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The Role of Institutions and Policies in Creating High European Unemployment: The Evidence

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  • Thomas I. Palley

Abstract

The conventional wisdom is that high European unemployment is the result of job markets that are rigid and inflexible. This paper presents new empirical evidence that challenges this received wisdom. A major contribution of the paper is that it fully accounts for both micro- and macroeconomic factors, as well as taking account of cross-country economic spillovers. The evidence shows that macroeconomic factors dominate in explaining unemployment. These factors are robust to changes in empirical specification. Labor market institutions do matter for unemployment, but not in the way conventionally spoken about. Unemployment benefits and union density have no effect. The level of wage bargaining coordination and the extent of union wage coverage both matter, but if properly paired they can actually reduce unemployment. Lower tax burdens can also reduce unemployment, but a far more cost-effective fiscal approach is to increase spending on active labor market policies. The bottom line is that high unemployment in western Europe has been the result of self-inflicted dysfunctional macroeconomic real interest rates, and slower growth that raised unemployment. Moreover, they all did so at the same time, thereby generating a wave of trade-based spillovers that generated a continentwide macroeconomic funk and further raised unemployment.

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  • Thomas I. Palley, "undated". "The Role of Institutions and Policies in Creating High European Unemployment: The Evidence," Economics Working Paper Archive wp_336, Levy Economics Institute.
  • Handle: RePEc:lev:wrkpap:wp_336
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    References listed on IDEAS

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    1. Thomas Jordan, 1998. "An Empirical Observation on Central Bank Independence and Real Output," Open Economies Review, Springer, pages 221-227.
    2. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
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    Cited by:

    1. Frédéric Reynès & Paola Veroni & Aurélien Gaimon & Vincent Lapegue & Noé N'Semi & Maël Theulière, 2008. "Does the interaction between shocks and institutions solve the OECD shocks and institutions solve the OECD Unemployment Puzzle ? A Theoritical and Empirical Appraisal," Sciences Po publications info:hdl:2441/9726, Sciences Po.
    2. Angel Asensio, 2008. "(Post) Keynesian alternative to inflation targeting," Post-Print halshs-00335560, HAL.
    3. Jan-Egbert Sturm & Bjørn Volkerink, 2003. "How to Measure the Tax Burden on Labour at the Macro-Level?," CESifo Working Paper Series 963, CESifo Group Munich.
    4. Angel Asensio, 2007. "Inflation targeting drawbacks in the absence of a 'natural' anchor," Post-Print halshs-00189225, HAL.
    5. Aurélien Gaimon & Vincent Lapegue & Paola Veroni & Noé N'Semi & Frédéric Reynès & Maël Theulière, 2007. "Does the interaction between shocks and institutions solve the OECD unemployment puzzle ? A theoretical and empirical appraisal," Sciences Po publications 2007-34, Sciences Po.
    6. Paola MONPERRUS-VERONI & Frédéric REYNES & Aurélien GAIMON, "undated". "Does the Interaction between Shocks and Institutions Solve the OECD Unemployment Puzzle? A Theoretical and Empirical Appraisal," EcoMod2008 23800091, EcoMod.

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