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Saturday, February 24, 2007

Maximizing Flexicurity: Finding the Optimal Mix of Flex and Security

Louis Uchitelle of the NY Times says there is reason to doubt the claim that labor market protections in Europe and Japan explain most of the differences in output growth and other measures of economic performance between Europe, Japan, and the U.S.:

Job Security, Too, May Have a Happy Medium, by Louis Uchitelle, NY Times: For more than a decade, many American economists have pointed to Europe and Japan as prima facie evidence that layoffs in the United States are a good thing. The economies in those countries were not nearly as robust as this country’s. And the reason? Too much job security...

American employers, in sharp contrast, have operated with much more “flexibility.” Hiring and firing at will, they shift labor from where it is not needed to where it is needed. ...

This shuffling out of one job and into another shows up in the statistics as nearly full employment. Never mind that the shuffling does not work as efficiently as the description implies or that many of the laid-off workers find themselves earning less in their next jobs, an income roller coaster that is absent in Europe and Japan. A dynamic economy leaves no alternative, or so the reasoning goes among mainstream economists.

“Trying to prevent this creative destruction from happening is a recipe for less economic growth and less productivity,” said Barry Eichengreen ... at the University of California, Berkeley.

Starting in the mid-1990s, Europe and Japan did wallow in recession or weak growth while the American economy expanded at a spectacular clip. But no longer. Growth is slowing in the United States just as it speeds up in the 25-nation European Union and in Japan. Unemployment rates in those countries are also beginning to come down...

As the gaps close, does that mean that job security, in the European and Japanese style, is the right way to go after all? The question would be easier to answer if the European Union countries and Japan had stuck to their orthodox job security. They have not. On their way to revival, they adopted some of America’s practices.

“A number of countries have found ways to make their labor markets more flexible, without sacrificing their greater commitment to a government role in equalizing incomes,” said Paul Swaim, a senior economist at the Organization for Economic Cooperation and Development in Paris.

So the old dichotomy — insecurity versus security — is gradually giving way to a new debate. “It is obviously the right mix of security and insecurity that has to be achieved,” said Richard B. Freeman ... at Harvard...

The guideposts in this search for the right mix should not be just economic growth rates and unemployment levels. These are too often affected by business cycles. Many American economists, bent on demonstrating the payoff from layoffs, paid relatively little attention to the cyclical reasons for the underperformance of Japan and Europe. “Sometimes we forget these cyclical forces,” said Sanford M. Jacoby ... at the University of California, Los Angeles. ...

Cycles count. But so do labor policies.

In some European countries, employers are using temporary and part-time workers much more than they did in the past. That gives them leeway to expand and contract their work forces without having to add full-timers who are protected against layoffs. ...Japan ... also relies for “flexibility” on part-timers and temps.

If cost-cutting is necessary in Japan, there is a pecking order, says Yoshi Tsurumi, an economist at Baruch College in Manhattan... Dividends are cut first, then salaries — starting at the top. Finally, there are layoffs — if attrition is not enough to shrink staff. “The matter of flexibility is important,” Mr. Tsurumi said, “but the Japanese notion is to retrain and transfer people within an organization.”

Elsewhere, France and Germany have eased job protection for employees of small businesses. ... And the Danish model is getting a lot of attention. Employers in Denmark are relatively free to lay off workers, but the state then steps in with benefits that replace 70 percent of the lost income for four years. Government also finances retraining and education, pressuring the unemployed to participate and then insisting that they accept reasonable job offers or risk cuts in their benefits.

The Danish government devotes 3 percent of the nation’s gross domestic product to retraining, compared with less than 1 percent in the United States. And, of course, everywhere in Europe, the state pays for health insurance and for pensions that often encourage early retirement by replacing big percentages of preretirement income.

“What the Europeans and the Japanese understand is that modern economies can sustain social protections without killing the golden goose,” said Jared Bernstein, a senior economist at the Economic Policy Institute in Washington.

That is an understanding that perhaps will take root among American economists and policy makers, deprived as they now are of their long-running contention that job security resulted in weak economic growth in Europe and Japan.

Here's a pretty lukewarm endorsement of the flexicurity model in a working paper from Jianping Zhou at the IMF. The paper makes a point similar to a point made above, that part of Denmark's success has been from reforms since the 1980s giving people an increased incentive to train for and take new jobs. In particular, eligibility for programs has been tightened while the time people are allowed to be on some programs has been shortened. Still, relative to many countries, the programs offer substantial income protection:

Danish for All? Balancing Flexibility with Security: The Flexicurity Model, by Jianping Zhou, February 2007: ...V. Concluding Remarks The Danish flexicurity model has been widely praised for its association with a low unemployment rate and a high standard of social security for the unemployed. The model combines a high degree of labor market flexibility with a high level of social protection. While most European countries are facing chronically high unemployment rates and the needed labor market reforms often face strong political opposition, the flexicurity model looks increasingly attractive to policymakers in Europe.

However, whether the Danish model should and can be adopted by other European countries to reduce unemployment is not obvious. First, Denmark has traditionally had a combination of a flexible labor market and a high level of income protection. Economic performance under this system has varied, as demonstrated by the economic crisis during the early 1980s and the remarkable labor market performance in recent years. Second, other countries have been able to reduce their high unemployment rates to low levels with rather different social models (e.g., Ireland, Sweden, and the United Kingdom). Finally, generous unemployment benefits often raise moral hazard issues that might hinder effective implementation of the Danish model. In this regard, a strict job search requirement and tight eligibility criteria for unemployment benefits are key.

The Danish model is costly. The tax burden in Denmark is heavy because of the need to finance the country’s high spending on labor market programs and unemployment benefits. As most countries that are tempted to adopt the Danish model will typically start from a high unemployment level, a move toward the Danish model will, in the short run, trigger a sharp increase in the cost of unemployment benefits and active labor market policies, thereby widening the tax wedge, with an adverse impact on labor demand and supply. This implies that the Danish model may not be suitable for countries facing high unemployment and budgetary difficulties. Using a calibrated model for France, the paper finds that implementation of the flexicurity model could be costly, and reduction in structural unemployment during the first few years might be limited.

Nonetheless, certain key aspects of the Danish model could usefully be studied and considered by other countries. Among others, they include the various relationships between the population’s willingness to accept labor market flexibility, its confidence in a well functioning social safety net, and the accompanying need to develop effective labor market policies in order to avoid high costs and perverse incentives. The Danish government’s constant awareness and analysis of the challenges facing the flexicurity model and its ability to respond to them with policy actions are noteworthy in this regard. For instance, since the economic crisis in the early 1980s, reforms have been implemented to shorten the maximum period for participation in active labor market programs and tighten the eligibility criteria for unemployment benefits.

    Posted by on Saturday, February 24, 2007 at 05:51 PM in Economics, Social Insurance | Permalink  TrackBack (0)  Comments (43)

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