On Friday, Eurostat, the statistical office of the European Union, announced that the unemployment rate in the euro area continued to fall in May, from 10.2 to 10.1 percent. While this constitutes a considerable recovery from its high of 12.1 percent in the second quarter of 2013, there is still a long way to go back to the pre-crisis level of 7.3 percent. Moreover, this number shrouds the highly diverse situation within the euro area, with Germany and Greece sitting at the two ends of the spectrum. Both countries entered the crisis with an unemployment rate of 7.5 percent in the second quarter of 2008. After a minor bump in 2009, the German labour market consistently strengthened and now stands at an unemployment rate of 4.3 percent in the first quarter of 2016. This development is mainly attributed to increased wage flexibility due to the so-called Agenda 2010 and the extended use of short-time labour subsidies during the crisis (e.g. Rinne & Zimmermann, 2012 and Krause & Uhlig, 2012). Once been labeled Europe’s “sick man”, Germany now has had the lowest unemployment rate in the euro area for more than two years. Greece, on the other hand, has fallen into a deep depression, intensified by the Greek government-debt crisis and, as argued by many, darkened by austerity policies (just whether budget cuts or tax hikes have been more devastating depends on whom you ask, for example Paul Krugman or John Cochrane). The unemployment rate mirrors this crisis, rising to a shocking peak of 27.9 percent in the third quarter of 2013 and recovering at a slower pace than the Eurozone average, considering pre-crisis levels, decreasing to 24.3 percent in the first quarter of this year. The youth unemployment rates (capturing the unemployment share of the active population younger than 25) present a similar picture.
While Germany historically had a lower-than-average youth unemployment rate, it further declined to 7.1 percent from 10 percent in 2008. In Greece, youth unemployment climbed from its low of 20.9 percent in 2008 to a dreadful 59.9 percent in the first quarter of 2013 and remains high at 51.1 percent in the frist quarter of 2016. But although youth unemployment is surely tragic for those affected and distressing for societies and has been identified as a priority issue to be resolved by European leaders (prominent examples being ECB president Mario Draghi and German chancellor Angela Merkel), one thing is worth pointing out: There seems not to have been a structural break in the relationship between youth and total unemployment in the euro area in the aftermath of the crisis, with the ratio between the youth and the total unemployment rate staying remarkably stable at approximately 2.1. In Greece, this ratio even fell from about 2.8 before the crisis to roughly 2.0 in recent quarters (Note that this number is likely biased downwards by emigration of young Greek workers). These figures suggest that the Eurozone does not face a unique youth unemployment crisis but rather has to tackle general labour market disintegration.
Obviously, the unemployment rate only serves as an indicator and cannot depict the state of an economy in its entirety. It describes the share of employed individuals of the active population, where the active population or labour force includes both employed and unemployed people. To count as unemployed in a statistical sense, an individual has to be currently without work, available to work in the near future and actively been looking for work in the recent past. If workers who are available are so discouraged that they stop looking for work, they drop out of the labour force and cause the unemployment rate to underestimate the slack in the economy. But while this effect has been discussed broadly as a problem in the US (e.g. Erceg & Levin, 2014 and Fujita, 2014; I plan to write about this issue in a future post), it appears not to have had an impact in the euro area, where activity rates have not been caused to fall by the crisis. However, unemployment rates might still misrepresent the labour market situation if workers who are accounted for as “employed” work less or in less-qualified jobs than they would like to.
Before the crisis, Greece had an employment-to-total-population ratio of 76 percent among the 25 to 54 years old, with 1.6 percentage points accounted for by part-time underemployment, denoting people who work less than they want to (Looking at this “prime-age” demographic prevents being misguided by educational or retirement trends). While the employment ratio fell to 65.4 percent in the fourth quarter of 2015, the “sufficient” employment ration, ignoring part-time-underemployed individuals, plunged even more steeply from 74.4 to 61 percent, with part-time underemployment rising from 1.6 to 4.4 percent. This rise in underemployment continued throughout the recovery since the end of 2013. Germany, on the other hand, started out with a higher employment ratio of 81.1 percent, almost exclusively due to a much higher part-time underemployment rate of 5.7 percent, commonly attributed to the aforementioned Agenda 2010 (e.g. Hassel, 2014). Since then, sufficient employment climbed from 75.4 to 80.2 percent, accelerated by a drop of part-time underemployment to 3.2 percent. Considering these statistics, the discrepancy between the labour market developments in Germany and Greece appear even more substantial. Even more so given that Eurostat only records part-time underemployment and does not account for underemployment due to overqualification which likely has developed in a similar way.
Despite the vast differences between the Greek and the German economies, represented by its labour market statistics, the European Central Bank is commissioned to devise a monetary policy that fits both of them. To illustrate this dilemma in a very simple way that should, of course, only be understood as an intellectual game, consider the central bank policy rule by Taylor (1993):
r = p + 0.5y + 0.5(p – 2) + 2
where r is the target rate, p the rate of inflation, y the output gap in percent and the consistent inflation target 2 percent and normal nominal interest rate 4 percent. The output gap can be approximated by utilizing Okun’s (1963) law, which states that a one percentage point increase in unemployment rate leads to a roughly two percent decrease in output. Conservatively assuming that Greece has a high unemployment rate of 10 percent at full employment (due to a high structural unemployment) while presuming that the German economy already runs close to full capacity and reaches full employment at four percent, output gaps of about 24 and 0.6 percent can be derived, respectively. Plugging in the average inflation rates over the last twelve months provided by the OECD (-1.2 and 0.2 percent), the formula yields central bank target rates of -14.8 percent for Greece and 0.7 percent for Germany. Considering substantially higher normal nominal interest rates for Greece, for example due to higher expected growth paths and intrinsically lower utility discount factors, only changes the results in magnitude. Again, these figures are not meant to be accurate and clearly are not very realistic but they serve to illustrate the trade-off the ECB faces when deciding on a monetary policy to fit all its member states’ economies. A policy that is still too restrictive for Greece might already cause an overheating of the economy and the development of financial bubbles in Germany.
The lack of competitiveness is often identified as the core problem that causes these vast differences between economies in the euro area (i.e. Sinn, 2014). This theory posits that labour productivity (measured by unit labour costs) in the periphery countries is too low in comparison to the core countries. It is hard to test differences in labour productivity, however. Simply dividing hourly labour costs by hourly productivity yields the labour share of output which per se allows for no inference about labour productivity. However, one can look at the development of unit labour costs within countries. According to the OECD, since 2008, unit labour costs have increased by roughly 16 percent in Germany and decreased by about 5 percent in Greece and they still seem to move in the same directions. This is a strong indicator that labour productivity has been initially and probably still is too low in Greece to be competitive. In the traditional case with flexible exchange rates, this discrepancy is resolved by a depreciation of the currency of the relatively unproductive country. If both countries are members of the same monetary union, however, this process has to be replaced by wage deflation in the unproductive and wage inflation in the productive country and a catch-up effect in productivity. But while exchange rates can adjust very quickly, wages tend to be sticky, especially downwards and changes in productivity evolve slowly (Looking at Greece, labour productivity fell in recent years). This can lead to a lengthy and economically dreadful adaptation process before the initially unproductive country regains competitiveness. In a fiscal union, this process can be additionally accompanied by a subsidy program to ease economic distress (A prime example is the west-to-east transfer in reunified Germany after 1990).
In the current European political environment it can be assessed as highly doubtful that anytime soon the euro area will be embedded in a fiscal union that can compensate economic disparities between member states like the one that can be observed between Germany and Greece. It remains to be seen how long it will take Greece, still affected by austerity policies, to adjust economically through the channels of wage deflation and productivity growth and if its labour market indicators can again match Eurozone averages in the not-too-distant future. Until then, a look at Greek and German labour markets helps to understand the economic (as well as political) distress the Eurozone faces.
Erceg, C. J., & Levin, A. T. (2014). Labor force participation and monetary policy in the wake of the Great Recession. Journal of Money, Credit and Banking, 46(S2), 3-49.
Fujita, S. (2014). On the causes of declines in the labor force participation rate. Research Rap Special Report, Federal Reserve Bank of Philadelphia, 6.
Hassel, A. (2014). The paradox of liberalization—understanding dualism and the recovery of the German political economy. British Journal of Industrial Relations, 52(1), 57-81.
Krause, M. U., & Uhlig, H. (2012). Transitions in the German labor market: Structure and crisis. Journal of Monetary Economics, 59(1), 64-79.
Okun, A. M. (1963). Potential GNP: its measurement and significance. Yale University, Cowles Foundation for Research in Economics, pp. 98-103.
Rinne, U., & Zimmermann, K. F. (2012). Another economic miracle? The German labor market and the Great Recession. IZA Journal of Labor Policy,1(1), 1.
Sinn, H. W. (2014). Austerity, growth and inflation: remarks on the Eurozone’s unresolved competitiveness problem. The World Economy, 37(1), 1-13.
Taylor, J. B. (1993). Discretion versus policy rules in practice. Carnegie-Rochester conference series on public policy (Vol. 39, pp. 195-214).
This article was partly inspired by a great visualisation piece by the Financial Times.
written by Jonas