What is the relationship between inequality and unemployment? This question is perhaps the most important issue in the political economy of Europe, and it has relevance for other regions with developing transnational ties, including the United States and the North American region.
One widely-held view is that high unemployment rates in Europe are due to that continent’s generous social welfare systems and ‘rigid’ wage structures, or, in other words, to the equality that is the characteristic goal of social democracy. Though this view has lately come under attack,footnote1 it remains the received wisdom for most economists, for the new policy-makers of the so-called Third Way, and, of course, for the business press. In this view, low unemployment in the United States is credited to that country’s ‘flexible labour markets’, willingness to tolerate increasing wage inequality, and high absolute levels of inequality in wages.
This view is strikingly inconsistent with the facts. For example, it implies that, within Europe, countries with more inequality should have less unemployment. It would also appear to imply that countries with high wage levels should perhaps have more unemployment, and certainly not less, than countries with lower wages. But the opposite is true in both cases. Unemployment has always been higher where inequality was greater in Europe. And now, as Europe has integrated, a corresponding transnational pattern has emerged. It was never the case that the richer countries had more unemployment, as a rule. Twenty-five years ago, unemployment across countries in Europe was, in fact, largely uncorrelated with per capita national income; labour markets perhaps cleared, or did not, on a national basis. But, in the late 1970s, a strong and systematic negative relationship emerged which has been sustained ever sincefootnote2. Today, national unemployment rates are systematically lower in the richer and more equal countries of Europe where wages are high and social welfare systems are strong. Meanwhile it is the lower-income countries with the weakest social welfare systems and the most inequality, such as Spain, where unemployment is highest in today’s Europe.
The conventional view also implies that pay inequality in the United States, where unemployment is presently quite low, must be higher than in ‘Europe‘. But, while this is true for comparisons between the United States and individual European countries, such comparisons ignore differences in income levels between the countries of Europe. When these are accounted for—and Europe is today an integrated continental economy—it is not obvious that the United States is in fact less equal. Our methods, which employ measures of inequality that can be ‘grouped up’ to the European level, permit the calculation of a dispersion index that is directly comparable between the us and Europe as a whole; this index shows a higher value for Europe.
Further, the conventional view implies that, in the United States, unemployment should have fallen when inequality rose, in the 1980s, and vice versa in the 1990s. But wage-rate inequality, in
We suggest two simple reasons why inequality and unemployment may generally show the positive association that we observe, while the associations between unemployment and income, and between inequality and average income, are both negative.footnote4 One is that unemployment causes inequality. The other is that inequality may cause unemployment. Regions with low average incomes are marked by large numbers of relatively impoverished people in low productivity occupations, and, thus, by high inequality across occupations, industries, and sectors. Many such people seek any available exit from their status, even if they recognize that the chances a priori of finding a substantially better job are low. In other words, so long as appealing alternatives to low-income employment exist, even—indeed, especially—when they are not widely accessible, people form up into the queues of the unemployed.
This does not happen to the same extent in high-income countries. It is true that the lures of the truly high-wage jobs are even greater in such countries. Unemployment insurance and other safety nets are stronger in rich countries than in poor ones. Conventional thinking focuses on such measures of social welfare generosity as benefit replacement rates, and predicts higher unemployment in more generous countries. And, yet, contrary to the views of the anti-labour Right, such open invitations to unemployment are not, in fact, accepted to the same degree. Why not?