Tuesday, June 4, 2013

Only A Crisis Will Solve Europe's Youth Unemployment Problem

“President François Hollande of France called Tuesday for “urgent action” to tackle alarmingly high rates of youth unemployment across the European Union, saying that mounting disillusionment among the “post-crisis generation” threatened the very future of the European project. “We need to act quickly,” Mr. Hollande told a gathering of government officials, business leaders and students in Paris. “In this battle, time is the decisive factor.”--New York Times, May 31st.

Europe has scheduled a summit conference this month to focus on one of its most worrisome problems: youth unemployment, which ranges between 25% and 50% in the south. The solution, they will conclude, is a EUR 6B program of targeted government programs to improve the employability and mobility of young people. (That’s EUR1000 per unemployed youth.)

If there is one word that should be eliminated from any policy discussion these days, it is “targeted government program”. Targeting is what ignorant people do when they have chosen to ignore the consequences of their policy choices. Policy determines the level of youth unemployment, not the absence of targeted programs. Targeting is inherently aimed at symptoms and cosmetics, not policy correction.

Europe’s malady is caused by the lethal combination of inflexible nominal wages, a falling price level, and a strong currency. Effective labor costs in the eurozone periphery rose quite dramatically following EMU. Prior to EMU, these countries used inflation and currency depreciation to permit rising nominal wages. Post-EMU, nominal wages have risen faster than prices at the same time that the currency has remained strong, this resulting in real effective wage appreciation. Adam Smith would say “No problem: wages must fall, and those who are overpaid must be replaced by cheaper workers.” But Adam Smith never saw a European labor law.

Under European labor law and custom, nominal wages rise, wages increase with seniority not productivity, entry-level positions (including benefits) are priced much too high to make hiring economic, and overpaid unproductive labor at all levels of the enterprise is protected. The millions of young unemployed workers who would happily work for one denarius are priced by law at three denarii, and no one is buying at that price. If businesses hire at all, they opt for temps, contractors or employees off the books. Once you really hire someone, you have to pay them a lot of money, give them full social benefits, and promise never to sack them for any reason.

Is there a way for Europe to reduce real wages despite rigid nominal wages? Yes: by causing prices to rise faster than wages, i.e., real wage depreciation, plus a weaker currency. This is how Southern Europe was able to remain competitive prior to EMU despite labor market rigidities.

Now, if you were to ask the ECB or the Bundesbank about this problem, they would answer that the peripherals have all made substantial progress in reducing labor market rigidities through structural reform, which would be nice if it were true. But it isn’t true and in fact it wouldn’t even be necessary if the Southern Europeans could resume their time-tested inflation/depreciation regimes. Go to Barcelona and ask the owner of a factory about how labor market reforms have allowed him to hire more young people.

So what is the outlook for youth unemployment in Southern Europe? That is easy to forecast: it will rise until the political system cracks.

I would call your attention to the increasing hostility in Europe to non-European immigrants. These foreigners were welcome when the economy was booming, but now they are seen as alien parasites competing with native young people. The unskilled jobs that were once available to native youth have been taken by immigrants, who will work longer hours for less and have limited “rights”. 

The combination of rising youth unemployment and the growth of immigrant communities has resulted in rising civil disorder. Rising civil disorder will accelerate the cracking of the political system, which can’t come too soon. Ironically, the political legitimacy of Europe’s system of government is postponing the needed political crisis. Less legitimate regimes would have crumbled sooner.

The sooner Europe’s political system fractures, the sooner the authorities will be forced to reflate, which will solve the problem. The US underwent deflation for almost four years (1930-33) and lost a generation. How many generations can Europe afford to lose?


Jason Norin said...

Unemployment should be dealt with accordingly. Having been secured by an income insurance is important but without addressing the main issue, we won't have a peace of mind.

Naum Franpos said...

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