1. What Happened to European Mass Unemployment? Tito Boeri Bocconi University 26/06/2008

2. 1994 OECD Jobs Study “The labour market has become particularly worrying in Europe… (…) in comparatively inflexible Europe, on the other hand, both relative employment and unemployment rates deteriorated”. “The high incidence of long-term unemployment in most EC countries is associated with low inflow rates into unemployment. The opposite relationship – low incidence of long-term unemployment and high inflows into unemployment – holds for North America”.

3. 6 8 10 12 199519961997199819992000200120022003200420052006 as a % of the labour force 1,5 3 4,5 6 Unemployment EU 15Long term Unemployment EU 15 Since then

4. Outline A European dream… turning into a European nightmare Why? A closer look at transitions across labour market states Can we “cheat” the employment labour productivity tradeoff?

5. A European dream “The Community shall have as its task (…) to promote throughout the Community (…) a high degree of convergence of economic performance, a high level of employment and of social protection, the raising of the standard of living and quality of life, and economic and social cohesion and solidarity among Member States”. Rome Treaty, March 25, 1957

6. LU SE FI DE DK GR PT FR IT UK BE NL IE ES Log (Unemployment rate 1995 / Unemployment rate 1985) -.5 0.5 1 11.522.53 Log (Unemployment rate 1985) Convergence: Did the countries with high unemployment experience the strongest decline in unemployment? 1985 - 1995

7. AT NL DK PT UK DE BE GR SE IT IE FR FI ES Log (Unemployment rate 2006 / Unemployment rate 1996) -.5 0.5 11.522.53 Log (Unemployment rate 1996) Convergence 1996 - 2006

8. No convergence 1985 - 1995 Convergence 1996 - 2006 LU SE FI DE DK GR PT FR IT UK BE NL IE ES -.5 0.5 1 Log (Unemployment rate 1995 / Unemployment rate 1985) 11.522.53 Log (Unemployment rate 1985) AT NL DK PT UK DE BE GR SE IT IE FR FI ES -.5 0.5 Log (Unemployment rate 2006 / Unemployment rate 1996) 11.522.53 Log (Unemployment rate 1996)

9. Convergence in unemployment rates also within EU countries since the mid 1990s 0 0,5 1,0 1,5 2,0 2,5 198619871988198919901991 199219931994199519961997199819992000 20012002 2003200420052006 Squared root of Sum of Squares TotalBetween Within (Nuts II regions)

10. -0,15 -0,1 -0,05 0 0,05 0,1 0,15 0,2 0,25 0,3 -0,3-0,2-0,100,10,20,3 It is not inactivity. It is employment Δ Unempl 2006-96 Δ Empl 2006-96 Δ Empl = - Δ Unempl Unemployment and Employment expressed as a fraction of the working age population IRE ES DE AT PT GR BE NL FI FR SE IT UK DK - Δ U < Δ E - Δ U > Δ E

11. Whatever measure of labour slack we use 0 2 4 6 8 10 12 14 16 1994199519961997199819992000 Unemployed workersDiscouraged workers Measure of labour slack (in millions) EU Countries: DK, BE, FR, IRE, IT, GR, ES, PT.

12. 0% 10% 20% 30% 40% 50% 60% 70% 80% DKNLSEUKAUTFIIEPTDE EU15 ESFRLUGRBEIT Lisbon is no longer a mirage Employment to population rates and the distance from the Lisbon Employment Target Source: Eurostat 1995 2006

13. The dream came true? Since 1995, the UE15 has 4 millions less people unemployed. Decline seen in 11 countries out of 15. Associated with 21 millions more jobs. Reducing cross-country and within country unemployment differentials. Supposedly more “social cohesion”, but…

14. …Europeans are unhappy Satisfaction with work or main activity in EU10 12 13 14 15 16 17 18 19941995199619971998199920002001 years Fully satisfied as a % of respondents Source: ECHP

15. Declining job satisfaction notably in the countries with the strongest unemployment decline Source: www.eurofund.europa.eu

16. Reducing unemployment is not a popular business Under Berlusconi II (June 2001- May 2006) 1,354,320 jobs were created. Yet support for the Govt fell by 43%. Under Prodi II (May 2006 - December 2007) 432,512 jobs were created. Yet consensus fell by 51%. Aznar had to go in spite of 4,982,050 jobs created and halving the Spanish unemployment rate.

17. Italy 50% 52% 54% 56% 58% 60% 1985198619871988198919901991 19921993199419951996199719981999200020012002 20032004 200520062007 Employment as a % of population in working age 5% 6,5% 8% 9,5% 11% 12,5% Unemployment as a % of labour force EmploymentUnemployment

18. Spain 5% 10% 15% 20% 25% 198519861987198819891990 1991199219931994199519961997199819992000 20012002 2003 200420052006 35% 45% 55% 65% 75% Unemployment Employment Employment as a % of population in working age Unemployment as a % of labour force

19. Outline A European dream….. turning into a European nightmare Why? – a simple explanation – looking at flows Can we cheat the employment labour productivity tradeoff?

20. The simple explanation Lower unemployment could simply be related to demographics. Insofar as unemployment rates are higher for the young people than for the other age groups, the ageing of Europeans may involve a reduction of unemployment. Is this the reason why we no longer see mass unemployment in Europe?

21. No. It isn’t -7-6-5-4-3-201 AT BE DK FI FR GR IRE IT LU NL PT ES SE Within group variation in U ratePure demographic effect 1995-2004 Variation of Unemployment as a % of the Working Age Population

22. Also more migrants, but they have higher unemployment rates than natives 1995-2004 Variation of Unemployment as a % of the Working Age Population -6-5-4-3-2 0 1 AT BE DK FI FR GR IE LU NL PT ES SE Migration composition effectVariation in U rate of natives and migrants -7

23. -0,8 -0,6 -0,4 -0,2 0 0,2 0,4 0,6 0,8 1986198719891991 1993 1995 1997 19992001 2003 2006 Inflows/Outflows as a % of the working age population 5 15 Unemployment as a % of the labour force Inflows EU15Outflows EU15U rate EU15 Unemployment declined with larger unemployment inflows 8 11

24. Employment t Unemployment t Inactivity t Employment t-1 94,6 Unemployment t-1 Inactivity t-1 Yearly Average 2001 – 2004 93,53,03,5 30,047,322,6 3,71,8 Let us look at transition matrices Out of 100 hundred unemployed, 30 find a job within a year …. …and 23 leave the labour market altogether another 47 remain unemployed….

25. What do these transitions imply in terms of the long-run unemployment rate? 0% 2% 4% 6% 8% 10% 12% 2001-20041991-1995 Unemployment rate in the long runCurrent Unemployment rate 1991-19952001-2004

26. 1985 – 1988 2001 – 2004 Mobility Index = (S- tr(M))/(S-1) where S denotes the number of labour market states and tr(M) the trace of the transition matrix 28% Employment t Unemployment t Inactivity t Employment t-1 93,13,23,7 Unemployment t-1 29,056,514,1 Inactivity t-1 2,81,795,5 93,53,03,5 30,047,322,6 3,71,894,6 In Europe more mobility across labour market states than 15-20 years ago Mobility Index 32% Employment t Unemployment t Inactivity t Employment t-1 Unemployment t-1 Inactivity t-1

27. GR FR PT IT AT FI IE NL ES BE -.5 0.5 -.10.1.2.3.4 log(U rate 2006 / U rate 1996) log(Average Mobility Index 1996-2004/Average Mobility Index 1985-1995) Increase in mobility in the countries with the strongest unemployment declines

28. Why did mobility increase? Multivariate analysis (across countries and over time) of the determinants of mobility indexes. Reduction in the strictness of Employment Protection Legislation (EPL) for temporary contracts increases mobility by 5%. Reduction of EPL strictness for regular contracts increases mobility by 2%. Controlling for GDP growth and the share of immigrants in the population.

29. 0 2 4 6 8 10 12 14 16 18 N° of Reforms Countries: EU 14 1986-1990 1991-1995 1996-2000 2001-2005 1986-19901991-1995 1996-2000 2001-2005 Acceleration of reforms of EPL Employment Protection Legislation Temporary contractsRegular contracts

30. The growth of temporary employment in Europe 10 11 12 13 14 15 199519961997199819992000200120022003200420052006 % of employees with temporary contracts 60 61 62 63 64 65 66 67 Employment rate EU15 (%) % of employees with temp. contractsEmployment rate EU 15

31. A port of entry?… 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 181920212223242526272829303132333435 France Denmark Netherlands Italy Spain Portugal Age % of employees with temporary contracts

32. … or a dead end? Spain Permanent Contracts Fixed Term Contracts Inactivity Unemployment Permanent Contracts97,21,1 0,7 1,0 Fixed Term Contracts4,882,6 3,5 9,0 Inactivity0,42,4 93,3 3,9 Unemployment2,520,1 10,4 67,0 2003 2004

33. Temporary contracts: a longlasting phenomenon 0% 5% 10% 15% 20% 25% 30% 35% SPAINITALY Current share of FTC Self- employment Long-run share of FTC Current share of FTC Long-run Share of FTC

34. Social cohesion? Dualism temporary-permanent contracts creates longstanding asymmetries (this is not properly social cohesion)….

35. Moreover Also workers with permanent contracts may suffer a capital loss with EPL reforms as their welfare includes expectations of future job losses. “Insiders” cannot be fully insulated from reforms! Decline in their welfare associated with an increase in the probability of job loss (λ) is -(w-w r )/(r+λ) where w is the market wage, w r is the reservation wage and r is the interest rate

36. 0% 20% 40% 60% 80% 100% 120% 140% 199419951996199719981999200020012002200320042005 Easier to (re)enter the labour market but often at lower wages Entry wage in a new job as a % of the average wage for different groups Source: ECHP (BE, DE, DK, ES, FR, GR, IE, IT, LU, NL, PT, UK), EUSILC (AUT, BE, ES, GR, IE, IT, PT, UK ).

37. As wage increases are mostly related to tenure (unconditional wage-tenure profiles,source ECHP) 0 100 200 300 400 500 600 1234567891011121314151617181920 tenure mean wage GermanyUKFranceItalySpainSweden

38. Outline A European dream….. turning into a European nightmare Why? A look at transitions across labour market states Can we “cheat” the employment/productivity tradeoff?

39. How to make Europeans happier about lower unemployment? Providing more employment security is not an option. More labour market risk makes risk-averse individuals unhappy unless it is accompanied by higher wages. We need higher wages to provide popular support to reforms in Europe. But higher wages require higher labour productivity.

40. Can Europe increase both employment and productivity? Source: Groningen Growth & Development Centre, Total Economy Database 40% 50% 60% 70% 80% 90% 100% 1960196319661969197219751978198119841987199019931996199920022005 120 140 160 180 2007 Hourly labour productivity (US=100) (left scale) Employment (in millions)

41. What do employment protection reforms do to labour productivity? On the job destruction margin: they reduce the number of low productivity jobs. This increases productivity. On the job creation margin: they may discourage investment in human capital as shorter tenures reduce incentives to training on-the-job. This reduces productivity.

42. How to “cheat” the tradeoff then? Increase wages-productivity at entry. More investment in human capital. Before the job: better education systems via compulsory evaluation of all schools On the job: –tenure track to permanent contracts (no segregation into temporary contracts) –decentralised wage bargaining that rewards productivity rather than simply tenure

43. Reallocation increases average productivity and wages LdLd Ls1Ls1 LsLs LdLd Ls1Ls1 LsLs wage productivity wage productivity w1w1 w Employment Reallocation surplus w w1w1