Spain's unemployment rate, at a staggering 21 percent in 1997, is the highest among industrial countries. Similarly striking is the variation of unemployment rates among its 17 regions, ranging from less than 14 percent in the Balearic Islands to more than 32 percent in Andalucía. A finer level of geographical disaggregation is that of the 50 provinces, which are subsets of regions, where unemployment rates vary even more widely, ranging from 8 percent in Lleida, Cataluña, to 36 percent in Jaén, Andalucía (Figure 4.1). Moreover, these differences have persisted for several years and show no signs of abating.

Spain's unemployment rate, at a staggering 21 percent in 1997, is the highest among industrial countries. Similarly striking is the variation of unemployment rates among its 17 regions, ranging from less than 14 percent in the Balearic Islands to more than 32 percent in Andalucía. A finer level of geographical disaggregation is that of the 50 provinces, which are subsets of regions, where unemployment rates vary even more widely, ranging from 8 percent in Lleida, Cataluña, to 36 percent in Jaén, Andalucía (Figure 4.1). Moreover, these differences have persisted for several years and show no signs of abating.

Figure 4.1.
Figure 4.1.

Unemployment Rates by Province

(1997, second quarter)

Source: Instituto Nacional de Estadistica.

Such large, persistent differences in unemployment rates are considered a problem for three reasons. First, in the early stages of a recovery wage pressures will arise in areas with relatively low unemployment. With limited labor mobility, high unemployment in other areas will not moderate those pressures; higher inflation may soon spread to the whole country, with no commensurate decline in unemployment. In other words, large geographic differences in unemployment rates may cause the nonaccelerating inflation rate of unemployment (NAIRU) to be higher than it would be otherwise. Second, persistent unemployment imbalances constitute evidence that the labor market does not function properly, in that adjustment to past shocks is exceedingly slow. Imbalances also suggest that there may be scope for reducing unemployment in those areas where it is more severe, thereby lowering the nationwide unemployment rate. Third, for a given national unemployment rate, the overall human cost may be higher if the unemployed are not distributed evenly over the country's territory. For example, overall social welfare is lower if one family has two members unemployed and another has both members employed than if both families have only one member unemployed.

This section analyzes the reasons for the persistence of geographical unemployment imbalances and the low speed of adjustment to regional labor demand shocks. It argues that, under present labor market arrangements, these imbalances are unlikely to be corrected in the near future. In particular, the current wage-bargaining system appears to be excessively centralized and results in nationally set wages that are too high to reduce unemployment in high-unemployment areas. To support this claim, this study provides new evidence that there are no significant differences in unit labor costs and real wages between high-unemployment and low-unemployment areas, resulting in muted incentives for firms to migrate and implying that incentives for workers to migrate are only provided by differences in unemployment. The study makes policy suggestions to reduce the NAIRU and promote faster adjustment to regional shocks. The study argues that the wage-bargaining system should be decentralized to the individual firm level. It also suggests a number of measures that are likely to have the greatest impact on low-skilled workers, where the problems are most serious.

Geographic Differences in Unemployment Rates and Their Persistence

In the wide range of unemployment rates among Spanish regions, the distribution patterns are not easy to identify. Generally speaking, southern agricultural regions, such as Andalucía and Extremadura, and some of the northern regions with declining industries, such as Pais Vasco, Cantabria, and Asturias, tend to have higher unemployment. At the same time, the geographical distribution of unemployment rates in Spain is not as straightforward as in other countries characterized by large regional differences.1 In Spain, there is no clear north/south divide; there is no simple relationship between unemployment rates and proximity to continental European markets; the sectoral composition of output provides only a partial explanation for unemployment differences; and, perhaps of most interest, the correlation between unemployment rates and GDP per capita and productivity is relatively low.

Even though generalizations may not be easy, it is clear that a regional dimension of the unemployment problem exists: in fact, regional dummies explain in dividuals' employment status to a significant extent when controlling for personal characteristics such as age, gender, and education. In addition to the large differences among regions, there is also substantial variation in unemployment rates among provinces within regions. Again, it is difficult to identify clear patterns, but provinces dominated by large cities seem to have somewhat higher unemployment rates than provinces with only small urban centers.

Whatever the determinants of the geographic distribution of unemployment rates, there is compelling evidence that the current pattern has persisted for a long time. The sharp increase in unemployment experienced by the country as a whole since the late 1970s has affected all regions. There have been almost no changes in the regions' unemployment rate rankings, and absolute differences in unemployment rates have widened considerably. Figure 4.2 shows the unemployment rates for Spain's 17 regions and indicates that there are only a few points where lines intersect, and the spread is much wider at the end of the period than at the beginning.

Figure 4.2.
Figure 4.2.

Unemployment Rates by Region

(In percent)

Source: Instituto Nacional de Estadistica.

Scatter plots of the average survey unemployment rates in 1980 and 1995 for provinces reveal a remarkable correlation between the provinces with higher unemployment rates today and those that had higher unemployment rates one and a half decades ago (Figure 4.3, top panel).2 These correlations are much higher in the case of Spain than for the United States and somewhat higher than for other European countries, especially the United Kingdom (Decressin and Fatas, 1995, and Obstfeld and Peri, 1998). These persistent imbalances in unemployment rates constitute prima facie evidence that something is not functioning properly in the Spanish labor market.

Figure 4.3.
Figure 4.3.

Persistence of Unemployment in the Spanish Provinces: Survey Rate and Registered Rate

(In percent)

Sources: Instituto Nacional de Estadlstica; and Instituto Nacional de Empleo.1The vertical axis represents unemployment in 1995. The horizontal axis represents unemployment in 1980.

There is little doubt that geographic unemployment differences are large and persistent, in spite of uncertainties surrounding the “real” unemployment rate and the size of the underground economy in Spain. At the same time, a brief discussion on the reliability of the data is in order. The most important question in this context is whether high measured unemployment in certain areas might simply reflect a larger underground economy. In that respect, the most widely used measure of unemployment—that based on the National Statistical Institute's survey, which is conducted along internationally accepted guidelines—is judged reliable. Workers in the underground economy are not asked to, nor do they have any incentive to, report themselves as unemployed in the survey. Nevertheless, in light of the extremely high unemployment rate—21 percent for the country as a whole—estimated by the survey, it has been argued that the registered unemployment rate, which amounts only to 13 percent, might be a more reliable measure. In principle, those employed in the underground economy could well register themselves as unemployed, but in practice the checks conducted by the unemployment benefits offices may help reduce this problem. Using registered unemployment data, the same pattern of large and persistent geographic unemployment differences remains quite striking (Figure 4.3, bottom panel). Registered unemployment rates in 19953 ranged from 11 percent in Rioja to more than 20 percent in Andalucia among Spain's 17 regions; and from 7 percent in Lleida, Cataluña, to 24 percent in Cádiz, Andalucía, among Spain's 50 provinces.

Potential Adjustment Mechanisms

In a well-functioning labor market, one would expect geographical unemployment differences resulting from past shocks to be reduced, if not altogether eliminated, relatively quickly. Below is a brief description of the potential adjustment mechanisms.

  • Migration of firms. Ample availability of unemployed labor in a given area should encourage firms to move there, particularly if widespread and persistent unemployment has reduced wages, and this labor is now cheaper (adjusting for differences in productivity) than elsewhere. This is a relatively unexplored mechanism, owing to the limited availability of information on the migration of firms, but in a well-functioning market it could play a major role in reducing unemployment differences.

  • Creation of new jobs by existing or new local firms. Following a decline in labor demand, if lower wages were to result from the new availability of unemployed workers, job creation by existing or new local firms would be encouraged, thereby beginning to reverse the initial decrease in labor demand.

  • Changes in the labor force participation rate. When an area is characterized by high and persistent unemployment, it is likely that some unemployed workers will become discouraged and drop out of the labor force. Of course, this is a less desirable way to reduce unemployment than through other mechanisms.

  • Migration of workers. When unemployment is very high in a given area, it is reasonable to expect that unemployed workers will migrate to seek jobs elsewhere. Unemployment itself is obviously the most powerful incentive to migrate. However, if a decline in labor demand were to be accompanied not only by higher unemployment but also by a decline in wages, the incentives for the unemployed to leave the area would be even greater. Since this last mechanism played an important role through the 1960s, it is interesting to analyze why it has ceased to do so.

Migration flows, both toward other countries and within Spain, were very large in the 1960s but dropped sharply beginning in the late 1970s. The main reason for this decline is likely to be that absolute unemployment rates rose in the whole country as well as in the rest of Europe. It is well known that workers tend not to migrate—regardless of how bad prospects are in their current location—if the chances of finding a job elsewhere are low. This phenomenon of falling migration at a time of rising absolute unemployment has been well documented not only in the case of Spain (Bentolila, 1997), but also in other countries, including Germany (Decressin, 1994), Italy (Attanasio and Padoa-Schioppa, 1991), and the United Kingdom (Pissarides and Mc-Master, 1984). The rise of the absolute unemployment rate does not provide a full explanation, however, for the reluctance of labor force participants to move, because less than half of unemployed workers declare they would be willing to fill a vacancy in another region.

In sum, a number of mechanisms may reduce imbalances in unemployment rates, but they have failed to operate in the case of Spain. Among them, wage flexibility plays a key role because declines in wages in high-unemployment areas could spur a sizable migration of firms, although migration of workers may be rather insensitive to wage differentials.

To What Extent Do Wages Adjust?

In spite of large and persistent differences in unemployment, unit labor costs and real wages do not differ much between the high-unemployment and the low-unemployment areas. This is contrary to what one would expect in a well-functioning labor market, one in which wages in areas long bedeviled by high unemployment would normally decline to attract firms and encourage workers to leave, thereby correcting unemployment imbalances.

In addition to large imbalances in unemployment rates among the Spanish regions and provinces, there are also considerable differences in salaries, prices, and productivity in various parts of the country. For example, consider the differences between the province of Barcelona, one of Spain's most economically advanced cities with an unemployment rate of 18 percent, and the province of Badajoz, Extremadura, in the agricultural south with an unemployment rate of 32 percent. Nominal wages are 21 percent higher in Barcelona than in Badajoz, but consumer prices are also 16 percent higher, resulting in a real wage differential of only 5 percent. Productivity is 37 percent higher in Barcelona than in Badajoz, resulting in unit labor costs that are 16 percent lower in the former than in the latter.4

The comparison between Barcelona and Badajoz illustrates three simple points. First, there are considerable differences in wages, prices, and productivity, as well as in unemployment rates, among the various parts of the country. Second, even when there are large differences in nominal wages, differences in prices and in productivity may imply that differences in real wages or in unit labor costs are much smaller. In some cases, differences in real wages or in unit labor costs are even of the wrong sign, thereby promoting further geographic divergence in unemployment. Third, differences in unemployment rates do not seem to be closely associated with differences in real wages or unit labor costs, as shown below by more systematic analysis.

A simple, systematic way of analyzing the relationship between unemployment and real wages or unit labor costs is to rank the 50 provinces by their unemployment rate, split the sample in half, and observe cross-sectional averages of the variables for the two groups. Findings based on this procedure and previously unexplored data (see Appendix), indicate that low-unemployment provinces do not have significantly lower real wages or unit labor costs than high-unemployment provinces in either an economic or a statistical sense. This would not be a matter of concern in a country where unemployment rates were fairly uniform or merely temporary; but in a country where unemployment differences are large and persistent, it would be desirable for wages (adjusted for consumer prices and productivity) to reflect such differences. Lower wages in high-unemployment areas would constitute a helpful market mechanism to correct unemployment imbalances.

Real wages are only marginally higher in the 25 provinces with lower unemployment than in the 25 provinces with higher unemployment because the slightly higher nominal wages are offset to a considerable extent by higher prices (Table 4.1).5 The real wage differential is insignificant both in an economic and a statistical sense, and is insufficient to encourage workers to move away from high-unemployment provinces.

Table 4.1

Real Wage and Unit Labor Cost Differentials and Their Sources

(Percent differences between low-unemployment and high-unemployment areas)1

article image
Source: Authors' calculations based on Institute National de Estadistica data. See Appendix for details.

The data are 1989–95 averages. There are 17 regions and 50 provinces in Spain. Provinces are subsets of regions. The numbers presented in bold are the differences between the cross-sectional averages for the low-unemployment and high-unemployment groups of provinces and regions. The numbers in parentheses are p-values of the test of the null that the two cross-sectional averages are equal. The two groups are defined by ranking the provinces and regions on the basis of the unemployment rate, and splitting the whole sample in half. All averages are geometric, to maintain the approximate validity of the identities: real wages = nominal wages - prices, and unit labor costs = nominal wages - productivity, GDP per person = productivity + employment/population ratio for the average of the differences. CPI-level comparisons across provinces are only available for 17 provinces. Provinces within the same region are assumed to have the same CPI level. Nominal wages are based on survey data.

Difference in percentage points.

Unit labor costs are even somewhat lower in provinces with low unemployment because higher productivity more than offsets slightly higher wages. Even though the unit labor cost differential only amounts to 1.53 percent and is not statistically significant, the signal to firms, albeit small, is to move away from high-unemployment areas. Table 4.1 also shows that the same patterns are observed if the analysis is conducted at the regional level.6 Thus, even though large differences occasionally occur in real wages and unit labor costs among Spanish provinces and regions, these differences are not systematically linked to differences in unemployment rates, and therefore do not foster a correction of unemployment imbalances.7

These comparisons of unit labor costs must be interpreted with caution, owing to two types of data limitations. First, the data refer to average, rather than marginal, unit labor costs. The latter are the relevant measure for an entrepreneur choosing where to locate a new firm, and may differ considerably from the former, as in the case of a very modern plant being set up in a relatively backward area. Second, the data refer to overall unit labor costs, rather than to unit labor costs for a particular type of worker in a specific sector.8 Therefore, significant differences in unit labor costs might exist between high- and low-unemployment areas for certain types of workers and sectors, although these would be offset by opposite differences for other workers and sectors.

The current patterns of real wages and unit labor costs do not bode well for a prompt reduction in geographic unemployment imbalances. In this respect, the situation in Spain bears a striking resemblance to the case of Italy, another country characterized by large imbalances in unemployment rates among its regions. In Italy, the 1996 unemployment rate stood at 22 percent in the south, compared with 8 percent in the north. In the same year, unit labor costs were 2½ percent higher in the south than in the north, implying that firms had an incentive to migrate away from the south. At the same time, the incentives for firms to migrate away from high-unemployment areas are small, and certainly lower than, for example, in Germany, where unit labor costs are about 30 percent higher in the east than in the west despite the fact that the unemployment rate is much higher in the east (18 percent) than in the west (11 percent).

Not only are wage levels too similar in high- and low-unemployment areas to facilitate a correction of imbalances, but there are no significant differences in wage growth rates between high- and low-unemployment provinces, suggesting that there is no tendency for the situation to improve. The average wage increase negotiated over 1992—95 in all agreements between trade unions and entrepreneurs in the 25 provinces with higher unemployment rates was identical to that in the 25 provinces with lower unemployment rates—both of which amounted to 5.14 percent.9 This result is consistent with other findings that wage increases do not seem to respond to local labor market conditions.10

How Does the Labor Market Adjust to Shocks?

Because of Spain's large and persistent geographic unemployment differences, the labor market adjusts exceedingly slowly to local shocks. This portion of the study analyzes in detail that adjustment process by estimating the extent to which migration takes place, the unemployment rate rises, and the participation rate falls, in response to a drop in labor demand in a given province. It traces these effects through time, comparing the immediate effect with the outcomes observed after a number of years.

The questions above are addressed by estimating a vector autoregression system (VAR) of employment growth, the employment rate, and labor force participation for the 50 Spanish provinces over 1964–92. The framework adopted is identical to that developed by Blanchard and Katz (1992), who first applied it to the United States, and similar to that applied by Decressin and Fatás (1995) to Europe, and Bentolila and Jimeno (1995) to the 17 Spanish regions on quarterly data for 1976–94. As a consequence, the results obtained can be compared with those of the foregoing studies.11

The system is the following:

Employment growth:
Employment rate:
Labor force particination rate:

where all variables are differences between province / and the national average in order to focus on developments at the provincial level that are not the result of nationwide developments: Δeit is the first difference of the logarithm of employment; leit is the logarithm of the ratio of employment to the labor force; and lpit is the logarithm of the ratio of the labor force to the working age population. There are two lags for each right-hand side variable to allow for feed-back effects from labor force participation and the employment rate to employment growth. For example, a decrease in labor force participation could lower wages, thereby facilitating an increase in employment growth. The system is estimated by pooling all observations, while allowing for different province-specific constant terms in each equation, because some provinces may have higher average employment growth, employment rates, and labor force participation rates than others for reasons that are not captured by the explanatory variables.

The effects of a fall in employment can be traced through time by analyzing the impulse response graphs based upon the estimated parameters of the system above. Those effects can be interpreted as resulting from a decline in labor demand, under the reasonable assumption that most of the year-to-year changes in employment reflect changes in labor demand, rather than labor supply.12

The immediate response to a decline in labor demand in a given Spanish province does not differ much from that observed in other countries, although the effects on labor participation are greater in some cases. In response to a one percentage point negative shock to employment growth, the unemployment rate immediately increases by 0.31 of a percentage point, while the participation rate decreases by 0.65 of a percentage point (Figure 4.4). The remaining adjustment to the fall in employment is accounted for by migration. The simultaneous effect on the unemployment rate is similar to that estimated by existing studies for both the United States and Europe. The immediate response of the participation rate is similar to that observed in Europe but much higher in Spain than in the United States, suggesting that the phenomenon of the “discouraged worker” plays a larger role in the former than in the latter.

Figure 4.4.
Figure 4.4.

Response to a One Percent Negative Employment Shock in a Given Province

(In percentage points)

Sources: Instituto Valenciano de Investigaciones Económicas; and IMF staff estimates.

There are more important differences between Spain and other countries in the extent and composition of adjustment to a negative employment shock after several years. In the case of Spain, migration is not sufficient to bring the unemployment rate back to its preshock level even after more than a decade. The participation rate rises back to its preshock level, which it reaches after ten years. These results contrast sharply with those obtained by other studies for both the United States and the rest of Europe, where unemployment rates return to their preshock levels after about five years. In the United States, adverse employment shocks result in a relatively small decline in the participation rate, a small increase in the unemployment rate, and rapid migration in the first few years. After about five years, both the participation rate and the unemployment rate are back at their preshock levels, and employment remains permanently at or below the level attained through the initial shock, with migration being entirely responsible for full adjustment. In the rest of Europe, the overall pattern of the response to an adverse employment shock is fairly similar to that observed in the United States, although the effects on the participation rate and the unemployment rate are much larger in Europe during the first few years because migration is more sluggish than in the United States.

The analysis conducted above does not distinguish among different educational groups. Mauro and Spilimbergo (1999) find that highly skilled workers migrate very quickly in response to a decline in regional labor demand, whereas the low-skilled workers drop out of the labor force or stayed unemployed. This suggests that labor market adjustment is particularly sluggish among the low skilled.

Current Arrangements That Hinder Labor Market Adjustment

The empirical analysis above shows that the labor market adjusts exceedingly slowly to shocks and geographical imbalances in unemployment. This portion of the study examines those current policies and arrangements that prevent rapid adjustment to shocks. It also relates each of these features of the labor market to the groups of workers, skilled versus unskilled, that they seem to affect the most.

The key barrier to the reduction of existing geographical unemployment differences and the prompt adjustment to local labor demand shocks seems to be the current wage-bargaining system. This barrier affects labor force participants of all groups. A number of other current labor market policies and arrangements hamper the mobility of the low skilled, although probably not that of other groups. These include programs to help agricultural workers in specific depressed areas, such as Andalucia and Extremadura; minimum wage legislation; and the unemployment benefit system. Finally, a number of current policies and aspects of the housing market and in goods and other factor markets also hamper labor market adjustment for workers of all skill levels.

Labor Market Policies and Institutions

The Collective Bargaining System

The collective bargaining system, which covers the majority of workers and firms,13 plays an important role in preventing wages from falling sufficiently in areas with high unemployment. Information on exactly how many workers are covered by each type of bargaining arrangement is scarce, but perhaps the most representative type of arrangement is one in which a given economic sector, such as banking, has its own national round followed by regional and/or provincial rounds. By international standards, the bargaining system in Spain is considered to have an intermediate degree of centralization (Box 4.1).

The Effects of Bargaining Centralization

Theory and Cross-Country Studies. In a seminal study that initiated a burgeoning literature, Calmfors and Driffill (1988) argued that a fully centralized national bargaining system, or a fully decentralized system with wage setting at the level of the individual firm, was better than an intermediate system in which negotiations took place at the national/sectoral level. To support their claim, they presented empirical cross-country evidence of a hump-shaped relationship between countries' degrees of bargaining centralization and their macroeconomic performance (the latter measured by nationwide unemployment and inflation out-comes). The rationale for that empirical observation, they argued, was that negotiators at the national/sectoral level attempted to raise relative wages for their sector without taking into account the negative external effects in terms of higher national wages that they imposed on other sectors. An additional argument is that nationwide trade unions and entrepreneurs' associations may play a helpful role in containing wages as a part of disinflation programs. By contrast, firm-level negotiations yielded free market outcomes, and negotiators at the economywide level internalized effects on all sectors.

Spain is usually considered to have an intermediate degree of bargaining centralization (Layard, Nickell, and Jackman, 1991). Given the large differences in unemployment rates among the various areas of the country, Spain might benefit from opting for a fully decentralized wage-bargaining system. Under that system, it would be possible for wages to fall in high-unemployment areas, thereby fostering the creation of more jobs in those areas. Such decentralization becomes even more important as Spain enters EMU and consolidates its low-inflation regime, where relative price adjustment may become more difficult.

The Experience of the United Kingdom. At the beginning of the 1980s, the United Kingdom was also characterized by sharp differences in unemployment rates between its northern regions, which suffered from the decline of manufacturing industry, and its southern regions, which managed to create new jobs in the services sector. In 1980–84, the United Kingdom undertook a comprehensive and in-depth labor market reform, which effectively decentralized the wage-bargaining system from the industry or regional level to the firm level. Regional differences in unemployment have fallen sharply since then. For example, the unemployment rate dropped to 8 percent in 1997 from 15 percent in 1984 in the north of England, whereas it declined more slightly in the southeast of England, to 6 percent in 1997 from 8 percent in 1984. However, it remains uncertain whether that decentralization played an important role, especially because it was accompanied by other measures; the reforms may not have eliminated insider power (Ramaswamy and Prasad, 1994); and wages may still fail to respond to local conditions because large firms pay uniform wages to their employees, regardless of the geographic location of their various plants (Walsh and Brown, 1990).

On the surface, the complex patchwork of national, regional, provincial, and firm-level negotiations might appear to provide ample scope for geographic flexibility of wages, particularly when one considers that, measured by number of workers, more than half of the agreements signed are at the provincial level (Table 4.2). Also, there appears to be consensus that the number of bargaining units is excessive. Bargaining takes place according to a cascading system, however, in which the outcome of agreements at the broader levels are de facto accepted as minimum standards for the narrower levels. For example, nationwide sectoral agreements set wage floors that are binding on all firms in the sector. The labor market reform of 1994 made it possible for a firm to opt out of these agreements, although only in cases where its economic viability would be endangered by applying the sectoral wage increase, and with the mutual consent of the employer and workers. Not surprisingly, this option has been exercised very seldom. In any case, only about 10 percent of wage earners are covered by firm-level agreements, while about 65 percent are covered by industry-wide agreements.14

Table 4.2.

Wage Agreements by Type, 1995

(In percent of total)

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Source: Ministry of Labor, Anuario de Estadisticas Laborales y de Asuntos Sociales (1995).

In addition, to the extent that there is scope for wage flexibility, the bargaining parties may have chosen not to use it to its full extent. The two main trade union confederations, Unión General de Trabajadores and Comisiones Obreras, may have pursued a strategy of “equal work, equal pay,” resulting in a low dispersion of wage-rate increases, even since 1986 when the last economywide wage agreement was signed. Employers may have chosen to accommodate this strategy to preserve social peace and to adopt more capital-intensive technologies.

The April 1997 agreement between trade unions and entrepreneurs does not explicitly call for a change in the degree of centralization of the bargaining system, but its implementation could provide the opportunity to make improvements in that area. The social partners agreed in principle to examine ways of streamlining the bargaining system. Their main concern is that, at present, the same aspects of a contract, for example, working conditions and wages, are often negotiated at several levels of bargaining—national/sectoral, provincial/sectoral, and firm-level—which leads to duplication of effort and confusion. The agreement lends itself to various interpretations, but one positive aspect is that it stipulates that negotiations on wages can take place at the firm level.

Programs to Help Workers in Depressed Areas

Programs to help workers in depressed areas reduce incentives for these workers to accept lower wages (thereby attracting new firms) or to seek jobs elsewhere. An example is the agricultural employment plan, Plan de Empleo Rural, which provides farm workers in Andalucía and Extremadura with temporary jobs in state-financed infrastructure projects and unemployment assistance for a substantial portion of the remainder of the year. Under that program, which covers about 250,000 workers and accounts for about 5 percent of total expenditure on unemployment benefits in Spain, as few as 40 days of work a year entitle workers to 75 percent of the statutory minimum wage for 40–360 days a year, depending on their age. This program reduces workers' willingness to migrate or to take low-paying jobs in sectors other than agriculture and represents an institutional barrier to labor market adjustment with important consequences to the low-skilled workers in the regions where it is available.

Minimum Wage Legislation

Spain's statutory minimum wage, currently at 32 percent of the average adult wage,15 is not high by international standards.16 Nevertheless, it may play some role in preventing wages from falling sufficiently to encourage the creation of new jobs at the low end of the pay scale. Its importance in determining labor force participants' willingness to take up jobs is increased by the fact that it affects the level of unemployment assistance and the ceiling and floor for unemployment benefits. Moreover, Spain's minimum wage is applied nationwide, with no adjustments for differences in the cost of living in the various areas of the country. While this institutional feature of the labor market is probably of little consequence for the highly skilled, it may have important consequences for the low skilled, particularly in areas where productivity and the cost of living are low.

The Unemployment Benefit/Assistance Systems

Spain's unemployment benefits system is fairly generous by international standards, though not sufficiently so to explain why Spain's unemployment rate is higher than in other countries.17 Gross replacement rates are higher than the EU average in the first month of unemployment, and net replacement rates are close to the EU average in the first month, but below the EU average in the sixtieth month of unemployment. The duration of unemployment benefits is equal to one-third of the last job's tenure, up to a maximum of two years;18 therefore, it does not stand out compared with other countries. Benefits amount to 70 percent of the previous wage for the first 6 months and 60 percent thereafter, with a floor of 75–100 percent of the minimum wage and a ceiling of 170–220 percent, depending on the number of children. Once eligibility for unemployment benefits expires, workers are entitled to means-tested unemployment assistance for another 3–30 months, depending on age, number of years' work prior to dismissal, and number of children, which amounts to 75 percent of the statutory minimum wage. The Spanish unemployment compensation system is rendered particularly generous by the possibility of cumulating unemployment benefits paid by the state with generous dismissal benefits paid by the employer.19

Unemployment protection reduces job search efforts by unemployed workers and raises the participation rate, thereby contributing to high unemployment and low labor mobility. Antolin and Bover (1997) find that, after controlling for personal characteristics, the unregistered unemployed, who do not receive unemployment benefits, are more mobile than the employed and the registered unemployed. Such adverse effects are particularly harsh on the low-skilled workers because benefits are capped. One positive feature of the current design of Spain's unemployment benefits system is that benefits are determined as a percentage of the previous wage. Therefore, if policy measures, such as the decentralization of the wage-bargaining system, were to be undertaken and resulted in lower wages in high-unemployment areas, unemployment benefits in those areas would fall correspondingly.

Housing Market Arrangements

Current arrangements in the housing market also contribute to limiting the geographic mobility of labor. In particular, the market for rental housing is relatively undeveloped and illiquid in Spain, with more than three-fourths of the population living in owner-occupied housing, compared with about 60 percent in a sample of more than 20 OECD countries (Oswald, 1996). The most striking restriction is that the minimum duration of a rental contract is five years. Illiquid rental markets make it difficult for workers to move, especially the less affluent groups of workers, that is, typically the low skilled.20

Policies and Institutions in Goods and Other Factor Markets

While it is difficult to assess the flexibility of goods markets and the degree of capital mobility in Spain relative to other countries, some current institutional obstacles seem to be important. To take just one example, it is often difficult to obtain permits to open a new large retail outlet. Such rigidities in goods and factor markets also influence the speed of adjustment to labor demand shocks. For instance, suppose that the demand for labor drops in a given region, and wages fall as a result. Lower wages might attract new firms to that area, but if there are institutional obstacles to such a move, as in the case of large retail outlets, adjustment to the initial shock will take a long time.


There are large and persistent differences in unemployment rates among Spanish regions, and there are no signs that these differences can be reduced in the near future under current policies and arrangements. Labor market adjustment to shocks is sluggish, especially among the low skilled. This study has identified a number of measures that would facilitate the reduction of unemployment in depressed regions and foster the speedy adjustment to shocks.

Reforms in several labor market institutions would make it easier for the labor market to respond to shocks and for unemployment differences to be corrected rapidly. The most important reform would be the decentralization of the wage-bargaining system to permit wages to fall in high-unemployment areas, thereby attracting firms and providing an additional incentive for the unemployed to migrate. This measure would benefit workers of all skill levels. Such a reform could only be undertaken with the consensus of the social partners who would have to implement it. Decentralization of the wage-bargaining system becomes even more urgent as Spain joins EMU and consolidates its low-inflation environment, where relative wage adjustment may become more difficult.

To permit a better-informed choice of policies for reforming the wage-bargaining system, it is necessary to establish exactly its current degree of centralization, for example, by estimating more precisely the proportion of wage settlements that are affected by negotiations at the national level. To that end, the trade unions and the entrepreneurs' associations should undertake a census of bargaining practices in Spain—a project that is needed in any case if the social partners wish to implement effectively their agreement in principle to streamline the bargaining system.

Other measures to reform the labor market may be initiated by the government and can have significant effects among the low skilled, where the problem is the worst, even if they have little impact on the high skilled. To provide the right incentives for people to take up employment, it would be desirable to eliminate programs that help workers in specific sectors in depressed areas, continue reducing the minimum wage as a ratio of the average wage, and further tighten the eligibility for unemployment benefits. These actions could be combined with targeted social welfare programs to protect the truly needy sections of the population.

Enhanced competition in other goods and factor markets would also help speed up the adjustment to new labor market shocks and the correction of past shocks, thereby contributing to the reduction of geographic unemployment differentials. In particular, liberalization should be undertaken in the housing market, especially at the low end where restrictions are higher and where benefits to the low skilled would be greatest. Finally, the evidence presented in this study provides an additional argument in favor of improving the educational level of the workforce.

A decentralization of the wage-bargaining system, combined with the other aforementioned measures, would lead to a considerable decline in wages in Spain's high-unemployment areas, with a corresponding decline in unit labor costs. Entrepreneurs would exploit this opportunity by setting up new firms in those areas, causing employment to increase. Eventually, unit labor cost differences would disappear, but in the meantime unemployment differences would be reduced as well.

Appendix: Data Sets on the Spanish Provinces

This section uses a number of relatively unexplored data sets on the Spanish provinces, including those on nominal wages, prices, and productivity; on wage settlements by province; and on population, labor force, and employment by province.

The data on employment, labor force, and working age (16–65) population by province for 1964–92 are drawn from M. Mas, F. Pérez, E. Uriel, and L. Serrano, Capital Humano, Series Históricas, 1964–1992, Fundación Bancaja, Spain (1995). This is a unique data set, in that nothing comparable to it exists for other countries. It provides working-age population, as well as active population, and employment data for the 50 Spanish provinces. The results are based on a very comprehensive data collection project conducted by the Instituto Valenciano de Investigaciones Económicas (IVIE). Since 1977, the basic source of information used for the project is the individual replies to the labor force survey by the Instituto Nacional de Estadística (INE).

Nominal wages data for 1989–95, which are published only by region, were supplied by province by Mr. Miguel Angel de Castro of the INE for this project.

The data on relative prices at a given point in time are only available by region and were drawn from the Encuesta Regional de Precios 1989, supplied by the INE. The data for 1989–95 by province were constructed using the provincial price indices relative (time-series) to 1990=100, assuming as a starting point for each province the relative (cross-sectional) price index in 1989.

Data on productivity by province for 1989–95 are drawn from Contabilidad Regional de España 1989–1995, INE.

The data on wage settlements by province, for 1992–95, are drawn from Anuario de Estadisticas Laborales, Ministerio de Trabajo, Madrid, Spain (various issues). They refer to the average of all wage settlements reported to the Labor Ministry.


For instance, the picture in Spain is not as clear as in Italy, where unemployment is higher in the southern regions, which are further from the markets of the rest of Europe, more agricultural, and less prosperous.


The scatter plots are similar in the case of the regions.


Registered unemployment tends to underestimate the geographical differences in unemployment because it excludes the 250,000 people covered by the rural employment program in Extremadura and Andalucía even at times when they are not working, which is often a large proportion of the year.


Higher productivity in Barcelona than in Badajoz may reflect a host of factors, including better infrastructure, a more highly qualified work force, a larger share of advanced sectors in total output, and more modern production plants.


Within price indices, large differences are observed only in the case of housing prices.


These patterns are also observed when national accounts data on the total employee wage bill are used instead of survey data to compute average wages in the various regions, and when value-added data are used instead of gross domestic product data.


Scatter plots and regression analysis also fail to find a close association between unemployment rates and real wages or unit labor costs.


The results are broadly similar when the analysis is conducted on the basis of data for industry only.


The cross-sectional standard deviation of the 1992–95 average wage increase settlements for the 50 provinces amounted to 0.27 of a percentage point. The data refer to wage increase settlements reported to the Ministry of Labor, which includes the vast majority of agreements signed by trade unions and employers.


Using data on wages from national accounts at the regional/sectoral level, Bentolila and Jimeno (1995) confirm that wages do not respond to regional unemployment rates, although they respond somewhat to productivity.


The specification of the VAR system follows exactly Blanchard and Katz (1992) to permit an international comparison of the results. Nevertheless, a number of alternative specifications were estimated to show that the results are robust to specification changes. The results are broadly similar if the system is estimated by using differences rather than levels of the employment rate, or differences of employment growth and levels of the other two variables. The results are very similar if three or four lags of all the variables are used, instead of two lags.


Formally, the identifying assumption is that ɛiet can be interpreted as an innovation in local labor demand. Correspondingly, current innovations in local employment growth are allowed to affect local employment rates and local participation rates, but not vice versa.


Collective agreements are legally enforceable and apply to all workers in a given firm whether they are unionized or not. It is estimated that about three-fourths of firms and workers are covered by collective bargaining agreements, even though the workers' unionization rate of 10—15 percent is low by international standards.


This is an approximation because the data from the Ministry of Labor refer to all agreements, with no information on which workers are covered by more than one agreement, as is very often the case.


This rate declined gradually from 40 percent in 1985. Workers of age 18 and under who are employed under training contracts may be paid 85 percent of the statutory minimum wage.


It is well below the average for EU countries that have a statutory minimum wage (more than 50 percent of the average adult wage). It is also below the average of the minimum wages set through collective agreements in EU countries that do not have a statutory minimum wage.


In particular, a thorough comparison between the unemployment benefit systems and other labor market institutions in Spain and Portugal reveals that the differences between these two countries are rather limited, raising the puzzling question of why unemployment is so much worse in the former than in the latter.


A worker must have been employed for at least 12 months in the past 6 years to be eligible for unemployment benefits.


Permanent workers hired before May 1997 typically receive their full salary for 45 days per year worked, up to a maximum of 42 weeks, if they are dismissed for “unjustified” economic causes, which tends to be the majority of cases.


On the basis of cross-country regressions, Oswald (1996) has suggested that undeveloped markets for rental housing may contribute to higher unemployment rates because workers find it more difficult to move to a new location where jobs might be available. However, his findings may result from the fact that high unemployment reduces migration, implying that a higher share of the population lives in owner-occupied housing.


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    Unemployment Rates by Province

    (1997, second quarter)

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    Unemployment Rates by Region

    (In percent)

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    Persistence of Unemployment in the Spanish Provinces: Survey Rate and Registered Rate

    (In percent)

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    Response to a One Percent Negative Employment Shock in a Given Province

    (In percentage points)