Why has the trade-off between unemployment and inflation improved so much in the UK since the mid-80s? Standard explanations focus upon the decline of trades unions, stingier unemployment benefits and the fact that the entry of China and India into the global economy has weakened workers' bargaining power by increasing the threat of offshoring.
Reading this paper, however, reminds me of another possibility. It estimates that among German trades unionists there is a negative correlation between workers' attitudes to risk and wages. Controlling for obvious things, unions with more risk averse members settle for lower wages.
This is simply because risk averse workers aren't going to risk unemployment by pushing for higher wages.
This reminds me of an old (well, pre-webbed) paper by Andrew Newell*, in which he argued that the low-inflation/low unemployment of the 1950s and 1960s ended because workers became more risk-tolerant. In the 1950s, workers were scared into accepting low wages because they remembered the mass unemployment of the 30s. However, by the late 60s this generation was retiring, and being replaced by a cohort that had known nothing but full employment. Its lack of fear of the sack led it to push for higher wages - thus raising the equilibrium rate of unemployment.
This can be spelled out in a standard "battle of the mark-ups" framework, shown here**. The PS curve shows the real wage which drops out of firms' pricing decisions; I've drawn it horizontal but nothing for our purposes hangs on this. The WS curve is the wage-setting curve; it slopes upwards because higher employment leads to demands for higher real wages.
The equilibrium rate of employment - the Nairu - is the employment level at which these two curves intersect - E* in our diagram. Any rise in employment above this would lead to demands for higher wages, to which firms would respond by raising wages to preserve their mark-ups. The result would be accelerating inflation. Only E* brings peace in the battle of mark-ups.
Newell's argument is that increasing risk tolerance in the late 60s caused the WS curve to shift left to WS', as workers demanded higher real wages at E*. That caused inflation to rise and employment to fall as higher unemployment was needed to hold inflation down.
Now, here's my question. Could it be - partly - that the Nairu has been low recently for the same reasons Newell said it was in the 50s? Workers in their 40s and older are scarred by memories of the 1970s, 1980s and 1990 recession, which causes them to fear unemployment and moderate their wage demands.
If so, might the equilibrium rate of unemployment rise in coming years as these retire, to be replaced by younger workers with happier experiences and lower risk aversion?
In other words, might it be that the instability of the 1970s-early 90s is in part the cause of the macroeconomic stability we have recently been enjoying?
Alternatively, might this suggest an overlooked benefit of the expansion of higher education? In creating a cohort burdened with high debt, this might help keep people risk-averse, and so keep the Nairu down. If so, perhaps the macroeconomic returns to education are greater than generally thought.
* The passing of the Golden Age, Centre for Labour Economics paper no.347.
**Any macro textbook goes into this in much more detail. Try Wendy Carlin and David Soskice's Macroeconomics: imperfections, institutions and policies.