In the Turbulence Lab

Posted in Issues

Japan goes to the polls today, Germany next Sunday. Is it an accident that these two aging veterans of World War II, the second- and third-largest economies in the world after the United States, have been experiencing a certain degree of stagnation?

After the war, each cleared away the wreckage of defeat, brought forth a huge new generation of children, and went to work.  In the space of just two generations, each regained prosperity — more than anyone had foreseen.

Having become rich, each then became optative. During the 1980s, Japan sought to expand its influence in Asia. An enormous asset bubble developed in its domestic economy as a result.  Working it out has taken most of fifteen years.

In the 1990s, Germany led the way, with France, to a genuine European Union, with a single central bank, a common currency and, at least in principle, coordinated fiscal policy and no internal borders.

Now each nation has become more cautious. Pursuing various structural reforms, reigning governments in each have been forced by foot-dragging members of their own parties to call elections.

In Japan, Prime Minister Junichiro Koizumi is expected to survive the election he called, thereby gaining a mandate to privatize the giant bank that is its government postal savings system. Japanese restructuring is well underway.

But in Berlin, Angela Merkel is expected to become the nation’s  first woman chancellor, replacing Gerhard Schršder on the strength of her promise to be Germany’s Margaret Thatcher — that is, permit a major restructuring to begin.

German unemployment — indeed, European unemployment — has been a problem since the 1970s. In the 1950s and the 1960s, European countries generally had lower joblessness.  But unemployment began increasing in the 1970s, rose still more in the 1980s and fetched up on a plateau in the 1990s from which it has stubbornly refused to budge.

Not all European economies have high rates:  Ireland, Austria, the United Kingsom and Denmark are all in the vicinity of 5 percent or less.  But Greece, Spain, France and Germany are all at nearly 10 percent — a rate not seen since the 1930s.

Many explanations of European unemployment have been advanced since the phenomenon was first observed: the influence of oil shocks, bad monetary policy, lagging capital accumulation, the influence of collective bargaining, the tax wedge, meaning the difference between take-home pay and the cost of labor to firms. An ever-more sophisticated economics focused on the institutions of labor markets has been a result.

The latest wrinkle is turbulence — a polite way of designating the rapid increase in the extent of the division of labor that the rest of us mean when we speak of an economic revolution. The idea is that, because of globalization, deregulation and rapid technological change, the rate of job creation and job destruction has increased since the 1980s, and that, as a result,  the European system of unemployment insurance and layoff taxes has tended to put workers on the sidelines.

Last month, Thomas J. Sargent of New York University presented to the Econometric Society meeting in London the latest is a series of models he and Lars Ljungqvist of the Stockholm School of Economics have built.  In them, the generosity of unemployment benefits and their interaction with layoff taxes play a major role.

In this hypothesis, promises that European government made in palmy days become onerous in a period of rapid change. Less generous benefits in the United States send laid-off employees back to work sooner in greater numbers, even if only to the local hamburger stand. With long-lasting unemployment benefits tied to obsolescent skills in European nations, many of those who are jobless become discouraged.  They simply give up looking for work.

But in a draft of a careful survey of the literature on European unemployment prepared for next month’s semi-annual panel of the journal Economic Policy in London, Olivier Blanchard of the Massachusetts Institute of Technology replies, “The general story is appealing, and most of us believe that, indeed, there is more economic turbulence today than there was thirty years ago.  There is one catch, however.  We all believe it, but the data just do not show it….”

Perhaps, he says, the data are too raw. Perhaps the action is taking place within particular industries and regions, rather than across the board.  After all, the old saw has it that it is the theory that decides what we can observe.  But evidence is so far is very slim of the big diminution of useful skills in laid-off workers that is supposed by Sargent and Ljungqvist.

Do economists know enough yet to confidently give advice, asks Blanchard? Of course they do, as long as they are somewhat cautious about it. There’s not much doubt that, as European governments sought to cushion or dampen the impact of shocks in the early 1980s, they sometimes made matters worse.  But that doesn’t mean they should give up trying.

The experience of the successful European countries, the Scandinavians, in particular, suggests that the tradeoff between efficiency and insurance need not be very steep, says Blanchard, especially if a degree of trust among business, labor and government can be maintained, or, perhaps, even created. (British labor unions seem to have changed their stripes.) The Japanese experience suggests the same. Beginning at the polls next week, the Germans will take another crack at the problem.