Europe’s Long Term Unemployment Problem: ‘Scarring’ & ‘Hysteresis’ Effects

Each time I make a presentation or give a talk on the health of the world economy and implications for Sri Lanka, I pause a bit on the Europe section to go beyond the immediate data on prospects for the forthcoming year to talk a little about a more medium to long-term issue that often gets missed. And that is the legacy effects – or ‘hysteresis’  – of the current high youth unemployment rate. I first wrote about it back in 2014, almost exactly a year ago today, in an article in memory of the labour economist and Nobel Laureate Dale Mortensen who I had met a few months prior to that. In it, I talked about the concept of ‘unemployment scarring’ and argued that,

There is substantial evidence suggesting that when people are unemployed at a young age they are more likely to be unemployed and welfare-dependent later in life, and more likely to earn lower wages, due to the “scarring effects” of youth unemployment. The effect is more pronounced the longer a young person spends out of work.

Just this week the IMF has released an interesting working paper on the ‘Risks of Stagnation in the Euro Area’, looking at some of the prolonged effects of the current crisis – one of which is the high unemployment and the ‘unemployment hysteria’ effect. The author, Huidin Lin, notes:

“The share of long-term unemployed, defined as the proportion of unemployed for longer than 12 months among the total unemployed, continues to increase, raising the risks of skill erosion and entrenched high unemployment. High youth unemployment could also damage potential human capital, and give rise to a “lost generation.” While weak demand plays a major role, more spending on active labor market policies would help increase employment opportunities, especially for the young”

Lin’s analysis showed that long-term unemployment could as high as 53% in the Euro area (see the Figure below).

Screen Shot 2016-01-29 at 4.13.06 PM

This has important implications for Sri Lanka, as currently around . Prolonged unemployment in Europe will depress wages and reduce purchasing power of the region’s people. It will have a significant impact on not just how much of Sri Lanka’s exports would be demanded there, but also who will buy them and what type of products will be demanded.

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