WESTERN EUROPE: THE UNEMPLOYMENT CRISIS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00895R000100150002-2
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 37
• Document Creation Date: December 21, 2016
• Document Release Date: January 3, 2008
• Sequence Number: 2
• Publication Date: December 1, 1983
• Content Type: REPORT

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Directorate of
Intelligence
Western Europe:
The Unemployment Crisis
Confidential
Confidential
EUR 83-10271
December 1983
COPY 3 7 3
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 Directorate of Confidential
Intelligence
Western Europe:
The Unemployment Crisis
Office of European
Analysis. Comments and queries are welcome and
may be directed to the Chief, European Issues
Branch, EURA
Confidential
EUR 83-10271
December 1983
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Western Europe:
The Unemployment Crisis
Key Judgments We believe Western Europe faces a continued period of high unemploy-
Information available ment, possibly averaging 12 percent through the end of the decade.
as of 14 November 1983 Although the public has shown an unusual tolerance for unemployment,
was used in this report.
this persistent trend will increase pressure on political and social institu-
tions and disrupt US-West European economic relations:
? By the second half of the 1980s, Western Europe may enter a period of
frequent oscillation between governments of the left and right because
incumbent leaders, unable to solve the unemployment problem, will
become increasingly vulnerable to opposition attacks.
? Political extremism may become rampant among young people as much
of an entire generation of youth faces years of joblessness or
underemployment.
? Foreign workers increasingly will become targets of resentment by the
unemployed, leading to social strains both within and among West
European countries.
? Trade conflicts between Western Europe and the rest of the world will
become more numerous and hotly contested as West European govern-
ments increasingly equate trade opportunities with job opportunities.
Recent trade disagreements with the United States over steel and
agricultural goods could become the rule, not the exception, and may
spill over into other areas such as political and military cooperation.
Moreover, the increasing importance of exports will put pressure on West
European countries to relax-or less strictly enforce-trade restrictions
on sales to the Soviet Bloc.
? As trade difficulties mount, protectionist pressures in Western Europe
will grow. New barriers against US products likely will be limited, but
restrictions against other countries, particularly Japan and the NICs,
may increase, forcing those countries to offset lost sales in Western
Europe by boosting sales efforts in the United States.
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EUR 83-10271
December 1983
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? Dim unemployment prospects also will make it more difficult for West
European countries to meet their defense commitments to NATO.
Unemployment already has caused a severe fiscal drain on governments,
and, with budgets likely to remain tight, pressure to curb defense
spending will mount.
Fundamental structural economic problems-rapid growth of the labor
force, accelerating labor costs, and inability to restructure industry-are
the main causes of Western Europe's unemployment problem; cyclical
economic conditions are only a secondary factor. The unemployment rate
in the region has been climbing almost continuously since 1970 and by
mid-1983 reached over 10 percent. During the 1970s the total population
increased very little, but the prime working-age population (ages 25 to 54)
grew at twice the increase of the previous 10 years. Simultaneously, wages
and nonwage labor costs skyrocketed, discouraging employers from ex-
panding their work force and forcing them to reduce jobs through attrition.
Western Europe's inability to move its employment base away from
declining traditional industries into high-growth areas further depressed
job creation in the 1970s.
We do not expect Western Europe will be able to solve its structural
unemployment problems quickly, and as a result the number of unem-
ployed will continue climbing, albeit slowly, thoughout the decade. Demo-
graphic trends will add even more prospective workers to the labor force
than during the 1970s. Economic growth probably will be insufficient to
offset the expansion of the labor force. Labor costs, on the other hand,
should moderate in part because of high unemployment, but this marginal
improvement alone will be insufficient to reverse the dismal unemployment
trends. We see little chance for a significant pickup in the pace of
industrial restructuring, thus employment growth will continue to be held
back.
Although the present course of macroeconomic policy should help to
promote an economic climate more conducive to improved economic
growth without rapid inflation, the underlying causes of Western Europe's
unemployment problem are not, in our view, being adequately addressed.
For the most part, governments are concentrating their efforts on employ-
ment programs-such as reducing working hours and government subsi-
dies for hiring long-term unemployed-which do little more than redistrib-
ute the present unemployment. Few countries are implementing plans that
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encourage overall employment by holding down nonwage labbr costs on
employers; nor are governments actively trying to reduce public interven-
tion in the economy-a major factor slowing the restructuring process.
Moreover, governments are continuing to prop up outmoded, uncompetitive
industries rather than promote investment in new, more dynamic indus-
tries.
Most of the uncertainty in our assessment probably lies on the upside.
Labor costs could moderate even more than we now expect, thus encourag-
ing job creation. As workers continue to lose jobs and factories in
traditional industries continue closing, unions may opt to preserve as many
jobs as possible rather than press for higher wages. In addition, Western
Europe may be able to restructure its industrial sector faster than we can
foresee at present. Nascent efforts to move into high-technology areas may
begin to pay off more quickly than we expect. Increased efforts to
capitalize on existing technology through joint ventures with Japanese and
US companies may help Western Europe become more competitive.
Moreover, real economic growth may be more rapid than we now expect,
particularly if the US recovery retains its momentum and the world trade
picture improves. Nonetheless, even under the best conditions, we would
expect these improvements to lower unemployment only marginally,
leaving it still high by historical standards.
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Western Europe:
The Unemployment Crisis
The struggle to overcome the highest levels of unem-
ployment since postwar reconstruction is unquestion-
ably the number-one economic problem facing West
European leaders today. By mid-1983 unemployment
in Western Europe had reached an estimated 18
million workers, 10.6 percent of the combined work
force. Half of those unemployed are citizens of only
four countries-France, West Germany, Italy, and
the United Kingdom; but the problem is more broadly
based because the unemployment rates are well into
double digits in several other countries (see table 1).
The employment situation in Western Europe has
been deteriorating almost continuously for nearly two
decades. Prior to 1974, unemployment grew slowly,
although the overall West European jobless rate
remained below 4 percent of the work force. Although
unemployment rates jumped precipitously during the
recessionary periods of 1974-75 and 1980-83, jobless-
ness continued to spread even in the intervening years
of relative prosperity (see figure 1).
The composition of the unemployed population is
nearly as disturbing as the overall levels. Unlike in
previous recessions when laid-off workers could find
alternative employment within a few months, a full 40
percent of those unemployed today have been out of
work for more than a year. Moreover, prime working-
age males (ages 25 to 54)-most of whom are the
main family breadwinners-have been losing ground
in the job market faster than women or youths. By
mid-1983, about 9 million of these men were unem-
ployed, accounting for one-half of total unemploy-
ment. In contrast, at the height of the 1974-75
recession, this age group only accounted for one-
fourth of the unemployed.
Perhaps more socially troubling is the high rate of
unemployment among young people. By mid-1983,
over 9 million people between the ages of 15 and
24--one out of every four-were unable to find work
Table I
Western Europe:
Midyear 1983 Unemployment
Rate
(percent)
Number Unemployed
(thousands)
Total
10.6
18,306
Big Four countries
10.1
9,577
West Germany
8.9
2,320
France
8.5
2,029
Italy
9.7
2,258
United Kingdom
12.4
2,970
Smaller countries
11.8
8,729
Austria
3.2
145
Belgium
11.9
510
Denmark
10.6
285
Finland
6.8
150
Greece
10.0
370
Iceland
1.3
1
Ireland
14.2
146
Luxembourg
1.3
2
Netherlands
17.4
841
Norway
3.4
61
Portugal
9.0
390
Spain
17.5
2,141
Sweden
3.4
135
Switzerland
0.8
52
20.0
3,500
in Western Europe. In the largest four economies,
youth unemployment rates range from a low of 13
percent in West Germany to over 30 percent in Italy.
In some smaller countries the situation is even worse;
in Spain, for example, over 40 percent of the young
people are jobless.
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Figure 1
Western Europe: Unemployment Rates
I I I I I I I I I I I I I I I 1 1
1965 70 75 80
frictional unemployment in the United States.' West
European unemployment prior to the 1970s, however,
had consistently been less than that in the United
States. Immediately prior to the economic disruptions
of the 1970s when most West European economies
were producing at high-capacity utilization rates,
unemployment in the region averaged about 3 per-
cent; we believe that is a fair guide to what the
unemployment rate would be today if cyclical and
structural trends were more favorable.
Cyclical Unemployment
The slowdown in economic growth that began in late
1980 has been an important, though only partial,
cause of Western Europe's unemployment problem.
The region's economic growth slowed from an annual
rate of 3.3 percent in the 1970s to 1.4 percent in 1980,
and remained essentially flat through 1982. The
slowdown particularly affected industrial output,
which dropped 3.5 percent between 1980 and 1982.
Meanwhile, the unemployment rate grew from 6.5
percent in 1979 to 9.8 percent in 1982.
We believe that frictional unemployment and cyclical
factors account for close to 60 percent of the unem-
ployment in Western Europe and attribute the re-
mainder to deep-rooted structural problems.'
Frictional Unemployment
The level of frictional unemployment-the "normal"
unemployment associated with a full-employment
economy-varies from country to country depending
on social as well as economic structure. We assume
that in Western Europe frictional unemployment is
about 3 percent. This rate is low compared with
' Frictional unemployment-that resulting from normal labor turn-
over during periods of strong economic growth; cyclical unemploy-
ment-that caused by temporary economic fluctuations; structural
unemployment-that caused by fundamental, longer term econom-
We estimate that the recent recession accounts for
roughly one-fourth of Western Europe's total unem-
ployment (see figure 2). To determine how much
unemployment is cyclically related, we used our
econometric model, the Linked Policy Impact Model
(LPIM),' to simulate the level of unemployment that
would have existed had Western Europe not been in a
recession. If the region had continued to grow at the
' Although no definitive estimate of US frictional unemployment
exists, the consensus among observers of the US economy is that
about 6 to 7 percentage points of the US unemployment rate is
accounted for by frictional factors. Since the aggregate unemploy-
ment rate for the United States in 1982 was 9.6 percent, cyclical
and structural factors would account for between 2.6 and 3.6
percentage points.
'The Linked Policy Impact Model is an econometric model of the
world. It economically integrates individual 200-equation models of
the seven major industrialized economies-West Germany, France,
Italy, the United Kingdom, Canada, Japan, and the United
States-and smaller models of regional economic groups-the
smaller developed countries, OPEC, and non-OPEC LDCs; the
centrally planned economies are represented only by trade-flow
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Figure 2
Western Europe: Causes of Unemployment"
`'The percentage distribution applies to 1982 when the total unemployment
rate reached 9.8 percent.
average annual rate of the 1970s, the LPIM simula-
tions indicate that unemployment would have reached
only 7.1 percent in 1982. In other words, about 2.7
percentage points of Western Europe's unemployment
rate in 1982 was caused by the recession, while the
remaining 7.1 percentage points resulted from other
factors.
Structural Unemployment
We calculate structural unemployment as that
amount remaining after accounting for frictional and
cyclical factors. By our estimate, the structural unem-
ployment rate in Western Europe could amount to 4.1
percentage points in 1982-42 percent of the region's
unemployment rate.
There are several structural factors that aggravate the
unemployment levels. Demographic trends-the baby
boom of the early 1960s and increasing female partic-
ipation rates-have rapidly boosted the supply of
labor. Escalating labor costs-both wage and
nonwage-over the past decade have depressed the
demand for labor by making it increasingly expensive
to hire workers compared with automating factories.
Figure 3
Western Europe and the United States:
Employment
60 1970
Western Europe
United States
Rising labor costs also have reduced the international
competitiveness of a number of traditional high-
employment West European industries, such as steel,
textiles, and autos, leading to company closures and
worker layoffs. At the same time, the West European
economies have been unable to reorient their econom-
ic base toward new industries in the high-technology
and services sectors
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The severity of Western Europe's structural economic
problems are even more apparent when comparing US
and West European job creation during the 1970s.
During that period, when economic growth was about
comparable for the two areas, the West Europeans
added only 5.3 million new jobs despite an 11.6- 25X1
million increase in the labor force; the United States
meanwhile added 20.6 million jobs with a jump of
24.2 million in the labor force (see figure 3). If job
creation in the United States had been as poor as it
was in Western Europe, by 1980 the unemployment
rate here would have topped 16 percent.
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Table 2
Western Europe: Working-Age
Population and Labor Force,
by Age for Selected Years
Millions Figure 4
Western Europe: Population and Labor Force
Changes, by Age Group
population
15-24
49.5
56.4
59.6
131.2
135.2
146.0
55-64
34.6
38.6
34.9
Labor force
145.9
152.2
157.6
15-24
90.8
95.7
19.8
65.0
150.0
36.2
163.9
Demographics Intensify the Problem. Western Eu-
rope's labor supply grew unusually fast in the 1970s
compared with the previous decade, thereby exacer-
bating the region's unemployment problem. From
1970 to 1980 the labor force expanded 7.7 percent-
adding almost 12 million more prospective workers-
compared with a growth of only 4.4 percent, or 6.4
million people in the 1960s. The total working-age
population grew only slightly faster than in the previ-
ous decade. Much of the more rapid growth in the
labor force was caused by the changing age distribu-
tion of the population. The number of people in the
prime working-age category-25 to 54-jumped dra-
matically and was coupled with increasing female
participation rates. Moreover, in the 1975 to 1980
period, the number of youths 15 to 24 looking for
work jumped sharply for the first time in two decades
(see table 2).
The rapid expansion of the prime working-age popula-
tion was caused by a combination of more people
coming into the lower end of this age group-a result
of increasing birth rates in the 1950s and 1960s-and
a smaller number of people leaving the group at the
upper age bracket-a result of heavy World War II
casualty rates. Between 1970 and 1980 the prime-
working-age population increased by 14.8 million
people, leading to a 13.4-million-person, or a 14-
percent increase in the labor force of this age group.
During the 1960s this group expanded by only 4.9
million people-a 5.4-percent rise (see figure 4).
4.9
55-64 4.0
1.2
1970-80
Total 21.0
55-64 -2.4
-2.7
0 Population
Labor force
11.7
The growing proportion of the female population
seeking work also contributed to the expansion of the
labor force in the 1970s. Between 1970 and 1980
female participation rates for the prime working-age
group increased from 43 percent to 48 percent. The
change alone would have led to a 2.6-million increase
in the female labor force over the decade, even if the
total number of working-age women was constant; the
number of working-age women actually grew by 6.2
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million, however. Major factors undoubtedly responsi-
ble for larger female participation were: increased
educational levels; a tendency toward smaller fam-
ilies; increased availability of household appliances;
higher unemployment among married men; increased
opportunities for women in service sectors, which tend
to be relatively attractive for women; and changing
social attitudes that encouraged more married women
to work.
The number of young people 15 to 24 years old
looking for work became another burden on the West
European labor market in the latter half of the 1970s.
The baby boomlet of the early 1960s boosted the
population of the 15- to 24-year-old age group by 5.4
million people in 1975-80, compared with only a 10-
million increase in the previous 15-year period. The
labor force of this age group actually declined by 1.1
million between 1970 and 1975, thus helping to offset
increases in other groups; during the following five-
year period, however, 2 million additional youths
began job hunting.`
The changes in the youth labor force resulted primari-
ly from a leveling off of participation rates following a
15-year fall as enrollment in full-time education by
youth leveled off. During the 1960 to 1975 period,
youth labor force participation rates dropped from an
average 69.5 percent to 56.4 percent as more and
more young people chose to continue their education
rather than immediately enter the labor force. The
youth participation rate dipped only 0.8 percentage
point from 1975 to 1980.
Labor Costs Rise. Surging labor costs-both wage
and nonwage-in Western Europe over the 1970s
contributed to the unemployment problem by depress-
ing the demand for labor. In the Big Four countries,
total labor costs in the manufacturing sector rose an
average of 60 percent in real terms between 1970 and
1980; Italian labor costs rose the most at 75 percent
and British costs the least at 40 percent (see figure 5).
In contrast, labor costs rose only about 12 percent in
the United States during the same period. With this
rapid escalation in the price of labor, companies
increasingly found ways to get more output out of
Figure 5
Big Four and the United States:
Index of Total Labor Costs, Wages,
and Nonwage Costs
Index: 1970= 100
Labor costs, both wage and nonwrage, rose faster in the
Big Four than in the United States .. .
Real labor 200
costs
Real nonwage 400
costs
-West Germany
- France
-Italy.
United Kingdom
-United states
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Table 3
Western Europe: Nonwage Costs as a
Share of Direct Wages, 1970-82 a
West Germany
42.1
44.3
46.9
49.8
52.3
56.1
59.8
61.8
64.5
66.3
68.3
70.6
72.6
France
59.0
59.6
60.8
63.0
64.6
69.1
70.1
71.4
72.3
75.0
76.6
77.8
83.8
Italy
77.7
98.7
94.2
90.7
91.4
87.6
84.4
86.1
United Kingdom
15.7
17.2
20.2
20.5
23.4
25.2
28.1
29.7
31.4
33.9
35.8
35.8
United States
31.4
32.8
33.7
34.6
35.4
36.3
37.4
38.7
"Nonwage costs" are defined here as pay for time not worked
(vacations, holidays, and other leave), all bonuses and other
special payments, the cost of payments in kind-before payroll
deductions of any kind and employer contributions to legally
required insurance programs and contractual and private benefit
plans.
Source: US Department of Labor, Bureau of Labor Statistics,
Office of Productivity and Technology, April 1983.
each worker-either by buying more productive
equipment or by eliminating featherbedding. For the
most part, this type of productivity increase did not
result in direct layoffs, but, rather, firms simply failed
to replace retiring workers.
Labor costs in Western Europe rose rapidly because
both wage and nonwage costs accelerated. The in-
crease in direct wages accounted for more than one-
half of the advance in total labor costs. Unions in
Western Europe were particularly powerful in the
early 1970s as economic growth was especially buoy-
ant and through strike action or threatened strike
action were able to extract sizable direct wage gains
from employers.' Between 1970 and 1980 real wages
in Western Europe grew about 40 percent. Of the Big
Four, Italy had the most rapid increase in real wages,
while the United Kingdom had the smallest increase,
about 20 percent. In the United States, on the other
hand, real wages grew only 2 percent during the past
decade.
contributions
Nonwage costs grew at a more rapid rate than wages
during the 1970s, not only because of union pressures,
but also because of public sentiment for greater
benefits to accrue to workers. For the Big Four
countries, these employer expenses more than doubled
in real terms over the last decade and in several West
European countries began to rival the cost of direct
wages (see table 3). In Britain, nonwage costs jumped
a mammoth 230 percent. As a share of direct wages,
however, British nonwage costs are still lower than in
other major West European countries, in part because
medical and dental benefits in Britain are paid under
a social-medical system funded by general revenues,
rather than by employment taxes. Nonwage costs also
more than doubled in West Germany between 1970
and 1980, making their share of direct wages roughly
comparable with those in France and Italy. The
Social Democrats came to power in 1969 after 20
years of more conservative Christian Democratic rule
and subsequently built an extensive social welfare
system paid for in part by employer and employee
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Of the Big Four, French and Italian nonwage costs
remained the highest as a share of direct wages
throughout the 1970s and early 1980s. French costs
rose steadily, continuing a trend begun in the 1960s.
In Italy, however, nonwage costs as a share of direct
wages peaked in 1976. Since then, successive Italian
governments, with moderate success, have intentional-
ly limited employer-paid taxes on employees in hope
of stimulating employment.
During the 1970s, the price of machinery and equip-
ment in Western Europe grew less rapidly than labor
costs, and, as a result, industries began to shift the
relative mix of labor and capital used in the produc-
tion process. Between 1970 and 1980 the price of
labor relative to capital' advanced 45 percent in
Western Europe; in the United States labor costs
increased relative to capital by only 25 percent.
Because of these relative price trends, West European
businessmen sought to increase labor productivity.
They invested in new capital equipment instead of
enlarging their labor force as demand expanded;
capital over labor was further encouraged by low real
interest rates in Western Europe during the 1970s.
Moreover, in those industries where demand was
stagnant, business began using existing capital more
effectively by eliminating unnecessary workers
through attrition. As a result, industrial productivity
grew more than 50 percent in Western Europe during
the 1970s, while unemployment continued to mount.
Our analysis shows that the countries with the great-
est increase in the price of labor relative to the price of
capital also had the biggest decline in the ratio of the
mix of labor and capital used in the production
process (see figure 6). The United States, with a
relatively small increase in its labor cost/capital cost
ratio had the least decline in the labor stock/capital
stock ratio and managed to increase industrial em-
ployment by 12 percent during the period.
? In this paper the price of capital-or capital cost-is represented
by a price index for new plant and equipment. We have not
attempted to estimate the total cost of capital, which would include
the cost of raising funds for investment purposes. The source of our
plant and equipment cost data is the OECD National Income
Although rising labor costs are not the only cause of
high unemployment, for comparison purposes we used
our LPIM to measure what would have happened to
West European unemployment had the region held
increases in relative labor costs to the same level as
did the United States. Our model simulation shows
that by 1982 about 5 million more workers in Western
Europe would have been employed, giving the region
an unemployment rate of only 6.7 percent, rather than
the actual 9.8-percent rate of that year.
Restructuring Proceeds Too Slowly. Western Eu-
rope's inability to adjust its economic base in the face
of stagnant or declining output in high-employment,
traditional industries, such as steel and textiles, has
further depressed the demand for labor. Rapidly
increasing labor costs and the advancing industrial
sophistication of many LDCs have resulted in a
number of old-line West European industries losing
domestic markets to import competition. At the same
time, Western Europe's agricultural employment has
dropped dramatically as technological progress has
increased agricultural productivity and reduced the
demand for labor. The region has not moved rapidly
enough, however, into new employment areas such as
high-technology-related industries and the service sec-
tor-two areas of exceptional growth in the United
States-to offset employment losses elsewhere. West
European technology lags that of the United States,
and, consequently, high-technology-related service
jobs lag as well. In addition, rapidly escalating labor
costs also have held back the growth of service
employment.
Despite rising agricultural output, farm employment
in Western Europe dropped by about 5 million work-
ers-17.8 percent-from 1970 to 1980 (see table 4
and figure 7). In the European Community, the
elimination of agricultural jobs was even more dra-
matic, down almost 30 percent. Ironically, the bene-
fits from the rise in production due to the increased
use of machinery, fertilizer, and pesticides were large-
ly offset by the higher costs of these inputs. Conse-
quently, farm incomes in the European Community
have stagnated in real terms since 1973, and farm
employment has been further discouraged.
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 75 -
50 1970 75 80
Figure 6
Big Four and the United States:
Ratios of Labor Costs to Capital Costs
and Labor to Capital Stock
Index: 1975=100
As Big Four labor costs relative to capital costs rose ... employment relative to capital declined .
Germany ___ Germany
125
50 1970 75
75
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50 1970
75 80
50 1970
50 1970 75 80
50 1970 75 80
United 150
Kingdom
United 1S0
Kingdom
75
50 1970 75 80 50 1970 75 80
50 1970
80 50 1970 75 80
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Table 4
Western Europe and United States:
Labor Force and Civilian Employment,
by Sector and Selected Years
Western United Western
Europe States Europe
26,596 3,567 22,296
57,548 27,029 54,612
48,082 75,208
Figure 7
Western Europe and the United States:
Employment Changes, by Sector, 1970-80
Agriculture
Industry
Services
Western Europe
United States
The manufacturing sector was unable to make up for
the jobs lost in agriculture because output in some
industries was depressed in part by Western Europe's
growing inability to compete successfully against
imports:
? The textile industry has been particularly hard hit
by import competition. While textile output in the
major West European countries has been dropping
almost continuously since the early 1970s, textile
imports have been rising rapidly; in dollar terms,
West European textile imports from outside the
region grew sixfold between 1970 and 1980.
United Western United Western United
States Europe States Europe States
30,918 54,235 30,315 52,545 30,194
? Steel output has dropped because other domestic
industries, such as autos, have increasingly substi-
tuted less expensive and lighter weight materials
and because of increased competition from low-cost
producers in newly industrializing countries (NICs).
? The shipbuilding sector is depressed because of the
present world ship glut-partially a result of lower
oil trade volumes-and an increase in the shipbuild-
ing capacity of some low-cost LDCs, such as South
Korea.
? Although the drop in auto output primarily reflects
the 1981 recession, the plunge in British production
is mostly due to increased competition from imports
(figures 8 and 9)
In the face of declining output in basic industries,
Western Europe has not been able to sufficiently
increase job opportunities in other sectors, particular-
ly in high-technology industry and services.
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Figure 8
Big Four and the United States:
Manufacturing Output and Employment
West 140
Germany
60 1970
France
140
120
100
60
United
Kingdom
140
60 1970
United 140
States
60 1970 75 80
1970 75 80
60 1970 75 80
- Employment
Production
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Figure 9
Production and Employment in Four Major
Industrial Sectors
Index: 1975= 100
West Germany France
Textiles Iron Shipbuilding Motor
and steel and repairing vehicles
t . i . i i LPL L '. L
70 v~1~ 1~ 40 1b ~Oq~S 1b ~Oq1 b ~O
Textiles Iron
and steel
Shipbuilding Motor
and repairing vehicles
40 va~~ 1r ~o~~S ~e
Textiles I ron
and steel
80 vat' o 41
~o ~b ~O 1b go 60
Shipbuilding Motor
and repairing vehicles
-L--i-i-I i L t_ _1_--i -Production
Iron
and steel
Shipbuilding Motor
and repairing vehicles
Iron Shipbuilding Motor
and steel and repairing sehicle,
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Table 5
International Trade in High-Technology Products a
for Selected Countries, 1970 and 1980
Million US $
(except where noted)
France
West
Germany
Italy
United
Kingdom
EC Nine
Japan
United
5,233.4
26,713.5
5,650.0
15,973.1
3,275.2
20,717.1
2,228.8
6,705.9
Trade balance
-64.5
4,826.7
318.1
1,958.2
5,996.4
3,421.2
9,267.2
Exports (percent
-1.7
100
12.4
59.8
28.9
153.5
38.2
greater than
imports)
Exports
25,841.5
52,558.2
18,033.1
31,768.9
157,808.6
42,068.7
65,614.0
Imports
25,125.2
33,687.0
16,371.6
20,335.8
126,502.7
11,187.0
34,966.4
Trade balance
716.3
18,871.2
1,661.5
11,433.1
31,305.9
30,881.7
30,647.6
Exports (percent
2.9
56.0
10.1
56.2
24.7
276.0
87.6
greater than
imports)
a "High-technology products"-as defined by Lester A. Davis in
Technology Intensity of United States Output and Trade, Office of
Trade and Investment Analysis, United States Department of
Commerce, July 1982-are those 10 products that in the United
States incorporate the greatest amount of research and develop-
ment both in their final production process and in their components.
To compare high-technology trade across countries, this definition
was applied to other countries as well. The top 10 products consist
of selected items within these SITC categories:
While the service industries in Western Europe grew
moderately during the 1970s, employment expansion
in this sector remained substantially slower than that
in the United States. Services employment in Western
1. Guided missiles and spacecraft.
2. Communications equipment and electronic components.
3. Aircraft and parts.
4. Office, computing, and accounting machinery.
5. Ordnance and accessories.
6. Drugs and medicines.
7. Industrial inorganic chemicals.
8. Professional and scientific instruments.
9. Engines, turbines, and parts.
10. Plastic materials and synthetic resins, rubber, and fibers.
Europe jumped almost 20 percent from 1970 to 1980,
creating about 12.5 million additional jobs. In the
United States, on the other hand, services employ-
ment bounded upward by over 35 percent, in part
reflecting a higher percentage of females working and
a related strong demand for restaurant and fast food
establishments. If Western Europe had been able to
increase jobs in this sector as rapidly as did the
United States, another 10 million jobs would have
been created.
Traditionally, the West European service sector has
employed a much smaller share of the work force than
the United States. In 1970 the relative shares of
Western Europe's and the United States' service
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sector employment to total employment were 43
percent and 61 percent, respectively; by 1980 the
shares had increased to 49 percent and 66 percent,
respectively. Western Europe's relatively smaller serv-
ice sector is in part due to the emphasis on reindus-
trialization after the Second World War-Western
Europe concentrated on rebuilding its industrial base
while the United States, with its industries still intact,
was able to support an expanding service sector
Western Europe's inability to move out of oldline
industries into new, more advanced industries, includ-
ing services, is a result of a number of complex and
interrelated economic, political, and social factors.
inst fficient Investment. Venture capital is not readily
available in Western Europe, thus investment funds
are inhibited from flowing into innovative, newly
emerging companies-the very companies needed to
foster the restructuring process. Stock markets in
n1ost West European countries are not well developed,
forcing entrepreneurs to raise capital by borrowing
from banks-which by their conservative nature are
predisposed not to finance small risky undertakings.
In the United States, on the other hand, a well-
developed stock market has made venture capital
more available, thus helping to create the thousands
of new, small firms that have been instrumental in
producing new products and new jobs. In addition, tax
laws in Western Europe have inhibited investment
because interest payments on loans cannot be deduct-
ed as an operating expense-unlike the situation in
the United States. Investment has been further held
back by the declining profitability of many West
European firms-profits have been squeezed by in-
creasing production costs-particularly labor costs-
and increased competition from foreign producers.
Unwillingness to Change. Much of labor and manage-
ment in Western Europe appear satisfied with the
status quo, preferring not to adopt new technology.
Labor unions point to automation as a major cause for
job losses in the seventies, and the strong political
position of unions has contributed to government
efforts to maintain employment in traditional indus-
tries-the same industries in which union member-
ship is concentrated. Much of management simply is
unwilling to venture into untested areas. A statement
by Eckert Van Hoover, a member of the board of
directors of Deutsche Bank, represents a pervasive
West European business philosophy, "The banking
profession clearly has the expertise to sail into the
world of electronic banking, but not without paying a
price. If the price means giving up the identity of the
banking profession as we know it today, then to me
the price is too high."
Regulatory Rigidities. A plethora of government reg-
ulations within West European countries has added
innumerable delays and expense to doing business and
has decreased the private sector's flexibility. In West
Germany, for example, establishing a new business
requires applications for up to 150 approvals; moving
a plant to a new location entails obtaining several
hundred permits. In France, it normally takes two
years to incorporate a business. Regulations on serv-
ices have impeded business expansion across West
European countries. West Germany and France, for
example, permit only locally established firms to write
insurance policies. The company may be foreign
owned, but must be registered in the country con-
cerned. Professional qualifications-such as for doc-
tors, lawyers, and accountants are not universally
recognized, thus professional services cannot move
easily across borders. For example, the requirements
for becoming a certified accountant vary from coun-
try to country, and only nationally certified account-
ants can do business in each country.
Small Domestic Markets. The small size of individual
West European country markets forces many compa-
nies to seek out foreign markets in order to reach
economies of scale in the production process, thereby
adding additional uncertainty to corporate planning
and increasing marketing and production costs-on
top of already high labor costs. Although the EC
countries have improved the economic integration of
the region by eliminating tariff barriers among them-
selves, Western Europe remains a collection of highly
individualistic countries, each with its own language,
culture, and customs. Thus, penetrating even a neigh-
boring market can be difficult and costly. In the
United States and-to a lesser extent-Japan, the
domestic market alone is sufficiently large to enable
companies to benefit from economies of scale.
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Big Four: Fiscal and
Monetary Policies
West Germany's 1983 budget contained no major
stimulative programs that would induce employment
and pared social benefits by $2.2 billion in an effort
to hold down the deficit. The draft 1984 budget also
carries an austerity label and calls for even more
social spending cuts. Monetary policy has eased over
the past year and a half however, parallel to the
declining rate of inflation.
In France the Mitterrand government is now trying to
repair the damage done by the expansionary policies
followed during its first year in office. From mid-
1981 to mid-1982 Paris sharply boosted welfare
benefits and other government spending and increased
the money supply in an effort to stimulate the
economy. Although France avoided the decline in
GNP that afflicted most of its neighbors, economic
growth was miniscule, and the country soon found
itself saddled with rapidly worsening inflation and
soaring budget and balance-of-payments deficits.
Paris began to retrench in June 1982 and in March of
this year imposed what is basically a classic austerity
program: a package of spending cuts and tax in-
creases designed to cut aggregate demand but which
also will raise unemployment
Despite the gloomy unemployment picture, West Eu-
ropean governments have made few efforts to put
people back to work-a sharp change from their
response to the 1974-75 recession. Although most
governments have adopted a number of minor pro-
grams aimed at subsets of the unemployed, such as
youth or older workers, none have implemented
broad-based anticyclical economic policies intended to
increase aggregate employment. We believe the West
Europeans are not likely to initiate any major new
employment-creation programs over the next few
years or to adopt measures to correct the more
fundamental factors depressing labor demand
In the United Kingdom Prime Minister Thatcher has
stuck firmly to conservative policies aimed at restruc-
turing the British economy, despite an unemployment
rate now approaching 13 percent-the highest rate
among the seven major industrial countries. Thatch-
er's policies have been strikingly successful against
inflation, which has been cut from a 22-percent rate
when she took office in 1979 to 4 percent for the 12
months ending in April 1983.
Italy has been unwilling to give further stimulation to
the economy because of the already huge budget
deficit. The Bank of Italy, in particular, has resisted
calls for lower interest rates. Unemployment appears
to be even less of a political issue in Italy than
elsewhere in Western Europe. In addition to generous
social welfare programs, strong family ties, which
provide a financial umbrella, have eased the burden
of joblessness. Moreover, some of the officially unem-
ployed probably have jobs in the extensive under-
ground economy
The limited policy response in part reflects the real-
ization by government leaders that the expansionary
policies of the mid-1970s were not particularly suc-
cessful, either in boosting economic growth or in
creating jobs.7 More importantly, however, govern-
ments are reluctant to increase expansionary efforts
because most West European countries entered the
current recession with inflation rates and budget
' In the appendix we analyze the impact of stimulative fiscal and
monetary policies on the unemployment situation. In general, we
conclude that the limited benefits from such policies would be more
than offset by the negative impact of higher inflation and larger
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Reduced Working Hours. Government initiatives and
suggestions to private industry in this area are aimed
at protecting existing jobs as well as creating new
positions. In the Netherlands new civil servants are
now being hired only for a 32-hour week with no
change in hourly wages. In Belgium, the Martens
government has proposed a 5-percent reduction in
working hours accompanied by a 3-percent reduction
in wages and a 3-percent increase in employment.
Individual companies have made similar agreements
in many industries, and it is estimated that 50,000
new jobs will have been created as a result of this
program by the end of 1984.
Government Hiring Subsidies. In an attempt to lower
the high cost to the employer of hiring new employ-
ees, the British Manpower Services Commission has
proposed outright subsidies to employers who hire
the long-term unemployed. It proposes a subsidy of
around $75 per week to companies hiring workers
who have been unemployed between six and 12
months and of $100 a week for a person unemployed
over a year. These subsidies would be paid at the full
rate for nine months and at half the rate for a further
nine months.
Early Retirement. These plans are experiencing a new
popularity with some government encouragement.
The first round of early-retirement plans in the early
seventies has already sharply cut the rates at which
men over 60 are remaining in the labor force. Now
plans call for further lowering retirement ages. Sever-
al major West German companies have introduced
phased retirement from the age of 55. In Belgium a
new subsidized early-pension system has been intro-
duced allowing workers to retire at 60 without reduc-
tion of pension. One new employee must be hired for
each early retiree.
Reducing Wages. In the past year, most major gov-
ernments have been active in promoting moderate
wage gains or outright wage freezes. Wage modera-
tion is viewed by some countries, especially Belgium,
as a means of restoring international competitiveness
and thus leading to a greater demand for labor. Last
year the Belgian Government instituted a three-
month wage freeze followed by partial indexation.
Italy and France, however, still face high inflation in
their economies. France's wage-price freeze in 1982
and 1983 and Italy's restructuring of the scala mobile
were intended to lower double-digit inflation rates
rather than directly create increased employment
opportunities.
Direct Job Creation. Make-work measures have been
used modestly to create jobs usually for the long-
term unemployed or those who suffer some other
handicap. The Swedish Government has the largest
relief work program with close to 1 percent of its
work force in such projects; the British have about
half that number in their projects. More innovative
measures are being attempted by the British, French,
and Belgians. They have all recently introduced
modest plans to supply business startup funds rather
than benefits to the unemployed as a way of putting
the jobless back to work.
Apprenticeship Systems. The purpose of these pro-
grams is to give on-the-job training in private firms to
young people while paying them low wages at govern-
ment expense. West Germany already has one of the
most developed apprenticeship systems in Western
Europe. In the past, the early development of market-
able skills and workplace discipline resulted in an
unemployment rate for West German teenagers
slightly less than the rate for all workers. Recently,
however, as unemployment has significantly worsened
in West Germany, the unemployment rate for young
people has climbed to over /5 percent. Apprenticeship
positions are lagging the number of applicants for
these positions. There are only 335,000 training
places for 451,000 applicants.
Tighter Immigration Policies. Switzerland began re-
ducing the number of foreign workers in its work
force before this recession. Now other countries are
also considering tougher laws to make more jobs
available for their own citizens. An estimated 11
million foreigners live in northern Europe of which
4.7 million are in West German v. The West German
federal Government has issued a bill encouraging
foreign workers to leave the country by offering them
cash payments. They can also claim all their previous
contributions to the public pension funds, an option
not open to West German citizens. Labor Minister
Bleum expects 80,000 to 100,000 foreign workers to
return to their own countries voluntarily because of
these measures.
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deficits that were already exceptionally high by past
standards. In addition, high unemployment rates have
generated surprisingly little social unrest. The exten-
sive West European social welfare safety net has
eliminated much of the suffering caused by jobless-
ness. As a result, policymakers generally are sticking
with relatively conservative anti-inflationary policies,
despite mounting unemployment.
Although the present course of macroeconomic policy
should help to promote an economic climate more
conducive to improved economic growth without rapid
inflation, the underlying causes of Western Europe's
unemployment problem are not, in our view, being
adequately addressed. For the most part, governments
are concentrating their efforts on employment pro-
grams-such as reducing working hours and govern-
ment subsidies for hiring long-term unemployed-
which do little more than redistribute the present
unemployment. Few countries are implementing plans
that encourage overall employment by holding down
nonwage labor costs on employers. Moreover, govern-
ments are continuing to prop up outmoded, uncompet-
itive industries rather than promote investment in
new, more dynamic industries; according to the EC
Commission, subsidies by member governments to
their faltering steel industries totaled an estimated
$20 billion between 1975 to 1981 and nearly that
much again is planned up to 1985. Even if govern-
ments increase support for new industries, the more
fundamental economic, political, and social factors
that hindered industrial restructuring in the 1970s
will continue to operate.
A number of West European governments are imple-
menting programs to promote new industries in the
high-technology area. Most of the plans are small
scale and by themselves are unlikely to significantly
advance the region's high-technology competitiveness.
The European Community recently started the $1.3
billion Esprit Program that will fund over 10 years
efforts to better coordinate research and development
among the 10 EC members. Bonn already supports
scientific foundations and provides the integrated-
circuit industry with $150 million annually in support
for R&D funding. In a May 1983 speech, Chancellor
Kohl promised additional measures would be taken to
improve West Germany's international competitive-
ness in high-technology fields. Paris has planned to
spend $7 billion over a five-year period (1982-86) to
assist the electronics industry, although funds have
already fallen well short of government goals. Never-
theless, in our opinion, funding for high-technology
industries is likely to remain limited as long as
budgets in Western Europe are tight and governments
continue to prop up financially troubled traditional
industries.
Based on a simulation of our LPIM model, we believe
that the unemployment rate in Western Europe will
remain in double digits through the end of the decade.
For the region as a whole, we expect the rate will edge
up somewhat to perhaps 12 percent by 1990. These
judgments are based on several key assumptions. On
the negative side:
? Demographic trends will add even more prospective
workers to the labor force than during the previous
decade, thereby placing upward pressure on the
unemployment rate.
? Overall economic growth prospects are dim.
? No fundamental change in the factors that have
hindered Western Europe's restructuring thus far.
On the plus side, we believe that the rise in the
relative cost of labor compared with capital will slow,
thereby leading employers to hire more workers than
would otherwise be the case if labor costs continued to
rise at the pace of the 1970s (see table 6)
Most of the uncertainty in our assessment probably
lies on the upside. Labor costs could moderate even
more than we now expect, thus encouraging job
creation. As workers continue to lose jobs and fac-
tories in traditional industries continue closing, unions
may opt to preserve as many jobs as possible rather
than press for higher wages. In addition, Western
Europe may be able to restructure its industrial sector
faster than we can foresee at present. Nascent efforts
to move into high-technology areas may begin to pay
off more quickly than we expect, particularly if
increased efforts to capitalize on existing technology
through joint ventures with Japanese and US compa-
nies help Western Europe become more competitive.
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Table 6
Western Europe: Baseline Projection for Economic
Conditions and Unemployment Through 1990
Western Europe
Real GNP growth rate
Labor/capital cost ratio
Labor force growth
Employment growth
Unemployment rate
Big Four
Real GNP growth rate
Labor/capital cost ratio
Labor force growth
Employment growth
Unemployment rate
West Germany
Real GNP growth rate
Labor/capital cost ratio
Labor force growth
Unemployment rate
France
Real GNP growth rate
Labor/capital cost ratio
Labor force growth
Employment growth
Unemployment rate
Italy
Real GNP growth rate
Labor/capital cost ratio
Labor force growth
Employment growth
Unemployment rate
United Kingdom
Real GNP growth rate
0.5 0.8 2.2 2.4 2.4 2.4 2.4
2.4
2.2
0.8 0.8 0.8 0.8 0.8 0.7 0.7 0.7
-0.5 -0.7 0.7 0.5 0.5 0.4 0.5 0.5
9.8 11.1 11.2 11.5 11.8 12.0 12.2 12.4
2.4 2.4 2.4 2.4 2.4
0.6 0.6 0.6 0.6 0.5 0.5 0.4 0.4
- 1.1 1.0 2.9 2.5 2.5 2.5 2.5 2.5
1.9 4.0 4.0 4.0 4.0 4.0 4.0 4.0
0.3 0.3 0.3 0.3 0.2 0.1 0.0 -0.1
-2.3 - 1.5 0.3 1.0 0.0 0.0 0.0 0.0
7.5 9.1 9.2 9.4 9.6 9.7 9.7 9.7
1.9 -0.1 0.2 2.5 2.5 2.5 2.5 2.5
3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0
1.0 1.0 1.0 1.0 0.8 0.6 0.6 0.6
-0.3 -0.2 1.0 0.6 0.5 0.5 0.5 0.5
8.5 9.6 9.6 9.9 10.2 10.3 10.4 10.4
-0.3 0.4 2.9 2.5 2.5 2.5 2.5 2.5
1.0 0.7 1.0 1.0 1.0 1.0 1.0 1.0
0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5
-0.4 0.0 0.1 0.2 0.4 0.6 0.7 0.8
9.3 9.8 10.1 10.4 10.5 10.4 10.3 10.0
3.0 2.0 2.0 2.0 2.0 2.0
Labor/capital cost ratio 3.0 2.7 2.7 2.7 2.7 2.7 2.7 2.7
Labor force growth
Employment growth
0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7
-1.0 -0.4 0.5 0.3 0.3 0.2 0.2 0.2
2.4
2.2
0.6
0.5
12.5
2.4
2.8
0.3
0.4
11.5
2.5
4.0
-0.2
0.0
9.5
2.5
3.0
0.4
0.5
10.3
2.5
1.0
0.5
1.0
9.6
2.0
2.7
0.7
0.2
16.0
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Table 7
Western Europe: Working-Age Population
and Labor Force Trends 1980, 1985,
and 1990
1990
Working-age population
251.2
259.0
264.6
163.9
170.6
177.6
Source: OECD, Demographic Trends 1950-1990, Paris, 1979 and
OECD, The Challenge of Unemployment, Paris 1982.
Moreover, real economic growth may be more rapid
than we now expect, particularly if the US recovery
retains its momentum and the world trade picture
improves. Even if all of these conditions improve,
however, unemployment rates in Western Europe are
likely to remain high by historic standards through
the end of the decade.
Demographics To Worsen
Labor force trends will be even more of a problem
during the 1980s than in the previous decade. Projec-
tions by the OECD show that the labor force will
expand by about 13.7 million people during the
present decade-an 8.4-percent increase compared
with a 7.7-percent increase during the 1970s (see table
7). In other words, Western Europe will need to create
13.7 million new jobs just to keep unemployment from
rising in the 1980s; during the past decade employ-
ment increased by only 5.3 million workers.
As in the previous decade, the expansion of the labor
force during the 1980s results primarily from a
change in the age distribution of the population and,
to a lesser extent, changes in participation rates by
sex. The OECD estimates that the working-age popu-
lation in the 1980s will increase somewhat less than in
the 1970s but will be more concentrated in the prime
working-age group-the age group with the highest
participation rates. Even in those countries such as
West Germany where the working-age (15 to 64 years
old) population is expected to decline in the second-
half of the decade, the prime working-age group will
still expand. In West Germany as well as most of
Western Europe, the number of young adults (15 to
24 years old) in the population will decline as will the
labor force of that age group. Female participation
rates are expected to continue rising, although some
offset will come from projected lower participation
rates for males.
Slow Economic Growth
Slow economic growth will be another factor keeping
unemployment high during the rest of the 1980s.
Although most economies in Western Europe began
in mid-1983 to pull out of the recession, we do not
expect economic growth to accelerate to the high
levels following the 1974/75 recession. For the re-
mainder of the decade, we estimate growth will
average about 2.4 percent a year for the region as a
whole, compared with an average of 3.3 percent
annually during the 1970s. Already tight fiscal poli-
cies will probably be continued as governments
further attempt to reduce large deficits that have
developed over the past 10 years. In a number of
countries, governments are cutting back spending
plans, including politically sensitive social programs.
Little help is likely to come from exports either, as the
important LDC market will be plagued by the over-
hang of on-going financial difficulties. With oil prices
likely to remain slack for some time, even the once
lucrative OPEC market will probably show little
growth.
Interestingly, our projection of high unemployment
through 1990 is not significantly dependent on our
estimate of economic growth because the most impor-
tant problems in Western Europe are structural.
Using our LPIM we simulated the employment im-
pact of faster economic growth. More rapid than
expected economic growth in Western Europe could
occur for a variety of reasons. For example, the US
economy may remain more buoyant than most private
forecasters are predicting, or world trade may expand
at a faster clip than present conditions lead us to
believe. According to our econometric model, if eco-
nomic growth averaged 3.4 percent a year for the
remainder of the decade-reasonably high by 1970s
standards-the unemployment rate in 1990 for West-
ern Europe as a whole would be 3.2 percentage points
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Table 8
Western Europe: Impact on Unemployment of
Faster Economic Growth
Western Europe
Real GNP growth rate
Employment growth
Unemployment rate
Big Four
Real GNP growth rate
Employment growth
Unemployment rate
West Germany
Real GNP growth rate
Employment growth - 2.3 -1.5 0.7 0.7 0.7 0.7 0.7 0.7 0.7
3.4 3.4 3.4 3.4 3.4 3.4
1.0 1.0 1.0 1.0 1.0 1.0
3.4 3.4 3.4 3.4 3.4 3.4
0.8 0.8 0.9 0.9 0.9 1.0
3.5 3.5 3.5 3.5 3.5 3.5
1.2 3.5 3.5 3.5 3.5 3.5 3.5
1.4 1.1 1.0 1.0 1.0 1.0 1.0
Real GNP growth rate 1.9 -0.1
Employment growth -0.3 -0.2
Unemployment rate 8.5 9.6
Italy
Real GNP growth rate
Employment growth
Unemployment rate
United Kingdom
Real GNP growth rate
Employment growth
Unemployment rate
-0.3 0.4 3.9
-0.4 0.0 0.5
9.3 9.8 9.8
below our baseline projection (see table 8). Of the Big
Four, West Germany would benefit the most from
more rapid economic growth-we calculate that the
unemployment rate would drop 4 percentage points
below the baseline projection by 1990.
Slower Rise in Labor Costs
Labor cost trends in the remainder of the 1980s
should have a positive impact on employment. We
believe that a number of factors affecting both wage
and nonwage costs are working to hold back the rise
in total labor costs, and as a result the labor-to-capital
cost ratio should increase less rapidly than in the
previous decade. In our baseline case, we project that
for Western Europe as a whole, the relative cost of
3.5 3.5 3.5 3.5 3.5 3.5
0.5 0.9 1.0 1.2 1.3 1.6
9.7 9.4 8.9 8.3 7.6 6.6
3.0 3.0 3.0 3.0 3.0 3.0
0.7 0.8 0.8 0.8 0.8 0.8
labor should advance an average of only 2.2 percent a
year during the rest of this decade, down from 3.8
percent a year in the 1970s.8 With a smaller increase
in labor costs relative to capital costs, business should
hire more workers than if labor costs rose more
rapidly.
Increases in direct wage costs should moderate be-
cause excess labor will continue to flood labor mar-
kets, thus putting downward pressure on real wages.
B Ratios for individual countries vary considerably, but in general
we assume that labor-to-capital cost ratios will advance one-third
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Table 9
Western Europe: Impact on Unemployment of Constant
Labor/Capital Cost Ratio
Western Europe
Labor/capital cost 2.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Employment growth -0.5 -0.3 1.3 1.1 1.1 1.2 1.2 1.2 1.2
Unemployment rate 9.8 10.8 10.4 10.0 9.7 9.3 8.9 8.7 8.4
Labor/capital cost 2.2 0.0
Employment growth
Unemployment rate 9.4 10.0 9.4
West Germany
Unemployment rate 7.5 8.2 6.8
France -- -- - - ---- --
Unemployment rate
Italy
0.0 0.0 0.0 0.0 0.0 0.0
1.7 1.7 1.7 1.7 1.7 1.7
5.5 4.1 2.6 0.9 0.9 0.9
0.0 0.0__ 0.0 0.0 0.0 0.0
1.7 1.7 1.7 1.7 1.7 1.7
Unemployment rate
United Kingdom
2.6 0.9 0.9 0.9
0.0 0.0 0.0 0.0 0.0 0.0
1.0 1.2 1.3 1.5
8.6 8.0 7.3 6.4
High unemployment already has decimated union
membership, which has in turn reduced labor's ability
to press for higher wages. In the past two years, real
wages in Western Europe were essentially stagnant.
Although some pickup in real wages is likely com-
pared with the recent recessionary years, the advances
in real wages during the remainder of the 1980s
probably will not return to the pace of the 1970s.
Nonwage labor costs also should not rise as rapidly.
Several West European governments already are cut-
ting their generous social welfare programs, which in
turn should reduce upward pressure on employer-paid
payroll taxes. The West Germans have cut planned
social programs in this year's budget, and the French
have recently cut first-year unemployment compensa-
tion by three-fourths for people who have worked less
than six months.
A more dramatic-but unlikely-slowdown in the
escalation of labor costs would improve the employ-
ment picture considerably over our baseline case.
According to our LPIM, if labor costs relative to
capital costs remain constant, unemployment in West-
ern Europe would progressively decline during the rest
of the decade and by 1990 would be below 8.5 percent
(see table 9). Unemployment would drop the most-
5.8 percentage points below the baseline projection-
in the Big Four, with West Germany showing the
biggest improvement.
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Table 10
Western Europe: Impact on Unemployment of Rapid Rise
in Labor/Capital Cost Ratio
Western Europe
Labor/capital cost
2.2
3.9
3.9
3.9
3.9
3.9
3.9
3.9
3.9
Employment growth
-0.5
-0.9
0.4
0.2
0.1
0.1
0.1
0.2
0.2
Unemployment rate
9.8
10.6
11.7
12.2
12.7
13.2
13.7
14.2
14.6
Big Four
Labor/capital cost
2.2
4.4
4.4
4.4
4.4
4.4
4.4
4.4
4.4
Employment growth
- 1.1
-0.9
0.1
-0.1
-0.1
-0.1
-0.1
-0.1
0.1
Unemployment rate
9.4
10.8
11.3
12.0
12.6
13.1
13.7
14.2
14.7
West Germany
Labor/capital cost
1.9
6.3
6.3
6.3
6.3
6.3
6.3
6.3
6.3
Employment growth
-2.3
-2.1
-0.5
-0.8
-0.9
-1.0
-1.0
- 1.0
I.0
Unemployment rate
7.5
9.7
10.5
11.4
12.3
13.1
13.8
14.5
I5.0
France
Labor/capital cost
3.0
5.3
5.3
5.3
5.3
5.3
5.3
5.3
5.3
Employment growth
-0.3
-0.5
0.7
0.3
0.1
0.1
0.1
0.1
0.1
Unemployment rate
8.5
9.9
10.1
10.8
11.3
11.7
12.1
12.5
12's
Italy
Labor/capital cost
1.0
1.9
1.9
1.9
1.9
1.9
1.9
1.9
1.9
Employment growth
-OA
0.0
0.1
0.2
0.4
0.6
0.7
0.8
1.0
Unemployment rate
9.3
9.9
10.4
11.0
11.3
11.6
12.0
12.4
11 -.9
United Kingdom
Labor/capital cost
3.0
3.6
3.6
3.6
3.6
3.6
3.6
3.6
3.6
Employment growth
- 1.0
- 0.6
0.2
0.0
-0.1
-0.1
-0.2
-0.2
-02
Unemployment rate
12.3
13.4
13.8
14.4
15.0
15.7
16.4
17.0
17.7
On the other hand, if relative labor costs rise more
than we expect, unemployment would worsen. Ac-
cording to our LPIM, a resumption of the relative
labor costs pattern of the 1970-80 period would lead
to escalating unemployment throughout the decade.
For the region as a whole, unemployment would rise
to nearly 15 percent by 1990 (see table 10). Unem-
ployment would be a staggering 5 percentage points
higher in West Germany, rising to 15 percent. The
rate would climb to nearly 18 percent in the United
Kingdom.
Limited Progress in Restructuring
We believe the slow pace of industrial restructuring in
Western Europe is likely to pick up somewhat during
the next several years, but not enough to enhance
appreciably the region's employment prospects. Ven-
ture capital will likely become more available, thus
encouraging the creation of new, more innovative
companies. Over-the-counter stock markets already
are growing in the United Kingdom, France, and
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Sweden, albeit from a very small base. Investment by
existing companies in new production methods also
should increase as the economic recovery proceeds
and profits show some improvement. Although unions
continue to balk at automating production lines, some
reduction in the level of resistance is appearing. In
recent press conferences, leaders of West Germany's
largest labor association-the West German Trade
Union Federation (DGB)-have stated that they are
willing to accept automation and modernization of
factories if the union is consulted beforehand and
displaced workers are provided retraining opportuni-
ties. Business as well is showing some signs of adapt-
ing to the new economic environment by increasingly
pursuing joint ventures with US and Japanese compa-
nies in an attempt to acquire new technology
In addition, governments are gradually becoming
aware of the economic rigidities created by excessive
regulation and are starting to address these problems.
The West German Government, for example, has
established an interagency group to identify and
eliminate regulations and requirements that inhibit
market adjustment and increase costs for the private
Although these various factors seem to be moving in
the right direction, we believe many more economic,
political, and social adjustments are necessary if
industrial restructuring is to proceed fast enough to
correct the unemployment problem. Additional meas-
ures aimed at promoting the adjustment process will
take time to implement, and more time will elapse
before the economy will appropriately react. Western
Europe's industrial problems took years to evolve;
they will require years to solve.
We believe that persistently high unemployment will
increase pressure on political and social institutions in
Western Europe and increase tensions between these
countries and their trading partners. During most of
the postwar period, economic growth has helped
moderate conflicts over social inequality and trade
policy. Sluggish growth combined with continuing
record jobless rates, however, will reduce maneuver-
ability and make these conflicts more contentious.
High and rising unemployment already has made
incumbent governments vulnerable to charges that
they are unable to devise solutions to unemployment
and could threaten their political survival. In polls
throughout the region, overwhelming majorities of
respondents say unemployment is their countries'
leading economic problem and that government is
responsible for solving it. To be sure, voters may
become inured to high unemployment rates particu-
larly if-as in the June 1983 UK elections-other
economic indices are improving and noneconomic
issues become more prominent. In addition, Western
Europe's highly developed social welfare net has
helped prevent mass demonstrations and civil disrup-
tions. If, as we expect, the electorate sees no decline in
unemployment over the next several years, campaign
promises of opposition parties will become more ap-
pealing during the next round of national elections-
scheduled for West Germany in 1987, and for France
and the United Kingdom in 1988. As a result, many
West European countries may be entering an era of
frequent oscillation between governments of the left
and right. In Turkey, where unusually high unem-
ployment will be coupled with other economic prob-
lems and the lack of longstanding democratic tradi-
tions, joblessness could contribute to more serious
political instability.
Continuing high unemployment, combined with social
welfare cutbacks and low real wage increases, may
incite greater militancy on the part of West European
labor for jobs and higher pay. High jobless rates have
weakened organized labor's bargaining position and
moderated its wage demands in recent years; but,
once recovery takes hold and rank-and-file union
members see no gains for themselves, they may renew
demands for higher wages, as has been the recent
experience in the US automobile industry
Youth unemployment poses particularly serious long-
term problems for Western Europe and could lead to
political extremism among this group. Much of an
entire generation faces years of joblessness or under-
employment. Resultant feelings of despair and discon-
tent can easily engender disillusionment with
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democratic institutions. College-educated youth, who
normally would become their countries' political and
intellectual leaders, are especially susceptible either to
political alienation or to extremism of the right or left.
Persistent unemployment will also continue to exacer-
bate other social strains within and among West
European countries, in our judgment. Foreign workers
are likely to be a particular target of resentment. In a
recent French opinion poll, for example, 51 percent of
the respondents said the repatriation of foreign work-
ers would be the best way to solve the unemployment
problem. The foreign guest worker problem already
troubles West Germany's relations with Turkey
and-to a lesser extent-with Yugoslavia. The issue
of labor mobility also is a stumblingblock in the
European Community's accession negotiations with
Spain and Portugal.
it cannot sell elsewhere.
Continuing high levels of unemployment may cause
West Europeans to more favorably view trade with
the Soviet Union and Eastern Europe. Exports to the
Bloc, as well as exports anywhere, have become
increasingly important because foreign sales translate
into jobs. The unemployment problem will put pres-
sure on West European governments to relax-or less
strictly enforce-trade restrictions on sales to the
Bloc. In addition, Western Europe's disadvantage in
high-technology areas may force the region to turn
East to sell the less technologically advanced products
unemployment.
The dim unemployment prospects also will make it
more difficult for West European countries to meet
their defense commitments to NATO. Unemployment
already has caused a severe drain on government
budgets. These expenses seem certain to continue and
thus will keep the guns-versus-butter issue in the
forefront of public debate. With West European
budgets likely to remain tight for some time, pressure
to curb defense spending will mount. Opinion polls in
Western Europe indicate strong support for cutting
defense spending and little support for curtailing
social programs-particularly in a period of high
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Appendix
Western Europe: The Cost of Stimulative
Economic Policies
Our analysis indicates that stimulative fiscal and
monetary policies are not the panacea for Western
Europe's unemployment problem. The cost of bring-
ing unemployment down through anticyclical policies
would be accelerated inflation and deteriorating cur-
rent accounts-the very maladies governments have
been trying to cure for the past few years. These
negative side effects result in part because expansion-
ary policies have no impact on the more fundamental
structural problems that are depressing employment
growth. According to our Linked Policy Impact Mod-
el (LPIM), West European countries together would
have to implement fiscal and monetary policies that
would be large enough to boost real GNP growth 2 to
5 percentage points faster than we presently expect
just to bring unemployment in 1984 back down to the
1982 rate. To lower unemployment further-back to
acceptable levels-would require continued govern-
ment stimulation for a number of years. The longer
expansionary policies are applied, however, the more
rapid prices rise, and the worse the current account
position becomes.
The Policy Options
We explored three possible macroeconomic policy
approaches to Western Europe's unemployment
problem:
? An increase in nominal central government con-
sumption spending.
? A reduction in personal taxes collected by the
central government.
? An increase in the money supply
Using our LPIM, we determined how large the
stimulation packages would have to be to reduce
unemployment to a predetermined target. Our as-
sumed policy target was to bring down the unemploy-
ment rate in each of the Big Four West European
countries to the 1982 level in 1984 and to reduce it a
further I percentage point each in 1985 and 1986.
Hitting this target by 1986 would require a fall of
about 3.8 percentage points for the group as a whole
as our baseline unemployment projections show un-
employment in the Big Four countries will reach 11.2
percent by 1986, compared with 9.4 percent in 1982
(see table 11). In each simulation, the policy variable
was adjusted until the target was met. In effect, the
policy variable was adjusted until real GNP growth
was rapid enough to bring the unemployment rate
down to the target range. The amount of improvement
in economic growth-and hence the degree of eco-
nomic stimulation-necessary to reach the target rate
of unemployment varies by country in part because
the gap between the 1982 unemployment rate and our
1984 projected baseline unemployment rate differs
from country to country. After determining the neces-
sary size of the stimulation package, we evaluated the
impact of the policy on inflation and the current
account.
A fundamental assumption in our simulations was
that the West Europeans acted together in imple-
menting the policy in question. In view of France's
bitter experience of the past two years, we believe it is
extremely unlikely that any of the countries would
attempt a go-it-alone approach to stimulating its 25X1
economy. 25X1
A second key assumption was that labor costs relative
to capital costs would only rise about 2 percent
annually compared with 3.3 percent annually in the
1970s-the same assumption used in our baseline
projections. The relation between the price of labor
and capital is crucial to our projections.
Finally, under the increased government spending and
reduced taxation options, we assumed that half of the
resulting budget deficits would be financed through
money creation. The other half of the deficit would be
covered by direct borrowing from the public.
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Increasing Government Spending. According to the
LPIM, government spending in the Big Four West
European countries would have to increase an average
3.2 percentage points in real terms in 1984 over the
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Table 11
Big Four: Baseline Projections
Unemployment Real GNP
Rate Growth
(percent) (percent)
1985
1986
1985
1986
13.5
13.8
baseline projection, 6.1 percentage points in 1985, and
6.8 percentage points in 1986 to pull down unemploy-
ment to the target rate in those years (see table 12).
The necessary changes in government spending, how-
ever, vary considerably from country to country with
Italian real government spending up only 0.5 percent-
age point in 1984 while British spending jumps 7
percentage points. The very small increase in Italian
Government spending necessary in 1984 results in
part because the unemployment rate that year needs
to drop only 0.8 percentage point from our baseline
projection to reach the target rate. In the United
Kingdom, on the other hand, the 1984 unemployment
rate must drop 1.2 percentage points from the base-
line projection to reach the target rate. Moreover,
increased government spending in Britain has a rela-
tively less positive impact on real GNP-and hence
Inflation Current
(percent) Account
Balance
(billion US $)
-1.0
-2.0
job creation-than in the other major West European
countries because the British tend to direct a higher
portion of their incremental income to imports.
For the most part, changes in government budget
deficits reflect changes in government spending. The
United Kingdom, for example, has the largest per-
centage-point increase in real government spending
and the largest percentage-point jump in its nominal
budget deficit. To some extent, however, the size of
the percentage-point increase in the budget deficit is
influenced by our baseline projection for the deficit.
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Table 12
Big Four: Impact of Increased Government Spending
Target Real
Unemployment Government
Rate Spending
Change from baseline projections
(percentage points, except where noted)
Nominal Real GNP Inflation Current
Government Growth Rate Account
Deficit Rate Balance
(billion US $)
Big Four
1984
-1.2
3.2
20
3.5
1.5
1985
-2.5
6.1
50
2.4
3.8
1986
-3.8
6.8
1985
1986
France
1984
Italy
1984
-1.0
2.5
1.7
1985
9.0
4.0
3.2
1986
8.0
2.7
2.9
United Kingdom
1984
-1.2
7.0
72
5.2
1.5
1985
12.4
175
2.8
6.6
-18.2
-46.1
-15.5
0.6
-7.3
-14.9
-17.4
-22.1
In countries where the baseline deficit is small-such
as the United Kingdom-a comparable change in the
nominal deficit leads to a proportionally larger per-
centage-point increase in the budget deficit
In each of the Big Four, inflation and the current
account worsened as government spending was raised
to bring down unemployment. The higher British
propensity to import causes Britain's inflation and
current account position to worsen the most. By 1986,
inflation would be 15 percentage points higher and
the current account deficit $22 billion larger than in
the baseline projection. Only in Italy is the inflation-
ary impact so small as to not likely result in a political
backlash. Moreover, the large current account deteri-
oration that accompanies increased government
spending in West Germany, Italy, and the United
Kingdom suggests that, even if these countries began
to pursue stimulative fiscal policy, they soon would be
forced to change course because of their worsening
international payments position. France's current ac-
count, however, would improve somewhat in 1984 and
deteriorate by only $2.2 billion in 1985 and $3.6
billion in 1986. The French current account performs
relatively better because the French economy tends to
increase imports more slowly in response to a rise in
real GNP. Moreover, French exporters traditionally
benefit more from increased real economic growth
elsewhere in Western Europe than do exporters in the
other Big Four countries
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Table 13
Big Four: Impact of Reduced Taxes
Change from baseline projections
(percentage points, except where noted)
Target
Real
Nominal
Real GNP
Inflation
Current
Unemployment
Taxes
Government
Growth
Rate
Account
Rate
Deficit
Rate
Balance
(billion US $)
Reducing Taxes. In general, our LPIM simulations
show that tax reductions must exceed spending in-
creases in order to bring about the same advance in
real GNP-and hence a drop in unemployment-
because not all of the tax windfall goes directly to
consumption; some portion of it is saved. For the Big
Four as a group, taxes in real terms must be reduced
5.7 percentage points below our baseline projections in
order to reach the target unemployment rate in 1984,
12.7 percentage points in 1985, and 15.9 percentage
points in 1986 (see table 13). The size of the tax
reductions in West Germany needed to hit the target
unemployment rate are the largest of any Big Six
country primarily because the West German saving
rate is the highest. France needs the smallest drop in
taxes for the same reasons it had the smallest increase
in government spending under the previous scenario.
4.0
2.3
-3.3
140
1.5
4.3
___
-15.3
150
1.8
6.1
-17.0
5.2
2.8
-18.5
-23.5
The tax reduction in the United Kingdom is less than
that in Italy in part because Britain's saving rate is
the lowest among the Big Four
Naturally, changes in government budget deficits
reflect changes in taxes-the greater the reduction in
taxes the larger the increase in the budget deficit. As
in the government spending scenario, however, the
percentage-point increase in the budget deficit is also
influenced by our baseline projection for the deficit.
The economic impact of cutting taxes to reduce
unemployment to the target rate is similar to that
caused by increased government spending--inflation
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i:ontiaential
Table 14
Big Four: Impact of Increased Monetary Base
Target Nominal
Unemployment Money
Rate Supply
1985
-2.5
West Germany
1984
-1.7 24
1985
-2.9 2
1986
-4.1
Italy
1984
1985
1986
United Kingdom
1984
accelerates and the current account deteriorates. In-
flation tends to be somewhat greater under the tax-
cut option in part because the increase in the budget
deficit is larger than under the government spending
scenario. Although the degree of deterioration in each
country's current account varies between the two
policy options, the aggregate Big Four current ac-
count worsens by about the same amount under both
scenarios. Just as in the government spending option,
inflation and the current account worsen to the point
that the tax-cut option would almost certainly have to
be modified in order to maintain control over prices
and international payments
Boosting the Money Supply. Sole reliance on mone-
tary policy to reduce unemployment is the least
realistic policy option of the three we tested. The
Change from baseline projections
(percentage points, except where noted)
Real Real GNP Inflation Current
Interest Growth Rate Account
Rates Rate Balance
(billion US $)
9.7 -64.6
5.6 -16.9
2.1 -16.1
-8.3 2.4 7.6 0.9
-2.4 2.4 2.4 -4.6
5.2 -5.7
29.0 -37.4
53.0 -39.6
inflation and current account deficits generated by
monetary stimulation almost certainly are not politi-
cally or economically acceptable.
According to the LPIM, the nominal money supply in
the Big Four would have to increase 19 percentage
points over our baseline in 1984, 14 percentage points
in 1985, and 17 percentage points in 1986 to boost
real GNP enough to hit the target unemployment rate
(see table 14). In each of the countries the necessary
money supply growth is enormous, but especially in
the United Kingdom-by 1986 the money supply
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must expand 55 percentage points over our baseline,
an unrealistic scenario. Britain requires such a tre-
mendous hike in its money supply-and drop in real
interest rates-to achieve the target unemployment
rate because it must generate more real GNP growth
and compensate for greater leakages to imports, as
was the case in the previous two scenarios.
Inflation and the current account worsen appreciably
in all countries, but again the changes in the United
Kingdom become unrealistically large. Rapid British
money supply growth leads to rapid inflation, a
massive increase in imports, and comparable deterio-
ration in the current account. The monetary policy
option is not likely to be pursued by West Germany,
France, or Italy; it would be an absurd policy for the
United Kingdom
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