Monday, 30 May 2011

Spain’s Persistent Problem

The fifth largest economy in the EU is currently suffering the highest level of unemployment in the developed world. A staggering 20.6% of the Spanish working population is jobless, or nearly 5 million people (compare that with 3 million jobless in Germany which has a population twice the size). However, the absolute level of Spanish unemployment is not the only problem; its persistence is equally worrying.

Historically, we observe that the US jobless rate (blue line) seems to continually return to a base level of 4-5% whereas the EU rate (black line) and especially the Spanish rate (red line) do not exhibit this tendency. In other words, Spaniards must face the likelihood that high unemployment is going to stick around for a while.

Why should there be such a dramatic discrepancy between two highly developed countries such as Spain and the USA? There are many proposed explanations, ranging from labour market malfunctions to cultural differences. However, there is one theoretical explanation which I find particularly appealing and intuitive. It has to do with Employment Protection Legislation (EPL). The role of EPL is to prevent unfair practices in the hiring and firing of employees and consequently represents a barrier (or cost) to firms in changing their level of labour employment. The theory is that these costs are sufficient to discourage firms from terminating contracts but also from taking on new ones (since they expect it is a decision which will not be easily reversible). So as a result of strict EPL, employment levels do not adjust easily, temporary shocks have long term effects and unemployment becomes a very persistent problem. Where does Spain rank on the spectrum of EPL strictness?

Although this model makes no predictions regarding the absolute level of unemployment I find it to be a compelling example of the way in which over-regulation can clog up markets and well-meaning legislators can exacerbate the problems they are looking to solve.

There's an interesting animation that shows how the unemployment figures are rising in the USA at:

Post written by Stephen Devlin - 3rd year MA (Hons) Economics

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