Tuesday, May 26, 2009

Flexible labor markets and the co-relation of economic growth

The steeply rising US unemployment rates in comparison to the relative calmness and stability in labor markets across Europe, despite the much bigger adverse shock on the real economy in the latter, raises questions about the superiority of the much trumpeted flexible labor markets in the US. In fact, unemployment in the US appears set to go past that in the EU 15, with the March rate for the United States (8.5%) being higher than the rates of 11 of the 15.



In an excellent post, John Quiggin questions the efficiency of the America's labor markets with the flexibility it affords to hire and fire workers, on the grounds that the variance of unemployment rates is minimal. Quiggin writes, "Generally speaking, employment protection laws lower the variance of employment and unemployment but have no clear effect on the average levels." In other words, the EU unemployment rates while being higher in expansions, will be lower in contractions. He also feels that, when comparing US and the EU, "there is a sharper class divide, and less social mobility in the US than in the EU".

As Floyd Norris writes, the resilience of uenmployment rates in EU can atleast partially be attributed to the social "safety nets in many Western European economies (which) made it easier for people to keep their jobs as the economy declined".

As the ongoing crisis unfolds, as many hallowed principles of economic theory bites the dust and as conventional wisdom takes bruising knocks, it is becoming increasingly clear that the rising tide of global economic growth over the past two decades concealed the worm of disaster. Co-relations were mis-interpreted for being causations and economic theories were constructed on very brittle edifices. The more definitive test of a theory is when subjected to adversity and how it responds during an economic crisis.

Update 1
Lane Kenworthy comes to much the same conclusion by comparing the employment rates for the two most recent business-cycle peak years - 2000 and 2007 - during which the US was one of just a few nations where employment rates declined.

Update 2
Even as Euro area unemployment rate rose to 9.2% in April 2009, here is a NYT op-ed on how labor market de-regulation may be coming to an end in Europe and workers protections and greater unemployment insurance is going strong.

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