European Labor Market - Essay Example

? European Labor Market The proper functioning and the organization of the labor product markets has been in an indirect relation with the economic growth as the increase in demand is compensated by the supply in the domain of less regulated market and because of the fact that the research incentives largely depends on the institutions, competition and openness. The capacity of appropriating profits in the exchange for research expenditures has been specially addressed within the purview of the new growth theory. The macroeconomic policy and the competitiveness in price are also important to the growth. The fiscal and the monetary policy also may lead to the reduction of the cyclical imbalances and uncertainty and also low interest rates which helps in the encouragement of investments. The empirically based studies concentrate on the evolutionary models or on management literature which emphasize on the price competitiveness and the shares of the export market as an important tool in the investigation of the contribution of the strategies induced in the balancing of the costs and productivity (Aiginger, 2004). The paper will focus on different aspects of the unemployment of the Sweden and various policy implications from 1970s till date with the help of various economic theories. Unemployment in Europe from the decades of 1970s The sharp decline in the unemployment increased drastically across the globe with the crash of the Bretton Woods system of fixed exchange rates. But unlike many areas of the world, unemployment in several European countries has never returned back to the low levels during the Golden Age after the Second World War. The unemployment in the European Union is a major problem. The Euro zone members encountered high levels of unemployment rates and it increased rapidly in the early 1970s in parallel to the consolidation of an integrated economy and its size and the complexity has been approaching as that of the USA which presents a sharp contrast (Nixson & Artis, 2007, p. 354). The hardcore explanation which stands in this way is that the growth of the industrialized economies became much more unstable and became vulnerable to frequent shocks which include oil price shocks or the exchange rate fluctuations from the period of 1970 onwards. The countries with the flexible labor market rules such as modest unemployment benefits, light employment protection legislation and a low degree of union power which are used in the management of the absorption of these shocks with a much accelerated pace with the comparison to other rigid institutions . The enhancement in the number of the unemployed in Europe can be attributed to the interaction between shocks and institutions. But it has also been encountered often that extensive unemployment benefits generate the problem of moral hazard where the workers receive fractional protection against unemployment and they are less likely to search jobs. People studded with strong work ethics will be finding it difficult to rely on the benefits without actively looking out for jobs while the others try to remain on the benefits as long as possible. Therefore the average values in a country have an impact on the size of the moral hazard problem and hence on the cost of providing generous unemployment benefits. Expectations will be on the countries where the workers generally posses a weaker work ethic in order to have a lower ‘replacement ratio’ which is the level of benefits relative to wages (Michau, 2009, p. 14). The employment rate is the number of the total employed and the self employed population of the working age. In the early 1960s the EU 15 the employment ratio was higher than that of the USA but it fell in the 1970s but picked up pace in the 1990 with falling sharply with the recession of 2008-2009 ( El-Agraa, 2011 p.373). In recent years defenders of the European social model proposed that capitalism augmented by a generous and interventionist welfare state which have taken the praising to Scandinavia to a sky rocketed level. The Nordic region posses the world's highest taxes and most generous welfare benefits but still Sweden, Finland and Denmark have delivered strong growth and low unemployment, and rank among the world's most competitive economies. The acceleration in unemployment in the 1970s merged with a number of adverse shocks globally. In the 1970s, the prices of the raw materials prices increased highly and as a result the high rate of productivity growth that had characterized the post-war period had almost came to an end. The workers were not fully able to adjust to the changes and the shocks led to a tremendous increase in the cost of labor, and hence also the increase in unemployment. During the 80s high rates of interest prevailed as a consequence of the large increase in the cost of capital. In turn this led to the low accumulation of capital and lower rate of employment growth and higher unemployment (Blanchard, 2009). The unemployment in the European Union accelerated and reached the summit in the decades of 1990s. The unemployment rate is still high today with a varying degree of heterogeneity across various countries (Blanchard, 2005). This has attracted the attention and increased the level of complexities of the policy makers and the people associated with the neutralizing mechanism of unemployment in the European countries. A graphical exposition below depicts the unemployment rate of the EU 15 from 1960s to the year 2000. (Blanchard, 2005). Fig.1 The unemployment rate of the European Union from 1960s to 2000 Now from the above diagram, reflection of the natural unemployment rate and the actual rate is not clear. Since the year 2000, the inflation of the EU 15 was roughly constant around the range of 2% using the cost of price index (CPI). If a stable inflation rate is to be taken to be an indication that unemployment is roughly at the natural rate then it suggests that in the present day the EU15’s actual unemployment rate is close to the natural rate. The increase in the actual unemployment rate since 1970s in the majority of the part reflects an increase in the natural rate. But the above stated proposition needs to be supported by the actual notion of unemployment along with the concepts of natural rate and the actual unemployment rates which will be discussed in the section following the next segment. Unemployment in Sweden In 1980s, the performance of the Swedish labor performed really well and it was literally a success story when the unemployment in the Western Europe showed escalated figures and the Swedish unemployment remained drastically low with respect to the international standards. The rate of the average unemployment rate was around the vicinity of 2 per cent and by the end of the decade it declined to a level of 1.5 percent. The ratio of employment to the population was also tremendously high. In the year 1990, the aggregate employment rose to a percentage of around 83% of the working age population with the comparison of around 61 per cent as the European average and in the OECD nations the percentage was around 65 %. As it can be seen that these optimistic outcomes could be viewed as an amalgamation of the policies including blend of co ordination of wage bargaining which helped in the delivery of the wage moderation and active labor market policies which facilitated the balance between the vacancies and the unemployed job seekers. Although this accelerating pace of the performance of the labor market of Sweden showed fluctuations in the period of 1990s. In the span of period 1990 and 1993 the rate of unemployment increased from a percentage of 1.6 to a rate of 8.2 which resulted in the fall in the employment to rate of around 73 per cent of the working age population. In the next five successive years in the middle of 1990s, the official rate of unemployment clustered around the rate of 8 per cent and the extended measures of unemployment reached double-digit figures. The performance of Swedish labor market seemed to get converged with the average of the European Union. The prospects of the sustained labor market improvement seemed to be remote in the mid of 1990s and the sustained recovery was an immediate priority. From the period of 1997 and onwards, the employment rates enhanced and the unemployment declined in a rapid pace. At the end of the year 2000, the unemployment figures reached around the level of 4 per cent which remained at the constant level in the period of 2001 and 2002. Thus the focal point in this case may be attributed to the intensification of the unemployment rates in the period of 1990s. Adverse macro economic shocks, bad governmental policies are chiefly responsible for the inauspicious international developments. The failures in the policy can be dated back to the early 1970s where an inability in pursuing a restrictive aggregate demand policy for stabilizing the inflation under levels of control. The bias in the inflationary spirals became enhanced in the late 1980s in a period which was jet propelled by the intervention of the financial liberalization (Holmlund, 2003, p. 1). Fig. 2 (Unemployment, total, 2011) In the above diagram the significant point which is highlighted is that of the enhancement of the Swedish unemployment in the decades of 1990s. Relevant theories of labor models with respect to Swedish labor market Unemployment One of the primal measurements of the economic health is unemployment. The factor of unemployment is crucial in the determination of the strength of an economy. If the efficiency of the economy is to be maximized, then the all the individuals in the economy would be employed at a certain wage rate. An unemployed person is simultaneously unproductive as well as a huge drain on the resources of the society. Unemployment is really a powerful statistic involved in the strategizing optimal policies and implementing the same (Griffiths & Rotheim, 2007, p.2). Two views of unemployment can be mentioned in this case. The first one is the classical view and the second one is the Keynesian view. Classical view of unemployment The classical economists assumed that the labor market is similar to the goods market where the price adjustment will ensure the equality between the demand and supply. With the rise in demand, the price of labor which is the wage rate will also increase (The Classical View of the Labor Market, 2010). Under this purview the unemployment viewed as an indication of smooth labor functioning is obstructed in some ways. The assumptions of the Classical approach are that the behavior of the market depends on the idealized demand and supply model (Griffiths & Rotheim, 2007, p.2). The Classical labor demand curve The demand for labor in the economy can be view as an accumulation of the individual demands of every worker by the firms in the economy. Every labor faces identical demand curve. Thus unemployment can be defined from the stand point of an individual firm which will reflect the picture of the whole economy. The primal motive of every firm is the maximization of profit. An employer will hire or employ a labor to a point or as long as it will earn profit or increase it. The only expense which the company incurs is that of the cost of capital and the wages which will be paid to the workers. There are other costs like marketing, advertising costs but they are not considered for the sake of simplicity. The production function of each of the firm is associated with the quantity produced (z), number of the workers (l) and the number of units of capital employed (k). z, l and k are the variables considered in the production function. Now let us assume that the revenue per product sold be p, wage per worker be w and the rent or cost per unit of capital be r. p, w and r are constants in the model. The profit of the employer can be defined as the amount obtained by the difference between the revenue earned and the cost incurred through employment of labor and capital. Let the profit function of the employer be and it can be written as follows: The firm will follow the regime of profit maximization or the cost minimization. But we will concentrate on the profit maximization regime. Now from the first order condition of profit maximization can be given by the following equations: Considering equation (3) we get, This is the equation for the labor demand curve in the classical model. Here the partial derivative of the function with respect to capital is kept constant i.e, 0 for establishing the comparative static result. The expression is referred to as the marginal product of labor as it represents change in the output for each change in the number of workers. From the law of diminishing marginal returns the marginal product of labor will increase in the initial stage and will then decrease with the addition of employment of labor. After a certain point the firm will not be able to employ more laborers and it is given by the point i.e, where the marginal product of labor is equal to the wage rate paid to the workers. Initially the profit will increase and it will reach a point when the profit will be zero and then it will diminish eventually which is shown in the following graph: Fig. 2 Profit maximizing structure of the classical model (Griffiths & Rotheim, 2007) The function describes the way in which the aggregate demand curve of the economy is expressed. As wage decreases, the point at which will move to the right and the company can hire additional workers without reducing profitability. It can be inferred that the demand for the labor increases with the decrease in the wage rate thus representing the inverse relation between wages and labor which is shown in the following diagram as follows: Fig. 3 Classical Labor demand curve (Griffiths & Rotheim, 2007) The Classical labor supply curve and the determination of the market equilibrium The supply of labor comes from the perspective of the people who are utility maximizers and the utility maximization profile differs within different people. The people usually choose between work and leisure and the utility functions of different suppliers change with time and the aggregation of all the utility functions will give rise to the supply curve and the elasticities of the labour supply for each worker varies with the wage rates. The supply curve is a positive function of the wage rate and it is shown by the following graph below: Fig. 4 Classical Labor Supply Curve (Griffiths & Rotheim, 2007) The equilibrium occurs with the interaction of the demand and the supply curve and is shown in the diagram below: Fig. 5 Market equilibrium (Griffiths & Rotheim, 2007) In the above diagram, the equilibrium occurs at the point where the demand and the supply curve intersect and W1 and L1 are the market clearing wage rate and labor. Without any external shock the market will clear if any disturbance from the equilibrium occurs. Unemployment in the Classical Model The unemployment in the classical model exists when the existing wage in the market is greater than the equilibrium market wage. In many specialized industry the wage rates are legislated and the set above the market clearing wages and there creates the emergence of unemployment. This can be depicted in the diagram below: Fig. 6 Unemployment in the Classical Model (Griffiths & Rotheim, 2007) In the above diagram, the equilibrium wage is W1 but if the preexisting wage in a particular sector of any industry be above the market equilibrium, then the there will exist unemployment as in the above diagram the unemployment in the sector is shown by the amount L3L2. Under the purview of the classical economics, an ideal labor market will always reach equilibrium over time. The graph depicts that at the wage rate level W2, the firm will employ L3 units of labor but L2 amount of the laborers are willing to deliver services. In this case the assumption is that there is no presence of any external shocks in the labor market and any types of interference. The unemployment exists in a non-ideal labor market which does not change the fact that the market will continue to tend towards equilibrium. Frictional unemployment In the purview of this type of unemployment, a certain amount of time is spent in between the job tenure of the individuals. The names of the people will be included in the list of unemployment while they are attempting in finding a job. The labor market is a dynamic market and there will be certain number of unemployed person at one particular juncture. The unemployment rate may remain in the constant position but the individuals who are unemployed will change over time. The frictional unemployment is in the acknowledgement of the fact that the things in the adjustment take time which is a harsh reality (Mankiw, 2011, p.603). Studies have been made on the performance of the Swedish economy in contrast with that of the European states. Among the purview of the welfare state institutions there is a tendency of decreasing equilibrium unemployment in the tranquil economic times and the employment protection rules makes it costly for the firms in laying off the workers. After the World War II in the period of 1950s and 1960s as a result the unemployment rates were lower in European countries as compared to that of US. The lower rates of the unemployment were consistent with the protection policies which locked the employees in their current job. This results in a decline in the frictional unemployment in tranquil economic times that allows transferability of employees’ skills between jobs. The easy way in which the unemployed workers are in the search process of getting jobs guarantees that the average duration of unemployment spells remains low in a welfare state, despite generous unemployment benefits as in Europe in the 1950s and 1960s. The high unemployment rates in Sweden in the 1990s can be attributed to the structural unemployment which is elaborated in the next segment (Ljungqvist & Sargent, 2010, p.215). Structural unemployment It is that kind of unemployment in which the skills, education and expertise of the workers do not match with the job openings provided by the employer. This type of unemployment lasts for a longer period of time. In the industry of rocket science there can be higher or lower unemployment in the submarket than the national market. In case of the rocket scientist industry, if the agreements of the trade be such that it allows for outsourcing in other countries then the labor market for the rocket scientist will perish in the domestic country (Schmitt, & Warner, 2011, p.1). The employment protection legislation (EPL) was prevalent in Europe and also in Sweden which made it harder for the employers to hire new employees in their companies or firms. The EPL made it more risky for the employers in the hiring process of the new employees and thus the outflow from the unemployment decreased which in turn enhanced the unemployment. Although the program enhances the employment structure by various policies like on job training, reduction in the unfair dismissals and so on. But the degree of unemployment generation by the EPL was greater than the employment creation and it enhanced the unemployment of Sweden in the 1990s. The growing number of long-term unemployed and the early retirees became a major concern. Sweden changed its policy towards greater flexibility in the regulation of temporary work where the private temporary work agencies were allowed from 1993 and those companies provided brokerage most significantly for the rent temporary workers supplying 24,000 by the year 2000 with further relaxations in the temporary work contracts from 1997 and as we can see the unemployment reduced thereafter (Fregert, 2008, pp. 12-13). Voluntary unemployment The notion of the voluntary unemployment falls under the purview of the frictional unemployment and it generally takes place at a time when people choose not to accept equilibrium or a market clearing wage. The influx of certain amount of pride factor plays within the people which refrains them from being getting employed. A firm or a company may also offer a large number of unemployed people but it is generally below the market clearing wage. There will be a bargaining mechanism in the process of wage fixation between the employers and the employees. The spree of getting jobs varies from person to person which depends on their financial reserves and also will be affected by the welfare programs of the government which provides the unemployed with wage benefits (Perlman & Hughes, 1984, p.36). In Sweden, a major reform in 1974 supplemented the existing voluntary unemployment insurance system but it was only the groups at the margin of labor that received the benefits who were less unionized. The system was abolished in the year 1997 (Ljungqfvist & Sargent, 1994, p. 1043). Keynesian view of unemployment One of the greatest economists of the world, Britain’s John Maynard Keynes criticized the classical model and stated that such labor market mechanism can be explained in the domain of single and isolated markets but in reality the labor markets are not isolated. Keynes stated that a nation usually consumes a majority part of what it produces. The economy needed to have a balance between the demand level and the production level within the economy. He also pointed out that the individuals usually purchase majority of the goods produced within the society and greater the demand for the goods and services more is the requirement of the labor for the enhanced production. The labor market acts as a proxy for the overall economic health of the economy and unemployment is degenerating as because it decreases aggregate demand in the economy. According to Keynes, the level of output and the employment in the economy is determined through the aggregate demand or effective demand. “In a reversal of Say's Law, Keynes in essence argued that man creates his own supply, up to the limit set by full employment” (Keynesian economics, n.d.). Aggregate demand is connected to the demand for labor since greater demand signifies greater the production and companies need to hire more people for more production. Now if the aggregate demand falls, companies will lay off people because their work will not be required any more. Natural rate of unemployment and the actual rate of unemployment The conventional idea of the market is that unemployment will exist in reality as the labor market is not perfect and the level of employment and the unemployment will hover around the equilibrium value. The Natural Rate of Unemployment is the rate of Unemployment which states that the labor market is in equilibrium and it is generally the difference between the people who would like a job at the current wage rate and those who are willing and able to take a job and it is devoid of the cyclical fluctuations present in the business in reality (The Natural Rate of Unemployment, n.d.). But in the economy there exists business cycles and the labor market will be continually shocked by the overall economic cycle and the labor market will tends towards the equilibrium but will never reach that natural rate except only in the case when there is no economic boom or busts. Fig.7 Natural Unemployment rate and the actual rate of unemployment (Griffiths & Rotheim, 2007, p.11) In a study, Holmund with the help of the expectation augmented Philips curve found that the Swedish natural unemployment rate was higher in the 1990s than the decades earlier especially during the period of 1994 and 1995 the rising wage inflation was an indicator of the enhancement in the natural rate of unemployment. In some other studies also unemployment has been studied by bifurcating the parts into stationery and non stationary parts and the results revealed that the non stationery part followed the actual unemployment rate and the cyclical fluctuations were small (Lindblad, 2007, pp. 2-3). Bargained and warranted wage rate Along the path of the balanced growth path the wage rate must be consistent with the stable employment will grow at the rate of the Harrod-neutral technological progress and if the prices of the other factors of production rises then the wage must fall for the maintenance of the zero net profit for firm which is called the warranted wage rate and the wage rate set in the bargaining process is called the bargained wage (Blanchard, 2005, p. 10). Blanchard proposed that this notion was the key indicator of the increased unemployment in the year of 1970s and 1980s in a situation when the oil prices and the reduction in the total factor productivity growth and the outcomes of bargaining exceeded the warranted wages and the unemployment increased accordingly (Meager & Speckesser, 2011, p.13). Beverigde curve and the Swedish unemployment A Beveridge curve reflects the relationship between unemployment and the job vacancy rate. The higher the unemployment rate lower is the rate of vacancies. Empirics reveal that during the period of 1960s, 1970s, and 1980s the long term relationship of the vacancies and the unemployment was remarkable stable but from the 1990s it was found that the vacancies began to fell and the unemployment started to rise. From the period of 1991 to 1995 the unemployment rate increase almost 5 percent points while the vacancy rate changes a little. From 2000 onwards the curve shifted inwards indicating recovery (Wang & Wang, 2006, p. 18). Fight back moves and areas of focus The government of Sweden presented a Bill in April 1997 which directed on the guiding principles of the economic policies. The proposals stated that 8 billion was to be invested in the jobs in municipalities known as the ‘kalmar model’ adapted throughout the nation for the reduction in the unemployment rate. The policy indicated that the employers were able to recruit the unemployed people for raising the quality of the activity of the employers without providing them more than a fraction of normal wage. The Government also suggests that long-term unemployed persons over 60 should be able to keep their benefits without having to look for a job until the end of 1997 (Government proposes economic measures to reduce unemployment, 1997). The Swedish economy had encountered strong economic phase from 2010 and the gross domestic product increased by 5.5 per cent. The expansive monetary policies and reduced uncertainty led to the rapid increase in the household consumption. Some of the important areas on which the Swedish economy should be concentrating will be on the labor market reforms, higher wage rate in the time of the higher utilization of the resources, ensuring a surplus product, enhancing high quality education system, ensuring high degree of competitiveness and entrepreneurship, so on and so forth (Swedish national reform programme 2011, pp. 5-10). Conclusion The labor market of the Europe has been through economic doldrums and cyclical fluctuations and unemployment has been high from the period of 1970s and still it is persistent and in particular the Swedish unemployment performed well but exaggerated in the decade of the 1990s with the liberal employment policies of the country. The paper revealed the phenomenon through the lights of economic theory to reveal the patterns of unemployment and ultimately leads to the suggestions of the policies which will strengthen the Swedish economy further. References 1. Aiginger, K (2004), Labour Market Reforms and Economic Growth – the European Experience in the Nineties, available at, < http://www.oecd.org/dataoecd/41/58/34943545.pdf> (accessed on June 28, 2012) 2. Blanchard, O, J (2009), Explaining European Unemployment, available at < http://www.nber.org/reporter/summer04/blanchard.html>(accessed on June 28, 2012) 3. El-Agraa, A, M (2011), The European Union: Economics and Policies, Cambridge University Press 4. Fregert, K, (2008), Causes of structural unemployment in Finland and Sweden 1990-2004, available at (accessed on June 30, 2012) 5. Government proposes economic measures to reduce unemployment, (1997), available at < http://www.eurofound.europa.eu/eiro/1997/04/inbrief/se9704115n.htm> (accessed on June 30, 2012) 6. Griffiths & Rotheim, 2007, p. CLASSICAL AND KEYNESIAN ECONOMI C EXPLANATI ONS FOR UNEMPLOYMENT, available at (accessed on June 28, 2012) 7. Holmlund, B , (2003), THE RISE AND FALL OF SWEDISH UNEMPLOYMENT, available at < http://www.cesifo-group.de/portal/pls/portal/docs/1/1189782.PDF>(accessed on June 28, 2012) 8. Hughes, J. J & Perlman, R, (1984), The Economics of Unemployment:  A Comparative Analysis of Britain and the United States, Cambridge University Press 9. Keynesian economics, (n.d.), available at < http://www.martinfrost.ws/htmlfiles/keynesian_economics.html>(accessed on June 28, 2012) 10. Ljungqvist, L & Sargent, T, J (2010), How Sweden’s Unemployment Became More Like Europe’s, available at < http://www.nber.org/chapters/c5363.pdf> (accessed on June 30, 2012) 11. Ljungqfvist, L. & Sargent, T.J (1994), The Swedish Unemployment experience, available at < http://www2.hhs.se/personal/ljungqvist/sweden.pdf> (accessed on June 30, 2012) 12. Lindblad, H (2007) , Persistence in Swedish Unemployment Rates, available at < http://www2.ne.su.se/paper/hlindblad.pdf> (accessed on June 30, 2012) 13. Meager, N & Speckesser, S (2011), Wages, productivity and employment: A review of theory and international data, available at < http://www.eu-employment-observatory.net/resources/reports/WagesProductivityandEmployment.pdf>(accessed on June 30, 2012) 14. Michau, J, P (2009), European unemployment: how significant was a declining work ethic? available at, < http://cep.lse.ac.uk/pubs/download/cp294.pdf> (accessed on June 28, 2012) 15. Mankiw, N, G, (2011), Principles of Economics, Cengage Learning, 16. Nixson, F. I & Artis, M. J (2007), The Economics of the European Union: Policy and Analysis, Oxford University Press 17. Schmitt, J & Warner, K (2011), Deconstructing Structural Unemployment, available at < http://www.cepr.net/documents/publications/dws-2011-03.pdf> (accessed on June 30, 2012) 18. The Natural Rate of Unemployment, (n.d.), available at < http://www.economicshelp.org/macroeconomics/unemployment/natural_rate.html> (accessed on June 30, 2012) 19. Swedish national reform programme (2011), available at < http://ec.europa.eu/europe2020/pdf/nrp/nrp_sweden_en.pdf> (accessed on June 30, 2012) 20. The Classical View of the Labor Market, (2010), available at < http://wps.prenhall.com/bp_casefair_macrof_7e/32/8268/2116709.cw/index.html> (accessed on June 30, 2012) 21. Unemployment, total, (2011), available at (accessed on June 30, 2012) 22. Wang, B & Wang, L (2006), The Swedish Beveridge Curve and Matching Function, available at < http://econ.net23.net/econ/edu/cup/reports/2006/matching2.pdf> (accessed on June 30, 2012) Read More