Financial crises are followed by significant increases in unemployment rates and the Great Recession will be no exception. Employment will not increase in earnest until overall demand in the market recovers its pre-boom strength, which will take time since the reduction of debts (also known as the deleveraging process) has barely started.
However, the financial crisis is not the ultimate cause of current mass unemployment. The tendency towards rapid job destruction in recessions and weak job creation in expansions in Southern European countries is the consequence of their inadequate adjustment to the fast pace of globalization and technological change in recent decades. In the wake of a generalized fall in real interest rates during the early years of the euro, these countries have missed the opportunity to modernize their economic structures and to improve, or at least maintain, their positions in the international division of labor and value added creation.
On the contrary, these financial tailwinds triggered an appetite for credit in these countries that increased indebtedness to historical levels. Spain is a case in point. It took a massive housing bubble and a dramatic debt-fuelled increase in domestic demand to reduce the level of unemployment from the peak after the recession of the 1990s to the Eurozone average in 2007.
But the increase in employment was the only good news that the labour market produced in these years. Many other signals should have sounded the alarm bells about the weak foundations and the unbalanced nature of growth: stagnant or declining productivity, low wages, the high rate of temporary jobs (three times the OECD average), youngsters leaving school to work in the construction sector and a very high rate of school dropouts, insufficient incentives to work – in the midst of an extraordinary wave of legal and illegal immigration over two million people remained unemployed – and a sustained increase in income inequality.
The crisis has made clear that this growth model was unsustainable and that the eventual recovery will have to be based on very different foundations. The need to change their economic structures comes at the most difficult moment for these countries. European policymakers will have to exploit the very limited fiscal and monetary space still remaining and speed up the structural reforms needed to improve their competitiveness and to make the most of GDP growth in terms of employment, thus avoiding the risk of a jobless recovery.
Basically, labour market regulations have not changed much since the 1970s when emerging countries did not compete in the global world as they do now. Those were years in which less developed countries provided raw materials and some agricultural goods to the developed world and got manufactured goods, machinery and financial capital in return. This is no longer the case and the developed countries have to specialize in other things and increase productivity to maintain their economic and social status in terms of the welfare state.
Labor market reforms are country-specific, since each country has different employment problems. In some cases a change in collective bargaining is needed, in other countries two-tier systems (high firing costs for some workers on permanent contracts and zero costs for others in temporary jobs) exacerbate duality. We have ill designed unemployment protection schemes that do not encourage search and training, or the absence of active labour market polices. Countries with high rates of structural unemployment, like those in Southern Europe, have to change their regulations on most, if not all, of these fronts.
The combination of wage flexibility and human capital accumulation is the key to success in this endeavor. Human capital accumulation – reforms in schooling and apprenticeships, contracts, active labour market policies – is the way to sustain productivity growth, to incentivize firms to further R+D investment, to achieve higher earnings and more stable labour careers. But this may take time, especially for low-skilled workers, and it has to be complemented with sufficient wage flexibility to facilitate the employment of those workers who suffer the competitive pressure of emerging economies as well as those looking for their first job. Wage flexibility is also needed to reallocate capital and labour to dynamic industries and to prevent further job losses in firms that suffer temporary falls in demand.
Better skills and higher employment will help to avoid further increases in income inequality, although additional wage flexibility may have the opposite effect. Reducing inequality and tackling unemployment are not conflicting objectives in the long run, but they may appear so in the shorter term. Each crisis means a lower proportion of low-skilled jobs in advanced economies; hence workers in that segment of the labour market that cannot be trained to improve their skills will have to accept low-paid jobs.
The best way to reduce this source of inequality is better education and on-the-job training, but not everybody is going to succeed at that. For some workers the only choice will be either low paid jobs or unemployment. In some extreme cases income support and other public income transfers will be needed and governments will have to use the instruments of the welfare state and better designed labour market policies to ameliorate the situation of those at risk of being left behind.