Increasing Earnings Inequality and Unemployment in Developed Countries: Markets, Institutions and the "Unified Theory"
It is widely accepted that global forces of technology and trade have caused a profound shift in labor demand towards the most highly skilled, generating sharply rising earnings inequality in flexible labor markets (the U.S.) and persistently high unemployment in rigid labor markets (Europe). This paper critically assesses the evidence for this "Unified Theory." It finds little compelling empirical support for either the skill-biased demand shift explanation for high U.S. earnings inequality or the rigid labor markets explanation for high unemployment in Europe. This assessment challenges the policy orthodoxy of the 1990's that developed economies feature a strict inequality-unemployment tradeoff and that policy options are therefore limited to skills enhancement in the U.S. and labor market de-regulation in Europe. It is suggested that the theoretical dominance of the textbook supply/demand model has contributed to the neglect of labor market institutions for U.S. wage outcomes and tight macroeconomic policy for European unemployment.
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