Hysteresis and the European Unemployment Problem

European unemployment has been steadily increasing for the last 15 years and is
expected to remain very high for many years to come. In this paper, we argue that
this fact implies that shocks have much more persistent effects on unemployment than
standard theories can possibly explain. We develop a theory which can explain such
persistence, and which is based on the distinction between insiders and outsiders in
wage bargaining. We argue that if wages are largely set by bargaining between
insiders and firms, shocks which affect actual unemployment tend also to affect
equilibrium unemployment. We then confront the theory to both the detailed facts of
the European situation as well as to earlier periods of high persistent unemployment
such as the Great Depression in the US.