Book Description

The persistence of high unemployment has been one of the most puzzling developments of the past twenty years or so. In the UK, unemployment averaged 2.1% between 1966 and 1973, and since 1974 it has risen to an average of 7.5%. The prevailing view of the persistence of unemployment and of the continuous rise in the NAIRU is that explanations and solutions can only be found on the supply side and not on the demand side of the economy. Most economists regard the problem of job creation mainly as a matter of encouraging more employment with the existing stock of capital. However, any long-run analysis should consider that the capital stock may vary. The relationship between capital stock and employment may be a simple explanation which suggests that investment in new productive capacity increases the number of jobs, while the destruction of existing capacity may destroy jobs. It may also be that the fall in investment encourages asymmetric responses in the labour market and thus the persistence of unemployment. This paper is concerned with the determination of aggregate wages and unemployment in the UK. We try to explain the persistence of unemployment by beginning with theories that concentrate on supply side failures in the labour market. The model is extended by examining the relationship between capital stock and employment. It is argued that the fall in investment over the last twenty years or so is one of the major elements behind the fall in employment and that only a substantial rise in productive capital may reduce unemployment. It is also argued that capital scrapping during the two oil price shocks, combined with low investment subsequently, may have caused long-term unemployment. This is not to say that low skill or other worker characteristics are not important, but that investment-enhancing policies may have prevented long-term unemployment to some extent. Furthermore, we introduce a new dimension to the discussion of money wage determination and unemployment by incorporating non-linearities in the relationship. There are various reasons for expecting that wages adjust with different speed to disequilibrium errors. The asymmetric error correction model applied here, accounts for the different speeds of adjustment in response to deviations of the actual unemployment rate from the attractor, the NAIRU. The empirical investigation tests each of the hypotheses put forward. Firstly, we find that capital shortage increases NAIRU. Secondly, we test and establish that a fall in investment creates long-term unemployment, and thirdly, we provide evidence which suggests that the speed of adjustment in nominal wages depends on unemployment being above or below NAIRU.