Unemployment and the Productivity Slowdown: An Effciency Wage Perspective

Many OECD economies suffered a productivity slowdown beginning in the early 1970s. However, the increase in unemployment that followed this slowdown was more pronounced in European economies relative to the USA. In this paper we present an efficiency wage model, which enables us to identify two basic channels through which the productivity slowdown can affect workers’ effort incentives. Predictions of the model are consistent with the different trends in unemployment across countries over this period in the face of a similar slowdown in productivity. We also demonstrate how the link between growth and unemployment depends upon labour market institutions in such a way that we can reconcile the mixed empirical results observed in the literature.