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Not over yet:Softening the impact of the financial crisis on the labour market

Unemployment © Jasper Juinen Gettyimages.com

The EU unemployment rate is expected to increase to above 10% in 2009, reversing the downward trend which started a decade ago. Nonetheless, there is some cause for hope. Member States have allocated considerable budgets and attention to addressing employment issues. Moreover, most of the measures implemented thusfar seem to be temporary, targeted and timely. Such measures have helped lessen the impact of the crisis on unemployment. They now need to be embedded in a comprehensive, coordinated strategy to prevent the rise in unemployment from becoming structural.

Employment has been identified as Europe’s first priority. And indeed, a failure to address the employment issue could impact fiscal sustainability, long-term growth and social stability. Unfortunately, the employment outlook for Europe is gloomy. Initially, unemployment resulting from the crisis was concentrated in Spain and Ireland, but is now rising across all Member States. This is not surprising since the impact on employment is typically only felt 2 to 3 quarters after the beginning of a recession.

Although there are signs that the recession is bottoming out, unemployment is set to continue rising. Employment is expected to contract by about 2½% in both the EU and the euro area in 2009. As a result, the unemployment rate will increase to above 10% in the EU and close to 11% in the euro area. In general, European economies are likely to face a larger labour market adjustment than in previous downturns – though employment should recover more quickly than in the past. This is because recent reforms have increased labour market flexibility while making unemployment benefits less generous and tightening access to early retirement in most countries.

European principles for action

European principles for action are presented in “The EU’s response to support the real economy during the economic crisis: An overview of Member States’ recovery measures”, from DG ECFIN’s Occasional Papers series.

Measures should aim at reducing the costs of adjustment and speeding up transitions from old to new jobs in order to avoid more permanent losses in employability.

Protecting incomes of the most disadvantaged groups of the population is a priority and will itself stimulate aggregate demand given the high marginal propensity to consume of these income groups.

Policies should facilitate structural adjustment (improving unit labour costs), especially in euro area countries, to address divergences in external competitiveness.

Policies to address the crisis should not run counter to long-term reform strategies, notably the implementation of the flexicurity principles under the Lisbon strategy.

The good news

Unemployment (percentage of civilian labour force)

Unemployment (percentage of civilian labour force)

Employment outlook: worsening.

Unemployment is set to increase enormously in 2009 and 2010 across Europe, reaching double digit levels in the hardest-hit countries.

Source: European Commission (2009 spring forecast, DG ECFIN).

Despite the grim outlook, there is some cause for hope. Member States have put significant emphasis on employment in designing their recovery packages, and considerable budgets are being allocated to support employment: as much as 0.87% of GDP for measures aimed at raising household purchasing power and 0.14% for labour market measures. Moreover, job losses have been limited so far, particularly in the manufacturing sector, thanks largely to short-term measures to preserve existing jobs (such as short-time working, partial unemployment schemes or temporary layoffs) while the cost of unemployment has been kept down by extending the duration and coverage of unemployment benefits and social safety nets.

An assessment of labour market measures

An assessment by DG ECFIN experts shows that measures undertaken so far within the framework of the European Economic Recovery Plan are promising. The experts published their findings in “The EU’s response to support the real economy during the economic crisis: An overview of Member States’ recovery measures,” from the European Economy Occasional Papers series. They classified labour market and social protection measures in recovery programmes into nine broad types of action, and assessed them against a number or criteria including: timeliness, the degree of targeting, the time consistency of short-term support measures with long-term policy goals such as those in the Lisbon Strategy, and the possible need for coordination in light of cross-border spill-over effects.

Measures were also assessed in light of European principles for action and policy do’s and don’ts (see table). Most measures were found to meet these criteria as well as to be temporary, targeted and timely. Nonetheless, potential negative impacts further down the line must be anticipated and kept in check, even if the immediate priority is containing labour shedding, and even if measures need to be stepped up further as unemployment continues to rise. Questions remain, for example, regarding thereversibility of some policies, such as large-scale public job creation schemes. In addition, some 10% of measures are likely to have permanent adverse effects on public finances, while very few measures aim at improving the efficiency of welfare systems. A further 25% of measures are likely to generate considerable spill-over effects.

Policy do’s and don’ts

Policy do’s and don’ts are presented in “The EU’s response to support the real economy during the economic crisis: An overview of Member States’ recovery measures”, from DG ECFIN’s Occasional Papers series.
Do’s and don’ts are based on the principles and on the evaluation of the effectiveness of policies in previous crises.

Do’s:

  • Keep people in employment by providing financial support for temporary flexible working-time arrangements, combined with measures supporting employability and helping people transition to new jobs. Measures need to be coordinated to avoid negative spill-overs in other Member States.
  • Provide adequate income support for those most affected by the economic slowdown, while helping them not to lose contact with the labour market.
  • Invest in re-training and the upgrading of skills.
  • Consider measures such as lowering nonwage costs for low-skilled workers.
  • Tackle youth unemployment and support school leavers.
  • Reduce labour market segmentation by, e.g., better aligning employment protection for workers on temporary and permanent contracts.

Don’ts:

  • Avoid indiscriminate support for jobs in declining industries or regions as this could reduce economic efficiency and delay needed re-structuring.
  • Large direct job-creation schemes artificially inflate the public sector and are not sustainable in the long-run.
  • Policies that pursue economic re-structuring by encouraging early retirement for workers in declining sectors will have negative effects on labour supply and, given demographic ageing, the long-term sustainability of public finances.

Policies that seek to cut labour costs by reducing social security contributions and subsidies for shorter working time, for example, could create cross-border distortions in the hiring and firing decisions of multi-national corporations. “Because many firms have used working time reductions to maintain employment, we expect that a wave of re-structuring and redundancies is still to come,” warns Giuseppe Carone, Head of Unit for Labour Market Reforms within DG ECFIN and one of the authors of the study.

Against this backdrop, and in view of the considerable policy variation across Member States and the danger of distortions in the internal market, there is a clear need for stronger EU-level co-ordination.

Further information

Brussels Economic Forum 2009

 
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