Labour Market Reform in Europe

To solve the European unemployment problem, economists have usually advocated reforms that reduce labour market rigidities, which to increase the cost of labour: such reforms include less generous unemployment benefits, reductions in minimum wages and more flexible employment protection provisions. These recommendations are based on a cornerstone of modern economic theory: the notion of an “equilibrium rate of unemployment” to which the labour market converges in the absence of shocks, once all prices and wages have adjusted. This view holds that the equilibrium rate is entirely determined by real frictions at the microeconomic level, such as the workers’ bargaining power, information and incentive problems at the firm level, the efficiency of job search, etc. While these parameters themselves depend on the above-mentioned institutions, they do not depend on short-run fiscal and monetary policies, which only have a transitory effect on employment.