Tackling Unemployment: Return of the Two-Handed Approach

Unemployment in advanced economies averages 8% today, a sharp rise from 5 ½ % at the start of the Great Recession. European unemployment is particularly high—about 11% on average. What can be done?

In a celebrated mid-1980s paper, Olivier Blanchard, along with Rudi Dornbusch and others, argued that tackling the high unemployment and low growth in Europe at that time would require a ‘two-handed approach’: a combination of demand-side and supply-side policies. It is not coincidental that the IMF’s current advice to countries reflects the return of the two-handed approach.

In presentations delivered at the European Commission, ILO, World Bank and other venues, Prakash Loungani—advisor in the Research Department and co-chair of the IMF’s “Jobs & Growth” working group—has made the case for balancing demand and supply initiatives to tackle unemployment in advanced economies. He notes that, contrary to some assertions, unemployment and growth have remained linked during the Great Recession and the Not-So-Great Recovery. This preserves the hope that the jobs will return when the growth does.

Evidence suggests that the bulk of the rise in unemployment in most countries has been cyclical. Hence, as the Wall Street Journal noted recently, it’s time to “stop worrying about the ‘jobless recovery’ [and] start worrying about the recovery-less recovery.” Citing work on Okun’s Law by IMF authors and other recent evidence, the Journal concluded that “it isn’t unemployment benefits or other specific [structural] factors that are holding back hiring. It’s the economy, stupid.”

Several factors are behind the tepid recovery in output. In work done for the recent World Economic Outlook, Ayhan Kose, Prakash Loungani and Marco Terrones note that a key difference between the current global recovery and past global recoveries is that fiscal policy has not been able to provide the support this time that it did in the past—a point that has been picked by many observers including Paul Krugman (see the figure on fiscal spending below and Krugman’s essay here).

Real Primary Government Expenditures
Calibrating the pace of fiscal adjustment to growth conditions—and countering the effects of the adjustment through other policies if possible—to minimize the drag on demand is thus an essential part of the IMF’s advice to restore growth and lower unemployment. This is reflected for instance in the MD’s recent statement on Spain where she welcomed the government’s decision “to pursue a more gradual consolidation path” as a step to help the country in “securing a recovery and creating jobs.”

The two-handed approach does not neglect supply. In a recent Staff Discussion Note, Olivier Blanchard, Florence Jaumotte and Prakash Loungani discuss many labor market reforms that have been advocated in recent IMF programs in Europe. They argue that, by and large, these reforms can be expected to contribute to ‘micro flexibility’ (the ability of the economy to reallocate workers across jobs to boost productivity) and ‘macro flexibility’ (the ability of the economy to adjust to macroeconomic shocks).

Posted by at 1:39 PM

Labels: Unemployment

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