Unemployment curbing unemployment in europe

FEDERAL RESERVE BANK OF NEW YORK

I N E C O N O M I C S
May 2001

A N D F I N A N C E
Volume 7 Number 5

Curbing Unemployment in Europe: Are There Lessons from Ireland and the Netherlands?
Cédric Tille and Kei-Mu Yi

Since the mid-1980s, unemployment rates in Ireland and the Netherlands have plummeted, while the average rate for the European Union has maintained its longtime highlevel. Ambitious labor market reforms—including wage moderation and the tightening of unemployment benefits— have helped to bring the Irish and Dutch rates down. Other European countries would benefit from adopting similar reforms, but they are unlikely to see the same dramatic improvement in their unemployment numbers.
The average unemployment rate in the European Union has remained stubbornly highfor the past twenty years. Between the mid-1970s and the mid-1980s, the average rate soared from about 2 percent to more than 10 percent (Chart 1). After easing somewhat at the end of the 1980s, it hovered between 9 and 11 percent for most of the 1990s before dropping to 8.2 percent last year. But while the high average rate across Europe has proved difficult to subdue, two members of the EuropeanUnion—Ireland and the Netherlands—have managed to cut unemployment sharply during the period, bringing their rates to levels under the low 4.5 percent rate currently prevailing in the United States. How have these two countries escaped the high unemployment rates bedeviling Europe as a whole? Over the past two decades, most European countries have undertaken some labor market reforms. Ireland andthe Netherlands, however, have made the deepest and most widespread changes in their wage and work policies. The reforms enacted include wage moderation, income tax cuts, the tightening of unemployment benefits, and reductions in barriers to part-time work. In this edition of Current Issues, we assess the extent to which the Irish and Dutch reforms have helped lower the unemployment rates in thesetwo countries. We draw on existing academic research to evaluate the effect of the reforms, and we consider in addition how the timing of the reforms may have shaped their impact. After reviewing labor market developments within these countries, we go on to ask whether the Irish and Dutch reforms could be instructive for other European countries seeking to reduce their unemployment rates. Ouranalysis suggests that the reforms, particularly wage moderation, explain most of the turnaround in the Netherlands’ unemployment rate and at least part of the
Chart 1

Unemployment Rate
Percentage of labor force 20 Ireland 15 European Union average

10

5

Netherlands

0 1970 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 Sources: Organisation for Economic Co-operation and Development;authors’ calculations. Note: Unemployment rate = the unemployed /(the employed + the unemployed).

CURRENT ISSUES IN ECONOMICS AND FINANCE

improvement in Ireland’s. Two features of the reforms emerge as especially important in improving labor market performance. First, the changes were consensual, the product of agreements between employers, unions, and the government. Second, the changes werepart of a comprehensive package combining wage restraints with other initiatives that helped soften the impact of the restraints on workers’ net earnings. We conclude that adopting similar reforms could help other European countries reduce unemployment. Nevertheless, the gains would most likely fall short of those seen in Ireland and the Netherlands. Many of the advances brought about by the Irishand Dutch reforms—such as the increased participation of women in the workforce—had occurred earlier in other European countries. Thus, the scope for improvement in the unemployment rates in these countries would undoubtedly be smaller. Europe’s Chronic High Unemployment The European unemployment rate began to climb in the mid-1970s and hit 10 percent by the mid-1980s (Chart 1). For eighteen of...