Structural Unemployment

Structural unemployment is persistent, long-term unemployment. Isn't it redundant to say that unemployment is persistent and long-term? Not quite. What we have in mind is when a large share of the unemployed have been unemployed for a long time, and this has been true for many years.

Consider the following data from some leading European economies and the United States. In each case the average unemployment rate in the European economies between 1980 and 2004 was higher than in the United States, sometimes markedly so. In Italy and France, unemployment rates have hovered around 10% for several decades, while Spain has had long spans of unemployment near 20%.

Now look at the fraction of the unemployed who are unemployed for more than a year. In most of these economies, between 40 to 50% of the unemployed were long-term unemployed, compared to the United States at just 12.7%. In the United States, the fraction of the unemployed who were long-term -- it did shoot up in the 2008, 2009 recession, but has since fallen. This persistent, long-term unemployment is structural unemployment. One of the causes of structural unemployment is large, quick-hitting and relatively permanent shocks that change the number, location, and types of jobs. The 1970s oil shocks, the opening of trade with China in the 1990s, or the rapid rise of the internet would all be examples. It can take time to adjust to these kinds of big changes in the economy.

These shocks, however, they've hit both the United States and Europe. So why is structural unemployment a worse problem in Europe? The most likely answer is that European labor regulations have increased structural unemployment, in part by making it more difficult to respond to shocks. In the United States, for example, the most basic employment law is the At-Will Doctrine, which says that an employee can quit and an employer can fire at any time and for any reason.

Now there are many exceptions to the law. Employers cannot fire due to race, religion, and sex, for example. And, at-will employment can be changed by contract. Nevertheless, at-will employment remains the default U.S. employment law. The situation in Europe, in contrast, is often very different. In Portugal, for example, the constitution makes at-will employment illegal. Dismissing a worker instead requires “just cause.”

Now, that may seem like a good thing. Who could object to just cause? But in practice, what this means is that dismissing a worker in Portugal requires a complex and often lengthy process that requires union and government approval. Because it's difficult to fire workers in these countries, employers are also reluctant to hire. Imagine how hard it would be to get a date if every date required marriage. In the same way, it's more difficult to get a job when every job requires a long-term commitment from the employer.

Let's look at some data at how these labor market regulations affect unemployment. On the horizontal axis, we'll put the Rigidity of Employment Index, which the World Bank calculates to summarize hiring and firing costs and how easy it is for a firm to adjust hours of work. On the vertical axis, we have the percentage of the unemployed that are unemployed for long periods of time. You can see a clear trend. The share of long-term unemployment increases with greater labor market rigidity.

European labor law also differs from American law in another respect. European unemployment benefits are typically much more generous than American benefits. In the United States, for example, unemployment insurance might pay, say 30% of what a worker was earning in their job. It's not that much. In Sweden, Portugal, or Spain, a typical worker would get at least twice that much.

Now, a worker who's being paid only 30% of his or her previous wage -- they're going to be much more eager to find a new job than a worker who is being paid 60% of their previous wage. Now that's not necessarily a bad thing. Maybe it gives workers time to find better jobs, but it does mean that unemployment rates tend to be higher and are longer-lasting in Europe than in the United States. The European economies, because of these issues -- they've been trying to move towards more flexible labor markets since the 1990s, but the process is slow and difficult.

We can illustrate why with, "A Tale of Two Riots." In November of 2005, angry, predominantly immigrant and minority youth, rioted in Paris. The riots were triggered by accusations of police brutality, but they also reflected underlying problems in the labor market, most especially that 30% of the immigrant youth were unemployed. French firms were reluctant to hire young minority workers. Perhaps in some cases because of outright discrimination, but also because young workers are especially risky. Labor law made it difficult to fire and so firms were reluctant to hire. Once again, who wants to go out on a blind date if a date means forever?

Now the French government was aware of these problems and they proposed to change labor law, so that employment would be at-will, but just for workers under the age of 26. Such a law would have been good for immigrant youth, but the idea that they might be fired at will -- that offended more elite French students. So, these elite students, well, they started riots of their own. They took over university offices, they shut down universities all across France, and they were joined by hundreds of thousands of people who protested the proposed law. There were numerous clashes between the police and the protestors. The government backed down.

"The Tale of Two Riots" illustrates how restrictive labor law can create two very different groups: the Insiders -- who for the most part enjoy the protection of long-term stable employment, and the Outsiders -- the people who are frozen out of the regular labor market. They end up having high unemployment rates, and only intermittent and temporary employment. Dealing with structural unemployment and creating a labor market that's open to all workers -- this is one of the most serious issues facing some of the economies in the European Union.

Okay. In our next video, we're going to turn to another type of unemployment: cyclical unemployment.