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On flexible labour markets

I suppose they deserve half a clap for trying, if not for the rigour of argumentation. Crooked Timber, a leftish blog I read occasionally, tries to deny that flexible, relatively lightly regulated labour markets have fared better, or are superior to, the more heavily regulated, European ones, such as in France and Germany. Oh really? Let me quote a couple of lines:

“According to the latest Eurostat data, the unemployment rate in the US was equal to that in the EU-15 in March, and is now likely to be higher. Writing in the NY Times, Floyd Norris refers to the conventional wisdom that flexibility inherent in the American system — it is easier to both hire and fire workers than in many European countries implies that unemployment should be lower (at any given point in the business cycle) in the US than in Europe.”

It is “conventional wisdom” in the sense that it makes sense. Other things being equal – which they never are, of course – if you increase the cost, and hassle, of both hiring someone, and make it more expensive and difficult to fire someone if they fail to come up to scratch for any reason, then fewer people in general get hired. And it strikes me that that holds pretty robustly. Yes, unemployment may currently be as bad, percentage-wise, across the US as a whole as across the whole of the euro zone, although let it be noted that different parts of the US have differing rates of unemployment, as does the euro zone. But as the next paragraph demonstrates, it really will not do to try and claim that heaping labour markets with more costs and rules has few adverse effects:

Advocates of the US system make much of the deterrent to hiring associated with employment protection laws, but they ignore the other side of the coin. When the economy is contract, employment protection laws do in fact protect employment (if they did not, they would have no adverse effect on hiring either). On this basis there is nothing surprising in what we are seeing. EU unemployment rates should be higher in expansions and lower in contractions, which is exactly what is required for lower variance.

But – and it is a big but – if monetary policy is not run by idiots, thereby avoiding boom-bust cycles of great severity, then overall, the low-regulation labour market fares better, in the medium to long-run, than the alternative. If wage rates are allowed to fall in a recession, rather than be held up via artificial means, then yes, you will get, as America did in the early 1920s for example, a sharp, but short contraction, followed by a rapid recovery. But if you load lots of rules and regulations on, you get a 1930s-style decade of high, double-digit unemployment. And in measuring the impact of labour market laws, the duration of a period of high unemployment is as bad as, if not worse, than a period of high, but short-lived, unemployment.

And let’s not forget that in France, for instance, the country had high unemployment rates for much of the 1990s and early ‘Noughties, when much of the Western economy was booming on the back of cheap commodities, the rise of the BRICs, the dotcom boom, the Cold War “dividend”, and impact of partial free market advances in the US, the UK and some other countries. And yet hundreds of thousands, even millions, of Frenchmen and women, let it not be forgotten, languished on the dole or make-work projects. In 2005, for example, French unemployment was above 10 per cent.

Here is quite a balanced account of the benefits of a supposedly flexible labour market, including the pros and cons. This extensive study comes down pretty firmly on the side of the view that flexible labour markets are good overall.

In a way, what this comes down to is the trade-off between security for those who have a job already versus the freedoms of those who want to get another one or any job at all. To pretend that things such as regulations and costs of firing people will not influence behaviour is to deny that incentives matter, or that they affect welfare.

16 comments to On flexible labour markets

  • martin

    Stuff like Quiggin’s can only come from the firm belief that society owes its members jobs. Then any dismissal becomes unfair. Having lived and worked in both Europe and the US, he can take it from me that I wouldn’t have gotten any of my jobs in the US if both hiring and/or firing were as complicated and expensive as in Europe. Employers don’t hire, if they expect that they can’t fire and save. Unless one forces employers to act as providers of a social program. In which case society ought to own the companies. We’re getting there.
    Further, how does less employment protection adversly affect social mobility? Again, he can take it from me that I did much better from any unstable job than from predictable unemployment benefits. Paid for by society. Employment protection as yet another tool of social engineering.

  • Laird

    EU unemployment rates should be higher in expansions and lower in contractions, which is exactly what is required for lower variance.

    A superficially reasonable statement. However, it is not what the data actually shows. I don’t have access to combined EU unemployment data (couldn’t find it on a quick web search), but I was able to get comparative data for France (which, as far as I can tell, is the poster child for restrictive labor regulations) and the US from 1980 through 2009. What one would expect to see is that US unemployment rates should be higher than France’s at some times and lower at others, averaging close to the same overall rate but with the US exhibiting more volatility (i.e., a higher standard deviation).

    The truth, however, is that France has had a higher (usually significantly higher) unemployment rate than the US in every year since 1983. Furthermore, for the entire period from 1980 the median unemployment rate in the US was 5.8% (with a std dev of 1.5%), whereas in France it was 9.6% (with a std dev of 1.3%). So the data doesn’t support his hypothesis: not only does France have a consistently higher unemployment rate in all economic environments, but the difference between the median unemployment rates in the two countries is nearly three times the standard deviation, which is significant. Furthermore, the difference between the two countries’ standard deviations is not great, which demonstrates that the relative unemployment volatilities of the two countries is nowhere near as large as one would expect. Bottom line: France does enjoy slightly less volatility in its unemployment rate than does the US, but it pays for it in the form of a consistently, and substantially, higher overall level of unemployment. The “structural” difference between the two countries appears to be about 3%. Not what I would consider a good trade-off.

    I give Crooked Timber an “F” on its economic analysis.

  • Alice

    Interesting analysis, Laird. The only proviso I would attach is — do you believe the input data?

    Seems like Europe has a lot of disguised unemployment — long-term disabled people clogging up the golf courses; 4 year educational programs to become nurses & such like; and the armies of Equal Opportunity Outreach Coordinators.

    Of course, the US is heading down the same path. The only point is that it is a non-trivial task to make “unemployment” figures comparable.

  • Nuke Gray!

    More bad news- our Kruddy government is giving the unions here more powers, taking us back to the 70es in terms of employment. Back to “You can’t touch me, I’m part of the Union!”. Back to Pattern Bargaining, one-size-is-good-for-all!
    Oh, well, according to CATO, Canada is the new land of opportunity, with taxes falling below US levels! AND they’ve got lots of Shale oil reserves. Parlayvoo Canack?

  • Laird

    Agreed, Alice. I got my data from the BLS; it’s the best I could do. Take it for what it’s worth. I can only suggest that it should at least show the relative levels of “unemployment” (however ill-defined and poorly measured) between the two countries and the direction of change.

  • Current

    I think the OECD would be a better source, since they check that unemployment is measured in the same way across their data.

    That said, as other folks have pointed out Europe is full of disguised unemployment.

    I live in Ireland. Many of my unemployed friends are taking college courses now, often very pointless ones. That said I think the same is done in the US. The question is one of who is lying most.

    The accuracy of populations statistics is another sticky point. You can only measure % unemployment when those are in place. Here in Ireland immigrants are dodging all paperwork. I doubt populations statistics are reliable.

  • Manos

    Try the euklems database for relatively consistent employment and productivity data for the eu, eaa, us and japan, by sector, from 1970-2005.

  • hello, I’ve never commented on here before, but I just had to chime in with two thoughts…
    1) I believe the reason that I have had to work for so many complete morons as managers is that it is easier to promote the useless and transfer them to another branch than it is to fire them, and
    2) Surely, given this situation it is up to the businesses concerned to be more careful who they hire in the first place, rather than simply hire less people?

  • buwaya

    Check out the OECD data for labor force participation also. That sorts out some of the inconsistencies. France has, relative to the US, low youth and female labor force participation, reducing the overall employment rate (total employed/adult population). France and Belgium look very bad that way.

    Note that a lot of European countries show HIGHER labor force participation than the US, Britain among them.

    Note that one answer from the pro-Euro side is that the high US incarceration and military employment rate adjust the data towards the Euro side (if you leave out France, etc.).

  • Laird

    Manos, could you cite a web address for the euklems database? All I can find is one that appears to deal with productivity statistics (no indication that there is actual unemployment data there), and in any event requires a username and password to access the data. Do you know a way in?

    buwaya, the OECD data I found only covers the years 2000 – 2007, which isn’t particularly useful (not a long enough span, and it doesn’t have 2008 or 2009 which are the most meaningful years). Also, while the unemployment rates it gives for the US are identical to those in the BLS database, the numbers it shows for France are very different (generally about 0.5% lower). At least it does have EU data, but I don’t know how accurate it is. What that limited data does show, however, is that over the limited period shown the standard deviations for EU and US unemployment rates are identical (0.7), but the median unemployment rate for the EU is a full 5% higher than for the US (8.9% vs. 4.9%). So overall the EU suffers from substantially higher unemployment without even the benefit of lower volatility. Not a good tradeoff.

  • Laird

    Um, that should have been “a full 4% higher . . . .” I just noticed the typo. Oops!

  • Dom

    An interesting article:

    Unemployment and Labor Market Institutions:
    The Failure of the Empirical Case for Deregulation

    You can find the pdf at http://www.newschool.edu/cepa/papers/archive/cepa200404.pdf

  • Laird

    It might be “interesting”, but I’m not going to read 44 pages of turgid prose to find out! Most academic papers contain a summary at the beginning; it certainly would have been nice in this case.

  • Paul Marks

    It is often claimed that people face a choice between mass unemployment and the low wages and bad working conditions that government regulations, and government backed unions, supposedly prevent.

    Of course some wildly dishonest people, such as President Barack Obama, even claim that one can have a labour market controlled by government regulations and unions (with all the good things that supposedly come from this) without having mass unemployment – even that such regulations and government backed unions are “good for jobs”.

    However, more honest statists admit that a regulated labour market and unions with government granted immunities from the Common Law means more unemployment. What they argue is that the higher wages and better working conditions for most people (that they claim result from such interventionism) is worth the price of higher unemployment.

    But, in the longer term, it simply is not true that interventionism means higher wages or better working conditions than would otherwise be the case.

    In reality, by undermining the economy over the years, interventionism means BOTH higher unemployment and lower wages and worse working conditions than would otherwise be the case.

  • Dom

    The article linked to above is 24 pages. The rest is references and a data appendix. It has a conclusion at the end. This is a quote from it:

    “This paper critically assesses the evidence for this widespread belief that rigidities
    generated by labor market institutions lie at the heart of the unemployment crisis. We conclude that
    the evidence is far from conclusive. Expanding on an earlier review of recent literature, we find
    that the results of prior studies are in many cases problematic and often contradictory.”

    Myself, I think it is obvious that if we could look at all variables (which we can’t) we would find that less flexibility is a bad thing. Maybe it won’t lead to higher unemployment, but it will effect something. Economic policy is always like that.

    I have a cousin in Italy. The Garbage Collectors union is controlled by the communist party, and the government is always trying to appease them. The result? They get high wages, long vacations (even by Italy’s standard) and all the rest. My cousin is wasting his life waiting for a job as a garbage collector. The country needs doctors, and he is quite smart, but he’d rather loaf and wait to spend his life picking up trash. See what I mean?

  • Paul Marks

    Of course the Italian government health service (set up as recently as 1978 I am told) is as big a mess as the trash collection. But at least there is a lot of high quality private medical care in Italy.

    The Communist union control of garbage collection illustrates the point that the Communists are not really the enemies of organized crime that they pretend to be – as the garbage collection service has close links to organized crime.