Unemployment Benefits and the Persistence of European Unemployment

In this paper, we present a model of labor search in order to assess the role played by unemployment benefits in the increase of European unemployment since the mid 70's. Our main finding is that although benefits may reduce unemployment, they increase the vulnerability of the economy to employment shocks, which may result in a permanent increase in the rate of unemployment. The novel ingredient in our analysis is the simultaneous consideration of capital investment decisions and time allocation decisions. In so doing, we take into account the feedback between economic growth and unemployment. The predictions of our model provide some rationale for patterns in unemployment, capital accumulation and growth rates observed in some European countries