Market reform needed for jobs

In six of the 15 countries in the European Union, unemployment is now below 5 per cent; in only three is the rate in double figures. Jobs are being created at unprecedented speed in countries once considered archetypes of the kind of rigid economies investors sought to avoid.

Unemployment in Spain has fallen from 24 per cent in 1994 to 14 per cent this year. In France, job creation has been running at 400,000 jobs a year since 1997 - roughly 10 times the pace of the 1980s.

This performance raises two questions. First, why was the conventional wisdom, that Europe was destined for permanent mass unemployment, wrong? And second, is full employment a realistic ambition?

Until recently, the standard view was that European unemployment stemmed from high employment protection, costly minimum wages, generous welfare benefits and other structural rigidities. But this overlooked the fact that after the 1993 recession aggregate demand did not grow in line with potential output.

In the mid-1990s and even later, continental Europe was suffering from a huge output gap. So when growth picked up, job creation resumed.

But there is a second reason why job creation has been so buoyant. While generally reluctant to copy the US model, most European countries have reformed their labour markets. Employment protection remains high but companies have much more room to adjust payrolls to fluctuations in demand. Temporary contracts have become a new standard in Spain and account for half of youth employment in France. Unemployment benefits are still available for longer periods than in the US but in Britain, Denmark and other countries eligibility depends on active job search. And while minimum wages constrain settlements for the lowest paid, measures have also been taken to lower labour costs. Until recently, no politician would have dared raise the prospect of a return to full employment. But times have changed. The French prime minister, Lionel Jospin, has made full employment a goal by 2010. It was also mentioned at the EU summit in Lisbon in March.

However, the goal remains more challenging than the headline unemployment data suggest. In many European countries, two decades of mass unemployment have resulted in alternative forms of non-employment via early retirement, disability schemes, subsidies for domestic child care or, more simply, withdrawal from the labour force.

Recent projections suggest that bringing unemployment down to 5 per cent in France by 2010 would require the creation of only 160,000 jobs a year. But achieving a simultaneous recovery in participation rates would roughly double that figure.

Labour market reform must put increased emphasis on three priorities. Firstly, Europe must help people back to work. This means getting incentives right. The tax and benefits system and the way pensions are calculated often make work unattractive. Secondly, a job market must be created for those aged over 50. In several European countries it hardly exists at all.

Thirdly, the match between labour supply and labour demand must be improved. Getting a job is a complicated search process. It is vital that every effort is made to improve the efficiency of this search process.

Labour market reform alone will not be sufficient. As unemployment falls, the European Central Bank is likely to be concerned about inflationary pressures. However, excessive caution on the part of the ECB could bring the current cycle to a premature end. The EU's member states and the ECB must begin a dialogue on the inflation risks that exist and the measures that governments and social partners can take in response.

The writer is a member of the French Council of Economic Analysis. A full version, in English, of the report to Mr Lionel Jospin summarised in this article can be found at www.policy-network.org