Economics: Unemployed cast shadow over Europe

FACED with an appalling reality, a common human response is simply to ignore it. That is the attitude European governments are adopting to unemployment.

The charts show the scale of the problem. In the UK, unemployment rose from 4 per cent to 10 per cent in the recession of the early 1980s and finally peaked in 1986 at 11 per cent. In this recession, it began to rise from a trough of 6 per cent and is already at 10. On the Treasury's forecast growth rate for GDP in 1993, it will reach 11 per cent and go on to create new records in 1994 and beyond. And that is after a sequence of redefinitions, which took many groups off the unemployment register. By 1979 definitions, there are over 3.5 million unemployed now - more than 12 per cent of the labour force. The situation elsewhere in Europe is broadly similar.

In Germany, things are particularly difficult. As one chart shows, official unemployment in western Germany is about 7 per cent but, with the country in recession now, this is set to rise steeply to around 10 per cent by 1994.

Add eastern Germany and official unemployment for the country as a whole - currently 8 1/2 per cent - could approach 12 per cent. Yet that is the tip of the iceberg; it excludes immigrants and asylum-seekers looking for work, and all the short- time workers in the east and others being temporarily kept on to do nothing in government-owned or newly privatised companies. Total unemployment, including those groups not captured in the official statistics, is around 12 1/2 per cent right now and is highly likely to reach 15 per cent before the recession ends. In Eastern Europe, of course, the problem is on a still greater scale.

The policy of taking no notice of unemployment is a legacy of the 1970s and 1980s. In earlier post-war decades, governments believed they were responsible for maintaining full unemployment. After nearly three decades of it, however, accelerating inflation became a widespread problem in Europe, just as some Keynesian economists like Joan Robinson and Michael Kalecki had predicted. If the 'reserve army of labour' was removed by full employment, what would discipline rising wage demands? The answer seemed to be, not much. The oil shock of 1973 burst on this world of incipient inflation. Through the 1970s, governments tried hopelessly to juggle the competing claims of controlling inflation and maintaining full employment.

But public opinion was moving to regard inflation as the greater evil. In those days, unemployment affected at most 5 per cent of the workforce while inflation affected everybody.

Around 1979-1980, governments everywhere abandoned the commitment to full employment and concentrated on attacking inflation. In that they have been successful. UK inflation is at rates not seen since the 1960s; in France and elsewhere it is lower still. Only Germany, under the reunification shock, has inflation slightly above its 1960s average - and it will fall in the recession.

Economic theory reassured politicians that eliminating inflation would have no long-run or persistent effect on the unemployment rate. Alas, this comfortable doctrine has not proved to be true. Unemployment has fluctuated with the cycle but in Europe at least it has fluctuated around a rising trend. Each trough has seen lower inflation and higher unemployment.

The problem was for a long time still seen in terms of undisciplined workers pricing themselves out of jobs. When government let prices go, it was argued, the workers just caused inflation; once governments controlled inflation with tight money, wage-push caused unemployment. In the Thatcher-Reagan era the answer seemed clear: cut back access to social security and unemployment benefit, reduce the latter in real terms, bust the unions, privatise state enterprises to subject their workers to 'market forces', make the workers more insecure and the labour market more competitive. That agenda, or part of it, was followed in most OECD countries.

A cyclical upswing and a temporary drop in unemployment in the late 1980s led many to conclude that the medicine was going to work. Now only the zealots still think so. In the UK, inflation took off despite the slashed benefits, emasculated unions and high unemployment. When the slump came, unemployment soared towards new records. No end to mass unemployment is in sight.

In the current European policy debate, no pretence is even made that anything much is to be done about it. There is no hope - official.

Yet the growth of an unemployed underclass, crime and civil disorder, and growing insecurity as unemployment hits previously comfortable sectors and regions, mean that such fatalism will not remain politically acceptable. Perhaps the UK government can survive with unemployment over 11 per cent; British phlegm seems limitless. But in Germany, where racist attacks continue, the government, if not civil order, will be threatened by the unemployment rates that now look inevitable.

In France, one government is about to lose office because of unemployment - to an opposition that has no policy to deal with it. And the extreme Right polls over 10 per cent.

The New-Right solution of 'making the labour market work' seems unlikely to provide a solution on its own. Is it politically acceptable, given universal suffrage, for the unemployed to find work as domestic servants at subsistence wages as in Victorian times? Surely not. One possibility is to combine the competitive labour market approach with more aggressive demand management, boosting demand via government spending and low interest rates. Eventually this could take us back to the world of incipient inflation, but we are a long way from there at present. This 'solution' can only be pursued on a European level. A country trying to stimulate growth of demand on its own would hit insuperable balance of payments problems - especially the UK, which is running a deficit even in deep recession. Calls for a European growth initiative will certainly rise.

Another solution involves recognising that those in work are lucky. They must pay something for their luck. Taxes have to be raised to train the unemployed and to finance subsidised work. Either employment is created directly in the public sector to provide public goods or social services currently in short supply, or employment is subsidised to expand revision of private goods and services at prices people can afford.

An indirect way of doing this is by protectionism. Tariffs, in effect, tax consumers to subsidise the employment of fellow citizens to make import-competing products. This approach, too, can only be implemented at a European level. It is, of course, a 'beggar my neighbour' policy. The unemployed at home are being helped by creating more unemployed abroad, perhaps in poorer countries. That is why direct taxes and subsidies are a better solution. But politically, protectionism is the softer option because the 'tax' is less visible. If European unemployment continues to rise as foretold, the evolution of a 'fortress Europe' is a good bet. Bad enough, but there are worse outcomes. The last period of mass unemployment was ended by a European war.

The writer is chief economist for Lehman Brothers International. Christopher Huhne is on holiday