Fiscal austerity and the youth employment crisis
Fiscal austerity and the youth employment crisis
Iyanatul Islam and Anis Chowdhury
Lack of job opportunities for young people has become painfully evident in the advanced economies, and most notably in the Euro zone and the
Failure to find a job following a downturn can impose long-run ‘scarring’ effects on young people. These effects are manifested in reduced employment and earnings opportunities that can last decades. Young people with limited skills and from disadvantaged backgrounds are particularly vulnerable to ‘scarring’ effects. There are also well known social costs associated with high and persistent youth unemployment: higher incidence of unhappiness, higher crime rates, higher inequality, higher fiscal costs in terms of foregone output and lower tax revenues, and higher political and social tensions.
To what extent can the youth employment crisis of today be traced to the fiscal austerity programmes that have taken hold in more than 90% of the advanced economies since 2009? This fiscal retrenchment is particularly pronounced in the Euro zone and the
More than two years have elapsed since the start of this experiment and the outcomes have unfortunately not been friendly to the cause of fiscal austerity advocates or ‘austerians’ as they have sometimes been called. There is a high correlation (0.69) between percentage point changes in general government structural fiscal balance (% of potential GDP) and percentage point changes in youth unemployment rates in
More elaborate macroeconometric models suggest that the fiscal entrenchments will be associated with negative employment growth of the order of 0.2% over the medium term. This is line with the standard Keynesian dictum that fiscal consolidations are contractionary when actual output is below potential output. This appears to be the case for the Euro zone and the
Of course, these contractionary consequences can be offset by expansionary monetary policy and exchange rate devaluations. Yet, members of the Euro zone do not have an independent exchange rate policy, nor do they have independent monetary policy. The challenges of dealing with the lack of growth and jobs have to be tackled at the EU level. Calls are now being made by prominent economists and media commentators – along with long-standing critics of fiscal policy in the EU and advanced economies in general – that governments, most notably the Euro zone and
Policy-makers should go for a gradual approach to fiscal consolidation and find fiscally neutral ways in which targeted interventions towards job creation for young people can be supported. An example of a fiscally neutral intervention to assist young people find jobs is to make it mandatory for public sector organizations to hire long-term unemployed young workers for, say, two years, and spend an equivalent of the unemployment and job search benefits that would be spent on them. This will transform the role of government as a provider of unemployment and job search benefits to an employer of last resort.
Measures are also needed to boost consumer confidence and demand. This is not helped by wide-spread lay-offs or lowering of wages – the other plank of the current policy approach to the EU jobs crisis – as part of structural adjustment to boost productivity and competitiveness. While a reduction in wages by some firms may increase their profitability relative to competitors, when all firms within a country seek to cut wages, they can engender the ‘paradox of thrift’ and thus depress aggregate demand beyond the contractionary consequences of current fiscal tightening. Additionally, when all nations seek to achieve competitiveness by wage cuts, it amounts to competitive devaluations with no impact on exports, but adverse impacts on living conditions.
Critics of various alternative policy proposals that are now being offered might argue that they are irrelevant in dealing with the youth employment crisis. This is because poor youth employment outcomes are primarily seen to be the product of structural factors – such as a skills mismatch –onerous labour regulations and a poor business climate that constrain employment opportunities for young people. Indeed, one recent commentary that adopts a global perspective on the youth employment crisis and meticulously documents its social costs hardly touches on the fiscal austerity programme in the EU and does not ponder on its implications for young job-seekers. Instead, the menu of policy recommendations concentrates on supply-side measures, such as reducing the skills mismatch, reforming labour market institutions and improving the business environment. This narrative is not fully compatible with the stylised facts.
Structural factors are useful in understanding levels of youth unemployment, but they do not necessarily explain recent trends in youth unemployment. It is difficult to argue that the skills mismatch has worsened significantly between now and 2007. Furthermore, the dominant trend is a reduction, rather than an increase, in employment protection legislation across a large group of countries and especially in the advanced economies. Similarly, it is difficult to argue that the business environment in terms of red tape and bureaucratic impediments have worsened significantly in the aftermath of the 2008-2009 global financial and economic crises. What has changed is a decisive shift from fiscal stimulus to fiscal consolidation between 2009 and now. The costs of this shift are unfortunately being borne disproportionately by young men and women.
 Iyanatul Islam, ILO,
 Shierholz, Heidi et al (2012), ‘The Class of 2012: Labor Markets for Young Graduates Remain Grim’, Economic Policy Institute, Briefing Paper No. 340
 IMF (2012) World Economic Outlook
 For a review of the issues and evidence pertaining to fiscal austerity and growth, see Islam, Iyanatul and Anis Chowdhury (2012). Revisiting the evidence on expansionary fiscal austerity: Alesina’s hour?; http://www.voxeu.org/index.php?q=node/7679 [2 May 2012]. Islam, Iyanatul and Anis Chowdhury (2010). Fiscal consolidation, growth and employment: what do we know? G-24 Policy Brief No.57; http://www.g24.org/PolicyBriefs/pbno57.pdf [2 May 2012].
 The detailed findings are reported in Maki Matsumoto and Martina Hengge and Iyanatul Islam (2012). ‘Tackling the youth employment crisis: a macroeconomic perspective’. ILO Working Paper No. 124
 ILO and International Institute for Labour Studies (IILS) (2012). The World of Work Report: Better Jobs for a Better Economy (
Krugman (2012), Romer (2012a, 2012b), Summers (2012), Weisbrot and Montecino (2012), and Wolf (2012) have consistently criticized the stance of fiscal policy in the advanced economies in general and the EU in particular. Romer (op.cit) notes that successful cases of ‘back-loaded’ fiscal consolidation can be found in the experiences of
 Morsy, op. cit
 ILO/IILS (2012, chapter 3)