The functioning of the labour market and unemployment growth in Spain

The unemployment rate is proving to be the key manifestation of the severity of the crisis affecting the Spanish economy. According to EPA (Spanish Labour Force Survey) data, the unemployment rate rose from 9.6% at the beginning of 2008 to 17.9% in 2009 Q2, topping the 4 million mark. The rate of job destruction is higher than in other developed countries, even taking into account some of the singularities of the Spanish case. Thus, in countries facing a similar contraction in activity, but with a lower rate of growth in the labour force and with no comparable construction sector expansion, the unemployment rate has risen only slightly since the start of 2008 (for example, in France, by 1.3 pp according to Eurostat) or has even remained stable (for example, in Germany), although unemployment will foreseeably rise in these countries in coming quarters. However, when compared with countries that share similar characteristics in terms of property market developments and demographic trends, such as the United States, the United Kingdom and Ireland, Spain’s unemployment growth continues to stand out: the unemployment rate has risen by “just” 4 pp in the United States, slightly more than in the United Kingdom, and by 6.4 pp in Ireland, as opposed to more than 8 pp in Spain. This suggests that the Spanish labour market’s mechanisms for adjustment in the face of adverse shocks are not functioning correctly, as employment is bearing the brunt of the adjustment and this entails a high cost, in terms of long-term economic growth and social well-being. Moreover, these distortions are not only seen in periods of recession, but also in economic expansion phases, in the form of highly temporary and precarious employment, low productivity and real wage growth and an unemployment rate that has failed to converge with that of the euro area countries. These shortcomings in the functioning of the labour market reflect, inter alia, a lack of adaptation of the institutional framework. When it comes to determining how the labour market functions and its capacity to adjust in the face of serious macroeconomic shocks, there are four key labour market institutions: unemployment protection schemes, understood in the broadest sense (including unemployment benefits and severance payments); wage-setting mechanisms (the collective bargaining system); active labour market policies (designed to raise the employability of the labour force); and labour market intermediation mechanisms (the agencies that help match persons looking for work with firms offering work). The fact that employment is bearing the brunt of the adjustment is probably chiefly due to the first two of these institutions, i.e. the unemployment protection schemes and the wage-setting mechanisms. Moreover, several studies have demonstrated that the interaction between these two institutions is also key to understanding the labour market’s reaction to shocks: in fact it is clear that protection systems may affect the result of collective bargaining, and vice versa, that the degree of wage adjustment in light of a shock makes it essential for unemployment protection schemes to come into play. In this respect, the reasons that warrant the existence of these labour market institutions should not be forgotten: they provide guaranteed income for workers (who are thus able to maintain a more stable spending profile over time), they transfer part of the risk from individuals to firms, they oblige firms to assume the social cost of worker dismissals, they enable the unemployed to find work more suited to their skills and they balance the bargaining power of workers and firms, inter alia. All this explains why these institutions must be well designed, to ensure that labour market adjustments are efficient and entail the lowest possible social and economic cost. However, it should also be borne in mind that for these design improvements to yield optimum results, firms will have to operate in a more competitive environment on the product markets, to ensure that the consequent decline in corporate margins is passed through to final consumers. Accordingly, the next two sections of this article contain an overview of the existing unemployment protection and wage-setting institutions in Spain, placing them in an international context and aiming to identify their main shortcomings. There follows a review of some of the labour market reforms undertaken in other European countries that may serve as a reference framework for Spain. In particular, Germany and Austria made extensive changes to the design of their unemployment protection schemes in the 1990s and are, for the time being, demonstrating considerable resilience to unemployment growth, while Sweden is a paradigmatic example of how a collective bargaining system mid-way between past excessive centralisation and wage bargaining at company level may have an adverse impact on unemployment. Finally, the last section summarises the main conclusions.