Analytics, Education and Science, EU – Baltic States, Labour-market, Markets and Companies, Round Table

The article was prepared for the Roundtable-Seminar «Labor market in the Baltic States and the EU: patterns and paradoxes» held in the Baltic International Academy (BIA) on 7 December  2011. Its organisers: BIA, online magazine The Baltic Course, Employers' Confederation of Latvia and the Diplomatic Economic Club (DEC).

"Markets are like parachutes – they only function when open", Helmut Schmidt, former German Chancellor

We live in a global economy, where corporate borders are becoming increasingly more important than state borders, and where investment is able to move freely around the world, and in this global economy any government intervention,  bar market friendly initiatives, will harm growth in the long-run. In respect to the labour market, this means that governments should deregulate and decentralize them, or they will face inherently higher unemployment.

It’s broadly assumed that large multinational corporations are the ones who benefit most from globalization. This is true. The point though is that these large multinationals now have to compete on a global scale, and not all of them are able to withstand global competition. Just look at contemporary corporate history and you will see these mighty giants dropping like flies.

Out of the 500 largest US companies named in first ever S&P 500 list in 1957, a sobering 375 no longer existed in 2003. To make matters even worse, five more companies were in bankruptcy proceedings. Naturally, this sort of dynamism in global markets requires the adequate flexibility of national labour markets.

European experience demonstrates that countries with less regulation of the labour market, where it is easier for companies to increase and reduce the number of employees with a limited number of “closed-shop” professions, have higher growth rates and lower unemployment in the long run.

According to the 2010 data from the World Bank, Portugal, Spain and Greece are among the countries with the most rigid labour markets in Europe. The fact that these countries now face major financial difficulties is not a mere coincidence: research undertaken by DNB bank (DNB Working Paper: Labour Market Flexibility and the Impact of the Financial Crisis) clearly demonstrates that among the 60 surveyed countries, the ones with the most flexible labour markets had more mild recessions and the growth picked up sooner and stronger. Therefore, the new prime-minister of Italy, Mario Monti, says that reform of the rigid Italian labour-market is one of the main tasks of the new government. In his words the existing legislation “protects some, while discouraging new jobs creation”.

“We have a system that increasingly taxes work and subsidizes non-work”, Milton Friedman, Nobel prize- winning economist

Europe needs a free market. Europe needs to understand that only a flexible economy with a dynamic and flexible labour market will be able to adapt fast enough to the peace of changes in a modern globalised economy. This is the only way to build a modern, innovation rich “knowledge economy”.

What does this deregulation mean in practice? Well, it can mean many things. Such as changes in minimum wages to re-align them with true market prices for labour, limiting the power of unions and the decentralization of wage bargaining. Europe doesn’t need a welfare state, and it can’t afford it anymore. What we need is a carefully thought through social-net system that will stimulate people not only to come back to employment, but also to be geographically and socially mobile.  With all the single market rhetoric from Brussels, actual geographic mobility within Europe is low, which is one of the reasons why in the US 15% of employees change jobs annually on average, while less than 5% do so in Europe!

The problem of youth unemployment in Europe has received a lot of attention recently.  One of the reasons for this problem is the relatively high level of minimum wages in relation to the medium wages in some countries. It might be there for good reasons, but in reality all it does is make it economically unviable to employ naturally less experienced and less qualified young people. The positive example of a few countries where sub minimal wages for young workers were legalized demonstrates how this problem can be tackled with market-based solutions.

Having noted the relatively high rigidity of European labour markets and low mobility, there is no wonder why American GDP per capita is still almost a third higher then EU-15 average.

The choice between rigid labour market practices and economic competitiveness is especially self-evident in southern Europe, where for a long time reforms have been postponed for political reasons. Thankfully, it looks like economic sanity is coming back into fashion there: the new prime-minister of Spain has announced sweeping liberal labour market reforms

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When I was finishing this article I asked Edward Hugh, a Catalan economist dubbed by The New York Times as "the blog prophet of Euro zone doom", to comment on future reforms in Spain. In his opinion “the new PP government has a substantial majority and this is one of the few things it can actually do. So labour market reform will be substantial, and will happen”. He thinks that there might even be some negative consequences in the short-term as companies restructure. While this remains to be seen, we can safely conclude that free-market thinking is coming back. Hopefully it’s here to stay.