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Equilibrium unemployment Unemployment and stability Albert van der Horst CPB, The Hague October 29, 2003
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Equilibrium unemployment 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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Equilibrium unemployment Outline Equilibrium unemployment ► our approach ► in Europe ► & structural growth ► versus the EC approach ► & stability and growth pact
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Equilibrium unemployment Stable?
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Equilibrium unemployment 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 L W Wage curve Labor demand Labor supply -- u --
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Equilibrium unemployment 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 ► => tax shifting & sharing ► role of benefits (replacement rate)
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Equilibrium unemployment Wage equation TaxRRw(min)u(-1)Stationary France00,140,25-0,79yes Germany0,730-2,10yes The Netherlands0,130,75-1,07yes Spain0,210,25-0,68yes United Kingdom0,200,05-0,79yes United States0-0,40no
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Equilibrium unemployment 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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Equilibrium unemployment France and Germany
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Equilibrium unemployment The Netherlands and Spain
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Equilibrium unemployment United Kingdom
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Equilibrium unemployment Labor tax and unemployment Higher labor tax (1% GDP) ► raises equilibrium unemployment immediately ► raises actual unemployment gradually Jade simulation
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Equilibrium unemployment 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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Equilibrium unemployment Structural growth Y * depends on ► Labor supply ► Labor productivity ► Equilibrium unemployment CPBEC LSLS ProjectionHP filter Y/LHP filter U*U* ‘Equilibrium’‘NAIRU’
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Equilibrium unemployment EC Nairu Alternative approach by the European Commission ► trend estimate ► depend on change in inflation rate ► backward looking
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Equilibrium unemployment 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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Equilibrium unemployment 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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Equilibrium unemployment 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? 1) Structural approach: ΔEMU < 1% GDP Positive output gap: ΔEMU(structural) < ΔEMU 2) EC approach ΔEMU < 1% GDP Small output gap: ΔEMU(structural) ≈ ΔEMU
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Equilibrium unemployment Towards SGP The impact of tax changes differ between countries It is therefore suboptimal to opt for a single fiscal regime
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