Relative_Demand_Shifts_and_Unemployment

Olivier Blanchard *
April 1998
The third factor often mentioned in discussions of European unemployment is
relative demand shifk. The basic argument is the following:
Everywhere in the OECD, there has been a shift in relative labor demand away
from low-skill workers towards high-skill workers. In the United States, this has
led to a decrease in the relative wage of low-skill workers. In Europe, constraints
on the relative wage of low-skill workers have led instead to an increase in their
unemployment rate, and thus an overall increase in unemployment. As Krugman
has put it, facing a tradeoff between letting low-skill workers go jobless or penniless,
Europe has chosen the first, the US the second.
Variations on the theme replace “less skilled” by “less competent”. Increased returns
to increased competence (unobservable to econometricians, but observable
by f;rms) have led to larger within cell dispersion in the United States, larger
unemployment for the less competent in Europe. Or they replace “less skilled”
by “living in less productive regions”. Increased returns to geographical location
have led to higher local wages and inter-state migration in the United States,
but to high unemployment in excentric regions in Europe (the south of Italy for
example).
Like the arguments we saw earlier about the role of unemployment benefits, or
employment protection, this can again be seen as a “time bomb” argument. Wage
compression, across skills or across regions, is not new in Europe. In the past, it
did not lead to unemployment. But, the argument goes, in conjunction with a
shift in relative demand, it has led in the past 15-20 years to a large increase in
unemployment.
Start with the basic facts about the minimum wage and wage compression across
skills.