A job to do what comes naturally

The Natural Rate of Unemployment - Spanish Unemployment - Growth and Crisis in the Spanish Economy - Unemployment in Europe
January 26, 1996

European unemployment stands at a record level: the official European Union rate was 12 per cent in 1995. But the rate for Spain was twice as much. Nearly one in four of the Spanish labour force is estimated to be out of work. Even an adjustment for the hidden economy in Spain only reduces this by about 3 per cent. Why has European, and particularly Spanish unemployment escalated to these levels? This is a key question that a generation of post-1970s economists have continually had to ask themselves. The range of books under review provides an excellent opportunity to reassess some of the issues involved.

There is no shortage of analysis of Europe's employment problems. Since the ending of the long boom and the move from a demand-led to a supply-led policy regime the labour market has become the dominant arena for Anglo-American macro-economic discussion. At the forefront of this change in emphasis was the natural rate hypothesis examined in Rod Cross's edited volume. The natural rate of unemployment is that rate supposedly determined by underlying structural micro-economic conditions consistent with a steady rate of inflation; one that produces an equilibrium condition for the economy driven by adjustments in real economic variables. But the difficulty the natural rate has had in explaining the relentless rise in European unemployment is one of the reasons for its reassessment in this book. Both the pros and the antis have their say in the chapters, but it is a sceptical tone that finally characterises the book as a whole.

Three main issues are examined. First, why has the natural rate not attracted the actual rate, as it was predicted to do? Indeed, rather the reverse seems to have happened; the actual rate has attracted the natural rate. Here it is the relationship between real and nominal variables that occupies critical attention. Wages and prices are denominated in the monetary unit of account, not in real terms, so any economy-wide adjustments are likely to see deviations between equilibrium real and money values simply because of the complexity of the relationship between heterogeneous markets. The empirical reassessments of the natural rate hypothesis contained in the book indicate that the complicated mechanisms at work in the labour market require more subtle analysis than can be offered by a simple natural rate hypothesis.

Second, what alternative theoretical frameworks might be deployed to develop, or even substitute for the natural rate hypothesis? A number of alternatives are examined, chief among which are the related notions of hysteresis, path dependency and multiple equilibria (or disequilibria). The beginnings of an alternative paradigm and research programme are outlined here. There is argued to be a range of possible employment equilibria (not just a single natural rate), dependent on past employment levels, other underlying economic conditions and historical shocks to the economy. Along with the tendency of the economic system to carry with it the "memory" of these past conditions in the form of socially embedded practices and mechanisms, these processes lead to no necessary equilibrating adjustments in the labour or any other market.

Third, what has been the political economy of the strong embrace of the natural rate hypothesis among mainstream economists and policymakers? Confronting this question involves the most innovative aspect to the book. It is not often one finds political economy issues discussed so openly. In the context of European integration, for instance, the analysis of chapter 15 suggest a simple European-wide natural rate approach of relying on wage-price flexibility to resolve any differences in activity levels between countries might prove damaging and ineffective to the EU's overall performance. Instead the authors recommend active supply-side policies to reduce rigidities in labour market segmentation, but set in the context of strong "distributional" measures to combat any peripheralising tendencies in overall market integration. The interrelationships between economic and political ideas traced in other chapters are indicative of the strong political message embodied in the natural rate hypothesis.

Spain could almost constitute a test case for the natural rate framework and these other potential approaches. Indeed this is partly done in Spanish Unemployment and Growth and Crisis in the Spanish Economy. Although the first of these books considers the natural rate hypothesis as part of its analytical structure, it does not figure strongly. The analytical approach here is pragmatic. The rise in Spanish unemployment is attributed to a number of causes: the very heavy cost of getting inflation under control; an unusual importance attributed to low productivity growth; significant increases in unit labour costs; and the form of labour market bargaining where sectoral agreements set particularly high wage-level floors. As might be expected on the basis of this analysis, reform of the wage bargaining process is high on the policy agenda suggested by the book's authors.

The second book, by Sima Lieberman, offers a detailed and sustained historical reflection on the postwar trajectory of the Spanish economy as a whole. The story is a rather familiar though fascinating one: economic autarky and stagnation during the Franco period to 1959; booming growth and restructuring during the 1960s, mainly at the behest of favourable international developments; difficult transitional years in the mid-1970s as the Franco regime collapsed; economic crisis in the early 1980s, followed by major reforms in the late 1980s associated with EU entry; economic recovery through the late 1980s; and finally, the return of difficult macro-economic circumstances in the 1990s, associated with international recession and unemployment.

Leiberman's book adds some useful historical and institutional flesh to the bones of the contemporary Spanish unemployment problem. The recession in the early 1990s is attributed mainly to the restrictive domestic policy response to internal cost inflation, along with a desire to bring Spanish macro-economic conditions closer in line with the European average as integration and convergence processes gathered pace. In addition, severe structural problems in the real economy associated with a weak innovative capacity and poor industrial productivity are identified. It is clear from Leiberman's book that the Spanish economy can no longer be considered independently of that of Europe as a whole. Thus any solution to unemployment is probably reliant on Europe-wide initiatives. It is perhaps one of the weaknesses of Spanish Unemployment that it does not consider this larger context in seeking solutions to the unemployment problems it otherwise so ably identifies.

An advantage of Valerie Symes's Unemployment in Europe is that it does take a Europe-wide focus from the start. The other distinctive feature of her approach is to stress the socio-economic context of unemployment and the measures needed to tackle it. The book largely comprises a set of case studies of local community initiatives in various European urban areas, one of which is Barcelona in Spain. But it is policy at the EU level that is stressed in the final chapter. The socio-economic approach recognises the need to situate unemployment in an institutionalised historical and cultural context. This relates it to the "embedded" characteristics of the alternative approaches to the analysis of unemployment considered in The Natural Rate of Unemployment. Spanish Unemployment also recognises this by stressing the need to establish a distributional "social settlement" between interest groups for any successful sustainable reform of the labour market in Spain.

All these books suggest a re-emergence of an interest in the demand-side and the stimulation of aggregate demand as an integral part of any package to create employment opportunities. Thus the natural rate's almost exclusive emphasis on the supply side is in question.

The issue remains, however, whether it is now possible for any stimulation in aggregate demand to be considered in a single country framework, or whether it will have to be undertaken as part of a Europe-wide initiative. Along with the recognition that centralised national wage negotiation in a social compact setting remains a key element in any policy package, these analyses represent the emerging academic consensus in a post-natural rate age.

But despite the loss of an intellectual faith in the central object of reflection among many of the contributors to The Natural Rate of Unemployment the political economy of policy formation does not yet seem to have moved far towards this potential change in policy framework. The growing general academic disillusionment has yet to be properly reflected in official changes in policy stance. Even Spanish Unemployment testifies to the continuing strength of the orthodox view. Supply-side measures designed to improve the structural characteristics of the labour market remain the key element in a policy for achieving lasting reductions in unemployment. But these are at least set in combination with both demand adjustment processes and the need to secure a settlement on income distribution between the Spanish "social partners".

If only this menu of policy recommendations were to be seriously considered and actively pursued at the European-wide level, the prospects for employment in the EU could look much healthier. Is it time, once and for all, to dispense with those intellectual "Spanish practices" associated with the the natural rate hypothesis?

Grahame Thompson is a lecturer in the faculty of social sciences, the Open University.

The Natural Rate of Unemployment: Reflections on 25 Years of the Hypothesis

Editor - Rod Cross
ISBN - 0 521 47298 9 and 48330 1
Publisher - Cambridge University Press
Price - £45.00 and £19.95
Pages - 382

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