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Spanish labour market: no recovery in sight

Economic Report

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Faced with sky-high unemployment, Spanish policymakers have initiated radical labour market reforms since the financial crisis. While this will hopefully lead to a turnaround in the Spanish labour market in the long run, the outlook for the next several years remains bleak. 

Trends since the crisis

Spanish employment has shrunk steadily since early 2008 (figure 1). By end-2012, the number of employed was more than 17% lower than during the first quarter of 2008. The figure shows that a particularly large number of jobs were lost in the construction sector in the early phase, which is not surprising considering the massive housing market collapse. Total employment in the construction sector was down by more than 60% by end-2012 compared to its pre-crisis peak. Although the number of workers in the construction sector continues to decline, the services sector has accounted for much of the decline in the total number of jobs since mid-2011. In this sector, the drop in employment has been most severe in financial services and the transport sector. Despite the draconian austerity measures, public sector employment – including healthcare and education – began falling only slightly from mid-2011 onwards.

While employment fell sharply, the labour force has remained relatively stable since 2009. This has resulted in an unprecedented rise in unemployment, up to more than 26% of the labour force by the end of 2012 (figure 2).

Figure 1: Changes in employment
Figure 1: Changes in employmentSource: Reuters EcoWin
Figure 2: Unemployment
Figure 2: UnemploymentSource: Reuters EcoWin

This is steep even by Spanish standards, but should nevertheless be considered from an historical perspective. In the mid-1990s, Spain was also affected by a surge in the unemployment rate (above 20%), and the pre-crisis period – in which unemployment dropped to around 8% – should be regarded as an exception. Spain has a structurally high unemployment rate and, in addition, the labour market is relatively pro-cyclical, i.e., employment is strongly affected by swings in economic activity (IMF, 2012a). Figure 3 shows the correlation since the financial crisis between the change in Gross Domestic Product (GDP) and the change in unemploy­ment – known in economics jargon as Okun’s Law. It is apparent that Spain has been an exception from an international perspective.

Figure 3: Okun’s Law

Source: Reuters EcoWin, Rabobank

Specifics of the Spanish labour market

The extreme trends witnessed in the Spanish labour market are due in part to the specific labour market institutions that were in place prior to the reforms of 2010 and 2012. There were two factors at play that must be considered in conjunction: the strong employment protection and the rigid wage bargaining process.

Employee protection

Spain had relatively strong employment protection laws in place (figure 4), evidenced in particular by generous severance payments. Since these laws applied mainly to employees with permanent contracts, it became increasingly appealing to offer new workers temporary contracts (IMF, 2011). After the labour market reforms implemented in the mid-1980s, there was a sharp spike in the number of temporary contracts; up to more than one-third of total employment at the start of the crisis (figure 5). The IMF (2013) regards the large number of temporary contracts as the main reason for the high pro-cyclicality over the past few decades. There are other disadvantages associated with a dual labour market, including a rigid adjustment of wages to economic conditions, limited integration of young people in the labour market, limited investment in employee training/education and low mobility of workers with permanent contracts, which negatively affects labour productivity (OECD, 2012). Due to strong employment protection laws for employees with permanent contracts, wage growth has also remained high in recent years, despite the sharp rise in unemployment.

Wage bargaining

The Spanish wage bargaining process used to be coordinated mainly at the sector or industry level. However, there were also national guidelines in place for wage increases, which were generally used as a lower limit for the sector negotiations. Options for individual companies to depart from these guidelines (e.g. when faced with an economic downturn) were limited. This rigidity made it more difficult to retain jobs. Spain has also seen partially automatic wage indexation based on inflation (IMF, 2011). The setup of the wage bargaining process has contributed to a relatively strong positive correlation between the inflation rate and wage growth (IMF, 2012a).

Reforms

The Spanish government has introduced two major labour market reforms since the financial crisis: the first in June 2010, and the second in February 2012. The first reform was designed to change both the employment protection laws and the wage bargaining process. Although this represented an important first step, severance payments, for example, remained above the European average after the first reform. The second reform was more comprehensive and the adjustments were more substantial, with both the IMF and the OECD reporting a ‘significant’ improvement in the labour market institutions.

Figure 4: Employment protection
Figure 4: Employment protectionSource: OECD
Figure 5: Dual labour market
Figure 5: Dual labour marketSource: Reuters EcoWin, Rabobank

The initial step was to reduce severance payments. The maximum amount awarded for ‘unfair’ dismissal has been reduced from 45 days to 33 days for each year of service, subject to a maximum of 24 months (as opposed to 42 months). More importantly, however, the terms under which a dismissal can be regarded as ‘unfair’ have been more strictly defined, so that it is now less common for employers to have to pay the relatively high compensation. Although addressing the dual nature of the labour market was an important step, there remains a substantial difference between the severance payments awarded to temporary employees and that paid to permanent employees. If the above measures prove to be inadequate, the introduction of a standardised, uniform contract will need to be considered (OECD, 2012; Perez et al., 2012).

During wage negotiations, contracts at the company level are prioritised over agreements at higher levels. This makes it easier for companies to adjust wages and working hours to the economic and business conditions. The IMF (2012a) criticises the fact that, while the use of automatic inflation indexation is discouraged, it remains available as an option. One other purpose of the reform is to actively boost the labour market. Training programmes for job seekers will be intensified, and young people will receive financial incentives to start their own businesses. Also, the government is providing subsidies to employers for hiring young people and the long-term unemployed.

Outlook

Over the long term, the reforms described above can contribute substantially to the Spanish economic recovery. Provided the reforms are implemented completely, the IMF (2012a) has calculated that they could generate 4 to 5% additional GDP growth in 2017 on a cumulative basis and reduce unemployment by 3 to 4%-points. Perez et al. (2012) also demonstrate that reducing severance payments and encouraging permanent contracts can significantly reduce unemployment in Spain in the long run. For the immediate future, however, the economic impact of structural reforms will be negligible and even negative, particularly with regard to labour market reforms implemented during deep recessions (IMF, 2012b).

On account of the massive austerity drive by the government, private sector deleveraging, and tight credit conditions, the short-term economic outlook remains unfavourable. Against this backdrop, unemployment may very likely increase further, particularly this year. The return of economic growth, which we anticipate only gradually from 2014 onwards, can reverse this trend through job creation. It is therefore encouraging that, since 2012, wage trends have failed to keep pace with inflation (which has increased due to the VAT increase; figure 6). Further wage moderation – a consequence of the staggering rise in the jobless rate and the labour market reforms implemented – is highly desirable in order to promote job creation. Despite the high pro-cyclicality of the Spanish labour market, there are several reasons to expect that unemployment, after reaching its peak, will decrease from that level only gradually. For one, the labour force is set to increase in the coming years due to the pension reforms implemented in 2011. Older workers will be required to postpone retirement. From 2013 the retirement age will be gradually raised to 67 for those who have worked less than 38.5 years. In 2012, the 55+ age group was the only cohort in the labour force that was growing. Furthermore, population ageing will not reduce the labour force substantially in the coming years, unlike in many other countries. According to Eurostat population forecasts up to 2060, the dependency ratio (defined as the population over 65 divided by the working-age population, 15-64) will increase sharply to 56%, significantly higher than the expected EU average of 44%. However, this increase will not be significant until 2025, so up to that time population ageing will barely help reduce the unemployment rate.

Figure 6: Wage trends and inflation

Figure 6: Wage trends and inflation

Source: Reuters EcoWin 

One trend that presumably has not been factored into this population forecast is the changing migration flow. Whereas during the decade before the financial crisis the number of people moving to Spain was significantly higher than the number leaving – which contributed to the sharp rise in the labour force until 2008 – the country experienced a net outflow of migration in 2011 (EC, 2012; IMF, 2012a). This is the reason why the labour force has not increased since 2009. Note that this decrease may have been enhanced by the fact that some of the unemployed have stopped actively looking for work. OECD data show that Spain has the highest number of people who have given up on finding work amongst the eurozone member states, even if this percentage was still fairly low in 2011 (1.3% of the labour force). Once opportunities to find work increase, a portion of these people will certainly start looking for jobs again.

Finally, the steady decline in construction activity has created a mismatch between supply and demand in the labour market. At year-end 2012, unemployed workers in the construction industry accounted for roughly 16% of total unemployment. Additionally, construction-related services are also likely to be affected by the housing market slump. The sharp increase in the number of people who have been unemployed for more than one year (from 18% in 2008 to 41% in 2011) is an indication of the mismatch (figure 7). For this group of unemployed, retraining and/or emigration are vital.

Figure 7: Long-term unemployment

Figure 7: Long-term unemployment

Source: OECD

Conclusion

The labour market institutions that contributed to the rapid rise in unemployment since the crisis have been successfully addressed by the two reforms in 2010 and 2012. Although the country will be able to benefit from this development in the long run via stronger GDP growth and lower unemployment, the economic downturn will continue to dominate the labour market in the immediate future. As a result of the increase in the retirement age and the mismatch between supply and demand, unemployment will decline only gradually in the future. 

References

EC (2012), The 2012 Ageing Report, European Economy 2/2012.

IMF (2011), The Spanish labour market in a cross-country perspective, IMF Working Paper 11/11, January.

IMF (2012a), Article 4 consultation, IMF Working Paper 12/202, July.

IMF (2012b), Italy: selected issues. IMF Country Report No. 12/168, July.

IMF (2013), Okun’s Law: fit at 50?, IMF Working Paper 13/10, January.

OECD (2012), Economic Surveys Spain, November. Perez, J.I.G. et al. (2012), Evaluating the 2012 Spanish labour market reform, European Association of Labour Economists. 

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