Structural Unemployment Weakens Europe
Financial and economic crises in the past few years have aggravated structural unemployment across Europe.
High structural unemployment is caused in part by hysteresis across labour markets.
Reforms are needed to improve labour market functioning and bring output closer to potential.
Europe has struggled with structural unemployment since the early 1980s. The financial, economic and sovereign debt crises of the past half decade have aggravated the problem, leaving Europe’s labour markets functioning far less efficiently than others around the world. So although European economies seem to be recovering, they still need to reform labour markets to ensure long-term economic growth and sustainable employment. Such reforms take time, however, so the situation is unlikely to improve soon.
Defining structural unemployment
Structural unemployment is the rate of joblessness the economy would settle into over the long term absent any short-term external or internal shocks. The rate is not observed directly, but estimated based on a country's economic fundamentals, institutional setup and economic policies. By this measure, unemployment in Europe has worsened significantly since 2008. Structural jobless rates are estimated to be near 20% for Spain, 17% for Greece, 12% for Portugal, and 10% for Italy. The rate in most euro zone countries hovers close to 9%, about 4 percentage points higher than the level deemed healthy for developed economies.
Structural unemployment has been driven higher in Europe by labour market hysteresis, or the long-term aftereffects of temporary shocks such as financial market turbulence or a housing market bust. Most European countries saw already-high unemployment rates rise sharply after the 2008 financial crisis, as well as a sharp increase in the length of unemployment: In Ireland and Greece, 60% of all those out of work in 2012 had been looking for jobs longer than 12 months. The proportion in other EU countries hovered around 40%, on average 3 percentage points above precrisis levels. With the exception of Scandinavia, Germany and the Netherlands, structural and long-term unemployment are problems shared across the European Union.
Structural unemployment and labour market hysteresis prevent an economy from fully utilising its resources. The effects take three forms: First, fewer people participate in the labour market, either because they have become discouraged or because long periods of unemployment make them undesirable to employers. Second, the quality and skill level of the labour force declines, affecting productivity. Third, increased government support to unemployed workers can crowd out other public investment.
The cost to long-run growth
It is estimated that the euro zone's potential economic growth rate has fallen by nearly 1.1 percentage points per year because of the crisis and malfunctioning labour markets. It is also likely that without significant policy changes, growth will not return to its precrisis trend. Countries most affected are those with the highest levels of long-term unemployment, some of which also have youth unemployment rates approaching 60%.
European countries must take action soon to avoid long-term consequences of poorly functioning labour markets. This will involve speeding up reforms despite continuing economic uncertainty. Germany’s Hartz reforms can serve as a blueprint. These restricted formerly generous unemployment benefits, extended protections to workers in temporary as well as permanent positions, and enhanced cooperation between universities and companies to better match labour supply with demand.
The Hartz reforms appear to have worked: Germany's headline and structural unemployment rates continue to decline and participation rates in its labour market are rising. Another approach involves a concept dubbed flexicurity by EU officials, and described as an integrated strategy for enhancing flexibility and security in the labour market. Countries that have adopted this approach, especially Denmark, Finland, Sweden and the Netherlands, have outperformed the rest of the EU.
Training, placement and incentives
Other reforms should also be adopted soon. Training programs need to be revamped to equip the long-term unemployed with the skills they need to find work. The need for comprehensive lifelong learning programs is especially acute in the southern countries, where this type of requalification is neglected. Development of job placement services, which are underfunded and mismanaged in a number of Central and Eastern European economies, would temper frictions in the labour market and help hasten the matching of supply and demand.
Further measures should include shifting the tax burden away from labour and changing the unemployment benefit system to reduce voluntary unemployment and stimulate economic activity. Taken together, these measures could help Europe’s labour markets work more effectively and restore its long-run global competitiveness. They would also mitigate the problem of labour market hysteresis, an important benefit should another protracted recession hit the Continent.
Martin Janicko is an Economist at Moody's Analytics.
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