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dr. Jozef Konings
Faculty of Business and Economics, University of Leuven (Belgium)
Joep.Konings@econ.kuleuven.be

Plunging stock markets, sky-rocketing oil prices and unhappy consumers paying double as much for their gas for the weekend round-trip to the sea side compared to last year. Politicians are panicking as the purchasing power of their electorate is melting down like snow in the sun. But it is not the purchasing power we should worry too much about, rather rising unemployment is likely going to be the main concern in the next 6 months. Most OECD countries are showing a strong slowdown in economic activity as pointed out by the OECD composite leading indicator released July 11. Compared to a year ago, this indicator is down by 4.3 points for the Euro area, resulting in an index of 96 last May, while the long term average index is normalized at 100. The same holds for the 7 major OECD countries, while China and Russia are up with respectively 1.9 points and 2.9 points.

Paradoxically, the current financial and economic crisis is the result of the success of the world economy aiming at reducing poverty world wide. The enormous success of the emerging economies such as China has caused an increasing demand and hence tension on the market for raw materials, resulting in rapidly increasing prices of intermediates, such as oil, steel, grain, etc.. As a result, final good prices have also gone up, but by less, which is not surprising as supply elasticities are typically larger for final goods than for intermediate ones.

The response of European countries and institutions, such as the European Central Bank (ECB), has been rather weak so far. The increasing interest rate policy that the ECB has been implementing is questionable for a number of reasons. First, the increasing inflation is not caused by high aggregate demand, but it is imported through mainly the high oil prices and increasing prices of other intermediates. It is the traditional cost-push inflation. Increasing interest rates dampens aggregate demand further, without having a big effect on imported inflation, but thereby increasing the likelihood of pushing the economy in a recession. Second, higher European interest rates will weaken the US dollar further, pushing up oil prices, which are in USD, even further. On top of this, workers being hit by inflation express excessive wage demands, which increases the risk of initiating a wage-price spiral as in the 1970s and 80s. The result will be increased unemployment and hence even less purchasing power for the people. It is exactly this increased inflow into unemployment, which is worrisome given the way many European countries, like Belgium, France and others, have structured their labor markets.

The key for guaranteeing welfare and purchasing power is not to increase wages as this undermines international competitiveness of countries that have to rely on trade in the world economy, such as Belgium and Slovenia, but rather increasing the activity rate of the population, which is also essential to cope with the aging population.

The conventional wisdom agrees with the fact the world supply of low skilled labor has risen enormously, which puts increased pressure on wages, especially of the low skilled, in the West. With the high employment protection legislation, the generous unemployment benefits and the wage setting mechanisms in most European countries, it is clear that the market response is an increase in the unemployment rate of especially the low skilled. However, also the world supply of high skilled workers has increased rapidly in recent years, especially in countries like India and China delivering a growing group of engineers and IT specialists. So, it is just a matter of time before it will hit the high skilled segment of the European labor market.

It is therefore essential that European labor markets get transformed from a situation in which workers have life-time jobs into a situation in which they have life time work, being able to compete with workers not only in Europe, but also and especially in China and India. Moving flexibly between jobs is going to be a key feature of a successful transformation of European economies coping with world labor markets. Monetary incentives should help to change the European worker’s attitude from having a life time job to having life time work.

A first important step is to transform the unemployment benefit system into a system for which it was originally designed – an insurance system. This implies that unemployment benefit gives protection for workers against the risk of temporarily falling without a job. A key problem is that many unemployed stay too long into unemployment because the system has no longer the monetary incentives in place for workers to intensively search for a job. There is increasing evidence by now that reducing the unemployment benefit with the time span that someone is unemployed increases the outflow rate out of unemployment into a job drastically. It is crucial to avoid long term unemployment as that group is lost for society, they loose skills, they get discouraged, are very hard to reintegrate into society, but most importantly they do no longer contribute to the generation of welfare. The mistakes from the oil shocks in the 70s should be avoided this time around. The oil shocks resulted in high inflows into unemployment and long term unemployment in the 80s, the latter occurred because the institutions were not ready to push the unemployed back into paid jobs in a relatively short time span.

Therefore limiting unemployment benefits in time and introducing degressivity in the unemployment benefit systems seems crucial. This should be combined with strong activation and monitoring measures from the moment people end up in unemployment.

Second, I propose a new tool to increase incentives to work: the introduction of an individual (un)employment account. An individual employment account is like a savings account on which the worker, but also the employer, is obliged to deposit a minimum monthly sum, which could be a fraction of the gross salary. When a worker looses his job he keeps this individual account and carries it on to the next employer. When he is unemployed he can, but is not required to, draw money out of his account to supplement his unemployment benefit. Obviously, it is into his interest to find a new job as fast as possible as a new job will increase the value of his individual employment account through new deposits, which at the end of his professional career will be paid out as a supplementary pension. The key of this system is that it creates an incentive to move out of unemployment fast.

This system also allows a worker to engage in life long learning, which is the third key ingredient to cope with the future recession and global tensions. Part of the individual employment account can be used to invest in training, ideally on the job training, which can be matched to investment by the employer into on the job training. Recent evidence¹ shows that on-the-job training increases firm level productivity, which is important for maintaining international competitiveness. Furthermore, on-the-job training also increases individual wages, which is not surprising as workers become more productive. However, wages increase by less than productivity increases, which is important if competitiveness gains are to be established. So far, firms invest not enough in on-the-job training. The European directive is that 1.9% of total labor costs should be invested in on-the-job training, however, most firms invest less than that.

Ultimately mobility is the key to a performing labor market and economy, but this mobility has various dimensions: mobility between firms, mobility between functions within a firm, mobility between states of employment and unemployment, mobility between skill categories, etc.. It is time that both workers and firms take up their individual responsibilities and take their own chances, before it is too late. Employers take a chance on those mobile workers, workers take a chance on those dynamic employers, dear reader, take a chance on my proposals!

¹ _{Konings, J. and Vanormelingen, S. (2008). “On the job training and firm level productivity”, working paper LICOS, KULeuven.}

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