It’s an olther article, but the economics of unemployment have not changed that much since, and it’s still a very good overview..
Labor Markets: Why employment performance differs
It is not only labor markets but also product market regulations that chiefly determine a nation’s employment performance.
NOVEMBER 1994 • William W. Lewis, René Limacher, and Michael D. Longman
Unemployment is widely viewed as the gravest economic problem for most industrial countries. In Europe, it has climbed steadily for the past 25 years to reach a postwar high (Exhibit 1). In the United States, it has been cyclical, with an average below that of Europe for the past decade. Japan has so far experienced low unemployment, although the early stages of economic reform and the recent rise in the numbers of the jobless suggest there is a risk that it will grow in the future.
To view the exhibits associated with this article, please download the PDF.
Much research has attempted to determine the causes of unemployment. Most of it has focused on macro analysis of the labor market. Though its findings are based on sound economic principles, the evidence available to test them is not conclusive. Despite references to the possible impact on unemployment of the markets for goods and services (product market) and for capital, no work to date has been able fully to determine this impact. To test conclusions about the labor market’s effect on unemployment, and to investigate the role played by product and capital markets, the McKinsey Global Institute studied employment performance in France, Germany, Italy, Spain, Japan, and the United States from 1980 to the early 1990s.1 We conducted analysis both at the level of the national economy and within seven industries: automotive, computers, furniture, banking, general merchandise retailing, film /TV/video, and construction (see sidebar Case summaries).
Our principal findings are:
- Japan and the United States have lower unemployment than Europe because they have created jobs in the market part of their economy, whereas European countries have lost jobs in theirs (Exhibit 2 and Exhibit 3).
- Product market restrictions were as important, if not more so, than workforce rigidity in explaining why job creation in Europe was below that in the United States, especially in high-growth service industries.
- The creation of large numbers of service sector jobs in the United States has harmed neither job quality nor wages.
- The United States has created more high-skill jobs than Germany and France (Exhibit 4). Those countries have improved their job skill mix primarily by destroying low-skill jobs.
- The wage distribution of service jobs in the US is almost identical to that of manufacturing (Exhibit 5).
For a summary of our findings for each country, see sidebar Performance by country.
Differences in employment performance ultimately stem from differences in the rates at which industrial economies evolve. All economies are driven by natural evolutionary forces. As agriculture developed beyond the point of providing for self-sufficiency in food, productivity increases released labor for employment in manufacturing and services. As a result, jobs in these sectors rose as a fraction of total employment in all industrial countries during the first half of the twentieth century. In the second half, manufacturing employment peaked in industrial countries. Service employment, however, continued to rise.
Today, productivity gains from innovative new products and processes continue to drive economic evolution and turnover in the labor market. Contrary to popular wisdom, productivity gains do not generally bring mounting unemployment and a declining economy. Rather, they provide more income for workers in old jobs, and free other workers to fill new jobs created by entrepreneurs. These entrepreneurs, in turn, produce innovative new products and services, which workers with increased incomes want to buy.
The supply/demand balance in the economy is not automatic. An imbalance in one direction can generate inflation; in the other, it can frustrate growth and usher in recession. Evidence shows that slow productivity growth does not relieve recession, any more than rapid productivity growth deepens it.
We would expect to see a pattern of primarily productivity improvement in the older industries (agriculture and manufacturing), and both productivity improvement and output growth in the newer industries (services). Our results broadly bear this out.
Governments are the chief reason why the process of economic evolution is working better in some countries than in others. Their actions to manage and control the evolution of their economies are the most important determinants of differences in employment performance. Most of these actions regulate individual service industries through restrictions on output in the product market.2 These restrictions hurt productivity, employment, or both together. If wages are free to fall, then employment can be maintained, but the loss in productivity keeps real wages low. If wages are maintained, then restrictions show up in unemployment.
Since product market restrictions are specific to individual industries, aggregate analysis is inadequate for identifying them and determining their impact. We have had to analyze them at industry level. This case work constitutes the main effort of our study, and differentiates it from most other research on the unemployment problem.
No industrial country should look to manufacturing for net job creation
No industrial country should look to manufacturing for net job creation. This is clearly evident in the computer industry: job creation from computer innovation now stems from the service dimension of applying the innovation (software and distribution), rather than from the manufacturing of the computer itself. The impact of hardware manufacturing on employment performance is almost negligible. Even in a high-tech industry, then, virtually all net job growth derives from services.
Our analysis identifies two important reasons for Japan’s superior employment performance in manufacturing. The first was its effort to catch up with the United States in plant and equipment per employee. The second was its overinvestment in capacity in heavy manufacturing and electronics during the bubble economy of the late 1980s.
Almost half of Japan’s growth in GDP came from investment, rather than consumption. Since the production of capital goods like machine tools is concentrated in the manufacturing sector, it is not surprising that Japan’s manufacturing output rose so strongly. Of the growth in manufacturing value-added, 71 percent came from machinery, equipment, and electronics, where capital goods tend to be produced. Employment in these industries is now beginning to fall because of overcapacity.
Japan had the greatest growth in manufacturing productivity throughout the 1980s. France and Italy also had high levels of productivity improvement. However, the European countries did not enjoy strong growth in domestic demand, and these improvements led to widespread job destruction in manufacturing.
Exhibit 6 shows the employment performance of the six countries for the three manufacturing cases studied—automotive, computers, and furniture—along with the total for the three taken together. The auto case illustrates the relatively strong employment performance of Japan and the relatively weak showing of France and Italy.
Japan had stronger growth in domestic demand for automotive products because of the low penetration of its domestic market in 1980. But demand was also partly driven by the bubble economy. As a result, Japan overinvested in automotive capacity. Its performance was also boosted by an improving trade balance in the auto industry, which shows how trade can affect employment at the industry level. All the same, our aggregate analysis revealed that the employment benefits produced by an improving trade performance in autos were entirely offset by a declining trade performance in other manufacturing areas.
In the automotive industry, the decline in manufacturing employment performance in France and Italy was partly caused by competitive pressure from the German industry through trade. At the beginning of the 1980s, Germany had a cost advantage over France and Italy, mainly because of its higher productivity. The consequent pressures led to massive restructuring of the French and Italian industries, resulting in a steep fall in automotive employment. As this example shows, trade can also have an indirect impact on employment performance through competitive intensity.
Constraints affecting services
Services constitute the only sector in industrial economies that is growing. In services, we chose particular industries in order to understand why the United States had an employment performance superior to that of any of the other countries studied. Exhibit 7 shows employment performance for the three cases selected—banking, general merchandise retailing, and film/TV/video. We also chose construction because not only does it reflect the superior employment performance of the US, but it is also a major sector of the economy.
Exhibit 8 illustrates the relative importance of various factors in explaining the differences in employment performance between the benchmark country with the highest net job creation (the US in every case) and the other countries. Employment growth rates are directly determined by output and productivity growth rates. These are in turn determined by industry dynamics, in particular, competitive intensity, innovation, and trade performance. Finally, industry dynamics are themselves determined by conditions in the markets for capital, labor, and products.
The service cases, along with construction, show that the United States had higher output growth across the board. We found that this distinction derived from important factors both within and beyond each industry. Important factors within the industry were more innovation and new product development, and fewer product market restrictions. The innovations that made big differences were securitization and derivatives in banking; specialty formats in general merchandise retailing; and new films, cable television channels, and video rental formats in the film/TV/ video industry. Industry-specific restrictions that constrained employment performance in Europe and Japan included product prohibitions and lack of transparency in banking; zoning laws and controls on the forms of competition in retailing; and a series of constraints, such as maximum numbers of homes per cable licence in Japan, in the various segments of film/TV/video.
Construction followed the same pattern of product market restrictions. Here zoning laws limit land use, thereby raising prices and suppressing demand for housing. These restrictions spill over into banking and retailing through lower demand for mortgages and a reduced land area available for shopping centers.
Factors outside the industries drove up demand for banking and retailing services to a much greater extent in the United States than elsewhere. These factors were productivity increases across the economy and new business formation, both of which gave rise to higher per capita incomes that increased demand for these services.
In services and construction, we found that labor market factors seemed to have less impact on employment performance than product market factors. The one significant exception is that relatively high labor costs in retailing in Europe kept prices high, suppressed demand, and made some new types of retailing less economic. These high labor costs are the product of union bargaining power, high minimum wages, and high unemployment benefits that leave people understandably unwilling to work at low wages—a problem that is particularly acute in Europe at present. The result in France, for example, is that the average retailing wage is higher than the average manufacturing wage.
Contrary to conventional wisdom, the availability of skilled workers from Germany’s apprenticeship program has not prevented an employment problem there; almost half (43 percent) of the country’s unemployed have followed such a program. Moreover, data on gross job creation and destruction indicate that business operations in Europe (with the exception of Germany) create and destroy jobs about as much as in the United States (Exhibit 9). Unions, it seems, do not limit workforce flexibility to the extent commonly believed.
Product market restrictions in the service sector are, in our view, probably the key factor behind differences in employment performance. For low-wage industries such as retailing and construction, high minimum wages and high unemployment benefits are also important.
The main implication of our findings for policy is that if industrial countries want to improve their employment performance, they must remove product market restrictions in services and let the economy evolve naturally. Product market restrictions are chiefly designed to protect existing interests, including existing jobs. Our research strongly indicates that such efforts invariably fail. In fact, in most cases they have exactly the opposite of their intended effect.
Preserving existing jobs in any industry slows productivity growth and weakens the competitiveness of that industry. Sooner or later competition from best practice comes along, and when it does, restructuring is severe. Afterwards, there will be fewer jobs in the industry than there would have been if it had practised continuous productivity improvement.
In low-productivity industries such as retailing and construction, we have found that reducing the minimum wage and cutting unemployment benefits will also help create employment. It is better, we believe, for low-skilled workers to be employed in these industries than to be unemployed. The economy will perform better, and income distribution objectives can be achieved by adjusting aftertax income, rather than by intervening directly in the workings of the market.
Lifting product market restrictions will also affect some noneconomic dimensions of society. Some areas that might be affected are the agricultural base, green space, the structure of urban development, popular culture, confidence in the banking system, fairness for each individual, and stability in individuals’ lives. We have not investigated the tradeoffs that would be involved against these other areas. However, the unemployment situation, especially in Europe, is so severe that lifting product market restrictions and making some of these tradeoffs seem necessary. If European countries had matched the job creation performance of Japan and the United States over the 1980s without suffering any productivity penalty, their GDP would be 5 to 15 percent higher and their unemployment problems would have disappeared.
What firms can do
Corporations clearly have a stake in the health of the societies in which they operate. Since unemployment now threatens the cohesion of some industrial countries, it is a natural concern for corporations. Indeed, some have been reluctant to restructure to improve their performance because they fear that job losses would exacerbate the social problem. Our findings show that such a reaction does not help. It simply postpones the unemployment problem and makes it worse when the inevitable restructuring finally occurs.
Corporations can best serve the societies in which they operate by boosting their performance through continuous productivity improvements and innovations that lead to successful new business formation. The main barriers in their path lie in current restrictions in the product market that reduce competitive pressure on corporations in the short term and allow them to delay restructuring. These regulations seem to be in the interests of both shareholders and employees, but they actually help neither in the long term. Corporations, especially those with potentially superior performance, should therefore urge governments to lift these restrictions.