digit rate.

Why the difference? While some blame Europe's high unemployment insurance and related benefits (chart), others are skeptical. They note that the big gap between European and U.S. jobless rates emerged in the 1980s. Yet Europe's jobless benefits were generous as early as the 1960s, when its unemployment was half that of the U.S.

Economists Lars Ljungqvist of the Federal Reserve Bank of Chicago and Thomas J. Sargent of the University of Chicago say this argument misses the point, however. They contend that generous jobless benefits have little effect on unemployment in normal, tranquil times, as in the early postwar period. In turbulent economic times, on the other hand, high benefits such as those prevailing in Europe can foster a state of persistent high unemployment.

In the early postwar decades, when the structure of industrial economies was more stable, notes Ljungqvist, both European and U.S. workers who lost their jobs could be confident of finding a similar job at similar pay without too much trouble. Skills acquired at one job were easily transferred to another job and commanded commensurate pay from new employers. Jobless benefits might be high, but wages received by job-changers were significantly higher.

All this changed in the 1980s and 1990s. Foreign competition, globalization, deregulation, and new technology altered industry structures and roiled job markets. In surveys of displaced U.S. workers from 1984 to 1994, for example, only 25% of those who found new jobs were employed in their old industries, and 38% suffered wage declines exceeding 10%. A Chicago Fed study of high-seniority workers laid off in the 1980s found that annual earnings were still down 25% after five years.

Similar forces have affected European labor markets. But with jobless benefits there running as high as 70% of former earnings, Ljungqvist and Sargent theorize that many laid-off workers with outmoded skills are in no hurry to take new jobs paying no more than current benefits. The longer they search for "the right job," however, the more their remaining marketable skills--and value to new employers--deteriorate.

The upshot is a vicious circle leading to chronic high unemployment. "The irony," says Ljungqvist, "is that today's turbulent economic environment has increased the perceived need for social insurance, while weakening its effectiveness as a transitional safety net." Europe's challenge is to redesign its insurance so that it still alleviates pain but encourages people to go back to work.

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