Question

How can trade between EU members affect unemployment? How could labour mobility have alleviated the unemployment differential in early 1990's? d) Do we observe labour mobility in reality? How does this relate to the theory of optimum currency areas?

Answer 1

Trade between countries part of European union can actually alleviate the problems of unemoyment. This fact is posited and evidenced in many research papers in economics. Also data of such countries from varous research institutions have found that unemployment has reduced with openess to trade on the assumption that there is labour market flexibility. Due to trade, and labour mobility , skills and productivities are exchanged leading to higher Marginal product of labour. So improved labour productivity leads to more job creation and job search.This is because those institutions in domestic economy which were working with low productivity labour either hires better skilled labourforce across regional boundaries or they they gets substituted by other competent competitors. In any case, specialization of labour takes place thereby raising incomes,employment and GDP.

In 1990s when various countries were opening to trade whether fully or partially, they witnessed inward capital flows ( investments flowing from abroad) ,thereby increasing money supply in domestic economy.This caused increase in investments in those sectors or projects which were earlier held back or stuck due to non availability of financing. Increase in investment requires labour , leading to increase in employment and job creation.

Now, suppose despite having sufficient capital if some countries are short of skilled labour force ( due to low population, unskilled labour etc.) , it could again become a deterrent. However labour mobility helps in alleviating the problem of unemployment. If country A could hire skilled trainers from country B who in turn could train workers in country A. Now workers once skilled can find work not only in their native country but also in other countries within the EU. This reduces the job search time and job effort. The outward shift of production possibility frontier due to trade openness increases output and employment. Also increase in incomes increase consumption and again increases output.

Labour mobility is a reality especially in those sectors where technology cannot replace labour. If a country employs nearly all of its workers in high skilled areas, then there is a requirement of low skilled workforce in other areas. So they may employ workers from different regions to carry out the work at much lesser cost.

As per theory of optimum currency areas, countries located in one geographical area, could be made better off if they use common currency instead of their native currency and open up trade. Their monetary policy will be centrally or jointly determined by the board of member representatives elected by respective countries.

However there are certain assumptions( though not limited) that have to fulfilled in order for this arrangement to work.

They are :-

• An integrated labour market with labour mobility.
• Flexibility of pricing of outputs and wages.
• The member countries must have similar traits, characteristics of the economy so that there is a one common business cycle.
• A centralized structure or system that redistributes excess income or growth such that benefits of inter regional trade are balanced and borne by all member countries.

Even though emergence of EU and euro is in reality an optimum currency areas many economists have argued over trade disparities which have been created, not meeting the assumptions etc or validity of optimum currency as trade competitiveness varies inter country within EU.