Question

It has been argued that the natural rate of unemployment is higher in Europe than in the United States. Carefully outline two explanations of why this might be the case?

Answer 1

At the end of 1997, Europe's average unemployment rate was just over 10 percent, more than twice the U.S. rate. Worse, since 1993, Europe's average (standardized) unemployment rate has exceeded 10 percent in each year. In comparison, the average annual unemployment rate in the United States since the war has never reached 10% in any year and the highest annual rate reported in the last ten years was 7.5% in 1992.The inability of European labor markets to achieve full employment is generally regarded as one of the European economic policy approach's most significant drawbacks. In the United States, and particularly in the United Kingdom and other English-speaking countries, high unemployment levels are seen as symbolizing inefficiency and dysfunctionalism, the remedy of which involves a radical transformation of the European economic management style. There is a tendency in Europe to think that unemployment is, in some sense, the price to be paid for labor market and social insurance arrangements that preserve the dignity of work and a harmonious society.

Yet, on the other hand, the antithesis of low unemployment market capitalism in the U.S., and high unemployment interventionist Europe on the other, is clearly too straightforward a matter record. Many European countries had lower unemployment rates than America for many years in the 1960s and 1970s. There has been a wide range of differences in unemployment rates in Europe. For example, in the 1980s, despite highly protective social institutions, the Nordic countries were among the lowest unemployment rates in any of the OECD countries.

In essence, any economy has a "natural unemployment rate" determined by institutional forces (such as social welfare policies), social factors, mobility, etc. For example, if one country has unemployment benefits for 3 months after being laid off, but another country provides unemployment benefits for 1 year, we would expect the second country to have a higher natural unemployment rate, as more people in the second country are willing to do so.