Squandering European Labour: Social Safety Nets in Times of Economic Turbulence
| Author | Lars Ljungqvist |
| Published date | 01 September 1999 |
| DOI | http://doi.org/10.1111/1467-9485.00139 |
| Date | 01 September 1999 |
{Journals}sjpe/sjpe46-4/q190/q190.3d
Scottish Journal of Political Economy, Vol. 46, No. 4, September1999
#Scottish Economic Society 1999.Publ ishedby Blackwell Publishers Ltd, 108 Cowley Road, Oxford OX4 1JF, UK and
350 Main Street, Malden, MA 02148, USA
SQUANDERING EUROPEAN LABOUR: SOCIAL
SAFETY NETS IN TIMES OF ECONOMIC
TURBULENCE
Lars Ljungqvist
ABSTRACT
This paper reviews the argument that high long-term unemployment in Europe is
caused by generous social safety nets in times of economic turbulence. We report on
the empirical evidence of a more turbulent economic environment and present the
theoretical arguments that establish a link between turbulence and high unemploy-
ment. We conclude thata cure to the European unemployment problem mustentail a
reform of the unemployment insurance system so that benefits decline over the
unemploymentspell. If the social consensus in Europe makesit difficult to implement
declining benefits, we suggest that a complementary way of providing incentives for
the unemployed would be to reduce their leisure by imposing work requirements.
The costs of [the long-term unemployed's] misfortunes are both personal and national, a
waste of lives and resources. No country can afford either.
Sinfield (1968, p. 21)
IINTRODUCTION
The last two decades of high European unemployment represent an enormous
waste of the labour force and individual misfortunes for those marginalized in
the labour market. The term `marginalized' is appropriate here since the
diagnosis of the European ailment is long-term unemployment. Roughly half of
all unemployed Europeans have been out of work for 12 months and over. The
hazard rate of escaping unemployment falls dramatically with the length of
unemployment spells. This key observation must be central to any theory of the
causes and possible cures to the unemployment problem.
This paper reviews the argument that high unemployment in Europe is caused
by generous social safety nets in times of economic turbulence. Empirical
support for a turbulent economic environment can be found in the literature on
displaced workers, as surveyed by Hamermesh (1989) and Fallick (1996). A
common finding is that high-tenured displaced workers suffer large persistent
wage losses. The studies are from North America but similar research that
corroborates earnings losses in Europe have just started to appear. Though, a
glaring difference is the much higher incidence of long-term unemployment
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Stockholm School of Economics and CEPR
{Journals}sjpe/sjpe46-4/q190/q190.3d
among displaced workers in Europe as compared to the United States.
Additional evidence of a more turbulent economic environment for US workers
is provided by Gottschalk and Moffitt (1994) who find that earnings instability
has significantly increased between the 1970s and the 1980s.
Theories that rationalize high European unemployment as a response to
increased economic turbulence are formulated by Bertola and Ichino (1995),
Ljungqvist and Sargent (1998) and Marimon and Zilibotti (1999). An
important message is that European institutions can be conducive to low
unemployment in tranquil economic times but the unemployment rate is prone
to rise sharply in times of economic turbulence. This review focuses on the role
of generous benefits with indefinite duration that prolong unemployment spells
and distort the unemployed's incentives to adjust to changing economic
conditions. An OECD study can serve as a point of reference, Martin (1996)
reports that replacement rates of 60± 70% in the fifth year of unemployment are
not unusual for single-earner households in Europe. We conclude that the
current European welfare system is ill-designed to cope with economic
turbulence and instead, it administers a mistreatment in the form of idleness
or long-term unemployment, not to mention misguided measures such as early
retirement and work-sharing.
We argue that a cure to the European unemployment problem must entail a
reform of the unemployment insurance system so that benefits decline over the
unemployment spell. A seminal paper by Shavell and Weiss (1979) brings out
declining benefits as an essential feature of any optimal unemployment
insurance scheme whenever individuals have private information about their
own behaviour. We add that such a design becomes even more important in a
turbulent environment where workers' past earnings are less good as indicators
of current earnings potentials. However, an undesirable side-effect of declining
benefits is the distributional impact which may not be deemed acceptable in
Europe. So if the social consensus in Europe calls for a rather high lower bound
on benefits, we suggest that a complementary way of providing incentives for the
unemployed would be to gradually reduce their leisure by imposing work
requirements.
Our discussion of the European ailment proceeds now with the diagnosis of
and the cause to the problem, the current mistreatment, and a recommended
cure with its side-effects.
II DIAGNOSIS: LONG-TERM UNEMPLOYMENT
Europe has suffered from high unemployment of around 10% for more than
two decades with a large element of long-term unemployment. Sinfield (1968)
got it right when pleading for a greater interest in the situation of the long-term
unemployed but his study in the 1960s was far ahead of its time. He enumerates
many difficulties in gathering information since:
a major characteristic of the issue of long-term unemployment is that it was
not seen as a policy issue as such in any of the countries visited (p. 23).
368 LARS LJUNGQVIST
#Scottish Economic Society 1999
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