Tuesday, March 13, 2012

Europe and the US: Dual Labor Markets and Youth Unemployment

A recent article in The Economist looks at youth unemployment in Europe and how it might be affected by the "two tier" or "dual" labor markets that exist in some European countries. Persistent high unemployment in the past was blamed partly on difficulties associated with terminating workers. This caused inefficiencies in the labor market that hindered progress. The solution was to create a class of workers that would be easier to terminate: temporary workers who would be given short-term contracts and could be either hired permanently or terminated easily at the conclusion. Employers saw an obvious advantage to this system and began hiring large numbers in this fashion.

The author uses Spain as the extreme example.

"As the unemployment rate approached 20% in the mid-1980s, the government introduced fixed-term contracts of between six months and three years, which were subject to lower dismissal costs than those for workers on open-ended contracts. At the end of a three-year contract firms could either convert a worker to permanent employment or send him packing. The reforms got results. Unemployment fell from nearly 18% when they began in 1984 to around 14% six years later."

"But the reforms had unintended consequences too. Temporary contracts surged, soon accounting for close to a third of Spanish employment. Workers churned from job to job: just 6% of temporary contracts were converted to permanent employment during the mid-2000s."

There are negatives for both employer and employees in this type of system.

"Volatility is but one cost of dual labour markets. Frequent job turnover makes households’ finances less certain, making it harder, for example, to save regularly for old age. More importantly, temporary employment discourages firms from investing in their workers. The cost to an employer of converting an expiring temporary contract into a permanent one is quite high because of a discontinuous jump in the cost of sacking the worker. So there is an incentive to get rid of him when his contract ends and to invest little in training him."

The author indicates that France and Germany have versions of a dual market that encourage the hiring of temporary workers as well. This chart is provided.

France and Germany are clearly doing better than Spain in terms of unemployment. Nevertheless, the author leads the reader inexorably to the conclusion that the easier it is to fire workers, the better it is for the economy.

"Germany’s labour market mirrors that of its peers. It, too, responded to eurosclerosis with flexible, second-tier contracts. Permanent positions protected by strong employment rules still dominate its labour market."

"Germany may have pursued wage restraint, but that is no easy route to prosperity. Indeed, dual labour markets are more likely to have the opposite effect. Permanent workers fearlessly seek higher wages, confident that job losses will fall first on temporary workers. Soaring Spanish unemployment has produced little wage moderation. During 2009 the pay of permanent workers rose by 4% in real terms."

And finally we arrive at this conclusion:

"And attractive as the German model is now, across decades American jobless rates are tough to match. The Anglo-Saxon preference for little or no employment protection may be the most effective at herding workers from declining industries to growing ones, driving job creation and innovation."

The emphasis is mine. The author seems to think that economics and economies obey fundamental physical laws and concepts that were effective "across decades" have relevance to the current situation. What worked in the US decades ago has little relevance to the current situation. One might look at the figures in the chart the author provided and conclude that youth unemployment is a function of the strength of the economy—period.

In an earlier article The Economist provided this chart comparing youth unemployment rates to unemployment rates for older workers.

If the US approach, which actually encourages companies to terminate workers when the economy slows, is better, one would expect to see some difference between the US and the rest of the world in terms of either total unemployment, or with respect to the rates of youth unemployment. In this context, the US and Spain look very similar. It would be hard to claim that youths have an advantage in the US economy. In terms of total unemployment rate, it would appear that the US, with its approach, is now just another country hoping that growth will overcome its structural problems.

This article served the purpose of reminding us that the US also has a "dual" labor market—one that is much more advantageous for employers than anything referred to here. In the US, companies have actually convinced young people that it is to their benefit to work for free for a year or two before even being considered for a low-paying, entry-level position with zero job security. This situation was discussed in The Fastest Growing Job Category: Unpaid Interning. If one wishes to create systems that are abusive to the young, Europe has a way to go to catch up with the US.

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