Why Europe needs better labour market reforms

Structural reforms of labour markets are almost universally advocated by international institutions. They are included as key conditions for delivering financial assistance under formal rescue programmes, and the nth Greek agenda of reforms is no exception in this respect. They are also strongly recommended to countries under the supervision of the EU macroeconomic imbalance procedure; a commitment to carry out these reforms is almost unavoidably requested. It is somehow paradoxical that these reforms are still given so much importance after a period in which many of the targeted countries had implemented many such reforms. Within a few years, Greece, for instance, carried out a reform of its unemployment benefit system (reducing its duration), almost halved its minimum wage, and reduced employment protection as well as the coverage of collective bargaining. Yet the new memorandum of understanding is asking for more labour market reforms (Campos and Coricelli 2015). Either the reforms were misguided or lost in translation, or conditions changed so that there is further need for more.

In a recent paper, we argue that labour market reforms, coupled with better tools of fiscal policy co-ordination, are indeed needed to correct the unbearable divergence of unemployment in Europe (Boeri and Jimeno 2015). In our assessment, the reforms implemented during the Crisis were partly misguided as they did not take into account some principles supported by wide and deep economic research. Furthermore, even well designed labour market reforms – when imposed on national governments by international institutions – backfired. The way conditionality was exerted did not lead national governments to take full ownership of the reforms and, hence, to make them work. We propose new forms of conditionality – notably ‘positive conditionality’ schemes – addressing these problems.

Why more labour reforms?

There are two reasons why labour market reforms are still so urgently needed in Europe.

• One is that unemployment differentials across Eurozone countries have never been as marked as they are today (see Figure 1).

These differentials are not only the result of the differential impact of the Crisis – the size, and nature of shocks on countries – they are also the result of dysfunctional labour markers reacting to the shocks.

• The second reason is that medium- and long-run perspectives are not bright because of the interactions between the debt legacy of the Crisis, and demographic developments and diminishing expectations of productivity growth (Jimeno 2015).

The interactions go both ways – declining working age populations and low productivity growth make it more difficult to deleverage, and adapting to a low growth scenario is more difficult because of the burden of the high private and public debt.

These factors are pushing the European economy into a deflation. Even though structural reforms may increase the deflationary bias in the short run (Egertsson et al. 2013), the truth is that the European economy is in such a dismal situation because of low productivity growth. This makes it more likely a ‘stagnation trap’, by putting a significant brake on nominal and real GDP growth.

Figure 1. Eurozone unemployment rates (%), average and extreme values

Which reforms should be implemented?

In many parts of Europe, labour market reforms during the last eight years were misguided and backfired. Theory and evidence tell us that:

• It is always better to have institutions allowing adjustment along several margins, not only employment.
• When implementing labour market reforms, it is important to take into consideration cyclical conditions.
• A very tough fiscal consolidation may be inconsistent with an acceleration of structural reforms, not only because such reforms may be politically more difficult, but mostly because they may just not be desirable under a strong fiscal contraction.

However, in Europe the reforms were implemented:

• Under a pro-cyclical fiscal policy due to an ill-designed EU policy coordination framework;
• Giving too much weight to measures that promote wage moderation, implement reductions in severance pay, and increase the retirement age in the midst of a major recession;
• Ignoring other, potentially productivity-enhancing reforms, such as those eliminating contractual dualism;
• Not encouraging adjustment along the intensive margin via short-term work, working time accounts, and plant-level agreements;
• Not using actuarial reductions to pensions as a sustainable way to reduce labour market slack.

Many of these reforms were based on recommendations by international institutions to national governments that were either under formal rescue programmes or suffering severe macroeconomic imbalances. Even when the diagnostics of labour market problems were right (Blanchard et al. 2014), recommendations from international institutions were ‘lost in translation’ as governments did not take full ownership of them. Other recommendations relied too much on measures that backfire during cyclical downturns, not acknowledging that labour market reforms that are good in normal times may not be desirable under major recessions.

Reforms under positive conditionality

The above suggests that a different approach to conditionality and to the way in which employment policies are promoted at the EU level is warranted. ‘Positive conditionality’ schemes can be devised which have the following properties:

• Are partial complements of national programmes, not substitutes for them,
• Reduce moral hazard, by making the access to the European programmes conditional on accepting best practices in employment protection legislation, wage setting, and entitlements to unemployment benefits; and
• Minimise expenditures and permanent transfers across countries.

In particular, the gradual introduction of individual accounts can make it possible that the benefits of the implementation of the programmes go directly to the workers rather than to governments, social agents, and other intermediaries. Moreover, having such benefits fully portable across national jurisdictions, they would be perceived as EU-wide entitlements, reducing barriers to transitory labour mobility, which could also play a role as a stabiliser in case of asymmetric shocks.

Examples of European programmes

Examples of the kind of European schemes we would recommend are given below.

• A European Employment Contract for Equal Opportunity

A new single-open contract with severance pay gradually increasing in worker tenure, just like in the new open-ended contract introduced in Italy and effective since March 2015. The contract comes with individual savings accounts into which both employers and some European Fund (combining Structural Funds with the European Social Fund) contribute.  Employers get some reduction in severance pay and some reduction in labour costs (as European contributions also play the role of deferred wage subsidies). Workers gain from more stable jobs (and from the wage subsidy). Additional European funding of active labour market policies or unemployment insurance can also be implemented by contributions to the individual accounts.

• A European Unemployment Insurance Programme

A complementary European unemployment insurance scheme available only to those countries that achieve substantial progress towards a better design of labour market institutions.

• Actuarial neutrality and the portability of pension rights across jurisdictions

Aiming at introducing flexibility in retirement age that could soften the cost of adjustment to macroeconomic shocks, while rejuvenating the workforce. The fact that differences in the age of retirement involve actuarially neutral adjustments also make the full portability of pension rights across jurisdictions sustainable and intra-EU bilateral agreements among social security administrations more transparent.

References

Blanchard, O, F Jaumotte, and P Loungani (2014), “Labour Market Policies and IMF Advice in Advanced Economies during the Great Recession”, IZA Journal of Labor Policy, 3:2.

Boeri, T and J F Jimeno (2015), “The unbearable divergence of unemployment in Europe”, ECB Sintra Forum.

Campos N F and F Coricelli (2015), “Reforming Greece”, VoxEU.org, 17 July.

Eggertsson, G, A Ferrero, and A Raffo (2013), “Can Structural Reforms Help Europe?”, Board of Governors of the Federal Reserve System International Finance Discussion Papers, 1092, November 2013

Jimeno, J F (2015), “The Long-lasting Consequences of the European Crisis”, ECB working paper 1832.

This article is published in collaboration with VoxEU. Publication does not imply endorsement of views by the World Economic Forum.

To keep up with the Agenda subscribe to our weekly newsletter.

Authors: Tito Boeri is the President of Italian Social Security administration (Inps). Juan F Jimeno (PhD in Economics, MIT, 1990) is Head of the Research Division of Banco de España since October 2004. 

Image: A priority ticket is seen as people line up inside an unemployment bureau in Athens September 6, 2012. REUTERS/John Kolesidis.