Miguel Fernández Ordóñez: Labour market experiences - towards more
efficient labour markets
Opening speech by Mr Miguel Fernández Ordóñez, Governor of the Bank of Spain, at the
high-level seminar on Labour market experiences: towards more efficient labour markets,
International Monetary Fund (IMF)-Banco de España, Madrid, 11 May 2010.
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Let me first thank you all for accepting the invitation to participate in this high-level seminar
on "labour market experiences: towards more efficient labour markets". In particular I would
like to thank Olivier Blanchard, chief economist at the International Monetary Fund, for
participating in this event and accepting to share with me these introductory remarks.
In fact, the idea of organising this seminar was originally from the IMF, which last autumn
suggested staging this event, mindful as it was of the potential role played by the Spanish
labour market institutions in explaining some of the specific inefficiencies of our economy.
The Fund viewed the conference as a way of promoting discussion about possible avenues
of reform. The Research Department of the Banco de España then took up the IMF's baton,
drawing on its long tradition of sound economic research and deep analysis on this topic.
We are certainly proud to have been able to assemble such an eminent and diverse group of
professionals on the occasion of this event in Madrid. The range of participants and audience
at this conference is precisely something I would like to stress, the main goal of the seminar
being to promote an exchange of views and flow of ideas and thinking among the various
groups having a say on this topic, namely academia, international organisations,
policymakers, social agents and the private sector. Only by covering all the different aspects
and by sharing the different country experiences on this matter can we expect to make the
right diagnosis of the problems and facilitate the acceptance and implementation of the
reforms that might be needed.
As you may be aware, I myself have repeatedly been suggesting the need for a labour
market reform in Spain. But it is not the goal of this conference to act as a platform for
announcing or defending the views of the Banco de España. On the contrary, its spirit is to
incorporate different views into the discussion and promote mutual learning. I should like
particularly to stress the importance of grounding and testing our opinions and proposals in
rigorous analytical and empirical economic research.
The main idea I would like to convey in these introductory remarks is that if during the crisis
economic policies have concentrated - with some justification - on measures that are
intended to have a short-term impact, the time has come to shift the focus onto reforms
which are designed to have only medium and long-term effects but that, through a change in
expectations can provide a shot of confidence, a key ingredient for resuming a sustainable
growth path.
The global economy is certainly recovering from its deepest downturn since World War II.
We have witnessed a period of crisis in which economic policies have reacted in an
unprecedented manner, focusing on countering in the short run the highly adverse economic
and financial situation. Major central banks reacted decisively by providing abundant liquidity
to financial systems and substantially cutting their key interest rates. These standard
monetary policy measures were later complemented by other, non-conventional measures,
to avert the threat of a drastic loss of liquidity in the financial system as a whole and support
the flow of credit to firms and households. Fiscal authorities, in turn, put in place a number of
measures aimed, first, at supporting financial systems and, further, at stimulating demand.
And there is broad consensus that this policy reaction was warranted and has played a
crucial role in halting the risk of collapse and containing the crisis.
After the foundations for a potential turnaround became discernible, the policy debate turned
to the appropriate exit strategies from these expansionary policies. In the case of monetary
policy, the central banks of the main developed countries have already announced - and
begun to implement in some cases - plans to withdraw their unconventional liquidity-support
measures. In the case of fiscal policy the challenge is successfully to apply fiscal
consolidation. That will require a significant effort if public finances are to be set on a
sustainable path.
However, it is also time to shift our focus from the short to the medium and long run and start
to address the structural problems of our economies. There are several arguments justifying
this need for a shift in policy perspective.
First, the historical evidence suggests that output may remain well below pre-crisis trends in
the medium run. The associated losses in capital, employment and total factor productivity
during the crisis could be long-lasting, leaving an enduring imprint on productive capacity.
And medium-term output dynamics may also be affected. In particular, investment has fallen
dramatically in the crisis, resulting in a slowdown in the rate of accumulation of productive
capital. This, when combined with higher rates of capital obsolescence, is lowering potential
growth in the short to medium run. In addition, these adverse effects could persist in the long
run if there is a permanent step-up in the cost of capital due to changes in attitudes towards
risk among investors. These developments may also affect the rate of technological progress
in the long run if, for example, they lessen the incentive to engage in innovative activities.
And we cannot forget the risk of the observed increase in unemployment translating into a
parallel increase in structural unemployment, an issue I will deal with later in my speech.
Therefore, structural reforms appear to be the only available tool to avert the risk of the crisis
exerting more permanent effects on both the level of output and the growth rate of the
economy.
Second, structural reforms cannot be seen in isolation from the other measures that are
needed, in particular those stemming from the exit strategies, but rather as a necessary
complement to them. As an example, the dramatic increase in fiscal deficits and government
debt levels during the crisis, exacerbating fiscal sustainability concerns for a number of
economies, would worsen if output losses were permanent and constrained government
revenues and expenditures in the future. By the same token, growth-enhancing structural
reforms may smooth acceptance of the fiscal adjustment or even reduce its magnitude if they
prove to be effective.
Past experience shows that structural reforms are often adopted in times of economic crisis
or prolonged episodes of slow or negative growth. This contrasts with the generalised view
that it is easier to cope with these reforms, since their costs are generally less painful, and
distributional effects less visible, when the economy is strong and income is growing rapidly.
And the reasons for this cyclical pattern of structural reforms seem to be related to the fact
that crises unmask weaknesses that were hidden by cyclical buoyancy, and these increase,
at least partly, the social support for change.
The labour market is clearly first among the structural reforms that are needed. For one
thing, labour markets play a key role in the functioning of the economy, in particular as a
mechanism for adjustment in the face of adverse shocks. And their functioning has
implications for competitiveness and productivity, two variables crucial for the long-term
growth of any economy and, in particular, for those countries participating in a monetary
union, as is our case. Likewise, there is sufficient evidence that labour market institutions
play a key role as determinants of their sound functioning. In particular, we have evidence
that labour markets have been pivotal in the response of the different economies to the
current crisis. And they can play a central role in the persistence of the negative effects of the
financial crisis in the medium and long run.
During the current recession output and unemployment responses differed markedly across
the advanced economies. For instance, the peak-to-trough increase in unemployment during
the crisis was around 7.5 percentage points in Ireland and Spain, while output dropped by
more than 8% in Ireland and only half as much in Spain. In the same vein, the
UK unemployment rate increased by only 2.5% although output fell close to 6% and
Germany underwent a decline in output of about 7%, but its unemployment rate actually
decreased. This suggests that labour market mechanisms for adjustment in the face of
adverse shocks are not working correctly in Spain, as employment is bearing the brunt of the
adjustment and this entails a high cost, in terms of long-term economic growth and social
well-being. These differences are not only seen in periods of recession, but also in economic
upturns, in the form of diverse levels of unemployment, and of productivity and real wage
developments.
And we know that there are major differences among countries as regards labour market
institutions, thus suggesting that such different unemployment or productivity outcomes may,
at least partly, be driven by regulatory differences. This is why it is important to look at the
experiences of other countries in order to share experiences and to try to draw some
conclusions on the pros and cons of the different institutional settings.
The medium-term effects of the crisis I mentioned before are also particularly dependent on
the functioning of the labour market. First, the crisis may imply the need for a substantial
reallocation of labour across sectors, something that may take time and increase
mediumterm frictional unemployment. Labour market institutions may, of course, play a key role in
galvanising or impeding this process. Think, for example, of a wage-setting mechanism
allowing for sectoral differences versus one that imposes uniform wages across sectors.
Second, long unemployment spells may cause permanent destruction in human capital,
giving rise to the process of "hysteresis" and leading to an increase in the structural
unemployment rate. The concept of "hysteresis" being identified, among the first authors,
precisely by Olivier Blanchard in 1986 in a joint paper with Larry Summers. Of course, this
effect may be larger if rigid labour market institutions complicate the task of finding a new job,
while the literature also finds that the level of the tax wedge or the inadequate design of
unemployment benefits are important drivers of structural unemployment. In addition, a
protracted recession may also reduce the potential labour force by discouraging vulnerable
workers from seeking a job. This effect is again not independent of policies, since there might
be social and financial incentives to stay away from the labour force, and the development in
the past of early retirement schemes for older workers subsidised by governments in some
countries is a good example.
Overall, looking at the research published, three elements of the labour market institutional
setting seem particularly worth looking at as possible determinants of the different outcomes
across countries: first, the legislation on types of employment contracts and unemployment
protection schemes; further, the institutional design of collective bargaining; and finally,
active labour market policies and labour market intermediation mechanisms. These three
elements broadly correspond to the current structure of this seminar, and will therefore be
treated in one way or another.
Let me conclude with two final points on the link between labour market reform and other
policy measures. First, labour market reform is also the best case where the
complementarities with the exit strategies needed are most obvious. If we take the Spanish
case as an example, we can see that unemployment benefits amounted to around 3% of
GDP in 2009. And the employment losses associated with this increase in unemployment
have also had a significant negative impact on public revenues. Thus, a non-negligible part
of the huge increase in the deficit in the past two years is directly or indirectly related to
labour market trends. Preventing this increase in unemployment from becoming structural
would greatly smooth the fiscal consolidation process.
That leads to me to emphasize a second point: it is important that different reforms should be
pursued in unison, and in particular that labour market reforms be accompanied by product
and services market reforms. In this regard, it is vital to push through structural reforms
providing for the elimination of obstacles to effective competition and of those that may
hamper the reallocation of productive resources. Indeed, only with competitive and flexible
product and services markets, would labour market reforms translate into higher activity and
employment rather than higher rents. Also this broad comprehensive reform approach can
help create the consensus that is needed for reform, as different actors perceive more clearly
the benefits of a comprehensive reform package, and not only the costs to them of specific
reforms. Some good examples of the benefits of this comprehensive approach are Denmark
or the Netherlands, countries that adopted a mix of labour market, public finance and product
market reforms that complemented and reinforced one another.
I do not want to take up any more of your time with these opening remarks. Let me simply
thank you once again for sharing your thoughts with us. Here's wishing every success for the
conference. Now Professor Blanchard will complete these introductory remarks. Olivier, the
floor is yours.