UNEMPLOYMENT, HYSTERESIS AND TRANSITION
| Author | Miguel A. León‐Ledesma,Peter McAdam |
| Date | 01 August 2004 |
| Published date | 01 August 2004 |
| DOI | http://doi.org/10.1111/j.0036-9292.2004.00311.x |
UNEMPLOYMENT, HYSTERESIS AND
TRANSITION
Miguel A. Leo
´n-Ledesma
n
and Peter McAdam
nn
Abstract
In this paper, we quantify the degree of persistence in the unemployment rates
of transition countries using a variety of methods benchmarked against the EU.
Initially, we work with the concept of linear ‘Hysteresis’ as described by the
presence of unit roots in unemployment as in most empirical research on this area.
Given that this is potentially a narrow definition, we also take into account the
existence of structural breaks and nonlinear dynamics in unemployment. Finally,
we examine whether CEECs’ unemployment presents features of multiple
equilibria, that is, if it remains locked into a new level whenever some structural
change or sufficiently large shock occurs. Our findings show that, in general, we
can reject the unit-root hypothesis after controlling for structural changes and
business-cycle effects, but we can observe the presence of a high and low
unemployment equilibria. The speed of adjustment is faster for CEECs than the
EU, although CEECs tend to move more frequently between equilibria.
I Intro ductio n
One of the foremost features of the transition process of Central and Eastern
European Countries (CEECs) is the appearance of open unemployment hidden
during the central planning regime. As reported in EBRD (2000) and IMF
(2000), this phenomenon has had a deep impact on poverty and social exclusion.
This is partly because the comprehensive social safety net left agents with little
experience in dealing with the uncertainty and adversity associated with
protracted unemployment. The labour-market reforms of the first half of the
1990s, especially the reduction of unemployment benefits, did not seem to have
the expected impact in reducing unemployment by improving matching (Boeri,
1997a).
1
Employment expanded at a much slower pace than output, pointing to
a high degree of persistence in unemployment, thus aggravating the social
problems associated with the transition to a market economy. Furthermore,
n
University of Kent
nn
European Central Bank
1
For reviews of labour-market developments in Transition Economies see also EBRD (2000),
Nesporova (2002) and Vidovic (2001), and Tichit (2000) for a comparative study of
unemployment dynamics among Eastern European countries.
Scottish Journal of Political Economy, Vol. 51, No. 3, August 2004
rScottish Economic Society 2004, Published by Blackwell Publishing, 9600 Garsington Road, Oxford OX4 2DQ, UK
and 350 Main Street, Malden, MA 02148, USA
377
with the prospect of EU membership, accession countries will continue to pursue
both product and labour-market reforms that are likely to exert important
shocks on employment (EBRD, 2000). This is especially true if labour hoarding
is reduced by the introduction of greater competition. Shocks are also likely
to come about for some countries because of macroeconomic stabilization
measures (i.e. budgetary consolidation, inflation and exchange rate stabilization)
to meet EU membership requirements.
In this paper, we quantify the degree of persistence in the unemployment
rates of transition countries using a variety of methods. As far as we are aware,
this is the first systematic attempt to do so. Initially, we work with the concept of
linear ‘Hysteresis’ as described by the presence of unit roots in unemployment as
in most empirical research on this area. Given that this is potentially a narrow
definition,
2
we also take into account the existence of structural breaks and
nonlinear dynamics in unemployment. Finally, we examine whether CEECs’
3
unemployment presents features of multiple equilibria: that is, if it remains
locked into a new level of unemployment whenever a structural change or
sufficiently large shock occurs.
The question addressed is important for several reasons. First, it has
implications for social protection and labour market reforms, as well as macro-
stabilization policy in the CEECs. The presence of hysteretic or highly persistent
unemployment would imply that unemployment could become a long-lasting
problem after radical reforms. For instance, for countries showing features of
multiple equilibria, reforms aimed at reducing non-employment benefits could
constitute large and long-lasting positive shocks if done during an employment
recovery phase. However, reforms carried out during rising unemployment may
not have the desired effect of changing equilibrium unemployment as the
positive labour market reform shock could be choked off by the negative
(demand or supply) shock affecting the economy. Second, it helps to understand
if the behaviour of unemployment in our set of countries is consistent with
recently developed models of labour markets in transition. Comparison with the
persistence profile in the EU could also help analyze the possible impact of
common shocks. For instance, if unemployment were to be more persistent in
the CEECs than in the EU, common negative shocks could increase migration
pressures westwards, and common positive shocks reduce them.
To undertake our analysis, we first work with the concept of Hysteresis as
stemming from the presence of a unit or near-unit root in unemployment rates.
We apply a battery of unit root tests on a set of 12 CEECs (benchmarked against
an EU-15 aggregate) to test for the existence of random-walk behaviour,
quantify the degree of persistence and account for possible breaks in our sample
and lack of power in our tests. Secondly, we use Markov-switching regressions
to analyze persistence, taking into account the possibility of a changing
2
For discussions of the concept and implications of Hysteresis in unemployment see Amable
et al. (1995) and Cross (1995).
3
CEECs in our sample comprise Poland, Romania, Slovenia, Croatia, Hungary, Bulgaria,
Czech Republic, Slovakia, Estonia, Latvia, Lithuania and Russia.
MIGUEL A. LEO
´N-LEDESMA AND PETER McADAM378
rScottish Economic Society 2004
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