So far, we have come up with four possible stories about unemployment. Can these theories help to explain differences between Europe and the United States?
First, it is generally the case that minimum wages are more generous in Europe than in the United States, so it is certainly possible that higher minimum wages in Europe contribute to higher levels of unemployment there. Second, there is some evidence that nominal wages are in some sense “stickier” in Europe than in the United States. Third, we can observe that unions are generally more prevalent and more powerful in Europe than in the United States. Thus some of the stories that we have told are potentially helpful in explaining differences between the United States and Europe.
However, all these theories are silent about the underlying movement of workers from employment to unemployment and back again. ***Figure 8.4 "Unemployment in the Labor Market" paints a static picture of a world that is in fact dynamic and fluid. There is no means in the framework to explore the role of unemployment insurance and other policies that differ across Europe and the United States. In addition, market forces may work differently in the labor market. In ***Figure 8.4 "Unemployment in the Labor Market", there are more workers wanting to work than there are jobs offered by firms. The standard story of market adjustment is that workers willing to work for a lower wage would approach a firm, offer to undercut the wage of an existing worker, and be immediately hired as a replacement. This is not how hiring and firing usually works in the labor market. Firms have a relationship with their existing workers; they know if their workers are competent, hardworking, and reliable. Firms will not readily replace them with unknown quantities, even for a lower wage.
For these reasons, researchers in labor economics think that Figure 8.4 "Unemployment in the Labor Market" is too simple a framework to explain the realities of modern labor markets. Instead, they frequently turn to a different framework more suited to thinking about labor market flows.
KEY TAKEAWAY
The unemployment rate is the fraction of the civilian labor force looking for a job but currently not employed. The BLS in the United States produces this number on a monthly basis.
During the early part of the 1980s, the unemployment experiences in the United States and Europe were similar. Up until 2008, the unemployment rate in Europe had been significantly higher than the unemployment rate in the United States. Very recently, however, the US unemployment rate climbed to European levels.
In a perfectly functioning labor market, the unemployment rate would be zero. Possible explanations of unemployment include rigidities in wages, the market power of unions, and incentive effects.
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Checking Your Understanding
Explain in your own words why the standard supply-and-demand framework predicts zero unemployment when it is applied to the labor market.
What wage is determined in labor market equilibrium—the real wage or the nominal wage?
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