Macedonia vs. Unemployment - Proposal Submitted to the Government - Part V

By: Dr. Sam VakninFormer Economic Advisor to the Government of the Republic of Macedonia

Labour Mobility, Unemployment Benefits and Minimum Wages

We are all under the spell of magic words such as “mobility”, “globalization” and “flextime”. It seems as though we move around more frequently, that we change jobs more often and that our jobs are less secure. The facts, though, are different.

The world is less globalized today than it was at the beginning of the century. Job tenure has not declined (in the first 8 years of every job) and labour mobility did not increase despite foreign competition, technological change and labour market deregulation. The latter led to an enhanced flexibility of firms and of hiring and firing practices (temporary or part time workers) but this is because many workers actually prefer casual work with temporary contracts to a permanent position.

Granted, people have been and are moving from failing firms and declining industries to successful ones and booming sectors. But they are still reluctant to change residence, let alone emigrate. Thus, jobs remain equally stable in deregulated as in regulated labour markets.

Yet, this phobia of losing one’s job (arising from the aforementioned erroneous beliefs) serves to increase both the efficiency and productivity of workers and to moderate their wage claims.

It is safe to assume that collective bargaining led to increased wages and, thus, to less hiring and less flexible labour markets. It is therefore surprising to note that despite the declining share of unionized labour in two thirds of the OECD countries – unemployment remained stubbornly high. But a closer look reveals why. Both France and the Netherlands (where unionized labour declined from 35% of the actually employed to 26%), for instance, extended the coverage of collective agreements to non-unionized labour. It is only where both union membership and coverage by collective agreements were both reduced (USA, UK, New Zealand, Australia) that employment reacted favourably. Thus, at the one extreme we find the USA and Canada where agreements are signed at the firm or even individual plant level. At the other pole we have Scandinavia where a single national agreement prevails. All the rest are hybrid cases. Britain, New Zealand and Sweden decentralized their collective bargaining processes while Norway and Portugal centralized it. The evidence produced by hybrid cases is not conclusive. Decentralized bargaining clearly reduced wage pressures but centralized bargaining also moderated wage demands (union leaders tended to consider the welfare of the whole workforce. Still, it seems that it is much preferable to choose one extreme or the other rather than opt for hybrid bargaining. The worst results, for instance, were obtained with national bargaining for specific industries. Hybrid Europe saw its unemployment soar from 3 to 11% in the last 25 years. Pure system USA maintained its low rate of 4-5% during the same quarter century. These opposing moves cannot be attributed to monetary or fiscal policies. This is because all economic policies are geared towards increasing employment. Budget cuts, for instance, depress demand and job formation in the short term but, by lowering real interest rates, they encourage investment and job formation in the longer term.

The cycle is:

Employment protection laws make it hard to fire workers and hard for fired workers to find new jobs. The longer one is unemployed, the lesser the chances of employment. Skills rust and the long term unemployed become the unemployable. Gradually, desperation sets in and the unemployed stop looking for a job. Their absence is conspicuous in that they do not restrain the wages paid to the employed. They have become part of the structural unemployment.

Blanchard and Wolfers studied 20 countries between the years 1960-96. They applied 8 market rigidities to their subjects. The average unemployment increased by 7.2% in this period. But in countries with strict employment protection unemployment rose by double the amount in countries with lax labour legislation. The country with the most generous unemployment benefits saw its unemployment rate grow by five times the rate of the stingiest country. And in countries with highly coordinated wage bargaining, unemployment has grown by four times its growth in countries with decentralized bargaining.

It is difficult to isolate these parameters from the general decline in productivity, the increase in real interest rates and technological change and restructuring. Still, the results are fairly unequivocal. Other research (the 1994 OECD one year study, the DiTella-MacCullouch study) seems to support these discoveries:

That flexibility is a good thing. It encourages employment, it leads to higher output and to a higher GDP per capita. The reason a transition from a rigid to a flexible labour market does not yield immediate results is that it increases the participation in the labour force. The rate of unemployment is, thus, affected only later, it lags the changes. But flexibility leads to lower rates of unfilled vacancies and to a lower persistence of unemployment over time.

Unemployment in Europe is structural (in Germany it has been estimated to be as high as 8.9%). It is the cumulative result of decades of centralized wage bargaining, strict job protection laws, and over-generous employment benefits. The IMF puts structural unemployment in Europe at 9%. This is while the USA’s structural rate is 5-6% and the UK reduced its own from 9% to 6%. The remedies, though well known, are politically not palatable: flexible wages, highly mobile labour, flexible fiscal policy.

Deregulation makes labour markets more flexible because it forces the worker to accept almost any job. Cutting or limiting jobless benefits has largely the same effect. Employers feel more prone to hire people if they can negotiate their wages with them directly and on a case-by-case basis and if they can fire them at will. Hence the debilitating effect of minimum wages and other wage controls as well as of job protection laws.

But all these steps must be implemented together because of their synergy. Research has demonstrated the impotence and inefficacy of half hearted half measures.

Some hesitant steps have been adopted by the governments of Germany and France (which trimmed jobless benefits), by Italy (which stopped linking benefits to inflation), by Belgium, Spain and France, which reduced the minimum wage payable to young people. Spain established two classes of workers with an increased bargaining power granted to those with permanent employment. Yet, some measures yielded quite unexpected and unwanted results. France legislated a reduced working week. Other countries imposed a freeze on hiring with the aim of attrition of the workforce through retirement. Yet, these last two remedies led to an increase in the bargaining power of the remaining workers and to real wage increases.

The only clear causal relationship is between unemployment benefits and the level of employment. The lower the unemployment benefits, the more people seek work and wages decrease. As a result, firms hire more workers. But, firms hire even more when dismissing workers is made easier and cheaper.

Paradoxically, the easier it is to fire workers, the more workers firms are willing to take on and the more secure workers feel knowing that their chances of being hired are better. They look harder for work and find it, reducing the level of unemployment and the costs to the state of jobless benefits. Having to spend less on unemployment benefits, the government can either cut taxes of improve the allocation of its resources. In both cases the economy improves and provides an added incentive to work. This is because, in a vigorous growth economy, the value of an extra worker is higher than the combined costs of his hiring and firing. This is especially true since the reservoir of the unemployed is comprised of the unskilled, the young and women, whose remuneration is closer to the minimum wage. In the USA the minimum wage is 35% of the average wage (in France, it is 60%, in Britain it is 45% and in the Netherlands it is declining relative to the median salary). It is a fact that when wages are downward flexible – more lowly skilled jobs are created. A 1% rise in the minimum wage reduces the probability of finding a job by 2-2.5%.

There is a debate raging between the proponents of minimum wages (they reduce poverty and increase the equality of wealth distribution) and their opponents (they destroy jobs). The OECD stated clearly that wage regulation couldn’t deal with poverty. The reason is that, as opposed to common opinion, few low paid workers live in low-income households and few low-income households have low paid workers. Thus, the benefits of the minimum wage, such as they are, largely bypass the poor.

Again, it is important to realize that unemployment is not a universal phenomenon. It is concentrated among the young and the unskilled. 11% of all people under the age of 25 in the USA are unemployed, almost three times the national average. A shocking 28% of those under the age of 25 are unemployed in France. The OECD says that a 10% rise in the minimum wage reduces teenage employment by 2-4% in both the high and low minimum wage countries.

In view of these facts, many countries (USA, UK, France) introduce “training wages” – actually, minimum wage exemptions for the young. But the minimum wage is still a high percentage of mean youth earnings (53% in the USA and 72% in France) and thus has a prohibitive effect on youth employment.

There is no disputing the facts that minimum wages compress the earnings distribution and reduce wage disparities between ages and sexes but they have no effect on inequality and the reduction of poverty among households. In US households with less than half the median household income only 33% of the adults have a low paid job (The equivalent figure in the Netherlands is 13% and in the UK – 5%). In most poor households no one is employed at all. On the other hand, many low earners have high paid partners. In the USA only 33% of earners of less than two thirds of the median wage live in households whose income is less than 50% of the national median household income. In the UK the figure is 10% and in Ireland – 3%. In each 5-year period only 25% of low paid Americans are in a poor family at some point (the figure is 10% in the UK).

These statistics show that minimum wages hurt poor families with teenagers (by making teenage employment prohibitive) while benefiting mainly the middle class.

(continued)