1. Mar 9 2004 Lesson 10 By John Kennes International Monetary Economics

2. Mar 9 2004 EMU and Labor Markets

3. Mar 9 2004 Financial markets match lenders and borrowers –the operation of these markets is improved by transparency created by euro –Creation of international intermediaries Labor markets match workers and jobs –The operation of these markets is is improved by transparency created by euro –Creation of international intermediaries Labor Markets (1)

4. Mar 9 2004 The Mundell OCA criteria is that labor markets are better integrated –The existence of the euro pushes this agenda –Controversy: Is there a tradeoff between labor market integration and the welfare state? Labor Markets (2)

5. Mar 9 2004 A subsitute for labor mobility is labor market flexibility How does Europe do on this front? Labor Markets (3)

6. Mar 9 2004 Dismal Labor Market Performance

7. Mar 9 2004 Beware of Averages!

8. Mar 9 2004 Not just the unemployment rate –Low rates of labour participation –Youth unemployment –Duration of unemployment spells General Picture –Many people do not hold jbs –People can remain unemployed for years running –Problem deeper in larger countries, with recent improvements in the UK and smaller countries Many other indicators of trouble

9. Mar 9 2004 General assessment is that labor markets are rigid in most of Europe A simple illustration: real wage stickiness. Why?

10. Mar 9 2004 Labor Market Adjustment to an Adverse Shock

11. Mar 9 2004 Real wage rigidity just one example Other features include: –Restrictions on hiring and firing –Restrictions on hours worked –Minimum wages –High unemployment benefits as disincentives to search for jobs More generally

12. Mar 9 2004 These features have been introduced to fight labour market imperfections and/or meet social objectives – economic justice They make labor market rigid but serve other purposes No universal response to this conflict A Deep Conflict

13. Mar 9 2004 A Few Examples (more details later) Market failureStandard solutionEconomic cost Dominant power of employers Minimum wages, labor protection laws, mandatory negotiations Reduces competition on the labor market Information asymmetry: no good knowledge of worker skill’s and efforts at work Collective wage negotiations Reduces competition on the labor market Workers are vulnerable to job uncertainty Mandatory health and unemployment insurance, retirement benfits Raises labor costs and reduces demand for labor

14. Mar 9 2004 Deepening integration excerbates competition Firms compete by reacting quickly and forcefully to opportunities or shocks Inflexible labor markets reduce the ability of firms to react Indirectly, social systems compete against each other The delicate balance achieved in each country becomes challenged. What is the link with Monetary Integration?

15. Mar 9 2004 Existing institutions differ from country to country They are the outcome of a long, and often conflictual, history A look at the most important ones illustrates the challenges posed by monetary integration. Labor Market Institutions

16. Mar 9 2004 General assessment is that labor markets are rigid in most of Europe A simple illustration: real wage stickiness. More generally

17. Mar 9 2004 Social Objective: protect workers from employers’ excessive powers Economic impact: an illustration. Collective Negotiations

18. Mar 9 2004 Collective Negotiations

19. Mar 9 2004 Social Objective: protect workers from employers’ excessive powers Economic impact: an illustration. Collective Negotiations

20. Mar 9 2004 Social Objective: protect workers from employers’ excessive powers Economic impact: Involuntary unemployment The role of the degree of centralization: –Plant level: induces some wage restraint –National level: induces some wage restraint –Branch level: less restraint Collective Negotiations

21. Mar 9 2004 Bargaining Coordination and Employment

22. Mar 9 2004 Social Objective: protect workers from employers’ excessive powers Economic impact: Involuntary unemployment The role of the degree of centralization The monetary union impact –One big market: current degree of coordination in collective negotiations decline –One central bank: more wage discipline Will trade unions respond by organising at the EU level Collective Negotiations

23. Mar 9 2004 Social Objective –Protect the weakest –Reduce inequality Economic impact: unemployment of the least skilled Minimum Wage Legislation

24. Mar 9 2004 Unemployment in France by Age Group (% of group labor force)

25. Mar 9 2004 Social Objective –Protect the weakest –Reduce inequality Economic impact: unemployment of the least skilled The monetary union impact –Enhances competition favours low cost countries –Accession of CEECs will sharpen this aspect –Trade unions fear social dumping and call for harmonization of social reforms Minimum Wage Legislation

26. Mar 9 2004 Social Objective: protect the wokers from a major risk Economic impact –Paid out of labor taxes: raises labor costs –Generous benfits reduce incentives to search for jobs –Overall, less employment and more unemployment. Unemployment Insurance

27. Mar 9 2004 Social Objective: protect the wokers from a major risk Economic impact: more unemployment The monetary union impact –Asymmetric shocks create temporary unemployment –Generous insurance may prolong adjustment –Pressure to reduce generosity, mainly duration of benefits. Trade unions fear social dumping Unemployment Insurance

28. Mar 9 2004 Social Objective: protect workers from employers’ arbitrariness Economic Impact: –Reduce firing during downturns –Limits hirings during expansions –Overall no lasting effect on unemployment, but reduces firms ability to deal with adverse shocks. Employment Protection Legislation

29. Mar 9 2004 Social Objective: protect workers from employers’ arbitrariness Economic Impact: no effect on unemployment but reduces firms’ flexibility. The integration and monetary union impact –Harder to deal with adverse schocks –Pressure to reduce strictness of legislation. Trade unions fear social dumping. Employment Protection Legislation

30. Mar 9 2004 Strictness of Protection Against Dismissals

31. Mar 9 2004 Social Objective: solidarity among workers in financing unemployment, health, retirement Economic impact: raise cost of labor, or reduces wages, or both. Payroll Taxes

32. Mar 9 2004 Social Objective: solidarity among workers in financing unemployment, health, retirement Economic impact: raise cost of labor, or reduces wages, or both. The monetary union impact –Enhanced competition favours low cost countries –Incentives to either reduce welfare payments or raise taxes. Politically difficult. Payroll Taxes

33. Mar 9 2004 Deeper integration desirable because it enhances competition on the goods markets More competition raises the economic costs of many labor market institutions A sharpening of the conflict between economic effectivessness and social objectives. Existing arrangements are threatened How to Respond to deeper Integration?

34. Mar 9 2004 1.Two-speed Europe 2.Deep reforms 3.Social Harmonisation Three Possible Evolutions

35. Mar 9 2004 Two-speed Europe Some countries flex their labor markets others retain their highly social existing arrangements Firms and risk-taking individuals move to most flexible countries Welfare conscious are attracted by welfare magnet countries Part of Europe grows fast with low unemployment, another part grows slowly with permanently high unemployment Possible Evolution No. 1

36. Mar 9 2004 Two-speed Europe: Already There?

37. Mar 9 2004 Deep reforms Thatcher takes over Europe Labour market institutions made more flexible Labour axes reduced Possible Evolution No. 2

38. Mar 9 2004 Social harmonization –The large countries export their welfare systems through social norms applicable to all EU countries Possible Evolution No. 3

39. Mar 9 2004 There is no obvious better way, just different socio- economic equilibria A somewhat arbitray typology: –The continental model –The Nordic model –The Anglo-Saxon model –The Southern European model –And the evolving accessing countries In the End