Pay for delay

Economics focus

Nov 5th 2009
From The Economist print edition

Wage subsidies and fatter jobless benefits have softened the impact of the recession but may yet hurt recovery

AMERICA may lead the rich world in periods of prosperity, but Europe has shown a greater talent for dealing with recession. Unemployment in the euro area has risen by 30% from its pre-crisis levels. America’s jobless rate has more than doubled. In Germany, the largest country in the euro zone, output fell far harder than America’s during the worst months of the crisis but Germany’s unemployment rate barely rose. Consumer spending has held up surprisingly well in a country where high saving is the norm even in good times. “Germany is calm,” says one official with satisfaction. By comparison, America is deeply troubled.

What explains the resilience of continental Europe? Some of it was already built-in. Job-protection laws make it costly for firms to lay off workers, and where posts are sacrificed, the newly unemployed are preserved from penury. They receive benefits worth around two-thirds of their lost salaries in most countries. Only in Italy are benefits anywhere near as skimpy as in America and Britain, where new claimants receive just 28% of their previous earnings. European governments also have fewer qualms about intervention. A new report from the OECD identifies 14 kinds of job-market initiatives put in place since recession struck. France ticks 12 of those boxes, more than any other country.

One policy in particular has helped keep a lid on unemployment. Schemes that subsidise the wages of employees working fewer hours than normal were introduced or expanded in 22 of the 29 countries surveyed by the OECD. Germany had around 1.4m workers on its short-time working scheme by the summer, equivalent to a cull of 400,000-500,000 full-time workers. That would add one percentage point to the jobless rate. Countries without these arrangements, such as America, Britain and Spain, have tended to suffer bigger rises in unemployment (see chart).

In normal times, wage subsidies would be frowned upon. But in a credit crunch they can be a smart use of fiscal resources. Firms worried about future sales, low on cash and deprived of credit, may too readily fire workers without a subsidy. That would only add to a downward spiral of confidence and spending. In Europe, the state funds generous jobless benefits in any case. Why not instead make it easier for firms to hoard workers and keep a skilled workforce intact for when the economy turns?

All policies have drawbacks, and those that help economies to absorb a shock will also tend to make the damaging effects linger. Subsidising jobs that are no longer viable will hold back recovery. The flow of workers from dying industries to new ones may be blocked. If sustained for too long, short-time working schemes can become artificial props for industries that need to shrink. A scheme in Spain, say, to pay construction firms to hoard workers would be madness when there is a glut of empty homes.

Firms may also be tempted to use wage subsidies as a cheap way of keeping their options open at the government’s expense. A well-designed scheme can curb this. In the Netherlands, businesses that lay off workers within three months of the scheme’s end have to pay back half the subsidy. The more workers that firms register for support, the sooner the subsidy runs out. A Swedish policy to prevent lay-offs due to weak cashflow looks even smarter. Instead of wage support, Sweden gives its firms the option to delay their social-security contributions. A punitive interest charge for firms receiving such help would root out all but the truly distressed. Other countries have trimmed their taxes on jobs in addition to (or instead of) wage subsidies.

Working hypothesis

Another way of softening recession is to expand the welfare system. Around half of the rich countries in the OECD survey have done so since the crisis began—by raising benefits, making it easier to claim them or providing for longer. Extra money for the jobless is an effective stimulus measure since cash-starved households are likely to spend it. But if benefits are kept high for too long they will make the jobless less keen to search for work. One way of striking a balance between short-term stimulus and long-term incentives is to increase the value of benefits but withdraw them sooner. That is what Poland and the Czech Republic have done. The recession’s length has forced America’s government to do the opposite. It used to offer just six months of jobless benefits, but has extended its support to stop people falling into poverty.

It may seem heartless to counsel against too much support for the unemployed but incentives matter even when unemployment is high. Firms in rich countries make hires equivalent to some 14-15% of all employment in deep recessions, according to the OECD. (Net job creation falls because there are more lay-offs.) More generous benefits will mean vacancies are filled less quickly, pushing up unemployment. Active help for those on benefits—training, counselling and so on—can also be neglected in recession. Switzerland and Denmark link spending on such policies to their jobless rates to ensure that a fixed amount of spending is not shared between a larger pool of unemployed.

Evidence from past deep recessions suggests that unemployment is unlikely to fall as quickly as it has risen. Indeed further increases seem likely in Europe, because jobs have not adjusted much to a lower level of GDP. In those circumstances, the temptation to prolong wage subsidies and buttress benefits will be great. It should be resisted. The unemployment rate in the euro area has risen far less than America, but both are now close to 10%. Pre-crisis rates in Europe were higher precisely because of its rigid jobs markets. It would be a shame if measures that have helped mitigate crisis were left to spoil prospects for recovery.