Assessing the recent labour market agreement in France

Gilles Saint-Paul 01 February 2008

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In my view, the recent agreement between employers and unions on labour market reforms is globally positive. While it is not a step in the direction of a fully flexible labour market (but this is not on the agenda anyway), it exploits existing margins of improvements in order to reduce non-wage labour costs to firms – in particular, the ones they face when deciding to get rid of a worker – while preserving the protection of the workers as they move between jobs. We are moving to a model of labour relations which is not perfect, but is a clear improvement over the present one. However, the risk of opportunistic behaviour by firms and workers with respect to the unemployment benefit system has not been taken into account, and this should eventually be fixed.

The looming paradigm behind the recent agreement is the Danish “flexicurity model”, which is based on protecting workers in the labour market, as opposed to protecting them in their current job.

The positive side of this is that indeed, flexibility increases for firms, but a negative side-effect is that the incentive to remain unemployed has somewhat increased. The flexibility doctrine claims that this can be fixed thanks to active labour market policies. It remains to be seen whether such effective policies can be implemented in France.

Firms have more flexibility in reducing their workforce

In the present model, job security for workers is mostly associated with litigation. While severance payments are minute, unions can get a lot of leverage by going to court; their bargaining power is a by-product of their capacity to be obnoxious. This incentive for opportunistic behaviour on the workers’ side creates inefficiencies in separation decisions. As a result, firms expect to pay large turnover costs and a substantial fraction of these costs is dissipated in litigation rather than being paid as a compensation for the worker. Firms have always complained about the huge uncertainties created by this system; they simply do not know how much it costs to get rid of a worker and for this reason do all they can to avoid offering permanent contracts, and rely heavily on temporary contracts when they hire people.

From the worker’s point of view, the system does not offer that much protection either. Quite often the worker will have a temporary contract which means being sure to lose one’s job. If the worker has a permanent contract, then the probability of losing one’s job is low. But if the worker ends up losing his job, severance payments are not that high, many benefits are not transferable, and then he suffers from the poor labour market conditions that rigidities have created.

A win-win reform

This suggests that there are positive gains from trade between unions and employers from just changing the system, and this is what the recent agreement tries to do. The most innovative provision is that employers and employees can now separate by mutual agreement, which gives workers statutory severance payment as well as eligibility for unemployment benefits. In exchange, the conditions under which the worker can challenge the agreement in a court are made more stringent, and a cap is put on the maximum compensation that the court can impose, as well as on the maximum delay under which the worker can resort to litigation. This clearly takes power out of the courts and restores private contracting.

Lower turnover costs?

To buy the support of the unions, the measure includes an increase in statutory severance payments. The reform reduces the tax imposed by the legal system on workers and firms jointly, while improving worker compensation. Hopefully (but only precise computations could show it), the firms will consider that the total firing cost they face has not increased and is much less uncertain than in the past. Workers benefit because they receive as severance payments a larger fraction of previous litigation costs. In any case, the statutory severance payments in France have always been very low by international standards, and it is plausible that the effects of the reduction in uncertainty and opportunism are an order of magnitude larger than those of the more generous severance payments.

The overall effect of this measure is to reduce the turnover costs imposed on the firms by the legal system and the inefficiencies associated with worker opportunism. This will mean more job destruction, but these are mostly inefficient jobs, and more job creation, with a greater proportion of permanent contracts in the jobs that are created. The net effect on employment is unclear. It is even possible that it will fall in the short run, as firms get rid of unprofitable jobs. But unemployment duration is likely to fall, and this will benefit the workers who lose their jobs.

Longer temporary contracts

Another innovation in the current reform is the creation of a lengthened temporary contract with a “well-defined object”. This has long been popular with the employer unions. They complained that it was impossible to hire workers for a specific project. Either the worker is given a temporary contract, which cannot exceed 18 months, or a permanent contract that means the firm cannot get rid of the worker after the project is completed. Unions were nervous about the project contract because they feared that firms could be officially organised around projects rather than employment relationships, which would undermine their bargaining power. This led to a compromise, which restricts these new contracts to skilled workers. It remains to be seen whether they could be extended to unskilled workers in the future.

The incentives to be unemployed have somewhat increased

The agreement has widened the scope for eligibility for unemployment benefits. In the past, workers were insured against involuntary separations; they are now insured against separations that they agree to. Will this lead to an excess level of separations? Presumably, workers who wanted to leave and become unemployed could always get their employer to pretend that they have been laid off. So I do not expect much change there, but this effect clearly does not go in the right direction.

Better benefits portability

Progress has been made on the portability of a number of social benefits when people lose their jobs. Portability generally makes it easier for workers to change jobs and should be commended. But in the present agreement, the counterpart of greater portability is an increase in both the effective severance payment and the effective unemployment benefit replacement ratio. For example, laid off workers can keep complementary health insurance during 7 months. But both parties, the employer and the employee, have to pay their share. This is unfortunate. The employer’s share acts as an additional severance payment, which is paid only as long as the worker does not find another job. So we cumulate the negative effects of severance payment on job creation with the negative disincentive effects of unemployment benefits on job search. Ideally, employer-based benefits should be abolished; they have no economic rationale, workers could get higher wages instead and purchase whatever benefit they want on the market. The distortions associated with portability problems would then disappear. The social partners should consider phasing out such benefits in exchange for higher wages.

The agreement therefore seems to have increased the incentives for firms and workers to inefficiently rely on the unemployment benefit system to separate when they would not want to do so if unemployment benefits did not exist. Olivier Blanchard and Jean Tirole, in particular, have recently argued that a tax on separations should be imposed to avoid this, in the spirit of the US “experience rating system”. Such an arrangement, designed to discourage separations, stands in contradiction with the philosophy of “flexicurity”, which is about promoting labour reallocation in the economy while insuring workers against the hardship of such reallocation. Given this trade-off between moving people to the most productive sectors and reducing the excess turnover generated by generous unemployment benefits, the agreement makes a clear choice.

Flexicurity might not work in France

The flexicurity doctrine says that active labour market policy, for example in the form of sanctions imposed on the unemployed, can be used to coerce them into accepting jobs. It means spending more resources to fight the adverse consequences of generous worker protection on job search. This approach is supposed to work in Denmark and other Scandinavian countries. It is not obvious to me that it will work in France. It will be harder to avoid collusion between civil servants at the public employment service (ANPE) and the unemployed to help the latter escape the sanctions. Furthermore, with PARE, there already was an attempt to impose sanctions on the unemployed for insufficient job search. Unions who were keen on reducing competition between insiders and outsiders were skilful enough to empty it of its content during lengthy renegotiations. If this turns out again to be difficult to implement, the only alternative will be a reduction in unemployment benefits.

Editors’ note: This column first appeared in French on our Consortium partner’s site http://www.telos-eu.com

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Topics:  Labour markets

Tags:  France, unemployment, labour market reforms, benefit system, turnover costs, temporary contracts

Toulouse School of Economics and Scientific Adviser to the Economic Studies Directorate at the French Ministry of the Environment. CEPR Research Fellow

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