Can labour market reforms boost plight of young people without jobs?

The euro zone’s southern countries fiscal and banking problems have exacerbated an underlying social challenge, one facing all countries, but most acutely those of southern Europe, namely that of providing job opportunities for young people. Even when their economies were performing better, Italy and Spain had developed dual labour markets, in which a large number of established employees enjoyed a high degree of job security, together with relatively good wages, while most young job-seekers could only obtain a succession of short-term jobs which provided little or no training. Now that these countries are in the second part of a double-dip recession, the opportunities for young people are even worse: half of those not in education under 25 in Spain, and a third in Italy, are unable to find a job at least other than completely unregistered jobs in the shadow economy.

Labour market reform is therefore rightly high on the agenda of these countries. Many economists and other commentators believe that, if job security were reduced, employment would increase, pointing to Denmark and the Netherlands, two countries which have achieved not only low levels of unemployment but high rates of participation by bringing into the labour force those, especially women, who in southern Europe do not seek jobs. These countries models are described as “flexicurity” since those who lose jobs have both relatively good unemployment benefits and a labour market which provides opportunities for re-employment. Unfortunately there are huge obstacles towards moving to this model. Allowing the easier dismissal of existing workers would certainly increase redundancies, but despite the evidence from countries like Denmark and the Netherlands that it would increase opportunities for new jobs, this cannot be proved and, from the perspective of trade union members remains a  matter of speculation, and under existing economic circumstances the prospects do not look very good. Moreover, it has to be pointed out that Spain and Italy already do have a large section (the second tier) of their labour markets which are highly flexible – some would say excessively so—and although this second tier has led in Italy at least to the creation of jobs which were not there before, they have by no means produced north European levels of employment even when economic conditions were better.  An obstacle particular to Italy is that this country at present only provides an adequate cushion of unemployment benefits to a limited group of the work force through the so called Cassa Integrazione. Those not covered by this fund receive negligible benefits. Efforts are being made to fill this gap in the social security system but these are limited the need to bring the public finances into surplus so as to begin to reduce the 120% of GDP public debt.

More fundamentally, the functioning of labour markets is dependent not just on the legal framework but on patterns of industrial and social relations which have developed over generations. The experience of countries with well-functioning labour markets should be given prominence and lessons should be learned but applying those lessons is not as easy as just tearing up excessive regulation. Labour markets are highly political and it is not easily possible to impose common euro zone rules that over-ride domestic politics on top of the increasing severity of fiscal rules needed to address the sovereign debt crisis.

Nevertheless Spain has brought about a significant reform which should limit dismissal costs for standard contract employees to a month’s pay for every year worked, ending the uncertainty over costs which had been such a disincentive previously, although this applies only to newly taken on employees. Those already employed before the reform retain existing rights. The reform has not yet resulted in any beneficial effects on job creation but this is likely to have to wait till the elusive economic recovery takes place.

Negotiations over a bill to reform labour markets in Italy put forward by Mario Monti’s employment and pensions minister, Elsa Fornero, was the major domestic policy preoccupation between March 2012 and the end of June when, after amendments by parliament, the bill was passed into law. It has been severely attacked by the employers’ organization, Confindustria, and by some Italian commentators. On one of the government’s objectives, the simplification of legislation, it certainly fails, running to nearly 100 pages of dense text. However it does make some significant changes, which should be for the better. With regard to the highly contentious Article 18 of the 1970 Workers’ Statute, regarding individual dismissals, it makes these considerably easier if they are for economic reasons. Protection against dismissal for disciplinary reasons can rightly still be contested in the courts. If the employee is vindicated he or she has a right to compensation but will no longer have an automatic right to be re-instated, the latter now is dependent on the judge.

Controversially, the new law makes some changes, which increase the rights of employees on short-term contracts. The law also increases the obligations of employers towards the training of apprentices, an aspect where the ministry claims to have the support of both sides of industry.

With regard to bringing young people into the labour force, an example that southern countries could benefit from looking at is that of Germany. Its latest youth unemployment rate in May 2012 was 7.9% compared to 37% in Italy and 50% in Spain. Of course the recent overall performance of the German economy has been much better than those of Italy and Spain, which clearly provides a more favourable background to taking on young people. But the German youth unemployment rate has throughout the cycle kept much closer to the overall rate—youth unemployment peaked at just over 15% in 2005. A likely reason for Germany’s better performance is the longstanding priority in German business culture to apprenticeships, backed up by a system of days released for external vocational education. Apprenticeship programmes are supervised and monitored by local chambers of commerce. Although the German system is an old one it has adapted to changed needs by introducing 43 (out of total of 344) new types of apprenticeship in the last ten years and changing many others. In other countries, employers often complain about the quality of school education, but results for German 15 year olds in the OECD’s comparative studies known as PISA have not compared favourably with other EU countries which reinforces the likelihood that low German youth unemployment is linked to the apprenticeship system.

The German labour market also benefits from reforms introduced in the mid-2000s under the heading Agenda 2010, although the reforms were incremental rather than consisting of a radical sweeping away of regulations.  Indeed in some ways it increased regulation. For example, employees serving notice now have a right to time off to seek new employment. An important change was a radical reform of the federal labour market agency, incorporating elements of a private job agency and integrating its work with the provision of benefits.

Arguably more important than government-driven reforms has been a decentralization of bargaining over wages and conditions, which has taken place over the last decade. This has increased the role of existing works councils, which have long been provided for by German law and have gradually come to be seen as a valuable tool by company management and owners for concerted approaches to competitive challenges. They have allowed greatly increased flexibility within companies for tackling changes in demand and between companies depending on the performance of companies.

Italy and Spain should likewise strive to increase the say of employees at company and local level, where large national trade unions cannot be expected to know the conditions. National agreements may continue but, as is the case now in Germany, they should be increasingly open to adaptation at company and local levels. However this does require central union organisations to be willing to devolve some of the powers.

Follow-up to summit undoes its good work

Euro zone policy makers have failed to follow up the small successes of June summit 29th with a consistent message which could inspire investors’ confidence. There were three main specific policy moves of significance and potential benefit that the summit agreed on: first that the European Stability Mechanism (ESM), when it comes existence as it is supposed to in the coming months, should be able to buy government debt of Italy and Spain without the same arrangements involving wide-ranging programmes of the type applied to Greece, Ireland and Portugal which are monitored by the troika of the European Commission (although there would still have to be policy commitments by the governments). Secondly, such debt if bought by the ESM should not become senior to other debt, which would have taken away any realistic chance that it could actually support the private sector market. And finally that, once the ECB has been given regulatory supervision over the euro zone banks, the ESM can provide capital to support troubled banks without that capital being underwritten by the government of the country in which those banks are based, so avoiding an sovereign debt burden that would weaken confidence in the ability of the country to manage its debt.

All three were significant moves and all should have had a beneficial impact on what at present appears the most intractable problem affecting the euro zone’s prospects, namely the threat that lack of market confidence in the solvency of Italy and Spain becomes self fulfilling by charging interest rates in those countries debts that becomes unaffordable. They did have such a beneficial impact but this was very short-lived and in little more than a weak the spreads between Italian/Spanish and German government debt had risen to even higher than they had been before the summit. This partly reflects the fact that though the agreements should have been helpful none will be decisive. Assuming the ESM comes into existence, it will have a lending power of €500bn against a Spanish government debt of €800bn and an Italian one of almost €2,000bn.

Given this gap, it is possible that there is nothing that can be done to prevent the gradual deterioration of the situation unless or until there is a massive underwriting of the weaker countries’ debt by the euro zone as a whole either through euro bonds or the ECB. This possibility has become more likely as a result of the follow-up from the summit. It is in the interests of the creditor nations to try to prevent this.

A lesson that should be learned is that it is not only important to reach agreements on policy but also to agree on how what has been decided is presented. If each country tries to interpret it in a way most favourable to its own domestic political situation, as has happened, the effect will be to undo any beneficial impact of the agreements on the financial markets.

Some criticism can be made against the governments of Spain and Italy. They both said that they were more favourably treated than Greece, Ireland or Portugal in that they had not agreed to the same Memorandums of Understanding and detailed monitoring. They needed on the contrary to tell markets they are doing just as much as these countries to correct their finances and reform their economies. However, both these countries have, following the summit, introduced swingeing further expenditure cuts on top of those previously put into effect. Given that such measures will intensify and prolong the second recession they are experiencing, it is hard to see how they can be expected to do more.

Criticism can also be directed at the post-summit comments and interpretations  of the creditor member states. The German has been more keen to emphasise what it has not agreed to (euro bonds) that what it has agreed to and Wolfgang Schauble, the German finance minister, has emphasized that the transfer of regulatory authority to the ECB will not happen till next year so that the rescue of the Spanish bank, Bankia, will in the meantime have to be added to Spanish debt. On the other hand the German parliament has given a large majority to legislation providing for the establishment of the ESM. Of great concern has been the apparent attempts of the Netherlands and Finnish governments to pull back from what their prime ministers agreed to at the summit. Both these countries face difficult domestic political situations with populist politicians exploiting voter concerns about the potential costs of participating in the ESM. However, the reality that they should explain to voters is that the whole euro zone is threatened with disastrous financial and economic consequences if major euro zone countries become insolvent. This is likely to be most difficult in the case of Finland. The Netherlands lies at the heart of the euro zone and its banks are heavily exposed to other euro zone countries. Finland is the only Nordic member of the euro zone and the Nordic countries are at present experiencing benign economic conditions. These conditions are still at risk from developments elsewhere in Europe including the euro zone but there is a danger that in order hold back the gains made by the populist and anti-euro True Finns in the 2011 election, the government and parliament will prevaricate in a way which could be highly damaging for the euro zone.  It may be that Finland will have to be treated as a special case able to negotiate special conditions for its contributions, although if other countries were to try to copy Finland the whole exercise could be threatened. But it would be better if Finnish politicians could recognize that Finland’s longer term prospects like other EU countries depend on preventing the euro zone crisis from continuing to deteriorate.