Fiscal Austerity and its Implications for Europe’s Youth Employment Crisis

Youth unemployment has reached disturbing proportions in advanced economies and most notably in the Euro zone.[1] This has emerged against the grim background of a lingering recession. Growth in the Euro zone has been virtually zero in the most recent quarter. Spain and Greece have the dubious distinction of having more than 50 per cent of their young people without a job.

As is well known, failure to find a job following a downturn can impose long-run ‘scarring’ effects on young people. These effects are manifested in reduced employment and earnings opportunities that can last decades. Young people with limited skills and from disadvantaged backgrounds are particularly vulnerable to ‘scarring’ effects. There are also well known social costs associated with high and persistent youth unemployment: higher incidence of unhappiness, higher crime rates, higher inequality, higher fiscal costs in terms of foregone output and lower tax revenues, and higher political and social tensions.[2]

A recent study by the ILO has shown that the increase in youth unemployment rates between 2009 and 2011 in the OECD tends to be higher for economies which have undergone strong fiscal tightening.[3] Simple regression estimates suggest that a one percentage point increase in the structural (cyclically adjusted) fiscal balance is estimated to raise the youth unemployment rate by 1.5 percentage points.

This estimate might seem higher than the one reported in an IMF study in which a one percentage point change in fiscal consolidation for a sample of 173 cases of OECD countries is associated with a 0.5 percentage point increase in the overall unemployment rate.[4] On the other hand, it is well known that the youth unemployment rate is much more sensitive to downturns than the overall unemployment rate.[5] Hence, the finding reported here is consistent with this pattern.

Critics might argue that the causal link between fiscal austerity and the youth employment crisis in Europe is misplaced. This is because poor youth employment outcomes are primarily the product of structural factors, such as a skills mismatch, onerous labour regulations and a poor business climate that constrain employment opportunities for young people. The menu of policy recommendations that follows from such a perspective concentrates on supply-side measures, such as reducing the skills mismatch, reforming labour market institutions and improving the business environment.

Structural factors are useful in understanding levels of youth unemployment, but they do not necessarily explain recent trends in youth unemployment. It is difficult to argue that the skills mismatch has worsened significantly between now and 2007. Indeed, a recent study undertaken by the Federal Reserve Bank of Chicago finds that there is ‘…limited evidence of skills mismatch’ in the US labour market.[6] Furthermore, the dominant trend is a reduction, rather than an increase, in employment protection legislation across a large group of countries and especially in the advanced economies.[7] Similarly, it is difficult to argue that the business environment in terms of red tape and bureaucratic impediments have worsened significantly in the EU in the aftermath of the 2008-2009 global financial and economic crises. What has changed is a decisive shift from fiscal stimulus to fiscal consolidation between 2009 and now. Sadly, the costs of this shift are being borne disproportionately by young men and women.