DP3424 Can Productivity Growth Explain NAIRU? Long-run Evidence from Britain, 1871-1999

Author(s): Timothy J. Hatton

Publication Date: June 2002

Keyword(s): unemployment , productivity growth

JEL(s): E32 , J64 , N14 , N34

Programme Areas: Labour Economics

Link to this Page: www.cepr.org/pubs/dps/DP3424.asp

The ‘new economy’ of the 1990s saw improving Phillips curve trade-offs coupled with faster productivity growth, particularly in the United States. This has led to a revival of the idea that there is an inverse relationship between productivity growth and the Non-Accelerating Inflation Rate of Unemployment (NAIRU). Because productivity trends evolve slowly, such effects have been difficult to identify using short runs of data. This paper investigates this relationship over a much longer period than usual. It draws on recently developed, historically-consistent, time series for the UK from 1871 to 1999. A two-equation model of unemployment and wage setting, that incorporates productivity effects, is estimated over the whole period allowing for shifts across major periods associated with changes in labour market institutions. The results indicate that trends in labour productivity do matter, but they go only part of the way towards explaining wide swings in average unemployment across the decades. Thus productivity is not the whole story, but it is some of the story. In addition, institutional changes appear to have enhanced the effects of productivity on the NAIRU, particularly in the post-Second World War era.