Gehrke, Britta

Weber, Enzo

LSE Research Online

Structural	labour	market	reforms	in	Europe:	timingmattersThe	German	government	implemented	large-scale	structural	labour	market	reforms	in	the	years	2003	to	2005	to	fighthigh	and	upward	trending	unemployment	rates	(see	Figure	1).	The	reforms	aimed	at	increasing	labour	marketflexibility,	improving	the	matching	of	unemployed	workers	and	job	vacancies,	and	decreasing	unemployment	benefitsand	their	duration.	Ever	since,	the	unemployment	rate	in	Germany	has	almost	steadily	been	falling,	as	also	illustratedin	Figure	1.	Even	the	Great	Recession,	which	led	to	an	enormous	decline	in	output,	hardly	affected	the	labour	marketin	an	adverse	way.In	contrast,	the	labour	markets	in	Italy	and	Spain	experienced	a	very	different	development.	Until	the	mid	2000s,unemployment	rates	were	at	similar	levels	compared	to	Germany.	However,	the	trend	in	Italy	and	Spain	wasdecreasing	(see	Figure	1),	whereas	unemployment	was	increasing	in	Germany	at	that	time.	Yet	after	the	GreatRecession	hit,	unemployment	rates	in	Italy	and	Spain	started	to	rise	tremendously.In	Spain,	unemployment	peaked	at	more	than	25	per	cent	in	2013.	In	Italy,	unemployment	rates	have	remainedhigher	than	10	per	cent	from	2012	onward.	In	response,	both	Spain	and	Italy	also	implemented	large-scale	labourmarket	reforms.	The	Spanish	reforms	in	2010	and	2012	flexibilised	wage	setting	and	reduced	employmentprotection.	Similarly,	in	Italy	in	2012	and	2014/2015,	employment	protection	was	substantially	reduced.However,	as	of	today	the	reforms	in	Spain	and	Italy	were	not	followed	by	as	positive	effects	on	the	labour	markets	asthe	German	reforms.	Unemployment	remains	high	in	these	countries	relative	to	pre-crisis	levels.	For	a	review	of	thereforms	and	their	effects	see	among	others	the	2012	study	by	Samuel	Bentolila	et	al.	for	Spain,	the	2015	OECDstudy	for	Italy,	and	the	2016	studies	by	Sabine	Klinger	and	Enzo	Weber	and	Andrey	Launov	and	Klaus	Wälde	forGermany.Figure	1.	Development	of	ILO	unemployment	rates	(in	%)	in	Germany,	Italy	and	Spain	from	2000	to	2016LSE Business Review: Structural labour market reforms in Europe: timing matters Page 1 of 3		Date originally posted: 2018-06-04Permalink: http://blogs.lse.ac.uk/businessreview/2018/06/04/structural-labour-market-reforms-in-europe-timing-matters/Blog homepage: http://blogs.lse.ac.uk/businessreview/Source:	International	Labor	OrganizationOur	recent	study	(chapter	5)	shows	that	these	different	reform	experiences	can	be	attributed	to	the	particular	timingof	the	reforms.	Labour	market	reforms	that	are	implemented	in	times	of	economic	crisis	while	demand	is	low	haveweaker	short-run	expansionary	effects	compared	to	reforms	that	are	implemented	when	the	economy	is	booming.Reforming	during	recessions	may	entail	short-term	costs	even	though	the	long-run	effects	are	positive.We	obtain	these	results	from	an	empirical	time	series	model	that	identifies	the	effects	of	labour	market	reforms	ingood	and	bad	states	of	the	business	cycle.	There	are	two	key	types	of	structural	reforms:	components	that	affect	thematching	of	unemployed	workers	and	firms	with	job	vacancies,	and	components	that	foster	job	creation	at	the	firmlevel.	Intuitively,	the	first	component	captures	reforms	connected	to	labour	supply,	whereas	the	second	componentrelates	more	to	labour	demand.	The	econometric	model	framework	is	specified	with	regard	to	the	established	searchand	matching	theory.	Intuitively,	we	interpret	the	components	not	explained	by	the	business	cycle	and	by	directeconomic	relationships	in	terms	of	unemployment,	vacancies,	productivity	and	wages	as	the	impact	of	policy,	i.e.,reforms.The	case	of	Germany	offers	a	unique	setting	for	the	study:	First,	Germany	has	experienced	large	labour	marketrestructuring	in	recent	years.	Second,	Germany	provides	very	detailed	and	high-quality	labour	market	data.	Theresults	on	German	data	for	the	last	30	years	show	that	reforms	that	improve	the	matching	process	have	indeedsubstantially	weaker	effects	in	recessions	than	in	expansions.	In	extreme	cases,	the	positive	effects	of	structurallabour	market	reforms	are	completely	offset	in	the	short	run	if	implemented	in	recessions.	For	reforms	in	job	creation,the	dampening	is	less	pronounced.	Notably,	the	results	are	not	specific	to	Germany.	Estimates	on	data	for	Spainconfirm	that	comparable	asymmetries	exist	in	the	Spanish	labour	market.	This	similarity	is	remarkable	given	that	theaggregate	performance	of	the	Spanish	economy	in	terms	of	up-	and	downturns	and	the	development	of	theunemployment	rate	was	very	different	compared	to	Germany.	In	Spain,	the	dampened	reform	effect	in	recessionsturns	out	to	be	more	pronounced	in	terms	of	job	creation	intensity.LSE Business Review: Structural labour market reforms in Europe: timing matters Page 2 of 3		Date originally posted: 2018-06-04Permalink: http://blogs.lse.ac.uk/businessreview/2018/06/04/structural-labour-market-reforms-in-europe-timing-matters/Blog homepage: http://blogs.lse.ac.uk/businessreview/An	alternative	approach	to	measuring	reforms	is	by	using	observed	indicators	of	labour	market	regulation.	Examplesinclude	replacement	rates	in	case	of	unemployment	benefit	receipt,	or	indices	of	employment	protection	legislation.While	these	indicators	have	the	advantage	of	clear	interpretability,	our	new	identification	resolves	some	of	thedifficulties	connected	to	them	(e.g.,	measurement	of	the	strength	of	the	reform	and	timing).	Further,	the	indicatorscapture	only	a	limited	part	of	legislation.	In	contrast,	our	new	identification	of	reforms	provide	a	big	picture	of	reforms.Nevertheless,	when	comparing	the	unobserved	reform	components	to	observed	indicators	we	find	considerable	co-movement.	Reforms	in	matching	efficiency	and	job	creation	intensity	occurred	in	periods	when	substantial	structuralchanges	as	measured	by	the	employment	protection	indices	or	the	replacement	rates	of	the	OECD	took	place.The	results	of	our	empirical	study	establish	a	strong	interaction	of	the	business	cycle	and	structural	labour	marketreforms:	Reforms	affecting	labour	market	mechanisms	turn	out	to	be	less	effective	in	recessions.	Interestingly,	theoptimal	timing	of	labour	market	reforms	is	thus	the	opposite	compared	to	what	is	often	found	for	fiscal	policy.Expansionary	government	spending	or	tax	cuts	directly	stabilise	demand	in	economic	downturns	and	can	be	morebeneficial	in	recessions.	Britta	Gehrke	and	Brigitte	Hochmuth	document	the	same	in	the	context	of	the	labour	marketpolicy	short-time	work.In	contrast,	implementing	reforms	to	alleviate	crises	turns	out	to	be	a	costly	policy.	Even	though	long-run	effects	ofstructural	reforms	are	beneficial,	the	short-run	costs	may	erode	the	public	support	for	such	reforms	and	even	worsenthe	crisis.	From	a	political	economy	point	of	view,	these	findings	provide	both	a	negative	and	a	positive	conclusion.On	the	negative	side,	they	explain	the	reluctance	of	governments	in	crisis	countries	to	conduct	reforms.	The	adverseshort-	to	medium-run	effects	disincentivise	such	a	strategy.	However,	the	results	also	show	that	outside	recessions,positive	reform	effects	may	materialise	much	quicker	and	can	encourage	public	support	of	unpopular	reforms.♣♣♣Notes:This	blog	post	is	based	on	the	author’s	article	“Reforming	the	Labor	Market	in	Good	and	Bad	Times:	AnyDifferences”	in	N.	Campos,	P.	De	Grauwe	and	Y.	Ji	(eds)	The	Political	Economy	of	Structural	Reforms	inEurope,	Oxford	University	Press,	2018.The	post	gives	the	views	of	its	authors,	not	the	position	of	LSE	Business	Review	or	the	London	School	ofEconomics.Featured	image	credit:	Photo	by	Sebastian	Dubiel,	under	a	CC	BY-SA	3.0-de	licence,	via	Wikimedia	CommonsWhen	you	leave	a	comment,	you’re	agreeing	to	our	Comment	PolicyBritta	Gehrke	is	assistant	professor	of	macroeconomics	and	labour	market	research	at	the	Friedrich-Alexander	University	Erlangen-Nürnberg	(FAU),	and	the	Institute	for	Employment	Research	(IAB).	Herresearch	interests	are	applied	quantitative	macroeconomics	and	econometrics;	business	cycles,	fiscaland	monetary	policy;	and	labour	economics.	Enzo	Weber	holds	the	chair	of	empirical	economics,	in	particular	macroeconometrics	and	the	labourmarket,	at	the	University	of	Regensburg.	He	is	head	of	the	research	department’s	forecasts	andmacroeconomic	analyses	at	the	Institute	for	Employment	Research	(IAB).	He	is	also	a	research	fellowat	the	Institute	for	East	and	Southeast	European	Studies	(IOS),	as	well	as	a	consultant	and	researchaffiliate	of	BE	Berlin	Economics.	LSE Business Review: Structural labour market reforms in Europe: timing matters Page 3 of 3		Date originally posted: 2018-06-04Permalink: http://blogs.lse.ac.uk/businessreview/2018/06/04/structural-labour-market-reforms-in-europe-timing-matters/Blog homepage: http://blogs.lse.ac.uk/businessreview/

Structural labour market reforms in Europe: timing matters

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Structural labour market reforms in Europe: timing matters

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