A Labour Market Perspective of the Austerity versus Growth Debate

The French electoral campaign has been widely read across Europe as a fight between the candidate of austerity and the candidate of growth, as much as these interpretational categories have been used to describe the frictions between Hollande and Merkel, exacerbated during the latest European Council summit. But this debate is misplaced, gives rise to wrong expectations and risks being self-defeating especially for the Left – conventionally falling within the supporters of growth due to its criticism of the recessionary impact of the fiscal compact. The main reason why an austerity versus growth debate is misleading is that it is possible to get austerity by decree, whilst it is not possible to achieve growth by decree.

The “austerity party” is not against growth. It calls for the same type of growth which all governments have tried to achieve over the last decade – through structural reform focusing on liberalization, privatization and employment policies based on the weakening of labour market institutions. By presenting growth as “their policy”, progressives neglect to criticize the type of growth conservative governments think should be achieved.

The question progressives should pose is whether growth can be achieved by way of intervention on the labour markets, as claimed by the ECB and the supporters of fiscal consolidation. Labour market institutions can adapt to global change by making a country more investment- and start-up-friendly. But they cannot actually create jobs out of nowhere. Far from being fuelled by labour market reforms, growth over the last decade among many countries now facing recession was based on asset hypertrophy. When unemployment is cyclical – resulting from credit crunches and cuts in government spending – there is no reason for the private sector to create jobs. Reforms aimed at easing firing can only have the effect of increasing unemployment and further depressing demand as long as the recession is on.

Some empirical evidence might prove useful: Italy – with its large use of atypical contracts at the margin and rather robust protection of standard employment – has experienced an overall limited increase of unemployment since the beginning of the crisis, but the increase disproportionately affected the atypical young workers. Among the under-25 unemployment rose from 20.5% in 2007 to 29.7% in 2011, whilst the increase has been of just 2 percentage points among the over-25. These numbers were negatively outperformed by the countries facing sectoral shocks, such as Spain – which saw an increase of youth unemployment of 30 percentage points – and Ireland – 20 points. Among the Mediterranean countries, flexibility or wage deregulation cannot be further increased at the margin, so where there is the direst need of job creation. Claiming that the Spanish youth do not work due to the rigidity of the Spanish labour market institutions means to deny that the sectoral shock in the construction sector played any role in the current increase of unemployment. An assumption which is at odds with reality.

This suggests that reforms extending or increasing flexibility for standard work contracts, as recommended by the troika to the peripheral eurozone countries, would have little effect on youth unemployment and do not foster growth. They can help job creation when growth picks up – but at the same pace it leads to job destruction in case of a recession. And embarking on austerity all together within a currency union is a recipe for not allowing growth to pick up.

But if the response of the “party of growth” is then to increase demand by way of relaxing budgetary discipline, fundamental constraints persist at the national level. Simply put, borrowing costs in deficits countries are unsustainable. And the assumption that Germany and other surplus countries should boost demand by profiting from negative borrowing costs does not hold: policy-induced reversal of marginal propensity to save relies on very weak empirical evidence, and peripheral countries’ industrial bases will not become more competitive if funds for infrastructure, education, and the quality of administration and the judicial system are subject to cuts, as they are under austerity measures.

This leads to the conclusion that the national level can do very little for growth both on the supply and the demand side, meaning that borrowing costs can only be reduced through the European level. Some well-designed form of debt unification and common issuance would lead to more jobs and growth than any labour market reform. This would imply an increase of Germany’s borrowing costs, even though it is now enjoying negative real interest rates. In other words, if growth has to be demand-sided, the money will have to come from Germany. This explains the disappointing results of the last Council, but this is not a surprise considering that Merkel’s electoral difficulties are likely to increase the toughness of the German position and therefore German isolation. But without this, any proposal for growth would be probably ineffective.