Wage Setting and Unemployment Persistence in Europe, Japan and the USA

In this paper we set out to directly distinguish between insider membership dynamics and other sources of unemployment persistence. Our findings suggest that there are not sufficient differences in insider membership dynamics between the European economies and the United States. Thus, one cannot appeal to this source to justify the difference in their unemployment experience after the mid-seventies. This is in marked contrast to the conclusion of Blanchard and Summers. We suggest that their conclusions are sensitive to the way of approximating the natural rate of unemployment. Our second conclusion concerns sluggishness in labour demand. We find evidence of significant sluggishness in the three European economies and no sluggishness in the U.S.A. and Japan. This tentatively suggests that the persistence of European unemployment after the recent demand and supply shocks may have to do with this source.In section 2 we briefly present a version of the Blanchard and Summers model of wage and employment setting. In section 3 we modify and extend the model, and present estimates of the hysteresis coefficient, that measures the extent to which past employment determines the size of the group of insiders in wage negotiations. In section 4 we briefly investigate sluggishness in labour demand, and the conclusions are summed up in the final section.

European Economic Review (with Alan Manning)

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