The European Central Bank relieved world financial markets not too long ago when it made clear its willingness to provide needed liquidity. Even in the face of new concerns about Spain, that commitment has helped calm markets. Less in the headlines, but perhaps even more welcome, are the fundamental economic reforms, particularly in labor markets, that have begun to emerge in the beleaguered nations on Europe’s periphery. These efforts ultimately promise a more durable response to Europe’s problems than any financial aid from the ECB or elsewhere.
For years, labor laws in Spain, Italy, Greece, France and elsewhere in Europe have come under criticism. The International Monetary Fund, analysts at the European Union itself, and German reform advocates have identified a bewildering complex of employment laws, regulations and practices that have imposed rigidities on labor markets in these economies; needlessly raised production costs; and increased their rates of unemployment, particularly among the young. According to the IMF, the situation has cut almost one percentage point a year off potential real growth rates in these countries, worsening their fiscal imbalances and blocking needed adjustments to the current debt crisis.
Tax laws, by discouraging two-income households, further block flexibility. Called the “tax wedge,” these burdens have sometimes climbed to over 40% of the additional income beyond normal income tax rates. Still more, high minimum wage laws have made it almost entirely uneconomic to employ low-skilled workers, leaving many unemployable and a burden on each nation’s social welfare system. The IMF estimates that minimum wages in Greece, Spain, and Portugal are close to 50% of the medium national wage. In France, they verge on 65%.
Unwinding such market impediments will not be easy and certainly cannot happen overnight. Still, it is encouraging that several of these nations have used the pressure of the crisis to begin the process. In just the last few months, for instance, Italy amended its 1970 labor law to allow layoffs for economic reasons, not just misconduct. Recent reforms also capped severance packages, admittedly to a still high maximum of 15 months of salary, and created a much less generous universal unemployment insurance scheme. Spain has reduced required severance; moved away from nationwide, one-size-fits-all collective bargaining arrangements; and allowed more flexible hiring and firing rules, both to relieve youth unemployment and to increase productive efficiency. France has moved more slowly, no doubt because it feels less immediate pressure than Spain and Italy, but even its new Socialist government has proposed a relaxation of hiring and firing rules, provisions to allow decentralized collective bargaining, and means to give firms more flexibility in setting workers’ hours.