Structural Unemployment

Structural unemployment is persistent, long-term unemployment caused by long-lasting shocks or permanent features of an economy that make it more difficult for some workers to find jobs.

Structural unemployment is persistent, long-term unemployment. Isn’t it redundant to say that unemployment is persistent and long-term? Not quite. In France, Germany, Italy, and Spain, for example, approximately 40% to 50% of the unemployed have been unemployed for more than one year and this has been true for about 20 years.2 In 2010 in the United States, 46% of the unemployed had been unemployed for more than 6 months (and perhaps 20% or so for more than one year), but this had been true for only about one year. The phrase “persistent, long-term unemployment” means that a substantial fraction of the unemployed have been unemployed for more than one year and that this problem has lasted for a long time. It remains to be seen whether the long-term unemployment in the United States will persist or whether this rate will fall to more traditional levels. Another way of saying this is that it is not yet clear how much of the current U.S. long-term unemployment is structural.

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What causes structural unemployment? One cause is large, economy-wide shocks that occur relatively quickly. Adjusting to these shocks can create long-lasting unemployment as the economy takes time to restructure. In addition to the oil shocks, the U.S. economy has had to restructure in recent decades because of the shift from a manufacturing to a service economy, because of globalization and because of new information technologies such as the computer and the Internet.

In the early 1800s, a militant group of textile artisans called the Luddites smashed newly invented mechanical looms because they feared that technological unemployment would lead to structural unemployment. The same fears resurfaced in the Great Depression and in the 1950s with the coming of electricity and automation. Today, many people fear that artificial intelligence will lead to unemployment for lawyers, doctors, and other professions previously considered immune to automation. So far, the worst fears of the Luddites have not come to pass. Labor-saving technology can create unemployment in some fields, but as workers move to other fields, total output increases, which raises the average standard of living and usually leads to higher wages. Since the time of the Luddites, technological change has dramatically increased the wages and standard of living of the average worker. Adapting to new technologies, however, isn’t always easy or quick and some workers can be left behind. It doesn’t help that firms often delay structural changes until falling profits force them to restructure or die. As a result, big structural changes often happen during recessions, and it becomes difficult to distinguish structural unemployment from the more temporary unemployment correlated with the business cycle (cyclical unemployment—see later in the chapter).

SEARCH ENGINE

Extensive data on the labor force and unemployment for a large sample of countries are collected by the Organisation for Economic Co-operation and Development (search for OECD Statistics).

Note that structural unemployment, if it lasts long enough, brings significant human costs in addition to the loss of economic output. Not only is the economy producing less but the unemployed suffer higher levels of stress, higher rates of suicide, and lower rates of measured happiness. Wanting a job—and not being able to find a good one—is a recipe for misery and social decay. Moreover, the stress of unemployment can last for a long-time—in one study, workers who lost their jobs in the 1970s had slightly higher probabilities of dying for as long as 20 years later compared to similar workers who had not lost their jobs in the 1970s.3

At some point unemployment can become chronic. It can be more difficult for an unemployed worker to find a job than for an employed worker to switch jobs. Unemployed workers face two problems. First, the longer a worker remains out of the labor force, the more his or her skills atrophy. An administrative assistant unemployed in 1998, for example, might have no idea what it meant to “Google something,” a critical skill for a job in 2002. Second, hiring managers may regard unemployment as a sign of laziness or other problems. Whom would you rather hire: a worker who is looking to switch jobs or a worker who has been unemployed for five years? Unemployment can become a trap, and this is another reason why unemployment rates in Western Europe are taking so long to return to normal.

Labor Regulations and Structural Unemployment

The late 1970s oil shock (as well as the other shocks previously mentioned) hit the United States as hard as it did Europe, but in the United States unemployment tends to increase with a shock and then decrease, while in Europe (especially in the big four continental economies—France, Germany, Italy, and Spain)—unemployment has increased with shocks and then remained at high levels. Table 30.1 shows that unemployment in the big four European countries has hovered around 10% or higher for 20 years and a large fraction of this unemployment has been long term. Why did unemployment rates in the United States and Europe behave so differently?

Table :

Table 30.1 Unemployment Rates in Europe vs. the United States, 1980-2004

Country

1980-1984

1985-1989

1990-1994

1995-1999

2000-2004

Fraction Unemployed for More Than One Year (2004)

France

 7.3%

 9.3%

 9.6%

 10.8%

 8.4%

41.6%

Germany

 5.9%

 6.4%

 6.7%

 9.8%

 8.8%

51.8%

Italy

 8.8%

11.6%

10.9%

11.8%

 9.3%

49.7%

Spain

15.9%

19.9%

19.6%

20.0%

11.7%

37.7%

United States

 8.3%

 6.2%

 6.6%

 4.9%

 5.2%

12.7%

Source: OECD Statistics and OECD Employment Outlook, 2005.

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Structural unemployment has been a more serious problem in Europe than in the United States because of labor regulations. More specifically, unemployment benefits, minimum wages, unions, and employment protection laws benefit some workers, but these regulations can also increase unemployment rates. All of these regulations are more generous and wide-ranging in Europe than in the United States, and that helps explain why structural unemployment is a more serious problem in Europe than in the United States. Let’s go through each labor market intervention in turn.

Unemployment Benefits Unemployment benefits are the most obvious labor regulation that can increase unemployment rates. Unemployment benefits include unemployment insurance, but also other benefits such as housing assistance that may be available in some countries. Table 30.2 shows how much of a worker’s take-home pay was replaced by unemployment benefits in France, Germany, Spain, and the United States in 1994.4 (We focus on 1994 because this is about midway through Europe’s long spell of unemployment.)

Table :

Table 30.2 Unemployment Benefit Replacement Rates in Europe vs. the United States, 1994

 

First Year

Second and Third Year

Fourth and Fifth Year

France

80%

62%

60%

Germany

74%

72%

72%

Spain

70%

55%

39%

United States

38%

14%

14%

Note: The data cover a worker with a dependent spouse and are net rates after taking into account taxes and other benefits.

Source: Ljungqvist L. and T. Sargent. 1998. The European unemployment dilemma. Journal of Political Economy 106(3): 514-550.

Martin, John P. 1996. Measures of replacement rates for the purpose of international comparisons: A note. OECD Economic Studies (26): 99-115.

In the first year of unemployment in France, the unemployment benefit system replaced 80% of a worker’s income. A worker who lost his or her job in France, in other words, faced only a 20% cut in pay. In fact, if we look only at income, and not at the satisfaction that comes from having a job, a French worker who lost his or her job was probably better off—after all, an unemployed worker had 80% of the income of an employed worker and much more leisure time (“unemployed workers” may also work for pay in the black market). In comparison, the unemployment benefit system in the United States replaced only 38% of a worker’s pay so a worker who lost his or her job faced a 62% cut in pay.

Unemployment benefits also last much longer in Europe than in the United States. In the United States, for example, unemployment benefits typically fall by more than half after just one year (although unemployment benefits are often extended in the United States when the unemployment rate is especially high). But in France, Germany, and Spain, unemployment benefits never decrease by so wide a margin.

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Given these figures, it shouldn’t be surprising that long-term unemployment is much more common in Europe than in the United States (see the last column in Table 30.1). In Europe, the price of unemployment is low, so more unemployment (leisure) is demanded. Or, if you like, workers in Europe can afford to remain unemployed for longer periods than workers in the United States.

In summary, unemployment benefits reduce the incentive for workers to search for and take new jobs. Now switching to look at the demand side of the labor market, minimum wage, unions, and employment protection laws reduce the incentive of firms to create and offer new jobs.

Minimum Wages and Unions In the left panel of Figure 30.4, we analyze the minimum wage (see Chapter 8 for a more extensive discussion). The minimum wage raises the price of labor from the market wage to the minimum wage, and as labor becomes more expensive, firms reduce employment from market employment to minimum wage employment Qd. At the minimum wage, the number of workers looking for work Qs exceeds the number of jobs Qd—thus, the minimum wage creates unemployment in the amount Qs - Qd.

The Minimum Wage and Unions Increase Unemployment In the left panel, the minimum wage raises the wage, thus decreasing the quantity of labor demanded. In the right panel, the union threatens to strike unless the firm pays the union wage. The increase in the wage decreases the quantity of labor demanded.

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The median wage is the wage such that one-half of all workers earn wages below the median and one-half of all workers earn wages above the median.

In Western Europe, minimum wages have been higher than in the United States. Between 2000 and 2007, for example, the minimum wage in France was about 40% higher than in the United States. Minimum wages in Western Europe have also been higher relative to the median wage than in the United States. (The median wage is defined so that half of all workers earn less than the median and half more.) In France, the minimum wage has been about 61% as large as the median wage. In the United States, the minimum wage has only been about 32% as large as the median wage.5 What this means is that the minimum wage will affect more workers and create more unemployment in France than in the United States. As discussed in Chapter 8, the minimum wage is more likely to create unemployment among young workers, who tend to be less productive, than among older workers. Thus, in both France and the United States, unemployment rates are higher among the young than the old, but in 2005 in France 21% of workers under the age of 25 were unemployed, while in the United States 11% of these workers were unemployed.6 The U.S. minimum wage, however, has been rising rapidly in recent years from $5.15 at the beginning of 2007 to $7.25 today.

A union is an association of workers that bargains collectively with employers over wages, benefits, and working conditions.

Unions are also more powerful in Europe than in the United States. A union is an association of workers that bargains collectively with employers over wages, benefits, and working conditions. In the United States, most (87%) workers are not governed by a union contract; instead, they have an individual contract (written or unwritten) with employers. In many European countries, however, 80% of workers or more are governed by a union contract.

Unions can provide value for workers and employers alike, but excessively strong unions have a very similar effect as minimum wages. Unions demand higher wages by using their power to strike and to prevent the firm from hiring substitute labor. In the right panel of Figure 30.4, the union raises the price of labor from the market wage to the union wage. As labor becomes more expensive, firms reduce employment from market employment to union employment Qd. At the union wage, the number of workers looking for work Qs exceeds the number of jobs Qd —thus, unions increase unemployment by the amount Qs - Qd.

The employment at-will doctrine says an employee may quit and an employer may fire an employee at any time and for any reason. There are many exceptions to the at-will doctrine, but it is the most basic U.S. employment law.

Employment Protection Laws In the United States, an employee may quit and an employer may fire at any time and for any reason. This is called the employment at-will doctrine. There are many exceptions to the at-will doctrine, the most important being that the doctrine can be changed by contract. Many workers, for example, have contractually guaranteed severance packages and tenured university professors cannot be fired at will. Employees can also be restricted by contract. Employees in some industries with a lot of trade secrets are often asked to sign a noncompete agreement when they are hired. If an employee who signs a noncompete agreement quits, he or she may be forbidden, for example, from working for a competitor for a set period. Public law also imposes certain restrictions; employers, for example, are forbidden from hiring or firing on the basis of race, religion, sex, sexual orientation, national origin, age, or handicap status. Despite many exceptions, the at-will doctrine can be thought of as the most basic U.S. labor law.

In most of Europe, labor law is quite different. Portugal’s constitution, for example, forbids at-will employment and requires employers to notify the government whenever a worker is dismissed. Moreover, if a Portuguese firm needs to lay off a group of workers, it must get the government’s permission. Nor can the firm choose which workers to lay off; instead, it must follow strict guidelines determining which workers will be laid off first (generally, the most junior workers are fired first). In addition, laid-off workers must be given 60 days’ notice, severance pay, and other benefits. Throughout Western Europe, public law and collective bargaining—not contracts—govern things like the length of the workweek, overtime pay, paid leave, temporary employment, notice periods, severance pay, and more.

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Hiring and firing costs make labor markets less flexible and dynamic. A European firm with an unexpected increase in orders, for example, will not simply hire more workers. If the firm hires more workers and orders then decline, it would be stuck with workers it could not lay off without incurring great expense. Thus, hiring and firing costs make firms more cautious and slower to act.

Greater job security is valuable to workers with full-time jobs, but the more expensive it is to hire and fire workers, the more difficult it will be for new workers and unemployed workers to find jobs. Imagine, for example, how difficult it would be to get a date if every date required marriage! In the same way, it’s more difficult to find a job when every job requires a long-term commitment from the employer.

The World Bank calculates a “rigidity of employment index,” which summarizes hiring and firing costs, as well as how easy it is for firms to adjust hours of work (e.g., whether there are restrictions on night or weekend hours). A higher index number means that it is more expensive to hire and fire workers and more difficult to adjust hours. Figure 30.5 plots the rigidity index against the percentage of unemployment that is long term (lasting more than one year). The red line shows the trend in the data; greater rigidity in labor markets is clearly associated with greater long-term unemployment. Notice especially that France, Germany, Italy, and Spain all have high rigidity and high long-term unemployment, while the United States has the least rigid labor markets and one of the lowest rates of long-term unemployment.

Hiring and Firing Costs Increase Long-Term Unemployment
Source: World Bank and OECD Statistics, 2003 data.

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A Tale of Two Riots The tale of two riots illustrates another effect of employment protection laws. Paris, the city of lights, was lit up by hundreds of burning vehicles in November 2005 as angry, predominantly immigrant youth rioted in the streets. The riots were triggered by accusations of police brutality, but poverty and unemployment were the larger underlying frustrations. Unemployment rates among the rioting youth were over 30%.7

Outsider riot
Paris suburbs, 2005
CORENTIN FOHLEN/MAXPPP/LANDOV
Insider riot
Central Paris, 2006
DENIS/REA/REDUX

French firms were reluctant to hire young, minority workers— perhaps, in some instances, because of discrimination, but also because the more expensive it is to hire and fire, the more reluctant firms will be to hire workers without experience and workers for which there is any perceived uncertainty about quality. Once again, if every date required marriage, would you go on a blind date? A blind date might be worth some risk if you can dump a loser, but who will go on a blind date if a date means forever? So with regard to firms, young workers are riskier than older workers. Workers without a job are riskier than workers with a job (recall our discussion of the unemployment trap). And minority workers or workers who in some way differ from the “norm” may be regarded as more risky than typical workers by some employers. Thus, employment protection laws tend to have the most negative effects for young, already unemployed, and minority workers.

The French government was aware of these problems and in response to the riots it proposed to change labor law so that for workers under the age of 26, employment would be at-will for the first two years. The idea was to reassure firms that hiring a young, immigrant worker could be more like a blind date and less like marriage. Of course, this at-will employment is the norm in the United States. For elite French youth, however, the idea that they could be fired at will was upsetting and an infringement of what they considered to be their rights. Several hundred students barricaded themselves in the Sorbonne, the famous Paris university, and called on students everywhere to protest.

Now it was time for the insiders, the young elite, to riot and they proved every bit as adept at burning cars as had the impoverished youth of the year before. Not surprisingly, the elite riots were effective—the French government quickly backed down from the at-will employment doctrine. Unemployment in France, especially among young, immigrant workers remains high.

Summarizing, employment protection laws have the following effects. They:

Create valuable insurance for workers with full-time jobs.

Make labor markets less flexible and dynamic.

Increase the duration of unemployment.

Increase unemployment rates among young, minority, or otherwise “riskier” workers.

Labor Regulations to Reduce Structural Unemployment

With active labor market policies, like work tests, job search assistance and job retraining programs focus on getting unemployed workers back to work.

In recent years, Europe has begun to change some of its labor regulations to try to reduce long-term unemployment. In Denmark, for example, unemployment benefits were limited to four years, and after one year workers who wish to continue receiving benefits must either enroll in job search or job training programs or take public employment. Denmark also subsidizes employers who are willing to train unemployed workers. Denmark and other countries now also have work tests—requirements that unemployed workers who want benefits must prove that they are actively seeking work.8 These types of laws are called active labor market policies.

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The United States has been a leader in testing active labor market programs. One of the most successful programs is the simplest—pay workers to get a job! In several large-scale experiments, randomly chosen unemployed workers were told that they would be paid a bonus if they found work early. The workers who were told about the bonus got jobs significantly sooner than those not promised bonuses.

Europe has also been slowly moving toward more flexible labor markets by allowing some exceptions to collective bargaining agreements for certain categories of workers such as young workers, temporary workers, and part-time workers. Remember, however, the tale of the two riots. “Insiders” have been very reluctant to give up their benefits for the sake of the unemployed “outsiders.”

Factors that Affect Structural Unemployment

Let’s summarize the factors that can increase structural unemployment. These are:

Large, long-lasting shocks that require the economy to restructure. For example:

Oil shocks

Shift from manufacturing to services

Globalization and global competition

Fundamental technology shocks (computers, the Internet, and—maybe—artificial intelligence)

Labor regulations:

Unemployment benefits

Minimum wages

Powerful unions

Employment protection laws

CHECK YOURSELF

Question 30.3

Define structural unemployment.

Question 30.4

Why does the term “employment at-will” accurately describe the United States but not Western European countries?

We also discussed some policies that can reduce structural unemployment. These include:

Active labor market policies:

Job retraining

Job-search assistance

Work tests

Early employment bonuses