Labour Market Flexibility and EMU Sustainability: The Effects of the French Law on Working Time Reduction

Europe currently faces two major labour market issues relevant for EMU. Firstly, there is a need to bring down the relatively high unemployment rate to avoid a shift in the political preferences in some member countries away from price stability to employment-creating but inflationary monetary policy. Secondly, there is a need for greater flexibility in the labour markets, which national governments have been reluctant to introduce in the face of strong political opposition. Recent developments in some member states seem to have moved in the wrong direction, rendering labour markets more rigid. This study examines what will be the effects on flexibility of the French law reducing the legal weekly working time and what this may mean for EMU. Very little literature examines the types of measures required to increase labour market flexibility going beyond wage flexibility and labour mobility, the main factors suggested by Robert Mundell, who pioneered optimum currency area theory in 1961. There are, however, a number of elements of flexibility that can contribute to the improvement of the eurozone’s capability to adjust to an asymmetric exogenous shock while minimising the employment effects. This paper identifies what other types of changes would contribute to the increase in labour market flexibility required to ensure EMU sustainability, and whether the new French approach contributes to the solution of the problem, or makes matters worse. The study first looks at the theoretical significance of labour markets in a monetary union, and then proceeds to construct a framework for the analysis of the employment effects of working time reductions before reviewing the analytical literature on this topic. The third chapter defines the elements of flexibility that can be influenced with a view to increasing EMU sustainability, finally analysing the provisions of the Aubry law in the light of the preceding definitions with the help of a simple NAIRU model. The report comes to a result running counter to the common perception of the French initiative, which is that the law simply imposes an additional constraint on the country’s labour market. While a rigidifying effect cannot be denied, it also provides for a number of measures that may well bring about a greater degree of flexibility. This raises the possibility that the legislation in question is in fact a Trojan horse policy, sold to the public on the basis of its (limited) employment-creating effects but really designed to create a suppler labour market. If this conclusion is an accurate reflection of reality, then the news for EMU is good: Despite public opposition to increased flexibility, it may well be achievable. The elimination of some rigidities may necessitate the introduction of a new one, but this give- and-take practice may allow governments to render their labour markets apt to respond to the requirements posed upon them by monetary union.