Long-Run Economic Performance and the Labor Market

Abstract

1. IntroductionThis article studies growth when the economy is not using all its productive resources to establish a bridge among two subdisciplines in economics: growth theory and unemployment theory. The former is dynamic and considers the impact on output of the growth in inputs under the assumption that unemployment is nonexistent. The latter is static and considers the determination of the rate of unemployment under the assumption that the growth of capital is nonexistent. Our goal herein is twofold. On one hand, we want to modify slightly the growth models to include the effects of persistent unemployment on long-run growth. On the other, we want to analyze the role played by the accumulation of capital in determining the unemployment rate.The underlying assumption in the neoclassical growth model is that, even if we admit sticky wages in the short run, in the long run, the labor market should have time to clear and the economy should return to full employment, understood as the level of employment compatible with frictional unemployment. Therefore, what is relevant when talking about growth is the growth of the labor force, not the growth of the employed labor force. However, if the equilibrium employment level in the labor market persistently differs from the more desirable frictional level, it is conceivable that this persistent deviation will have an impact on long-run growth. The average U.S. unemployment rate during the 1990s was 5.8% while countries such as France and Spain maintained double-digit unemployment rates in the 1980s and 1990s. It seems intuitive that double-digit unemployment during two decades should have long-lasting effects on standards of living. The disparate experiences of some European countries as opposed to the United States in terms of employment rates are due to very different institutional factors in the corresponding labor markets. This article studies the impact of labor market institutional variables on long-run growth.Despite a very large literature on both growth and unemployment, few papers have jointly studied these two phenomena. The exceptions are Furuya (1998) and Daveri and Tabellini (2000). Daveri and Tabellini study the implications of an increase in labor taxes on both unemployment and economic growth. The models in these two papers are of the overlapping generation class, but whereas in Furuya's, the labor market does not clear because of the existence of efficiency wages, in Daveri and Tabellini's, the labor market does not clear because of the existence of a union. Our model is a simple variation of the standard Solow model suitable for a first approximation to an empirical investigation of the interrelationship between economic growth and the labor market.We use a variation of Blanchflower and Oswald's (1995) wage curve, which is more suitable for integration with a growth model. The wage curve shows an empirical inverse relation between unemployment and wage levels. This inverse relation is consistent with models of noncompetitive wage determination. Basically, we use a reduced form of the open-trade-union Layard-Nickell (Layard and Nickell 1985, 1986) model of wage determination to explain why the equilibrium unemployment level differs from the frictional level. A weakness of relying on trade union behavior to explain unemployment is that, in most countries, not all workers are unionized. Union membership varies greatly across countries, but in most countries, a large part of the labor force is nonunionized. However, Blanchard and Summers (1986) argue that the trade union model can be interpreted as describing the behavior of a group of workers that acts as a group even if there is no formal trade union. The fact that both capital intensity and productivity affect the equilibrium unemployment rate is implicit in the Layard-Nickell model. We emphasize the importance of capital intensity in the determination of unemployment and incorporate unemployment into a growth model. …