Labour markets on the verge of a regulation crisis

Giuseppe Bertola 26 May 2009

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Unemployment is now just about the same in France and the Eurozone as a whole (8.8%) and in the US (8.9%). This is a rather unusual coincidence. The trends in Figure 1 show that in the 1960s unemployment in France (and other European countries) was much lower than in the US. It rose steadily in the 1970s, driven by the interaction of shocks and institutional features (Blanchard, 2006), reached the US level in the early 1980s and remained higher, only starting to descend in the 1990s. The data shown in the figure stop in 2007, when unemployment had been trending down in France and other European countries for some ten years towards its level 25 years before (and the US level).

Figure 1. Annual observations and 11-year centred moving averages

Data source: World Bank, WDI

Then, the crisis came. In 2009, the French and American unemployment rates are similar because they are both shooting up quickly. When oil shocks hit in the 1970s, unemployment did not rise as fast in Europe as in the US, prompting the prominent American economists quoted by Bertola, Blau, and Kahn (2002) to praise the performance of European labour markets. Now, the cyclicality of unemployment is different from what it used to be in Europe, and similar across the Atlantic. Figure 2 shows that the US unemployment rate increases by about 0.4 percentage points for each percentage point of GDP growth slowdown, both in 1962-82 and 1983-2007. Again taking France as an example, the average unemployment price of cyclical slowdowns was just 0.14 in the earlier period, but it is just about the same as in the US in more recent period.

Figure 2. Annual observations and linear regressions

Source: Same as Fig. 1

The fact that flexibility has come to labour markets in France and Europe has important policy implications. Not so long ago, policy-makers would worry about second-round inflationary pressures from collective wage bargaining. It was then comforting to find evidence that deregulation, deunionisation, and international and product market competition helped increase employment flexibility and keep wage reactions in check, as suggested by the empirical results of the European Central Bank’s Wage Dynamics Network. Now, employment and wage rigidities could usefully help stabilise domestic demand as the tsunami that hit asset holders is about to sweep over the working class. Countries like Spain that have enjoyed the largest deregulation-driven employment gains find themselves on the brink of a major breakdown in this recession. Just as exceptional financial returns that were perhaps brought about by poorly considered and unregulated leverage, perhaps the good employment performances of recent years were just illusions brought about by labour market deregulation?

If deregulation is what made it possible for European unemployment to decline slowly, it would be silly to restore old rigidities just because unemployment increases quickly in the crisis. As French GDP declines by some 3% in 2009, even the steep unemployment reaction displayed in the more recent panel of Figure 2 implies an increase that is less than half the difference between the average French unemployment in 1975-85 and in 1985-95. Labour market re-regulation is a real possibility, however, because unemployment and labour market institutions did not just interact with each other over the last few decades, but were affected by the two major structural trends of the time – international economic integration and financial development.

When the paths of European and American unemployment rates crossed in the early 1980s, globalisation also began to magnify the costs of labour market rigidities in terms of labour reallocation efficiency and the incentives to supply job finding and work effort. In the 1980s and early 1990s, European unemployment remained high – and growth declined – because labour market institutions that might have been appropriate in earlier times were unable to cope with new competitive pressures. Flexibility-oriented reforms logically followed. The empirical relevance of the relationship between reforms and integration for reforms is confirmed by evidence from the Economic and Monetary Union (EMU) experience. In theory, stronger “one market, one money” international competition should strengthen the negative implications of regulation and reduce its appeal. In fact, recent papers by Alesina, Ardagna and Galasso (2008) and me (Bertola, 2008) find that EMU countries did experience substantially faster deregulation of their product markets and some deregulation of their labour markets, especially in the segments where “secondary” workers find temporary employment. As a result, employment grew and unemployment declined everywhere – more strongly where economic integration was tighter.

Labour market rigidities, however, do not just reduce production efficiency. They also stabilise and equalise labour incomes – changes in labour market institutions account for all the increase in inequality that the data also associate with the EMU (Bertola, 2009). International markets may like labour market flexibility, but workers certainly dislike insecurity, especially when limited access to financial markets makes it difficult to smooth the consumption impact of income fluctuations. As shown in Figure 3, consumer credit is abundant in countries where labour markets are flexible and job tenures short. As rigid labour markets could not cope with internationalisation of production, their increasingly unpleasant unemployment implications were addressed not only by deregulation, but also by the vigorous development of financial markets in the 1990s and early 2000s.

Figure 3. Consumer credit vs. job tenure

Source: ECRI Research Report 2000

If the poor performance of financial markets in the crisis causes a loss of faith in their ability to protect workers’ consumption from labour demand shocks, a reversal of labour market reform trends is possible. Policy-makers, however, should not reconsider labour market policies in haste and in isolation. As in financial markets, past performance does not guarantee future returns in labour markets, and policy needs to be predictable and forward-looking. Only a comprehensive and (to the extent possible) internationally coordinated approach to the regulation of labour and financial markets will foster stability and prevent international economic disintegration.

References

Alesina, Alberto, Silvia Ardagna, and Vincenzo Galasso (2008) “The euro and structural reforms” NBER Working Paper 14479.
Bertola, Giuseppe (2008) “Labour Markets in EMU: What has changed and what needs to change,” European Economy - Economic Papers 338, European Commission, and CEPR DP 7049.
Bertola, Giuseppe (2009) “Inequality, Integration, and Policy: Issues and evidence from EMU” CEPR DP 7251.
Bertola, Giuseppe, Francine D. Blau, and Lawrence M. Kahn (2002) “Comparative Analysis of Employment Outcomes: Lessons for the United States from International Labour Market Evidence,” in A.Krueger and R.Solow (eds.), The Roaring Nineties: Can Full Employment Be Sustained?, Russell Sage and Century Foundations, and CEPR DP 3023.
Blanchard, Olivier J. (2006), “European unemployment: the evolution of facts and ideasEconomic Policy 21:45, pp.5-59.

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Topics:  Labour markets

Tags:  unemployment, regulation, crises

Professore ordinario, Università di Torino; CEPR Research Fellow

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