España tiene la idea correcta


Yesterday the Spanish Parliament passed labour market reforms aimed at driving the country’s unemployment rate beneath its current 20%; the highest of any Eurozone member.

These reforms, if somewhat late, are set to be sucessful. In any economy, the rate of unemployment is determined by the rate of hiring and the rate of job separation. If the former is greater than the latter, unemployment falls and vice versa.

The centrepiece of the reforms, reducing the severance pay employers must award laid off workers from 45 days wages for every 100 worked to 33 days wages for every 100 worked, incentivises both greater hiring and separation as it makes both cheaper. However, Spain is slowly coming out of recession; her firms are looking to hire not fire. In this context, the reform is catalytic to a recovery in the Spanish employment figures.

Of course, when the Spanish economy next nosedives these same reforms will facilitate a faster shedding of labour. Policies promoting labour market flexibility are often, wrongly, criticised on this account. They are deemed pro-cyclical, a violent exaggeration of boom and bust that results in employment being hit hard as soon as the economy falters.

Yet what does this criticism actually mean? Pro-cyclical policies are simply those enabling output and employment to adjust quickly to market conditions. Stripping away the non-wage costs of employment enables labour markets to better right themselves. Although more jobs may be shed in recession, the recession itself will be shorter because firms are freer to reorganise their production in light of the new circumstances, encouraging a quicker return to profit and expanding production. Longer term, structural damage is also likely reduced. If a business can spare itself by shedding labour quickly, it will still be around to hire again when conditions improve.

Spain seems to have grasped these ideas and I have confidence that employment will rise as she pursues labour market flexibility. Although the UK’s labour market remains one of the most flexible in the world, we would do well to defy complacency. It seems timely to re-examine our own labour market regulations and weed out remaining frictions.