Ending the scourge of dual labour markets in Europe

Samuel Bentolila, Tito Boeri, Pierre Cahuc

12 July 2010

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Never before has a crisis been so concentrated on youth in a large part due to labour market dualism – i.e. situations where there is a big difference between temporary- and permanent-contract workers. During this crisis there has not only been a hiring freeze but also mass layoffs of temporary-contract workers (typically held by younger workers).

As a result:

  • Eurozone youth unemployment climbed to 20% in May from 15% before the crisis,
  • in Spain 4 youngsters out of 10 participating in the labour market are unemployed,
  • in Italy it is one out of three,
  • in France and Sweden, two other countries with dual labour markets, the ratio is one in four.

And the worse is yet to come – unless labour market reforms are completed. There is no time to waste if we do not want to lose an entire generation.

European Governments made substantial efforts to reform labour market institutions when walking away from the Euro-sclerosis of the 1980s. During the 25 years preceding the Great Recession, there were some 200 reforms of employment protection in the EU15 countries, increasing labour market flexibility in over half of cases (fRDB-IZA 2010).

One effect of these reforms is to increase employment volatility (Bentollia 2008). Employment grows more during upturns than before the reforms. This contributed to the outstanding employment performance of the EU between 1995 and 2007. Unemployment fell by one fourth, long-term unemployment halved, and 21 million new jobs were created. This is the good side of flexibility. It’s bad side has become all too clear in the recession. The responsiveness of employment to declines in output has increased markedly in reforming countries. In other words, job losses would have been lower without the reforms.

But the reforms have only gone half way and it is time for governments to complete them. To achieve political viability, the reforms mostly entailed changing the rules only for new hires and introducing a wide array of new flexible, fixed-term, contractual types or expanding their scope where they already existed. There were almost no changes in rules on regular, open-ended, contracts.

This created two parallel labour markets – a labour market largely insulated from shocks (workers with permanent contracts) and a labour market of temporary workers, where all risks are concentrated. A striking example of this dualism is provided by the Spanish construction sector which was hit hard by the bursting of the housing bubble and the recession. In 2009, dependent employment fell by 25%, with losses of a 35% among fixed-term employees, whereas permanent workers’ real wages actually increased by some 4%.

Besides raising important equity issues, this asymmetry is highly distortionary. The coexistence of strong protection of permanent jobs with temporary jobs induces an inefficient labour turnover because firms are reluctant to transform temporary jobs into permanent jobs. Temporary workers receive much less training, since neither workers nor employers see any future in their relationship. This loss of human capital formation is likely to become more acute in the years to come. Recoveries from financial crises are usually associated with a large use of temporary contracts, since uncertainty and liquidity constraints discourage firms from making long-term commitments. The experience of Japan and Sweden in the 1990s is quite revealing. Upon leaving the recession, these two countries experienced a strong rise in the share of temporary contracts, which also meant less skill acquisition at the workplace for new generations of workers.

In most European countries workers on permanent contracts are strongly shielded. To give a few examples, in Italy permanent employees are protected from the start by norms forcing employers to reinstate workers in the firm in case of unfair dismissal. In France, economic dismissals are almost impossible when firms make positive profits. In Spain, economic dismissals are routinely challenged in Court, where employers lose in three-fourths of the time, so that they typically avoid going to Court by paying the worker severance at a penal rate upfront. Severance can be as high as 36 months of salary in Italy and 42 months in Spain. Court procedures are very slow and costly in all these countries.

In order to complete the reform path, Governments should now fight dualism in European labour markets. Measures taken so far are far from satisfactory. For example, on 16 June the Spanish Government approved a labour market reform lowering severance payment for permanent contracts. This will not solve the problem of dualism in the Spanish labour market, however, since administrative and court procedures for dismissals still make temporary contracts attractive for firms.

A better strategy is to allow for graded job security. In particular, governments could promote entrance to the permanent labour market in stages, making job security provisions increase smoothly as workers acquire tenure, with details to be defined on the basis of national legislations.

By making job security provision increase smoothly with seniority, it is possible to avoid the gap between jobs with a different status, which induces inefficient labour turnover, and take into account the psychological costs associated with job loss, which are typically increasing with time in the job. Flexibility would be preserved without the need for a perverse dual labour market structure.

References

fRDB-IZA (2010). fRDB-IZA Social Reforms Database.

Bentolila, Samuel (2008). “Lift the ban on Spanish labour reform”, VoxEU.org, 28 November.

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Topics:  Europe's nations and regions Labour markets Welfare state and social Europe

Tags:  labour market reform, Eurozone crisis, Dualism

Professor of Economics, CEMFI; CEPR Research Fellow

President, Italian Social Security administration (Inps)

Professor of Economics at the Ecole Polytechnique (Paris) and CEPR Research Fellow

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