Mar 9 2004

Lesson 10

By

John Kennes

International Monetary Economics

Mar 9 2004

EMU and Labor Markets

Mar 9 2004

• Financial markets match lenders and borrowers – the operation of these markets is improved by

transparency created by euro– Creation of international intermediaries

• Labor markets match workers and jobs– The operation of these markets is is improved by

transparency created by euro– Creation of international intermediaries

Labor Markets (1)

Mar 9 2004

• The Mundell OCA criteria is that labor markets are better integrated– The existence of the euro pushes this agenda– Controversy:

• Is there a tradeoff between labor market integration and the welfare state?

Labor Markets (2)

Mar 9 2004

• A subsitute for labor mobility is labor market flexibility

• How does Europe do on this front?

Labor Markets (3)

Mar 9 2004

Dismal Labor Market Performance

Unemployment rate (%)

0

2

4

6

8

10

12

1970 1974 1978 1982 1986 1990 1994 1998 2002

EU Euro area USA

Mar 9 2004

Beware of Averages!

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

BIG 4 UK SMALL 8 US

1969 1985 2003

Mar 9 2004

• Not just the unemployment rate– Low rates of labour participation– Youth unemployment– Duration of unemployment spells

• General Picture– Many people do not hold jbs– People can remain unemployed for years running– Problem deeper in larger countries, with recent

improvements in the UK and smaller countries

Many other indicators of trouble

Mar 9 2004

• General assessment is that labor markets are rigid in most of Europe

• A simple illustration: real wage stickiness.

Why?

Mar 9 2004

Labor Market Adjustment to an Adverse Shock

Mar 9 2004

• Real wage rigidity just one example• Other features include:

– Restrictions on hiring and firing– Restrictions on hours worked– Minimum wages– High unemployment benefits as disincentives to

search for jobs

More generally

Mar 9 2004

• These features have been introduced to fight labour market imperfections and/or meet social objectives – economic justice

• They make labor market rigid but serve other purposes

• No universal response to this conflict

A Deep Conflict

Mar 9 2004

A Few Examples(more details later)

Market failure Standard solution Economic cost

Dominant power of employers

Minimum wages, labor protection laws, mandatory negotiations

Reduces competition on the labor market

Information asymmetry: no good knowledge of worker skill’s and efforts at work

Collective wage negotiations

Reduces competition on the labor market

Workers are vulnerable to job uncertainty

Mandatory health and unemployment insurance, retirement benfits

Raises labor costs and reduces demand for labor

Mar 9 2004

• Deepening integration excerbates competition• Firms compete by reacting quickly and

forcefully to opportunities or shocks• Inflexible labor markets reduce the ability of

firms to react• Indirectly, social systems compete against

each other• The delicate balance achieved in each country

becomes challenged.

What is the link with Monetary Integration?

Mar 9 2004

• Existing institutions differ from country to country

• They are the outcome of a long, and often conflictual, history

• A look at the most important ones illustrates the challenges posed by monetary integration.

Labor Market Institutions

Mar 9 2004

• General assessment is that labor markets are rigid in most of Europe

• A simple illustration: real wage stickiness.

More generally

Mar 9 2004

• Social Objective: protect workers from employers’ excessive powers

• Economic impact: an illustration.

Collective Negotiations

Mar 9 2004

Collective Negotiations

Mar 9 2004

• Social Objective: protect workers from employers’ excessive powers

• Economic impact: an illustration.

Collective Negotiations

Mar 9 2004

• Social Objective: protect workers from employers’ excessive powers

• Economic impact: Involuntary unemployment• The role of the degree of centralization:

– Plant level: induces some wage restraint– National level: induces some wage restraint– Branch level: less restraint

Collective Negotiations

Mar 9 2004

Bargaining Coordination and Employment

Mar 9 2004

• Social Objective: protect workers from employers’ excessive powers

• Economic impact: Involuntary unemployment• The role of the degree of centralization• The monetary union impact

– One big market: current degree of coordination in collective negotiations decline

– One central bank: more wage discipline

• Will trade unions respond by organising at the EU level

Collective Negotiations

Mar 9 2004

• Social Objective– Protect the weakest– Reduce inequality

• Economic impact: unemployment of the least skilled

Minimum Wage Legislation

Mar 9 2004

Unemployment in France by Age Group(% of group labor force)

Mar 9 2004

• Social Objective– Protect the weakest– Reduce inequality

• Economic impact: unemployment of the least skilled

• The monetary union impact– Enhances competition favours low cost countries– Accession of CEECs will sharpen this aspect– Trade unions fear social dumping and call for

harmonization of social reforms

Minimum Wage Legislation

Mar 9 2004

• Social Objective: protect the wokers from a major risk

• Economic impact– Paid out of labor taxes: raises labor costs– Generous benfits reduce incentives to search for

jobs– Overall, less employment and more unemployment.

Unemployment Insurance

Mar 9 2004

• Social Objective: protect the wokers from a major risk

• Economic impact: more unemployment• The monetary union impact

– Asymmetric shocks create temporary unemployment

– Generous insurance may prolong adjustment– Pressure to reduce generosity, mainly duration of

benefits. Trade unions fear social dumping

Unemployment Insurance

Mar 9 2004

• Social Objective: protect workers from employers’ arbitrariness

• Economic Impact:– Reduce firing during downturns– Limits hirings during expansions– Overall no lasting effect on unemployment, but

reduces firms ability to deal with adverse shocks.

Employment Protection Legislation

Mar 9 2004

• Social Objective: protect workers from employers’ arbitrariness

• Economic Impact: no effect on unemployment but reduces firms’ flexibility.

• The integration and monetary union impact– Harder to deal with adverse schocks– Pressure to reduce strictness of legislation. Trade

unions fear social dumping.

Employment Protection Legislation

Mar 9 2004

Strictness of Protection Against Dismissals

Mar 9 2004

• Social Objective: solidarity among workers in financing unemployment, health, retirement

• Economic impact: raise cost of labor, or reduces wages, or both.

Payroll Taxes

Mar 9 2004

• Social Objective: solidarity among workers in financing unemployment, health, retirement

• Economic impact: raise cost of labor, or reduces wages, or both.

• The monetary union impact– Enhanced competition favours low cost countries– Incentives to either reduce welfare payments or

raise taxes. Politically difficult.

Payroll Taxes

Mar 9 2004

• Deeper integration desirable because it enhances competition on the goods markets

• More competition raises the economic costs of many labor market institutions

• A sharpening of the conflict between economic effectivessness and social objectives.

• Existing arrangements are threatened

How to Respond to deeper Integration?

Mar 9 2004

1. Two-speed Europe2. Deep reforms3. Social Harmonisation

Three Possible Evolutions

Mar 9 2004

• Two-speed Europe• Some countries flex their labor markets others

retain their highly social existing arrangements

• Firms and risk-taking individuals move to most flexible countries

• Welfare conscious are attracted by welfare magnet countries

• Part of Europe grows fast with low unemployment, another part grows slowly with permanently high unemployment

Possible Evolution No. 1

Mar 9 2004

Two-speed Europe: Already There?

Average annual rowth rates 1995-2003

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0.5

1

1.5

2

2.5

3

3.5

4

Big Three UK USA CEEC Three Small Nine

Mar 9 2004

• Deep reforms• Thatcher takes over Europe• Labour market institutions made more flexible• Labour axes reduced

Possible Evolution No. 2

Mar 9 2004

• Social harmonization– The large countries export their welfare systems

through social norms applicable to all EU countries

Possible Evolution No. 3

Mar 9 2004

• There is no obvious better way, just different socio-economic equilibria

• A somewhat arbitray typology:– The continental model– The Nordic model– The Anglo-Saxon model– The Southern European model– And the evolving accessing countries

In the End