The False Panacea of Labor-Market Flexibility

AMSTERDAM – Competitiveness has become one of the economic buzzwords of our time. Barack Obama trumpeted it during his State of the Union address in January, and European leaders from the Tory David Cameron in Britain to the Socialist José Luis Zapatero in Spain to Japan’s new Minister of Economics Kaoru Yosano have embraced it as a priority. But what sort of competitiveness do they have in mind?

Asked during an interview in September 2007 whether European governments should liberalize their countries’ labor codes, former United States Federal Reserve Chairman Alan Greenspan responded that Europe’s labor-protection laws significantly inhibited economic performance and resulted in chronically high unemployment across the continent. In the United States, people are fired more easily than in any other country, and the unemployment rate at the time was among the lowest in the world.

But it’s no longer September 2007, and US unemployment stands at 9.4%, not 4.5%. And, according to Greenspan’s successor, Ben Bernanke, there is no reason to assume that the unemployment rate will approach 5% – generally considered to be the natural rate of unemployment – any time soon.

In the 2000’s, the US lost two million private-sector jobs on balance, with the total falling from 110 million in December 1999 to 108 million in December 2009, despite massive consumer spending. That 1.4% decline came during a decade in which the US population grew by about 9.8%.

To understand what is happening, consider Evergreen Solar, the third-largest maker of solar panels in the US, which announced in January that it would close its main American factory, lay off its 800 workers there within two months, and shift production to China. Evergreen’s management cited the much higher government support available in China as its reason for the move.

Evergreen is only one of many cases suggesting that the US might find itself in the midst of what Princeton-economist Alan Blinder in 2005 dubbed the Third Industrial Revolution. According to Blinder, 42-56 million US jobs – about one-third of all public- and private-sector jobs in the country – are vulnerable for offshoring. Blinder also predicted that the flexible, fluid US labor market would adapt better and faster to globalization than European labor markets would.

If anything, we are only in the early stages of that revolution, and the outcome remains uncertain. But a preliminary comparison between Europe’s largest economy, Germany, and the US suggests that the former is better equipped to hold its own in the age of globalization.

German multinationals like Siemens and Daimler are ratcheting up investment to meet both emerging-market and domestic demand. The companies plan to add hundreds of thousands of jobs worldwide this year alone. While many of these jobs will be in Asia, both companies say that they will add high-skill jobs in Germany as well.

Is Germany’s labor-market rigidity to thank for that? It may indeed be part of the explanation. A recent study by the Central Planning Bureau in the Netherlands shows that workers with a permanent contract receive more employer-funded training than workers with a temporary contract.

For US employers, it is much easier to purge workers from the payroll – or, as Robert Gordon of Northwestern University puts it, to toss out every deck chair – than it is for German employers. Germany’s labor code bars such layoffs, but German employers also are presumably less inclined than US employers to shed workers, because they have invested more in their companies’ human capital. With fewer firm-specific skills than their German counterparts, American workers are more susceptible to layoffs.

Indeed, Siemens, apparently conscious of the benefits of labor-market rigidity, has taken the unusual step of promising its employees a job for life. Last year, the company sealed an agreement with the trade union IG Metall that includes a no-layoff pledge for its 128,000-strong German workforce.

A more important explanation for Germany’s current economic success may be the substantial government support that German industries receive on a structural basis, especially the car industry. The US economy, on the other hand, is bogging down in its policymakers’ persistent emphasis on consumption and tax cuts (most notably for the super-rich) over investment.

The US needs to change its economic-policy course. A decade of historically low interest rates has led to economic imbalances in favor of sectors that are highly leveraged: the financial sector, the housing market, and private equity. This has come at the expense of sectors that are more dependent on equity financing. Now that the housing bubble has burst, the US finds itself out-trained, out-educated, and out-maneuvered in the global competition for employment.

We now know that labor-market deregulation does not ensure economic resilience and rapid job creation. On the contrary, the best solution is probably a diversity of labor contracts. A certain amount of labor-market rigidity may make economic sense for jobs that require firm-specific skills and training, alongside greater flexibility for jobs that require fewer skills.

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