EU vs. US labour market: whoshould learn from whom? Ladislav Tůma Ondřej Kokeš European Economic Integration Fall 2011
Topic description EU and the US have become the largest world economies, but interestingly their labour markets have been diverging in the past 40 years. What has been the reason for this? What are the benefits and disadvantages? In the following presentation we will compare EU and US labour markets in the long run. As far as EU is concerned we will take into account EU-15 because we consider them to be mature labour markets that did not go through major transitions in the period examined. Here and after if we use Europe or European Union we refer to EU-15.
Current differencesThe differences between these two labour markets are bleedingobvious. Average wage earner works 1695 hours/year in the US compared with 1593 hours in the EU, which represents 13 workdays difference in 8- hour workdays. (Source: stats.oecd.org, 2009) US GDP amounts to 46 588 USD per capita and exceeds the European one by 33,5% (34 893 USD). (Source: stats.oecd.org, 2010, Per head, US $, current prices, current PPPs) Marginal tax rate in the EU is higher by 15 percentage points than in the US (OECD Economics Department Working Paper 301) Averege unemployment in the US over 10 last years was 5,56% whereas in EU-15 it was 7,85% (Current numbers are very similar though.) (Source: stats.oecd.org, 2000-2009)
Current differences OECD index of Strictness of employee protection that reflects regulations on dismissals and use of temporary contracts is 0,21 in the USA, which is significantly lower than 2,2 as an average value for EU-15 (min OECD=0,21 [USA], max OECD=3,72 [Turkey]) Union density is much higher in EU-15 it accounts for 33% of all labour force whereas in the USA it is only 12%. Minimum relative to median wages of full-time workers is 0,37 in the USA and 0,5 in EU-15. Higher relative minimum wage pushes low-skilled workers off the labour market and thus increases unemployment. See figure.(Charles Brown, Curtis Gilroy, Andrew Kohen 1982)
Look backCurrently the labor markets are very different, but has it always beenthis way? Hours worked per person were higher in Europe in 1970 but after, hours worked per person declined faster in Europe than in the USA. In 1977 Germans finally worked less hours than Americans and French did so in 1986.
Look back Blanchard (2004) argues that it was easy for Europe to grow when it was only catching up after WW2. However it later struggled because of insufficient inovation and its GDP per capita plateaued above 70% of the USA until today.
Look back Hours worked decreased faster in Europe, whereas GDP per capita EU-15/USA ratio grew slightly. Mystery? Not absolutely, more rapid growth of labour productivity in Europe than in the USA is responsible for the case.
Reasons for divergence Taxes imposed (Prescott 2004) Leftist policy consensus (Alesina et al. 2005) unions employee protection shorter work week, more vacation time social policies pension schemes"Hunt (1998, 1999) documents how German and French unions pursueda policy of work sharing, demanding a reduction in hours worked as aresponse to rising unemployment, with slogans like "work less—workall." Italian unions followed suit." (Alesina et al. 2005, p. 4)
Taxes natural consequence — taxes discourage people from working more so the higher tax rate, the lower labour supply? Prescott (2004) explores this phenomenon, examining data of G7 countries (France, Germany, Italy, UK, Canada, Japan, and the US) the major question is why the gap has widened so much between the periods 1970- 1974 and 1993-1996 his econometric models reveal a high elasticity (around 3) of labour supply his exact finding is that "marginal tax rate accounts for the predominance of differences at points in time and the large change in relative labor supply over time" so according to Prescott, taxes explain the majority of the decrease of hours worked in Europe a major flaw in this finding was later found, more on this later
Taxes do not come alone Good measure of tax increase incentives is a tax-to-GDP ratio. As Joumard (2001) notes, in 1970, the ratios for the EU and the US were similar. However, by the early 1990s, the ratio for the EU had increased by 8 percentage points while the US ratio remained stable. That signifies an increase of tax income in the EU. What is the causality? Imposition of taxes has its purpose, in this case these were higher expenditures in social related areas. But did European governments impose taxes to increase expenditures or vice versa? Martinez-Mongay and Fernandez (2000) found out that in the EU the increase of spending lead to a tax increase in the following period. So the whole process of divergence had its roots in social-aware policies imposed by leftist governments across Europe. (Alesina et al. 2005, Hunt 1998)
Taxes do not come aloneCompilation of graphs from Joumard (2001).The colored regions represent individual tax sources (description in the paper mentioned). The most important for us is theblack line specifying total tax receipts.
Social schemeSo why Europeans work less? Unionisation and employeeprotection are the key explanatory variables. Alesina (2005) denies Prescotts idea and shows that unionisation and employee protection are significant variabels in the econometric models that explain the difference. Following the crisis of 1973, labour unions promoted the motto "work less, work all”. Working time was cut down, and they succeeded in negotiating no changes in monthly wages, so the labour costs per hour increased (Hunt 1998). Thus European businesses substituted labour for capital. Capital-output ratio is for example 30% higher in France than in the USA (Blanchard 2004). It is not proven that those market regulations and unionisation created more jobs but they enhanced the social multiplier , concept introduced by Edward L. Glaeser, Bruce I. Sacerdote and Jose A. Scheinkman, which suggests that aggregate relationships, which a person can develop during leisure time, will overstate individual income elasticities. "The main difference is that Europe has used some of the increase in productivity to increase leisure rather than income, while the U.S. has done the opposite." (Blanchard 2004)
What has this all lead to?Social-aware policies that started in the 1970s formed a framework verydifferent from what is typical now in the US. strong employee protection with employee-centric policies, workers are better protected by laws, making the labour system more rigid, in a sense that it is more difficult to hire and let go employees. leisure mandatory vacation time is a major factor explaining the decrease of hours worked (Alesina 2005) on average, people in the Eurozone work 1581 hours per year, compared to 1695 hours in the US (stats.oecd.org, 2010) public goods and services institutions like public health systems are taken for granted in Europe
Rigidity of labour systemsThe lower ratio between long- and short-term unemployment (dividing the area of the green partby the orange part) underlines the rigidity of European labour systems.
So why does EU lag behind? It would seem that it is possible to close the gap between the EU and the US, but what would it take? As productivity in Europe surged, workers chose leisure over higher income. As the decrease of hours worked is tightly connected with the social benefits, an increase in working time would necessarily result in compromising in the social sector. Hypothetically, convergence is not out of the picture… but are Europeans willing to sacrifice their free time and social benefits?
Outlook for the futureIs aging of the population likely to dismantle the social aware Europeanlabour system? Currently old-age dependency ratio is 25,9% in the European Union. If the ageing has the same speed as of yet in following decades, the ratio will be 50,6% in 2050. It means that there will be one pensioner per two wage-earners. Without any adjustment this could endanger the core of the welfare state (Guerzoni 2011). However the European labour market has been able to adjust to ageing so far because it is expected and long-running process. Elongation of age of retirement is one of the most notable adjustments (Guerzoni 2011).What about migration? Can it help or will it exploit the European welfarestate? The case that increased migration will undermine popular commitment to social spending is not proven (Taylor-Gooby 2005). Immigration can be beneficial if the labour market is successful in turning immigrants into wage-earners rather than welfare-earners (Dixon 2003).
Our conclusionSo who should learn from whom? Even though the two labour systems started similarly, they have evolved into very different ones with varying priorities, especially in the social perspective. We can observe strengths and weaknesses of these systems that are unique to them. The US could adopt some socially aware policies as greater inequality may become even more pronounced in the future. That, historically, may lead to nationwide unrest. EU, on the other hand, might benefit from looser hiring policy that may be beneficial during economically gloomy periods. European countries might as well be forced to cut its welfare expenditures due to current debt crises. The big question is how they will cope with the coming population ageing, it will be very interesting to observe the development in the coming decades. To conclude — the two systems, while different, both serve their purpose and were designed with different (political) ideas in mind. We have yet to see if they stand the test of time.
Sources Alesina A., Glaeser E., Sacerdote B. (2005). ’Work and Leisure in the U.S. and Europé: Why So Different?’. NBER Working Paper No. 11278, April 2005. Blanchard Olivier. (2004) "The Economic Future of Europe". NBER Working Paper. No. 10310. March 2004. Prescott, E C. (2004). ‘Why Do Americans Work So Much More Than Europeans?’, Federal Reserve Bank of Minneapolis Quarterly Review, vol.28, No.1 July 2004, pp.2-13. Joumard, I., Tax systems in European Union countries, OECD Economics Department Working Paper 301, June 2001. Brown Charles, Gilroy Curtis and Kohen Andrew (1982). "The Effect of the Minimum Wage on Employment and Unemployment: A Survey". NBER Working Paper. No. 0846. Nov 1982. Martinez-Mongay, C. and R. Fernandez (2000). “Effective taxation, spending and employment performance, in M. Buti, P. Sestito and H. Wijkander (eds.), Taxation, Welfare and the crisis of unemployment in Europe, Edward Elgar. Glaeser E., Sacerdote B.,Scheinkman J. (2002). "The Social Multiplier". NBER Working Paper. No. 9153. September 2002 Hunt, J. (1998). "Hours Reductions as Work-Sharing". Brookings Papers on Economic Activity 1.
Sources Taylor-Gooby P.F. (2005). “Is the Future American? Or, Can Left Politics Preserve European Welfare States from Erosion through Growing ‘Racial’ Diversity?”. Journal of Social Policy. October 2005. Dixon Sylvia. (2003). “Implications of population ageing for the labour market”. Labour market trends. February 2003 Guerzoni B., Zuleeg F. (2011). “Working away at the cost of ageing: the labour market adjusted dependency ratio”. EPC Issue Paper No.64. Slide 14: Figure: epp.eurostat.ec.europa.eu/portal/page/portal/labour_market/, 2010