Understanding Unemployment in the Modern Economy

The level of unemployment varies considerably between countries. This book explains this by differences in their ability to neutralize economic shocks. The starting point is a review of the social and psychological literature in order to understand how joblessness affects people. The review shows that unemployed workers tend to reduce their search effort as time spent unemployed increases. The reason is that there are psychological costs attached to receiving rejections on job applications. So, if unemployment is allowed to rise, it may not come down again. Hence, counteracting negative shocks may have long lasting beneficial effects to the economy. However, the counteracting ability depends crucially on wage setting institutions. In this regard, decentralized regimes with generous welfare systems are the least favorable, and centralized regimes with the same generosity are the most favorable. Decentralized regimes with less generosity, as in the US and UK, lies somewhere in between. The last chapter in the book analyzes the consequences of decentralizing wage setting, both with and without a welfare reform.