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EUROPEAN UNEMPLOYMENT:
THE EVOLUTION OF FACTS AND IDEAS
Olivier Blanchard
Working Paper
11750
NBER WORKING PAPER SERIES
EUROPEAN UNEMPLOYMENT:
THE EVOLUTION OF FACTS AND IDEAS
Olivier Blanchard
Working Paper 11750
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
November 2005
Prepared for the Economic Policy Panel, London, October 2005. I thank Giuseppe Bertola, Ricardo
Caballero, Emmanuel Farhi, Thomas Philippon, Steve Nickell, Julio Rotemberg, Thomas Sargent, and Robert
Solow for comments. The views expressed herein are those of the author(s) and do not necessarily reflect
the views of the National Bureau of Economic Research.
©2005 by Olivier Blanchard. All rights reserved. Short sections of text, not to exceed two paragraphs, may
be quoted without explicit permission provided that full credit, including © notice, is given to the source.
European Unemployment: The Evolution of Facts and Ideas
Olivier Blanchard
NBER Working Paper No. 11750
November 2005
JEL No. E24, J6
ABSTRACT
In the 1970s, European unemployment started increasing. It increased further in the 1980s, to reach
a plateau in the 1990s. It is still high today, although the average unemployment rate hides a high
degree of heterogeneity across countries. The focus of researchers and policy makers was initially
on the role of shocks. As unemployment remained high, the focus has progressively shifted to
institutions. This paper reviews the interaction of facts and theories, and gives a tentative assessment
of what we know and what we still do not know.
Olivier Blanchard
Department of Economics
E52-357
MIT
Cambridge, MA 02139
and NBER
blanchar@mit.edu
Introduction
From the end of World War II to the end of the 1960s, European unemployment
was very low. In the 1970s, it started increasing. It continued to increase in the
1980s, and to reach a high plateau in the 1990s. It is still high today, although
the average European unemployment rate hides a high degree of heterogeneity
across countries.
This has been a tough learning experience, both for economists and for policy
makers. When the 1970s started, the concept of a natural rate of unemploy-
ment was just born, and still far from operational. The following quote from
Milton Friedman (1968) is revealing: “The natural rate of unemployment is the
level which would be ground out by the Walrasian system of general equilib-
rium equations, provided that there is imbedded in them the actual structural
characteristics of the labor and commodity markets, including market imper-
fections, stochastic variability in demands and supplies, the cost of gathering
information about job vacancies and labor availabilities, the costs of mobility,
and so on.”
One might have hoped that, with thirty years of data, with clear di®erences
in the evolution of unemployment rates and policies across countries, we would
now have an operational theory of unemployment. I do not think that we do.
Many theories have come and—partly—gone. Each has added a layer to our
knowledge, but our knowlege remains very incomplete. To use a well worn for-
mula, we have learned a lot, but we still have a lot to learn.
The purpose of this paper is to review the developments, both on the unemploy-
ment and the theory fronts, and give an assessment of where we are today. Let
me start with two caveats. I have not tried to be encyclopedic.
1
And, because
the editors unwisely encouraged me to do so, I have certainly focused too much
on my own research—one of the results being a Stiglitz–like bibliography. For
my defense, I would argue that it is broadly representative of the twists and
turns of our theories over the last thirty years.
I review the basic facts, across time and across countries, in Section 1. As
1. A more encyclopedic and very good survey, but now 10 years old, was given by Charles
Bean (1994). A more recent one was given by Stephen Nickell (1997). The standard reference
on unemployment in general, and European unemployment in particular, remains the book
by Richard Layard, Stephen Nickell, and Richard Jackman published in 1991 (2nd edition,
2005).
2
unemployment increased in the 1970s, the initial focus was on the role of shocks,
from oil price increases to the slowdown in productivity growth. This is the
topic of Section 2. As the shocks receded but unemployment remained high, the
focus shifted in the 1980s to persistence mechanisms, from the role of capital
accumulation, to the role of insiders in bargaining. This is the topic of Section 3.
In the early 1990s, the focus shifted yet again, this time towards the role of labor
market institutions, from employment protection to unemployment insurance.
This is the topic of Section 4. Since then, research has tried to sort out the
respective role of shocks, institutions, and interactions. The main directions of
exploration and the open questions are the topic of Section 5. The state of play,
and whether we know enough to usefully guide policy and reforms, are taken
up in Section 6.
1
Basic Facts
Figure 1 gives the evolution of the unemployment rate for the EU15 as a whole
(the 15 member countries of the European Union) since 1960. It shows the
steady increase in unemployment from 2% in the 1960s to 8% in the 1980s, and
a rough plateau—with cyclical declines at the end of the 1980s and 1990s—since
then.
Figure 1. EU15 unemployment rate, since 1960
1960
1970
1980
1990
2000
3
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