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This protest in Niagara Falls, Canada was organized to protest against cuts to education being proposed by the government of the province.

Unit 2 Unemployment, wages, and inequality: Supply-side policies and institutions

How differences in institutions, policies, and shocks affect macroeconomic outcomes

Before you start

This unit builds on the concepts and examples introduced in Unit 1. You should work through the WS–PS model in Unit 1 before beginning work on this unit.

2.1 A scarred generation

A permanent job meant more than the hope of economic security for Mar, a Spanish woman in her thirties. It was an opportunity to begin living by herself. ‘I cannot even pay my own rent.’ She belongs to the scarred generation that entered the labour market right after the 2008–2009 global financial crisis. She and those she grew up with were lucky if they found employment—even a job with little security and no future. Across Spain in 2013, more than half of her age group were searching for work.

When her temporary job finished and with no hope of a permanent one in Spain, Mar moved to Germany, searching for an opportunity to show her talent in writing and developing stories for TV and films. ‘This is what I am best prepared for. I have studied so hard for a job as a screenwriter or journalist. I speak three languages and feel very motivated. I want to be like my mother and pursue a decent professional career in an occupation for which I am well qualified.’

Mar’s mother, Carmen, is a senior journalist with a permanent job at the largest broadcasting company in Spain. She graduated in journalism in the early nineties. After that, she worked for several news agencies in Madrid until she finally achieved her current job 20 years ago. She has also been recently appointed as a trade union representative in the works council of the company and negotiated a wage rise of 4% for all full-time workers, a remarkable feat given that the company is struggling to compete with the new online broadcasting platforms such as Netflix and Disney+.

Carmen is happy that her daughter followed her in her career choice but cannot imagine why it is so difficult to get the kind of job she needs and deserves. Mar, it seems, did everything right: she graduated in journalism and got two master’s degrees and even started a PhD. She has worked in several jobs over the past years, as a receptionist in the hospitality sector, a community manager, and a part-time editorial writer in Berlin for a few years, and she recently finished a traineeship for a television channel. ‘How am I going to buy a house or become a mother if I do not even have a stable job?’, Mar complains. ‘My friends in Berlin have some stability that I lack here. After studying so hard, why would I not deserve the same opportunity here?’

Part of the reason why Mar has so much less job security than her mother is that it is difficult for employers in Spain to fire workers, and they negotiate with strong unions that demand high salaries. In the competitive market of filming, profit margins are thin. ‘Young people are creative and motivated. For the wage of one older employee, I could hire two recent and productive graduates,’ explains a manager of a local broadcast platform. ‘Young people also know a lot about technology and innovation. But I cannot afford the expensive firing costs. And for sure I do not want a strike in my company right now.’

Both institutions and policies explain much of the distress of the scarred generation and the differences between Spain and Germany.

The modelling we develop in this unit helps to explain why, over very long periods, unemployment rates differ between countries. Germany and Spain are large European countries that share many characteristics. As well as belonging to the European Union, which provides conditions for borderless trade and a common competition policy, firms based in both countries compete in global markets on the same terms. They share access to the same robot technologies and other labour-saving innovations.

The two countries seem to be equally vulnerable to what are generally considered the two potential ‘job killers’ for the high-income countries in the early twenty-first century—automation and globalization. Yet, as Figure 2.1 shows, for the period from 1960 to 2022, the unemployment rate in Germany averaged 4.9%, compared with a rate more than double this in Spain (12.7%).

In this line chart, the horizontal axis depicts the year, ranging from 1960 to 2022. The vertical axis displays the unemployment rate in %, ranging from 0% to 25%. Germany’s unemployment rate begins at around 1% in 1960 and starts to rise steadily at the onset of the first oil shock in 1973-74, plateauing at around 9% from 1994 to 2009, after which it falls steadily to around 4% in 2022. Spain’s unemployment rate begins at a higher level of around 3% in 1960 and rises rapidly at the onset of the first oil shock in 1973-74, plateauing at around 20% from 1984-1999. It then falls when the Eurozone is launched in 1999 to around 11% until the Global Financial Crisis in 2008 to 2010 when it rises rapidly to around 23%. Spain’s unemployment rate begins to fall from 2014, reaching around 15% in 2022.
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Figure 2.1 Unemployment in Spain and Germany (1960–2022).

D. R. Howell, D. Baker, A. Glyn, and J. Schmitt. 2007. ‘Are Protective Labor Market Institutions at the Root of Unemployment? A Critical Review of the Evidence’. Capitalism and Society 2 (1); OECD. 2023. Harmonized unemployment rates.
Note: Spain became an EU member state in 1986, while Germany was one of the original members.

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Figure 1.1

The comparison of Spain and Germany directs attention to the contrasting ways in which both labour and product markets work in different countries. We will examine some of the factors that affected structural unemployment in both economies in this unit. The organization of the labour market and the nature of labour unions that we cover in this unit can be represented in the WS–PS model introduced in Unit 1, and can help explain some of the differences behind the widely divergent unemployment trends across countries, as seen in Figure 1.1, reproduced here.

In this unit, we combine the WS–PS model with a tool for the analysis of inequality called the Lorenz curve, which is explained in the next section. Since citizens and governments want to have policies that can sustain high wages and employment and limit inequality, the combined model provides a framework to assess the effectiveness of these policies.