Thematic BlogSpot - US-Euro Area Unemployment Divergence
Six years since the start of the Great Recession, US unemployment has nearly returned to its pre-crisis level. By contrast, in the euro area, a double dip recession has stalled growth and pegged unemployment around 11.5%, compared to 7.5% in 2008. At his August 2014 central bank symposium speech, Mario Draghi called attention to this divergent post-2011 trend.
How real is this divergence? Note a drop off in the US labor participation rate starting in 2010, the same year unemployment begins to decrease. In fact, an OECD Employment Report notes a decline in the labor participation rate in the US, Spain, Brazil and Argentina.
Why has performance been so poor for euro area unemployment?
The role of crisis response policies is important. The ECB cites the fiscal drag and a downturn in public sector employment for exacerbating post-2011 job loss. Nearly all job loss in this second period was concentrated in countries adversely affected by government bond tensions. The monetary transmission mechanism has prevented monetary policy effectiveness, while cyclical factors include low demand and uncertainty of future growth, which in turn stalls business investment. A critical ILO 2014 report cites fiscal consolidation as a contributing factor to sustained unemployment, despite growth improvements. Other factors may be at play. Olivier Blanchard found that a lack of trust between labor and capital might explain higher structural unemployment rates in certain European countries, like France.
The common currency may bear part of the blame. Vox writer Matthew Yglesias suggests that the euro, by removing the external adjustment mechanism, resulted in durable high unemployment, required to bring down nominal wages. This is compounded by low labor mobility in the monetary union, as noted by Marco Incerti (CEPS report).
Unemployment is above 25% in Spain, but only 5% in Germany. Employment opportunities in the North have attracted workers from Ireland, Portugal, and Greece, but Spaniards and Italians seem reluctant to relocate. Only 0.3% of the EU population moves to another member state for work each year. Pierre Moscovici’s speech at Bruegel’s annual meeting also points to sub-optimal labor mobility in the euro zone. A World Bank policy research working paper by Justin Yifu Lin and Volker Treichel suggests that the common currency contributed to the crisis by exacerbating intra-European imbalances. As argued, appreciation led to a loss of competitiveness in periphery countries which adversely affected export performance and increased current account imbalances.
Reduced matching efficiency since the crisis is highlighted by Arpaia and Turrini. Matching efficiency has fallen the most in countries who experienced a rise in structural unemployment (Greece, Spain, and Portugal). But, most eastern European countries, as well as France and Spain, have seen stabilization or recovery in 2013. Results show that long term unemployment is the most significant determinant of matching inefficiency. Sectoral mismatch is significant, but less so in the post-crisis period. Skill mismatch is highly significant and even more so post-crisis. Active labor market policies increase matching efficiency.
As illustrated in the attached chart, the collapse of the construction sector played an important role in the first recession, but is less significant thereafter. By the end of 2010 the sectoral breakdown of unemployment is similar to the breakdown before the crisis, suggesting long-term structural mismatch, especially in services.
An influential new study by Carl Frey and Michael Osborne at Oxford University calculates how susceptible jobs are to computerization. Results show that low skilled jobs are at particular risk. Jeremy Bowles of Bruegel applied their data to the EU and find that, not surprisingly, northern EU countries (UK, Netherlands, Belgium, Germany, France, Ireland and Sweden) have computerization risk levels similar to the US, while southern and periphery countries are at a higher risk.
Structural or Cyclical: evidence from the Beveridge Curve— Given the long record of structural unemployment in Europe, how much of the current divergence is structural and how much is cyclical?
Low growth points to cyclical unemployment. But, post-2011 unemployment is likely structural, representing an outward shift of the Beveridge curve. An ECB statement notes that estimates provided from the OECD, IMF, and European Commission suggest an increase in structural unemployment across the eurozone from 8.8% in 2008 to 10.3% by 2013—though Peter Diamond and Aysegul Sahin remind us that outward shifts of the Beveridge curve are common occurrences in the US labor market and are only imperfect indicators of increases in structural unemployment.
Evidence across EU countries is heterogenous. Alfonso Arpaia and Alessandro Turrini show in a Vox EU post that the Beveridge curve has reacted differently across the eurozone. Evidence shows a uniform outward shift in countries suffering from debt crises, notably Greece, Portugal and Spain. In Germany, we see an inward shift of the Beveridge curve, representing reduced structural unemployment.
A special concern about youth unemployment is cyclical... and structural. The OECD 2013 Employment Outlook states that the young and low skilled are the real losers in euro zone unemployment.
Cyclical fluctuations are dominant. Despite the evidence of structural rigidities, youth unemployment is largely cyclical, as demonstrated by Banerjii, Blavy, Lin, and Saksonovs in an IMF staff discussion note. They show that business cycle fluctuations can explain up to 70% of changes in youth unemployment rates in stressed euro area countries. Youth unemployment rates are more than twice as sensitive to the business cycle than adult rates, partly due to greater concentration in SMEs and cyclically sensitive industries, like construction. Andre Sapir shows in a Bruegel post that the incidence of youth unemployment (the ratio of youth to total unemployment) has remained stable since before the crisis, only increasing along with the rise in adult unemployment. This confirms a cyclical approach to youth unemployment.
On the structural front, mismatch and cost factors remain significant for young people as well. The McKinsey Employment report found that despite high youth unemployment, employers in Europe cannot find the workers they need. The IMF finds that a 1-percentage point increase in hiring costs raises youth unemployment rates by .2 to 1.2 percentage points. Christopher Mahoney argues in Project syndicate that youth unemployment is caused by inflexible wages and a falling price level, and the only remedy is a combination of inflation and depreciation, not structural reform.
Youth unemployment may be exacerbated by income inequality, as argued by Harvard’s Mark Esposito and ESCP Europe’s Terence The in Project Syndicate. Many jobs, internships, and elite universities are available exclusively to youths from wealthy backgrounds.
How important is youth unemployment? Daniel Gros argued on Project Syndicate that Europe should avoid special policy responses targeted for youths and focus on adult unemployment, since the value added of adult workers is higher and they do not have the option of further studies. Yet most analysts highlight the risk of scaring, as synthesized in the McKinsey report.
How positive is the US unemployment performance? The risk of wage-growth-less and low employment. Unemployment in the US is down to 5.8% (and youth unemployment to 12.7%). October marked the 49th consecutive month of positive US job growth. Garcia notes on FT Alphaville that this growth streak has produced at least 200,000 jobs each month, proving a resilient labor market despite a deflationary scare in Europe, a Russian standoff, and revisions to the global growth prospects. But, Eduardo Porter (Economix) and Paul Krugman warns that these numbers may be deceiving. Janet Yellen noted that the Great Recession may have “caused persistent changes” in the job market, while insisting that underemployment can be tackled first with continued low interest rates.
Declining labor force participation explains a significant part of the unemployment performance. A study done by Thomas Klitgaard and Richard Peck at the NY Fed show that US decreasing unemployment is largely thanks to a shrinking labor force starting in 2009, explained in part by retiring baby boomers. According to August 2014 data, if the euro zone had experienced a similar drop in labor participation, its unemployment rate would be about 9.5% (compared 11.5%). Before the crisis, the labor participation rate of older women was lower in the eurozone. But since the crisis, european women over 45 are staying in the labor force longer, preventing a decline in labor force participation as seen in the US. This development accounts for nearly half of the euro zone’s divergence. Stefania Albenesi of the Fed notes that a flattening female labor participation rate since the early 1990s is the real culprit for the seemingly jobless recovery. The US may need to adjust to a new normal in which increased women participation can no longer ease the adjustment affects of recessions.
Low wages may be the flip side of the coin in the US labor market—with the Economic Policy Institute’s blog calling the US recovery the “wage-growth-less recovery” . Job growth has increased in 2014 relative to earlier years. But, real wages were down in the first half of 2014 across nearly the entire wage and education distribution. This is especially costly for the middle class. Dale Mortensen argued that middle class workers may have a hard time finding new employment outside of shrinking manufacturing or admin sectors. David Autor and David Dorn (American Economic Review) describe the polarization of the US labor market.
Euro area moving forward—to address both the structural and cyclical components of unemployment, policy solutions must tackle structural reform and growth. The IMF advises structuring labor-market institutions to provide micro and macro flexibility, as well as protect workers. Worker protection should take the form of unemployment insurance more often than job protection. Macro flexibility is trickier and relies on collective bargaining or public sector wage cuts. Addressing the inefficiencies of the monetary union is also key and CEPS warns against reducing labor mobility and the negative perception of foreign workers.
On youth unemployment, the McKinsey report suggests a role for the EU. The euro zone must facilitate information share, labor mobility, and determine successful matching strategies to minimize mismatch. The ILO recommends growth policies over austerity measures to promote job creation, and an adjustment of technical and vocational programs to reduce mismatch.
By Kasey Vosburg and Adrien Regnier
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