European labour markets: six key lessons from the Commission report

I haven't always been complimentary about the European Commission - either its economic analysis or its policy advice.  So it's nice to be able to be wholeheartedly positive about the excellent report "Employment and Social Developments in Europe 2012" (brought to my attention by this article by Ambrose Evans-Pritchard in the Telegraph, also excellent) produced by the Commission's Directorate-General for Employment, Social Affairs and Inclusion.

The report is really worth reading.  But it's close to 500 pages, and the main messages deserve as wide an audience as possible, so I thought I'd try to highlight them with some commentary. To my mind, the key ones are the following:

1.  Economic weakness in Europe, and the consequent rise in unemployment, are mostly to do with a lack of aggregate demand, which in turn is the result of mistaken macroeconomic policies - especially aggressive fiscal consolidation:

"Since 2011, the economic slowdown has gradually turned into recession in the EU, as the escalation of debt crises in several Member States led to significant policy shifts toward sharp fiscal consolidation by and large across the EU with adverse effects on aggregate demand. As a result, the previous timid employment growth has come to a standstill in the recent quarters and unemployment has reached levels not seen in more than a decade."

This is a statement of the obvious. Except that of course it is not obvious to a different bit of the Commission (the Directorate General for Economic and Financial Affairs-sadly the Directorate in charge of economic policy) which produced a shockingly bad piece of analysis in their November 2012 forecast arguing that fiscal consolidation wasn't really such a big deal (on the basis of an econometric analysis which would shame a first-year Masters student).  Nor, sadly, has it yet sunk in to our own Treasury, Office of Budget Responsibility and Bank of England, despite the best efforts of the likes of Adam Posen. 

2. Although financial markets may have stabilised - who knows for how long - things are getting worse, not better, in the real economy of the crisis countries.

"A new divide is emerging between countries that seem trapped in a downward spiral of falling output, massively rising unemployment and eroding disposable incomes and those that have at least so far shown some resilience – partly thanks to better functioning labour markets and more robust welfare systems, although there is also uncertainty about their capacity to resist continuing economic pressures."

So much for Commissioner Rehn's light at the end of the tunnel.

3.  Countries with more generous welfare states, but also more flexible labour markets, have fared best:

"countries with relatively un-segmented labour markets and strong welfare systems [Germany, the Nordics, and to some extent the UK] have fared better than those with highly segmented labour markets and weak welfare provisions [Southern Europe]."

So much for the absurd myth, popular in some quarters (especially the US) that the European crisis is caused by a "bankrupt welfare state" as the Wall Street Journal put it. The structural problems in Southern European labour markets are, as the report says, much more about segmented (two-tier) labour markets than about excessive generosity.

4.  Following on from this, structural reforms in labour markets are required in many countries - but they need to be based on evidence!  Segmented labour markets are a problem and raise youth unemployment:

"Many EU economies, particularly those with segmented labour markets, experience difficulties in integrating young people into the labour market, not only in terms of getting them out of unemployment but also in terms of matching their qualifications and skills with suitable jobs."

This suggests some types of so-called "deregulation" - especially making it easier to fire some types of worker, especially younger workers, while preserving protections for others, or exempting small firms only from some employment laws - would make matters worse not better. On this the UK government has got the balance mostly right, in particular by rejecting those recommendations from the Beecroft report which would have moved us in the direction of a two-tier labour market.

..and even in recession, minimum wages at a sensible level do more good than harm.

"the evidence that minimum wages would impact negatively on jobs even in a severe economic downturn is limited..[and] raising minimum wages has the potential to increase the tax base, as overall employment increases, and reduce the outlays for unemployment benefits and in-work benefits, thereby improving the overall fiscal stance."

5.  Where they were allowed to operate, the "automatic stabilisers" worked...(in both macroeconomic and social terms):

"In these MemberStates, the combined effect of robust automatic stabilizers (reinforced by initial discretionary measures) and more resilient labour markets in general helped mitigate the impact of the recession on overall household incomes and private demand."

...while where they were overriden, in the pursuit of "self-defeating austerity", things have got worse:

"Simultaneously, the social situation is deteriorating, especially in Member States in southern and eastern Europe, as the effect of national automatic stabilisers, which played an important role in keeping up household expenditure and protecting the most vulnerable in the first phase of the crisis, has weakened more recently."

This makes it even more puzzling that the Chancellor here has chosen to reverse his position and override the automatic stabilisers by cutting benefits for the unemployed and low-paid workers.

6. Latvia, Ireland (and even Estonia) may look like "success stories" to some in the Commission, and perhaps to the financial markets (at present) but the reality in terms of jobs and incomes is rather different.

Between 2008 and 2011, long-term unemployment rose more than three fold in Estonia; more than four-fold in Latvia, despite mass emigration; and almost five-fold in Ireland. This in countries that (unlike Greece and Spain) have been praised for their relatively flexible labour markets!  There is also a lot more on the rise in poverty and social exclusion in these and other affected countries. 

And finally, one point from me on the relevance of this to the UK policy debate.  Too often, discussion of eurozone and UK economic policy proceeds on two entirely separate tracks, as if the problems of one were completely different from, and irrelevant to, the other.  In one respect, this is clearly rational; borrowing in its own currency and with its own central bank, the UK cannot and will not default and hence has vastly more fiscal policy flexibility than eurozone countries, as I and others have repeatedly emphasised. But that doesn't mean that many of the issues, both macroeconomic and microeconomic, don't apply in both; virtually every point above is just as relevant to the UK as to the eurozone.