Is high unemployment here to stay?

Unemployment in the EU is unacceptably high. It has been falling since summer 2013, when it was 11 % in the EU and 12 % in the eurozone, but very slowly and unevenly, and we can’t be at all certain of the speed and quality of job creation.

Most countries in the EU have experience of unemployment at around 10% – the current average for the EU as a whole. But this average figure masks an unprecedented divergence within the EU because several countries now have unemployment rates higher than 20%, which is clearly unsustainable.

High unemployment doesn’t just mean that an economy is performing below its potential; it can also lead to social disintegration and even political instability. More and more people are therefore beginning to lose confidence in our democratic systems, making unemployment a wholly European drama.

But there is a European paradox here. The EU can be seen as a warehouse of good practices concerning employment, with some of the best examples anywhere in the world of skills development, social dialogue, good working conditions and efficient public employment services. Despite ever-closer frameworks for co-operation between EU countries, best practices have largely failed to migrate from stronger to weaker countries. The result is a very uneven landscape with strongly divergent trends when it comes to the workings of labour markets.

The EU isn’t short of ideas or of ambition on job creation, but employment policy, throughout the history of our integration, has always been lagging behind other economic policies like developing markets or ensuring fiscal stability. These lags also mean that labour market policy instruments occupy a lower, and less privileged, place on governments’ agendas.

So at the height of the eurozone crisis, the European Council was quick to establish the Fiscal Compact with its binding new rules and procedures, yet for youth unemployment the EU’s leaders preferred informal meetings that consisted of little more than enhancing the visibility of their concern and of existing Commission proposals like the Youth Guarantee scheme.

The “growth and jobs” mantra appears on the front page of many official documents, but it has become a unrewarding labour of Sisyphus to integrate measures to combat unemployment with other macroeconomic policies. The very influential Ordoliberal approach, originating from the German Wirtschaftwunder period, has no focus at all on high growth and employment.

Recognition of Europe’s need for more jobs, and in some member states a dramatic surge in employment, doesn’t date back just to the Great Recession of 2009 and the eurozone crisis of 2011-3. The EU’s Lisbon strategy and later its Europe 2020 strategy placed higher employment among the Union’s main priorities and targets. The European Social Fund (ESF) was pointed to as a strategic resource for this, and was reinforced by the new seven-year EU budget, the Multiannual Financial Framework (MFF), which introduced a minimum share for the ESF within cohesion policies.

When the Europe 2020 strategy was designed back in 2010, the idea wasn’t simply to respond to the latest crisis; strengthening employment policy was all about transforming the pre-crisis growth model and going for a 75% employment rate by the end of the coming decade. In spite of some useful progress thanks to the Lisbon strategy, the EU’s pre-crisis growth model was felt not to be inclusive enough. The consensus was that this was bad both for the Union’s output legitimacy and for its long-term growth potential in light of the shrinking and ageing of the European workforce.

This high employment strategy was almost immediately destabilised by the eurozone’s slow-down, and then by the recession. European labour markets were hit twice in three years, and we had to look for new instruments if we were to remain on target and achieve high employment in all the EU member states.

In April 2012, the Commission adopted an Employment Package for a job-rich recovery that sought to identify ways of boosting employment in the difficult new circumstances. For jobs, this was the most comprehensive policy document to be agreed on since the launch of the Europe 2020 strategy.

Just sitting back and waiting for employment to pick up thanks to renewed economic growth was obviously not an option. We faced an urgent jobs crisis with the longer-term prospect of rising structural unemployment, a steady loss of skilled labour and the further erosion of Europe’s growth potential. That’s why the Employment Package emphasised that both the preservation and the creation of jobs had to be pursued as direct and immediate goals, and as part of a wider effort to combat Europe’s economic crisis.

The Employment Package was innovative in many respects, but mainly because of its emphasis on stimulating demand for labour. The European Employment Strategy launched in 1997 had focused predominantly on supply-side issues like labour participation, adaptability and human capital investment. It was meant to improve the Maastricht framework for economic policy, and was certainly influenced by the OECD’s famous “Jobs Study” in 1994, which had argued that any jobs growth in an economic crisis would have to be kick-started by deregulating employment protection and reducing unemployment benefits – very much a supply-side approach with a strong flavour of Reaganomics.

Based on feedback from both labour and business representatives at a major conference on flexicurity in November 2011, this concept became sidelined in the Employment Package. Instead, we spoke about dynamic and inclusive labour markets, a concept which immediately turned out to be helpful for the Italian reform agenda championed by Elsa Fornero, and other efforts at that time in Spain, Portugal and elsewhere.

The key problem we have been up against since the second eurozone recession, though, has been how to boost job creation and demand for labour in a low-growth environment. And let’s make no mistake about this, we still face the same problem today despite the mild and fragile recovery that began in mid-2013. And unless we make major changes to our macroeconomic framework, the challenge of boosting employment at a time of low growth is likely to stay with us for quite a while.

The Employment Package drew some inspiration from the U.S. recovery. To strengthen demand for labour in Europe, we emphasised the need to reduce the tax wedge on low-paid workers, to deploy targeted hiring subsidies and to boost entrepreneurship, including social entrepreneurship.

The OECD advocated much the same approach at the G20 Summit in 2013, and then in September 2014 a Eurogroup meeting of eurozone finance ministers came out strongly in favour of reducing the tax wedge on low-paid labour. They called for it to be a clear policy priority on the structural reform agenda. It’s also generally recognised that maintaining existing jobs through better adaptability and through internal flexibility within companies, based on social dialogue, is equally important.

Boosting demand for labour also has a strong sectoral dimension. That’s why the Employment Package outlined ways to tap the jobs potential of sectors that are set to grow because of long-term structural trends, particularly the green economy, ICT and healthcare services. We later followed up on this sectoral dimension with such initiatives as the Grand Coalition for Digital Jobs and the Green Employment Initiative.

The second main strand of the Employment Package consisted of structural measures to make Europe’s labour market more dynamic and inclusive. The three main elements of this have been balanced labour market reforms, enhanced investment in skills and better conditions for labour mobility in what should be a genuine European labour market.

Balanced structural labour market reforms include the promotion of internal flexibility, a reduction of labour market segmentation, investment in a greater capacity of public employment services – including co-operation between them, and closer links between unemployment benefits and the mechanisms designed to encourage people back into work.

Stressing the need for more inclusive labour markets is important because it means the integration into the active workforce of people who would otherwise be judged as less productive. These are the very young and less skilled at the beginning of their careers, older workers – especially those who have been unemployed –, women – especially those with children –, and people with disabilities. Belonging to an ethnic minority like the Roma can also mean systematic disadvantage in the labour market as well as in society in general.

EU member states therefore need well-designed and powerful strategies if they are to introduce this more inclusive model and achieve higher employment. The good news is that in recent years the employment rate of older workers has been constantly increasing, and the EU-wide effort to introduce the Youth Guarantee looks set to result in greater security during the school-to-work transition.

Having said that, there is definitely scope for further efforts. A good example would be through supporting the social economy, meaning co-operatives and other socially-minded enterprises. They tend to be more resilient at times of economic crisis, and can be employers of last resort.

The vision of a genuinely European labour market highlights the potential inherent in cross-border mobility, and it also confronts two common fallacies. One is that immigration is a cause of unemployment, the other that labour mobility has a dominant role in addressing imbalances within the EU, and the eurozone especially.

The 2012 Employment Package was the first EU Communication to call for a decent minimum wage in all EU member states, and it also called for the first tripartite exchange of views on wage developments to involve EU as well as national social partners. It emphasised the importance of social dialogue in more general terms too as part of the EU’s pursuit of a job-rich recovery. It outlined ways to involve the social partners in European economic governance.

The policy agenda articulated in the Employment Package has since then been largely reflected in the recommendations issued in the consecutive European Semesters. It was followed-up on by the Youth Employment Package with its proposal for an EU-wide Youth Guarantee – a comprehensive scheme to improve the school-to-work transition and ensure meaningful work opportunities for all young people before they slip into the inactivity of prolonged unemployment.

Other follow-up actions include an EU quality framework for anticipating change and restructuring that is closely coordinated with the Commission’s industrial policy initiatives and the re-launching of the European Globalisation Adjustment Fund in the new EU budget.

But there have been two major reasons why the EU’s efforts to develop the demand side of labour market policy have been constrained. They are to be found in the area of macroeconomic policy making: the disinflationary bias in the eurozone’s monetary policy, and its bias towards internal devaluation.

Europe’s jobs crisis is linked to its weak macroeconomic performance, and notably to less effective fiscal and monetary responses than in the U.S. and Japan to the financial and economic crisis. The EU’s labour markets are being adversely affected by three key macroeconomic developments:

• First, there is a persistent gap in most member states between effective aggregate demand and potential output, and this combines with high unemployment, the large overhang of private debt, low inflation and nominal interest rates that are close to their lower limit. Our economies may be facing a chronic demand shortage for both consumption and investment. This relates to demographic trends, but also to widening inequalities and increased savings that are not being channelled into the real economy but instead are parked in financial instruments and real estate investments.
• Second, we are seeing an unprecedented polarisation of living standards and employment prospects right across the eurozone, and this is linked to the incomplete nature of the Economic and Monetary Union (EMU), and most notably the lack of aggregate demand management as well as of shared fiscal capacity. The design of EMU has until now forced macroeconomic adjustment to be carried out predominantly through internal devaluations, meaning through cost-cutting and layoffs as the principal ways of restoring cost-competitiveness.
• Third, Europe is struggling to reap the full jobs potential of structural changes that are now under way, mainly in terms of technological change and globalisation. The reason is that like product markets, the financial sector and public investment agencies, our labour market institutions are incapable of re-allocating labour and capital in a flexible manner that would give a strong boost to job-creation.

Taken together, all these factors should be ringing alarm bells not just for academics but for policy-makers too. Secular stagnation, depressed employment opportunities and the further widening of inequalities may well become permanent features of the European economy if it continues to be characterised by a large overhang of private debts together with very low inflation.

These macroeconomic factors are deeply rooted in the design of our monetary union, and I have long argued that it is primarily through reforming EMU that we would be able to make meaningful progress towards our 2020 target of 75% employment. EMU’s one-size-fits-all monetary policy is one of the key factors constraining the effectiveness of actions being taken to reduce unemployment. Achieving higher employment in a low-growth environment would require higher inflation expectations and consequently very low, or even negative, real interest rates.

Nobel Prize winning economist Christopher Pissarides made a memorable comment back in September 2012 at the “Jobs for Europe” conference organised by the Commission on the Employment Package. He argued that boosting employment would require the ECB to raise its inflation target to about 4%. And that, mind you, was when eurozone inflation was over 2.5%, whereas today it is below 1%. In other words, we have gone in the opposite direction, and employment levels in Europe have continued to decline.

What Pissarides was implicitly referring to was the so-called Phillips Curve, which many years ago used to encourage macroeconomic policymakers to pursue full employment by using the monetary and fiscal policies at their disposal. The original Phillips Curve had been based on the inverse relation between unemployment and nominal wage inflation observed in the UK, and was later re-stated as an inverse relationship between unemployment and overall inflation. The policy implication of the Phillips Curve is that increasing aggregate demand through monetary and/or fiscal policies is considered sufficient to increase labour demand and thereby bring unemployment down — provided we accept the somewhat higher inflation that goes with it.

At present, though, thanks to the imperfect nature of EMU, adjustment to economic shocks tends to occur not through expansionary fiscal or monetary policies that would temporarily drive up inflation and reduce unemployment, but through internal devaluations in deficit countries, which lead to low inflation or outright deflation and are accompanied by high levels of unemployment. Yet wage-inflationary pressures are much less likely nowadays than in the 1970s or 1980s because of the changes undergone by weakened trade unions, so that collective bargaining has become more decentralised and is easier to opt out of. In many EU countries, Spain and Germany for instance, nominal unit labour costs have been rising less than overall prices, thanks to deliberate wage constraint or inefficient product markets. The result has been a further compression of aggregate demand and an even more pronounced impact on unemployment.

What does all this mean? It means that while the Phillips Curve continues to be relevant, it has perhaps been neglected in macroeconomic policy. We rightly pursue structural reforms aimed at enhancing productivity in the medium and long-term so as to create more dynamic and inclusive labour markets. But we may well have forgotten that the way to the long term leads via several short-term episodes.

If we are to take the fight against unemployment seriously, then our inflation expectations need to rise. People, and especially those who are savers, need to accept the idea that very low or even negative real interest rates are needed for the sake of growth in the whole economy. Borrowing conditions therefore need to become much more favourable, especially for young people and for SMEs.

Higher inflation and lower unemployment cannot be achieved only on the basis of fiscal or monetary policies, nor just through structural changes like wage increases or a greater redistribution of wealth. It is concerted action on the combined fiscal, monetary and structural fronts that is needed, much as in the ‘Abenomics’ concept that Japan’s recently re-elected prime minister is advocating.

ECB President Mario Draghi’s speech in Jackson Hole last summer to fellow central bankers went in the same direction, in the sense that it emphasised the need for more flexible accommodative monetary policies and a more expansionary aggregate fiscal stance for the eurozone, enabling Europe to implement structural reforms without risking a further short-term contraction in its GDP and greater deflationary pressures.

Unfortunately, not everybody amongst Europe’s policymakers seems to have understood that Draghi wasn’t speaking about something a little extra, but rather about the pre-conditions for Europe’s economic recovery. Beyond the immediate need to survive the present crisis, the EU also needs a longer horizon if it is to convince citizens and the markets that its growth model is built on solid ground. That’s why a continuing EMU reform is so important to an economic recovery strategy.

Economic growth in the EU cannot be founded on a permanent muddling-through strategy, or on ad hoc solutions and a trial and error approach. We have since 2012 had a shared vision for the creation of the banking union, fiscal union and political union so as to become more resilient and to create stronger foundations for future growth. The Commission produced at the end of 2012 a detailed Blueprint for building a deep and genuine EMU, and since then some key elements of the banking union have been introduced. But it is clear that this rather minimalist banking union is too slow and too weak to revive investment and growth in the real economy; it must be flanked by a new EU level initiative focusing on investment.

In the absence of a real economic impact from the banking union, and without the political momentum needed for fiscal union, promoting investment is a crucial part of the public policy agenda. In a more far-reaching form, it could be developed into an investment union. But we should be under no illusions that any new investment initiative would be sufficient to overcome the severe imbalances of the eurozone. The debate on such other elements of a deeper and genuine EMU as automatic fiscal stabilisers at eurozone level therefore has to continue with even greater urgency. The promised June 2015 report on deepening EMU must not be a modest re-statement of the 2012 report by the presidents of the ECB, the European Council, the Commission and the Parliament. Instead, it needs to advance concrete options for strengthening counter-cyclical fiscal capacity at the EMU level.

When the Commission introduced a scoreboard in October 2013 of key employment and social indicators, this demonstrated that overall unemployment and youth unemployment and inactivity, along with income inequality and poverty all showed significant and dangerous divergence during the crisis, especially inside the euro area. What this means is that without adequate macroeconomic intervention capacity, only limited temporary results will be achieved.

In a deflationary environment, a protracted period of low or negative growth will cause the decline of both human and fixed capital, which will in turn undermine the EU’s growth potential; unemployment caused by a cyclical downturn will become structural if the downturn is not tackled in time. Given the very limited chances of overcoming such imbalances through increased labour mobility in the EU, a rule-based stabiliser mechanism becomes a very desirable solution.

There are solutions capable of sorting out the macroeconomic bias against full employment in the EU, even though the political complexity of implementing these solutions should not be underestimated. The EU is, however, in a race against time if it is to make the single currency sustainable and legitimate. Discussion of automatic stabilisers and EMU reform in general should therefore be seen as urgent, even if the necessary political momentum isn’t there. What this adds up to is that the ECB should be explicitly empowered to act as a true European institution and consider employment as much among its goals as price stability.

A reinforced macroeconomic framework would allow the EU to make a co-ordinated effort to strengthen the performance of labour markets in countries with higher unemployment, and to further co-ordinate employment policies. Nobody can say with any confidence how prolonged today’s high unemployment in the EU will be, but the range of policy instruments available to us allows us to draw a few timely lessons. First, the EU must make every effort to maintain its commitment to job creation and a return to full employment. The EU as a whole, including its economically weakest members, need to do much more than simply aim at restoring the pre-crisis levels of employment.

The structural reforms being undertaken by member governments should be supported by stronger EU-level co-ordination of national policies, and should also serve to encourage the transfer of best practices to the peripheral countries, where necessary with appropriate support for their implementation and for investment. Last, and very much not least, Europe’s commitment to full employment really should be integrated into the macroeconomic framework, including the eurozone’s monetary policy and the design of the EMU.