Unemployment: EMU Policymakers Focus On The Wrong Problem

Last week François Hollande lifted the veil on the much-awaited measures for tackling French unemployment (3.6m/10.6%), defined as a “national emergency”. The plan made the news mostly for the pledge to soften the famous 35-hour working week, which nevertheless remains vague. Besides that, the plan consists of two legs: the first is an attempt to fight the loss of skills of long-term unemployed workers by financing training programs. The plan also strengthens in-job training, a program that was successful in the past. The second leg is an attempt to boost low-skill employment, by subsidizing SMEs hiring workers at close to the minimum wage.

Commentators have immediately noticed that the resources allotted to these measures, around €2bn, are vastly insufficient – negligible compared to other plans like the “Pacte de Responsabilité” launched in 2014, that was worth twenty times as much (and that so far has not worked as hoped). In spite of its disappointing size, at least two things have to be welcomed in the announcement. The first is the dramatization of unemployment. While policymakers across Europe engage in a desperate race to show who looks more upbeat about the economy, probably in a vain attempt at invoking the confidence fairy, Hollande’s gloomy words are a much-needed call for realism. The state of the economy is dire, and unemployment in many parts of the old continent is stuck at levels that are simply unacceptable.

The second positive aspect of the announced measures is the recognition that the persistent weakness of the economy is creating a serious long-term problem. The academic literature pays increasing attention to the permanent effect of prolonged downturns that destroy skills and capital accumulation, hampering the capacity of the economy to grow in the long run. The work of Summers, Fatàs, and De Long among others, shows that bold countercyclical measures are needed not only to fight recessions, but also to sustain the potential growth rate of the economy. The obvious policy conclusion stemming from this recent research is that it is better to err on the positive side, and to overreact to a recession, than to be inertial and let the economy slip into a semi-permanent state of sluggish growth. Thus, the announced strengthening of active labour market policies has to be welcomed, even if it is probably insufficient in scale.

Yet, it is hard to cheer Hollande’s new plan, which once more fails to challenge the dominant Eurozone narrative on unemployment. Since 2010 France has been tackling unemployment as if it were mostly a labour market problem, thus trying to tamper with incentives to work or to hire, with labour costs and/or with (sometimes admittedly excessive) regulation. This narrative fails to see that the roots of unemployment often are to be found outside the labour market, in a stagnant economy. As most surveys show over and over again, labour market rigidities are not the main source of concern for European firms, which rather point to insufficient demand and tight credit as the primary reasons for their unwillingness to hire. It is maybe worth remembering that J.M. Keynes labeled his theory as “General” precisely because it highlighted the connections between markets. And in his famous chapter “on wages” the British economist warned about excessive emphasis on labour markets when tackling unemployment, a “derivative phenomenon” of insufficient aggregate demand.

The European economy seems to be stuck precisely in a Keynesian warp, with an aggregate demand deficit that is becoming chronic, with monetary policy that has lost traction in spite of the ECB’s heroic efforts, and with the rare signs of private spending recovery likely to be reversed as the global context becomes increasingly complicated. Such a situation calls for less tampering with labour markets, however necessary it may be in normal times, and more policies to support aggregate demand. France will actually do the opposite, as the cost of the new measures for the labour market will be covered by reducing expenditure elsewhere, thus further depressing aggregate demand.

The excessive focus on labour markets and on supply side measures, by no means peculiar to France, signals that the lesson of the crisis has not been learnt. The large political capital that European leaders have spent in reforming their labour markets could and should have been spent in trying to trigger a change of narrative in Europe, towards adopting a less ideological and more effective policy mix. We are not talking about uncharted waters. US pragmatism and policy coordination could serve here as a blueprint for effective policy action.