More on firing costs and unemployment during the crisis

My previous post has apparently produced some incomprehension. I thought it was a rather simple point, but I guess I should have been less telescopic.

Here is the point.

Spain’s unemployment has doubled since 2008, going from 10 percent to 20 percent. That is a hell of a shock to labor demand. Let’s assume, quite reasonably, that this shock to labor demand was unanticipated. Now, if the hiring costs were at all binding during this time, firms must have laid off fewer workers than they would have liked absent those costs. In other words, the unemployment rate would have risen even higher without firing costs.

If we now remove those firing costs, we make it easier for firms to shed the extra workers they have on their payroll. So unemployment has to increase.

Some commentators have the idea that with firing costs gone, the steady-state labor demand will be higher. I am not sure the empirical literature has established that point, but let me grant it for the purposes of the argument. So in principle some of the increased ability to lay off workers can be compensated by the desire to hire more workers since labor costs effectively have been reduced.

Can the second effect dominate the first? I don’t know. But given the magnitude of the negative demand shock during this crisis, I doubt it.

In any case, I find it weird that this policy is presented as a major tool for curing what ails labor markets at the moment.

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1. I think your assumptions are sound, and the conclusion too.

2. Rigid labour markets, however, may be a medium-turn problem as long as they hurt competitiveness. But this need not be the case, as we can see from Scandinavia, high degree of unionization, a broad set of labour market rigidities, and collective bargaining rather than flexible wage-setting led to increased competitiveness over a period of 50+ years. This again led to increased employment.

A good introduction to the issue would be an article by Karl Ove Moene and Mmichael Wallerstein published in Development Outreach in 2005. Unfortunately, I can not find it anymore...

[adam]

“Now, if the hiring costs were at all binding during this time, firms must have laid off fewer workers than they would have liked absent those costs.”

Here’s what you don’t get: the hiring costs being higher during this time would have meant that they would have HIRED less workers! It’s simple: if apples are too expensive, people eat fewer apples. If hiring costs are high, people hire fewer workers. That’s why unemployment increased WHEN THE LAW WAS IN PLACE!

And, moreover, your claim that fewer firings would have taken place is kinda silly. Businesses don’t fire people because bosses are sadists; they fire them because they NEED to cut costs to continue to operate profitably. If they can’t fire the people they need to fire to survive, they won’t just continue to operate and lose money, they’ll go out of business altogether, and in the process, cause even more unemployment by having the entire firm shut down. Had the costs of firing been lower, they may have fired a few workers and continued operating with many other workers. Thanks to stupid labor laws, the entire workforce of the firm is now unemployed.

This is what you macroeconomists continue to miss. You somehow continue to assume the world is obliged to operate according to your pie-in-the-sky aggregate models. In reality, in the real world, where everyone other than macroeconomists lives, none of these aggregates exist. Business functions based on straightforward financial analysis of costs and benefits of decisions. If you make hiring and firing too expensive, you’re going to destroy entire businesses and cause more unemployment.

Which brings me to an important question to you: The unemployment increased from 10% to 20% and this, as you mention, is a huge shock to the labor market. But it happened while these laws were in place: Can you honestly look me straight in the eye and tell me that this law didn’t EXACERBATE the problem of unemployment? Do you honestly think if this law was not in place, that more people would have been laid off? Really?

Look, after the economic bust happened, there needed to be major adjustments in the structure of the economy. A lot of people working in some of the over-bloated bubble sectors (thanks to expansionary monetary policy!) have to leave these sectors and move to new jobs. Basically, construction workers need to stop building houses no one wants and start working in restaurants, factories or do other useful stuff. You need labor market flexibility for this to happen. You NEED the construction companies to lay off a lot of workers, and you NEED restaurants and factories to hire a lot of them. This isn’t pretty, it’s not fun, and it’s not going to be easy for a lot of these people. And that’s precisely why monetary policy shouldn’t have idiotically inflated these bubbles in the first place. But now that monetary policy has blessed us with its infinitely wisdom and inflated these bubbles, the bubbles have burst and there’s no choice but for this correction in the labor market to happen. And any laws that restrict the freedom of people to hire and fire workers will simply delay the inevitable adjustment.

Finally, this is a bit off topic, but it’s a pet-peeve of mine so I’m going to have to say it. You said: “Let’s assume, quite reasonably, that this shock to labor demand was unanticipated.”

Now, I hate to be the one to break this to you, but the ‘shock’ being unanticipated matters to no one whatsoever in the real world; it only matters to you and your irrelevant Keynesian models. Sure, this kind of stuff helps you get tenure in Harvard, but no in the real world should ever pay any attention to it.

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[Riaz]

I could not read the original news. I see different effects of the cost reduction:
a) reduced cost of hiring would let employers hire and fire easy--- this should generate more flexibility.
b) Hiring would take place based on demand for real work/ real production--- the signals would flow more smoothly than dictated by a rigid/secured hire and fire framework

The effects discussed in this post looks very straightforward and I think it is important for one to appreciate that some of the policy proposals are perhaps response to the severity of the current situation and hence reflect good intuition.

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[Unemployed spaniard]

You have to consider two issues:

First,The point is that of duality. In spain you have a dual labour market with two third of the people on stable contract and one third on unstable contracts with very low firing costs. The problem is that the second group suffers the whole adjustment and makes unemployment extremely countercyclical. Moreover, it creates an insiders outsiders structures, where the outsiders are highly underrepresented in unions- this has made, for instance, that wages were still rising in 2007. The aim of the reform is to close the gap.

Second, the problem is that right now Spain is confronting a problem of structural change. So we need to lower the adjustment costs.

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Like Dani I am also concerned about the fact that labour market deregulation is presented by the OECD, the IMF and a large part of the economic profession as "a major tool for curing what ails labor markets at the moment".

That reminds me of a “Manifesto on Unemployment in the European Union”, published about ten years ago by a group of well-known economists, among them Robert Solow, Oliver Blanchard, Alan Blinder and James Tobin. In order to tackle unemployment, they advocated - where necessary - a broad supply side reform package which included also a “reform of job security legislation policies to reduce the ratio of firing costs to average wages.”
However, they cautioned against pushing labour market deregulation too far. They also warned against implementing such a reform in times of high unemployment. Here is what they said in this respect:

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However we recommend that these reforms be postponed to a more suitable time. To carry them out now, when the demand is greatly depressed and there is plenty of unemployment, probably a good deal of redundant labor in many firms and few vacancies would have simply the effect of condemning many workers to join the rank of the unemployed, initially reducing instead of increasing employment. It would therefore meet with an understandably bitter opposition of union and workers who might well succeed in maintaining the status quo. In our view, therefore, the reforms should be postponed until, and made conditional upon, the realization of more favorable labor market conditions (….)”.

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