Making Southern Europe less weird

Demonstrators take part in a protest against plans for new austerity measures on Oct. 20, 2011 in Athens, Greece. (Milos Bicanski - GETTY IMAGES)

In the American press, the European negotiations tend to get boiled down to a simple equation: Northern Europe wants to impose job-crushing austerity on Southern Europe, Southern Europe wants undeserved subsidies from Northern Europe. But it’s an equation with no answer: Too much austerity, and Southern Europe can’t grow, which means it can’t pay its debts. And though bailouts are nice for the recipients, they’re not a permanent solution, either. The only permanent solution is growth.

But one dimension of the European negotiations that hasn’t received much attention are the labor market reforms -- reforms that are meant to accelerate growth. One American policymaker in Europe speculated to me that that’s because we’re used to arguments over deficits, but we don’t really have a context for understanding “how weird the labor markets and regulations in Southern Europe are.”

In 2006, Jean-Claude Trichet, then-head of the European Central Bank, gave a speech touting the fact that the euro area had added 11 million jobs between 2000 and 2005 and cut unemployment from 10.5 percent to 8.6 percent. But for all that, per capita income growth was lagging behind the United States. “The main explanatory factor behind these developments is the diverging trend in hourly labour productivity growth between the euro area and the US,” Trichet said. “In the 1990s, hourly labour productivity in the euro area increased on average by 1.8 percent, decelerating to 1.2 percent in 2000-2004. By contrast, U.S. hourly labour productivity growth rose from 1.5 percent to 2.8 percent over the same periods.”

In a recent research paper (pdf), the International Monetary Fund made the same point. “Common across the euro area are a higher unemployment rate, a lower participation rate, and fewer hours worked” than in the US, they wrote. “While the amount of hours worked can arguably reflect preferences, other differences are more likely due to policies and institutions. In many euro area countries, employment participation is particularly low for females, older workers, and the young.”

The IMF identifies a number of labor-market practices they would like to see reformed. Unemployment benefits, for instance, top 75 percent of the previous year’s earnings in Luxembourg, the Netherlands and Portugal. The “implicit tax” on sending a second earner into the workforce “tops 70 percent when including social security contribution, benefits loss, and the cost of child care in Austria, France, Ireland, and the Slovak Republic.” Job creation in the service sector is held back by licensing and regulatory restrictions in Luxembourg, Italy, Germany, and Greece. There’s a huge problem across the Eurozone with “insiderism”: the tendency to need to know someone to get a job.

And so on. The IMF even included a spider-web graph comparing the levels of labor-market restrictions in different European countries with those in the U.S. (we’re the green line):

The bottom line? “Making better use of available labor would allow the euro area to live up to its growth potential and secure its inclusive social model. Providing more jobs with higher productivity will improve the sustainability of the euro area along several dimensions, not in the least in the fiscal arena. It will also allow for a more inclusive economy, with viable social safety nets,” concludes the IMF.

And to the Germans, the ECB and the IMF, this crisis is the way to get there. There is at least some recognition that the troubled countries in Southern Europe can only bear so much austerity without fatally compromising growth. But there’s also a sense that they can go much further in structurally reforming their labor markets in ways that will, in the long-run, help them and the Eurozone grow.

The IMF’s paper was written in 2010, before Europe’s crisis had become quite so dire. At that point, the organization’s recommendation was: “Larger EU transfers may well be necessary to induce reforms. This means going beyond the current EU budget, which is strictly limited by the Treaty, to a system that uses more transparent EU-wide instruments.” Today, it’s clear that larger transfers will be necessary if the Eurozone is to simply survive. But those transfers aren’t likely to come unless the ECB and Germany are confident that the labor-market reforms will happen, too.