More on Europe from Milton Ezrati

Economic Insights
Will Greece Set Sail from the Euro?

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Video Commentary

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Economic Insights
The Euro's Survival Requires German Engineering

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Audio Commentary
Eurozone Drama: Where Is Blücher?

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Economic Insights
Europe—Will the Greek Election Shift German Direction

For years, labor laws in Spain, Italy, Greece, France, and elsewhere in Europe have come under criticism. The International Monetary Fund (IMF), analysts at the European Union (EU) 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 1.0 percentage point a year off potential real growth rates in these countries, worsening their fiscal imbalances and blocking needed adjustment to the current debt crisis.

It would take volumes to describe all these dysfunctional labor arrangements. Illustrative, however, are the restrictions that France, Italy, and Spain have long imposed on hiring and, especially, firing. It has long been incredibly difficult and costly in these countries to let a full-time employee go. Firms often have to make the case for layoffs in arbitration, even in extreme economic situations. Legally required severance can rise to several years' salary. Such strictures have discouraged hiring altogether or impelled firms to hire only with limited, fixed-length contracts. In such circumstances, the young have had a hard time finding rewarding work, while these economies have lost the benefits of their talents and labor. What is more, older workers have clung to their secure, protected positions rather than follow jobs to faster-growing areas, hamstringing, in the process, firms’ abilities to take advantage of new lines of business.

If these practices, long enshrined in law, have not been enough to block flexibility and productive efficiency, additional rules have further limited the latitude of firms in these countries to adjust working hours, either to meet cyclical ups and downs or even to accommodate seasonal production runs. Companies even have had trouble drawing on the unemployed to meet varying staffing needs. High unemployment benefits, verging, according to the IMF, on 75–80% of the average worker's earnings, make even those out of work reluctant to follow jobs where they appear. Tax laws, by discouraging two-income households, further block flexibility. Called the "tax wedge," these burdens have sometimes claimed more than 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, consequently, a burden on each nation's social welfare system. The IMF estimates that minimum wages in Greece, Spain, and Portugal, for example, verge on 50% of the medium national wage. In France, they verge on 65%.

Unwinding such market impediments will not be easy, and they certainly cannot happen overnight. Still, it is encouraging that several of these nations have used the pressure of the crisis to begin the process. Italy, for instance, in just the past few months, has amended its 1970 labor law to allow layoffs for economic reasons, not just misconduct. Recent reforms also have 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 has 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 the means to give firms more flexibility in setting workers' hours.

The Italian experience speaks loudly to how the crisis has served these reform needs. The country has for years tried to amend its labor law and, until this year, has always failed. Past efforts faced intense resistance from organized labor and huge protests. The last two major reform efforts—one in 1999 and another in 2002—saw the Red Brigades actually assassinate the major reform leaders of the time. This year, there were no killings, the protests were modest (certainly by past standards), and some unions even declined to condemn the reform proposals.

These nations, however, have a long way to go. There will be backsliding, no doubt. Just recently, for example, the Portuguese government has had to cancel plans to make some workers contribute to their own pensions. But the efforts are more of a start than would have seemed possible just a year ago. The changes will also take a long time to have effect. But it is just such longer-term fundamental reform that will redress underlying differences within Europe and so get to the taproot of today's problems. Such reform is also critical if the ECB's monetary help is to do more than just paper over difficulties. To that extent, such remarkable change is even more encouraging than the ECB's welcome, more immediate efforts.