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iii) In a number of countries, where unemployment benefit schemes exist, a higher level of unemployment increases social welfare spending, worsening public accounts and jeopardising economic stability.

iv) Because of hysteresis, deflationary policies can have lasting costs on real variables also in the long run (see exercise 2, chapter 12), a possibility that is ruled out by the classical model.

Q6  Who are the 'insiders' in the labour market and who are the 'outsiders'? Discuss the relevance of this distinction to current unemployment in Europe.

Insiders are workers currently employed while outsiders are workers currently out of work, (unemployed).  The former are so called because they are 'inside' the process of bargaining wages and work conditions and are represented by trade unions. In the bargaining process, trade unions attach more importance to the level of real wage and work protection (rendering dismissals more expensive and difficult for the employer) than to the introduction of means for cutting unemployment through pay moderation and flexible work contracts.  In technical terms, recalling figure 14.2 - a, the cost of labour rises from (w/p)0 to (w/p)1 and this improves conditions for insiders but increases the number of outsiders (those who are now represented by section AB) and worsens their situation.

In analysing the importance of this distinction for Europe, students are encouraged to browse through figures for unemployment, wages and trade union membership in different European countries and in Europe as a whole vis-à-vis the United States.

European figures tend to show higher trade union participation, higher wages and higher unemployment compared to the United States. Furthermore, social protection legislation in place in most European countries acts to protect the unemployed through unemployment benefits which, on one hand, improve their social conditions but, on the other hand, increase the replacement ratio rendering the tackling of unemployment more difficult.

Q7  Is faster economic growth the answer to Europe's unemployment problem?

The relationship between growth and employment is neither simple nor linear.  Because of technological progress, growth can be sustained with low or no labour creation at all.  In developed countries, growth is attained intensively through higher productivity (more output per unit of labour) rather than extensively (same productivity but more units of labour).  Technological progress is not neutral: it tends to be concentrated in sectors, periods and countries where the cost of labour is high, by decreasing the number of workers and increasing their productivity.  Therefore, growth can be insensitive to unemployment if it is attained by a shift from labour-intensive to capital-intensive technologies.

Growth in itself is not the answer to unemployment, but it can certainly help to reduce it.  Faster growth means more demand for labour and higher wages.  Prospects improve and replacement ratio problem reduces.  But the link between unemployment and


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