Unemployment and stability

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Unemployment and stability

• Albert van der Horst
• CPB, The Hague
• October 29, 2003

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Just a minute

• European comparative analysis
• EU enlargement (immigration)
• Tax competition in the European Union
• Regional policy (geographical economics)
• European labor markets
• Competition and harmonization in Europe (a Level
  Playing Field)
• Workshop
• Stability and growth pact (January 9, 2004)

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Outline

• Equilibrium unemployment
• our approach
• in Europe
• structural growth
• versus the EC approach
• stability and growth pact

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Stable?
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Equilibrium

• Equilibrium is central in economic theory
• equilibrium where we go
• today where we come from
• Unemployment is a persistent phenomenon
• demand supply fails
• short-run imperfections are insufficient
• seems to be a stable equilibrium

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Equilibrium unemployment
Labor supply
W
Labor demand
-- u --
Wage curve
L
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Wage negotiations

• Firms prefer low labor income share
• opt for low wages
• Workers prefer high wage income
• take into account that unemployment leads to a
  reduction in income
• Negotiations
• gt tax shifting sharing
• role of benefits (replacement rate)

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Wage equation
Tax RR w(min) u(-1) Stationary
France 0 0,14 0,25 -0,79 yes
Germany 0,73 0 -2,10 yes
The Netherlands 0,13 0,75 -1,07 yes
Spain 0,21 0,25 -0,68 yes
United Kingdom 0,20 0,05 -0,79 yes
United States 0 -0,40 no
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Labor demand

• Firms maximize profits
• Higher wages reduce profits
• Reduction in employment improves profits
• Substitution between labor and capital

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Equilibrium unemployment

• Equilibrium unemployment rate depends on
• Tax wedge
• Benefits
• Minimum wage rate
• Interest rate

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France and Germany
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The Netherlands and Spain
13
United Kingdom
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Labor tax and unemployment

• Higher labor tax (1 GDP)
• raises equilibrium unemployment immediately
• raises actual unemployment gradually

Jade simulation
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Labor tax and growth

• A tax increase
• reduces structural GDP immediately
• reduces actual production gradually
• creates positive output gap (dotted line)

Jade simulation
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Structural growth

• Y depends on
• Labor supply
• Labor productivity
• Equilibrium unemployment

CPB EC
LS Projection HP filter
Y/L HP filter HP filter
U Equilibrium NAIRU
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EC Nairu

• Alternative approach by the European Commission
• trend estimate
• depend on change in inflation rate
• backward looking

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Labor tax and unemployment (2)

• Higher labor tax (1 GDP)
• raises actual unemployment gradually
• raises equilibrium unemployment gradually, but
  even before the implementation date

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Labor tax and growth (2)

• A tax increase
• reduces structural GDP gradually
• reduces actual production gradually
• slightly positive output gap initially (dotted
  line)

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Meet the EMU-norm

• What if a country proposes the EC to improve its
  budget by raising its labor tax rate (by 1 GDP)
• Choice 1 does the EC take negative growth
  effects into account?
• If yes, how?
• Structural approach
• ?EMU lt 1 GDP
• Positive output gap ?EMU(structural) lt ?EMU
• EC approach
• ?EMU lt 1 GDP
• Small output gap ?EMU(structural) ?EMU

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Towards SGP

• The impact of tax changes differ between
  countries
• It is therefore suboptimal to opt for a single
  fiscal regime