Labor market reform in Europe: where do we stand?

Labor markets have been at the core of Europe’s policy agenda for many years, particularly after the introduction of the euro. When exchange rates can no longer be adjusted, flexible labor markets are needed because they help face increasing competitive pressures and absorb external shocks associated with the globalization process. Europe is trying to respond to this challenge in a coordinated way within the so-called Lisbon Strategy. How advanced is this process? Where does Italy, a long time laggard in many areas of reform, stand today? What lessons are we learning?  

Labor market reforms in the euro area have moved essentially in three directions. First, most countries have tried to increase labour utilization by allowing for more flexible working time arrangements. Second, they have made wage bargaining more decentralized (more firm-level as opposed to collective bargaining). Third, several countries have introduced specialized work arrangements targeted for new entrants or marginal workers, like temporary contracts, trial periods and part-time jobs. This last set of reforms has been particularly effective in increasing employment and labour force participation. A case in point is Italy, where the unemployment rate has dropped by over 4 percentage points between 1999 and today – the largest drop in the eurozone— mainly due to the effect of part time and temporary workers.  

Of great interest is the lesson coming from the Nordic countries, the so-called flexicurity approach that shifts the focus from protection of workers in the same job to protection of searching workers. This recipe is twofold. First, increase also the flexibility of permanent contracts (thereby injecting flexibility also to the prime segment of the market, not only the marginal ones like young and women). Secondly, increase the availability of unemployment benefits, and improve the incentive schemes to improve job search and avoid discouraging workers from entering or remaining in the labor market.  

Despite the Lisbon rethoric, the range of reforms in the euro area presents a rather diverse and uncoordinated pattern. Part-time work regulation was relaxed in Belgium, France, Germany, Ireland, Italy, and the Netherlands. Weekly working time was reduced in France (from 39 to 35 hours) and in Belgium (from 39 to 38). In Germany, some sector collective agreements allowed firms to use a wide range of opening and flexibility clauses. Lower tax rates were introduced in Spain, France, Ireland, the Netherlands, Austria and Portugal, whereas changes in collective agreements procedure were introduced in Finland, France, Portugal and Spain. Finally several countries have allowed for a more extensive use of temporary contracts: France introduced in 2005 a new type of open-ended contract that allows for longer probation period, Finland reduced the notice period related to termination of employment, Italy reorganized in the 2000 the existing flexible contracts and introduced new forms of non-standard employment.  

Italy can teach a useful lesson concerning the mixed blessing of introducing flexible arrangement for marginal workers, while leaving essentially untouched the rest of the system. Two main problems afflict the Italian labour market. First, Italy has the highest degree of job protection of insider workers in Europe, as revealed by the lowest replacement rate (ratio of unemployment benefit over wages). Unemployment benefits are very low and insiders in the labor market (mid- to old-age workers, mainly males, with permanent non-rescindable jobs) are highly protected. Excessive protection of insiders together with the introduction of non-standard employment contract possibilities pushed to the limit the “duality” of the Italian labour markets, as firms tend to overuse temporary contracts (eg. by rolling over them). The reduction in measured unemployment has come at the expense of an increased duality of the market, with a prime segment overprotected and rigid, and a host of flexible, or even informal, work arrangements, and very little osmosis between the two. Job uncertainty (“precariousness”) has become a major political issue, and even a dangerous one, because it tends to be seen as a necessary implication of free markets more than it needs be, and it broadens the support for protectionist policies.  

Boeri and Garibaldi (www.lavoce.info) have advanced a proposal to reduce the duality problem. Their suggestion is that temporary contracts should be made probation periods (say, for six months) of long term permanent job contracts with standard protection guarantees. This appealing idea is based on the well-known development economics concept of “starting small”. The French in 2005 introduced a similar scheme, only with a longer probation period (two years). This approach falls short of the Nordic style flexicurity system in two important ways: it does not emphasize the need for adequate unemployment protection schemes and search incentives; it does not remove the rigidity of the permanent job contract, it only makes its effects more gradual. The duality generated by the coexistence of flexible temporary contracts and overly guaranteed permanent ones can only be resolved by replacing permanent contracts with open-ended ones, without fixed limits but rescindable under appropriate conditions. Temporary contracts can remain confined to special situations of part-time and provisional jobs; they should not be regular pathways to permanent work situations. Clearly, if open-ended flexible contracts are available firms won’t need to over-use temporary ones. Flexible open-ended contracts can be regulated in a variety of ways: for example by making tenure rights subject to certain productivity standards, therefore shifting the focus from working-hours oriented contracts (say working for 35 hours week) to output oriented contracts (say a certain amount of output within a certain time spell). The contract should also include schemes to relocate the worker to temporary unemployment in case such standard are not achieved, as well as standard guarantees such as unemployment benefits, compensation for relocation costs, etc.  

In sum, there is no shortcut out of making standard labor contracts more flexible. Making temporary arrangements preparatory for permanent ones, if the latter are not properly reformed, only shifts the problem, generates two-tier market structures and creates incentive for abuse (like firms making excessive use of fixed-term contracts to retain flexibility). The flexicurity approach teaches us also an additional lesson, namely that labor markets fit for today’s global economies can be made politically viable if they are supported by well developed unemployment management (not only protection) schemes. The sooner EU policymakers and trade unions learn these simple lessons the better, for Europe’s workers and for the euro itself.

6 Responses to "Labor market reform in Europe: where do we stand?"

  1. Guest   October 28, 2007 at 4:32 pm

    So the “inness” “outness” problem appears to be a major issue.

  2. Guest   October 29, 2007 at 8:43 am

    A most excellent and deep analysis. what are the political prospects for further labor markets reform in Europe? Not good as there is a backlash now; see Germany.

  3. eparisi   October 29, 2007 at 9:31 am

    Very nice analysis indeed! Interestingly, the IMF published a study last year analyzing the applicability of the Danish Flexicurity model to other countries: http://www.imf.org/external/pubs/ft/scr/2006/cr06342.pdfamong its conclusions:”The Danish model is costly. The tax burden in Denmark is heavy because of the need to finance the country’s high spending on labor market programs and unemployment benefits. As most countries that are tempted to adopt the Danish model will typically start from a high unemployment level, a move toward the Danish model will, in the short run, trigger a sharp increase in the cost of unemployment benefits and active labor market policies, thereby widening the tax wedge, with an adverse impact on labor demand and supply. This implies that the Danish model may not be suitable for countries facing high unemployment and budgetary difficulties. Using a calibrated model for France, the paper finds that implementation of the flexicurity model could be costly, and reduction in structural unemployment during the first few years might be limited.”Do you agree with this assessment? I still think flexicurity one of the most viable solutions to secure public support.

  4. Jozo   October 29, 2007 at 10:29 am

    What for one (employer) is flexibility, for another (employee) is insecurity. When you spend years fine-tuning your working skills for your employer needs, you are not well adapted to obtain another job quickly. Flexicurity could be a answer as long as employers are taxed to provide necessary funding, not all taxpayers, it would be prime example of privatizing profits and socializing costs.

  5. BJ   October 29, 2007 at 12:51 pm

    Jozo: If workers are to benefit from a generous security net, funding efficiency requires that they fund it too. If firms co-benefit, they co-pay. That’s what insurance is all about. Redistribution is a separate matter. I really think we should move on from outdated rhetoric, don’t you?

  6. Jozo   October 30, 2007 at 6:13 am

    I assume that it is shown by data, that it was corporations what benefited greatly in last decade of two from risk transfer on individual employees, not sharing productivity gains with them. It would be fair to take on some costs as well. With flexicurity, workers will for sure have cost of greater uncertainity in their lives.By implementing flexicurity, corporations get even more benefits of flexibility. I like to think that there is underlying assumption: This benefit to corporations will create more jobs and would improve well being for all citizens of the country. Hoewer if the assumption will be proven true or not is another question.