Home > Uncategorized > Europe proves that its unemployment, not GDP, that matters

Europe proves that its unemployment, not GDP, that matters

Great point from Karl Smith, responding to Scott Sumner.     At issue is what exactly the 1970’s taught us about macro.

From Sumner:

…the 1970s were not a decade of stagflation; rather we saw an extraordinary surge in aggregate demand:

NGDP growth averaged:  10.4%

RGDP growth averaged:   3.2%

Growth was normal, and inflation was very high…

But as Smith replies, there is something more going on here:

…we remember the 70s as an era of slow growth but indeed GDP growth was rapid. We remember the 70s as having a poor labor market, but as you can see the employment population ratio rose strongly during the 1970s.

…Not only did unemployment reach a post-war high during the 1970s but even during the best part of the 1970s it failed to fall below 6%, a value that had been near only associated with recessions in years past.

So.    GDP (especially NGDP) was expanding rapidly, and the employment-population ratio was reaching an all-time high.   We remember the 70’s as a lousy decade, however, because the unemployment rate was abnormally high (the labor-force participation rate was rising).

I’ve been harping on Europe, and I’d like to point out a similar regularity there.   Really, this is something that happens everywhere–China would be another good example.   At any rate, at the time of the creation of the Euro, Germany was Europe’s “basket-case” with a persistently high unemployment rate.

The story goes that Germany instituted neo-liberal “labor-market” reforms which unleashed the private sector, the unemployment rate went down and Germany became the competitive powerhouse that it is today.   Of course, this is not really what happened, in reality Germany’s unit-labor costs fell relative to the other nations on the Euro for the simple reason that Germany had an undervalued exchange rate.

The point I’d like to mention is that this was a popular change in Germany, despite the fact that the situation involved large real transfers to Greece.   Transfers that may not be repaid.   The really paradoxical thing is that a situation in which Germans were making (relatively) less money per hour  with the surplus transferred to Greek consumers and German capital was popular.   Moreover, (and in contradiction to the interpretation of the Weisenthal peice above) a rebalancing of European aggregate demand would mean a rise in German unit-labor costs (i.e. wages) and more consumption goods for Germans (see here).

The economics involved here are, I think, understood well enough; but the politics are a little weird.   In the political sphere, people seem to be fine with depressed wages–even though those wages ought to affect their personal utility directly–instead, German political preferences seem to be for tight labor markets.   I can think of one explanation, though its not at all standard–if people place a high enough value on the option to switch jobs, than a political preference for tight labor markets might emerge even if realized job switching is relatively uncommon.

The option value of switching jobs is something you always sense, you always get some utility from it so it has broad appeal even to the safely employed.   It is also the simplest solution (for workers) if there is employer abuse of some kind.   And regardless of why, the option value of switching jobs is going to be an increasing function of labor market tightness, so that tightness is something of a proxy for it.

Maybe I’m wrong, but I think this probably explains a lot of the politics of Europe now, as well as the US during Stagflation.

Categories: Uncategorized
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  1. June 17, 2012 at 2:18 pm

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