So, I’ve been mulling over this post, which discusses the findings of this paper, since I read it yesterday afternoon. The paper concludes, more or less, that economists ought to stop insisting that labor market rigidities and generous social policiesÂ in Europe are the source of their unemployment, because between 2000 and 2005, employment numbers for European workers aged 25 to 54 have nearly caught up to those for the same group in the United States. Now, I must say I was surprised to read those findings, but I was perhaps more taken aback by how incautious the paper was. Perhaps I was mistaken in thinking that it was meant to an academic exercise, but it struck me as improper that the authors chose the most advantageous population subset and the most advantageous statistic and don’t adequately explain why. In the data limitations section of their paper, they list several reasons why US data might overstate employment, but no other potential biases in either US or European data. They don’t try to eliminate, really, the chance that macroeconomic events affected different countries differently, and they don’t shoot for statistical rigor. Basically they say, here are some statistics that say what we want; please be so kind as to take them at face value.
I can’t I’m afraid. I have to point out a few problems that I feel are fairly serious.
1) So, the authors choose to analyze employment for workers ages 25 to 54. It’s not hard to see why. While Europe is close to closing the gap in that age group, they’re not in the same ballpark for workers younger or older. In 2004, the employment rate for people ages 15-24 was 54% in the United States and only 39% in Europe. In the same year, for workers aged 55-64, those percentages were 60% and 42%, respectively.
2) The authors attempt to justify the elimination of these groups from consideration based on the fact that, “welfare-state institutions sometimes act to reduce employment of younger and older workers quite intentionally.” That’s true, but to leave it at that is irresponsible. Governments that choose that path, often do so as a response to high unemployment. Because it is expensive to create overprotected jobs, employers do not generate enough jobs for younger cohorts, pressuring the government to both hasten the departure of older workers from the labor force and delay the entry of younger workers.
3) And while it sounds lovely to have a government that hustles you out of your job and into a pension plan at 55, it’s both perverse and damaging for European welfare states to do so given the severity of the demographic crisis they’re facing. In the United States, the current size of the population of people aged over 65 is about 21% of the size of the total labor force, while in Europe that percentage is 36%. By 2020, people over 65 will equal around 29% of the labor force in the US, while in Europe that percentage will be 45%. That, of course, does not include those younger than 65 that have been encouraged to leave the labor force to make room for the underemployed young. And it certainly doesn’t take into account the fact that the average person can expect to be alive and activeÂ until their mid-70s, at least.Â Looking at the numbers this way, it becomes clear that European governments are artificially reducing the active labor force at the youngest and oldest ends of the spectrum to try and boost employment in the middle. Unfortunately this is in no way sustainable from a budgetary point of view. It’s no wonder European 25 to 54 year olds are working so hard. They have to pay for a steadily increasing number of long-term students and pensioners.
4) Interestingly, the 2006 OECD study that the paper cites includes this working paper, assessing changes in labor policies over the past five years. It concludes (emphasis mine):
On average, changes in policies and institutions appear to explain almost two thirds of non-cyclical unemployment changes over the past two decades. In particular, high and long-lasting unemployment benefits, high tax wedges and stringent anti-competitive product market regulation (PMR) are found to increase aggregate unemployment. On average, it is estimated that a 10 percentage point reduction in the tax wedge, a 10 percentage point reduction of unemployment benefits and/or a decline in product market regulation by two standard deviations would be associated with a drop in the unemployment rate by about 2.8, 1.2 and 0.7 percentage points, respectively. By contrast, highly centralised and/or coordinated wage bargaining systems as well as some categories of public spending on active labour market programmes (ALMPs), such as labour market training, are estimated to be associated with lower unemployment. Extensive sensitivity analysis shows that these findings are robust across specifications, datasets and econometric methods.
5) US GDP growthÂ has been between one and two percentage points above Europe’s over the past five years (excepting 2001), while mean compensation growth has been three percentage points higher and unemployment three percentage points lower, on average, for the United States compared with Europe over that time. What does this suggest? Well, for one thing it means that, apart from the employment effects of labor market rigidity, there are allocation effects that hamper the use of resources in an economy and retard growth. Now you might say that there’s no point in having a growing economy if not everyone gets to take part in it. It should be obvious, however, that there are ways to share the benefits of that growth more effectively in the United States without hampering labor flexibility. In this we may be able to learn from the Europeans, at least on the subject of health care. Providing universal health insurance through the government would improve the well-being of American workers and reduce the expense of labor to business, thus encouraging businesses to create more jobs.
My point in saying all this is this: if the goal is supposed to be the crafting of good public policy, then it would help to begin with the best information about the conditions around us. It does no one any good to tease data into saying something misleading. Better to recognize where we can improve our policies and where Europe can learn from ours.