Abstract
Large differences among European Union countries in postcrisis employment growth to a large extent were driven by the need to adjust corporate balance sheets, which had greatly deteriorated during the boom years in some countries but not in others. To close the large gaps between saving and investment, firms reduced investment and cut costs to boost profits. With much of the cost adjustment falling on firms’ wage bills, employment losses were largest in countries under the most intense pressures to improve corporate profitability and with limited wage flexibility due to labor market duality.
Bas B. Bakker and Li Zeng
Since the onset of the global financial crisis, there have been striking differences in labor market developments among European Union (EU) countries. Between 2008 and 2011, employment dropped by 14 percent in Ireland, but increased by 2 percent in Poland and Germany. These differences partly reflect differences in real GDP growth. Latvia, for example, with the largest decline in real GDP between 2008 and 2011, also experienced one of the largest reductions in employment. Poland, which had the largest increase in real GDP during this period, also had one of the best employment outcomes.
However, in a number of countries, the losses in employment far exceed what could be expected given the drop in output. This is particularly the case in Bulgaria, Ireland, and Spain. Spain had roughly the same decline in GDP as Italy, but employment dropped by only 2 percent in Italy, while in Spain it fell by 11 percent.
From Precrisis Borrowing Binge to Postcrisis Balance Sheet Repair
Between 2003 and 2008, the debt of the nonfinancial corporate sector increased sharply in many countries. The increases were particularly large in Bulgaria, Ireland, and Spain. The increase was the counterpart of a sharp deterioration of the nonfinancial corporate sector’s saving-investment balance, which reflected both rising investment, and—in about half of the countries—a decline of corporate saving, that is, retained profits. By 2008, corporate investment exceeded saving by more than 5 percent of GDP in Latvia, Spain, Slovenia, Bulgaria, and Portugal. The large gap made firms vulnerable to a sudden deterioration of financing conditions.
Once the global crisis hit, and capital flows dropped, the large saving shortfalls were no longer sustainable, and firms had to adjust. Between 2008 and 2011, the corporate saving-investment balances improved in almost all countries. The improvement was most dramatic in Latvia, Lithuania, and Spain. The improvement in the saving-investment balance resulted not only from cutting investment but also from boosting corporate profits and saving (viz., retained profits). Firms boosted profits by cutting costs, and much of the cost adjustment fell on firms’ wage bills.
The differences in the extent to which corporate profit shares have increased between 2008 and 2011 are striking. It is noteworthy that the sharpest increases in corporate profitability occurred in countries where the debt had increased and profitability had fallen during the precrisis years, likely reflecting that pressures to boost profits were higher in these countries.
Corporate Restructuring Hurt Output and Employment
The increase in profit shares was associated with a reduction in output and an increase in labor productivity, both of which hurt employment (Figure 1):
During 2008–11 there was a negative relationship between the increase in the profit share and GDP growth. Profit shares increased sharply in several countries with large output declines, while they declined in a number of core euro area countries where output increased. This suggests that—for this particular period—causality did not go from GDP growth to profits, but rather that corporate restructuring (which boosted corporate profits) had a negative impact on GDP.
Larger profit share increases were also associated with bigger increases in labor productivity. The increase in productivity likely reflects restructuring by enterprises to produce the same output with fewer workers. It may partly also reflect a composition effect, as sectors with lower labor productivity (including, in particular, the construction sector in some countries) were hit disproportionally by the crisis.
Change in Profit Share of Nonfinancial Corporate Sector, 2008–2011
Citation: IMF Research Bulletin 2014, 001; 10.5089/9781484346266.026.A002
Sources: IMF, World Economic Outlook database; Haver Analytics; and IMF staff estimates.Change in Profit Share of Nonfinancial Corporate Sector, 2008–2011
Citation: IMF Research Bulletin 2014, 001; 10.5089/9781484346266.026.A002
Sources: IMF, World Economic Outlook database; Haver Analytics; and IMF staff estimates.Change in Profit Share of Nonfinancial Corporate Sector, 2008–2011
Citation: IMF Research Bulletin 2014, 001; 10.5089/9781484346266.026.A002
Sources: IMF, World Economic Outlook database; Haver Analytics; and IMF staff estimates.The combination of a sharp increase in labor productivity with a decline in output is very different from the positive relationship observed during normal times. Between 2003 and 2008, faster GDP growth was associated with higher labor productivity growth. Between 2008 and 2011, this relationship broke down, and labor productivity growth was fastest in some of the countries with the largest output declines.
Labor Market Duality Did Not Help
There are large differences across European countries in the duality of the labor market. In some countries a large share of employment consists of temporary jobs. In these countries there is a stark difference between insiders (who have permanent jobs and cannot easily be fired) and outsiders (who have temporary jobs).
We would expect that countries with dual labor markets will see sharper reductions of employment than other countries. For a given level of output, profit shares can be increased either through employment reductions or wage declines. In countries with dual labor markets, it is likely that much of the adjustment will go through employment reductions rather than wage cuts, as insiders have little incentive to adjust wages, while outsiders can easily be fired. Indeed, we show in our paper that in countries with a high share of temporary employment, real wage growth is much less sensitive to unemployment changes.
Econometric Analysis
Econometric regression analysis confirms that the three factors discussed—real GDP growth, corporate balance sheet repair, and labor market duality—all contributed to the large cross-country differences in employment growth during 2008–11. The results are robust to introducing other precrisis imbalance measures to the model, such as current account deficits and the size of the construction sector.
A decomposition exercise illustrates the important roles of both the increase in corporate profits and labor market duality in the large drop in employment that occurred in a number of countries. Figure 2 shows that among all the countries where employment dropped by more than 7 percent, with the notable exception of Greece, the increase in profits accounted for more than 50 percent of the job losses. The figure also shows that labor market duality contributed over 4 percentage points to the employment losses in Spain, Poland, and Portugal.
Decomposition of Employment Growth 2008–11
Citation: IMF Research Bulletin 2014, 001; 10.5089/9781484346266.026.A002
Sources: IMF, World Economic Outlook database; Haver Analytics; and IMF staff estimates.Decomposition of Employment Growth 2008–11
Citation: IMF Research Bulletin 2014, 001; 10.5089/9781484346266.026.A002
Sources: IMF, World Economic Outlook database; Haver Analytics; and IMF staff estimates.Decomposition of Employment Growth 2008–11
Citation: IMF Research Bulletin 2014, 001; 10.5089/9781484346266.026.A002
Sources: IMF, World Economic Outlook database; Haver Analytics; and IMF staff estimates.Policy Implications
The analysis in this paper suggests that the large employment losses in many countries have been the result of a corporate adjustment process, which helped restore the financial health of the corporate sector. While the adjustment has deepened the recession, it has also helped set the stage for renewed growth.
It is difficult to determine ex ante when the corporate adjustment will have run its course. There are, however, signs that in at least some of the crisis-hit countries, the process may be nearing its end. For instance, in Ireland, the profit share stopped increasing and the wage bill ended its decline during 2012. At the same time, its employment started growing again and the unemployment rate started to come down.
The results also suggest that there is a trade-off between wage adjustment and employment losses and that in some countries employment losses would have been smaller if wages had adjusted more. Wage adjustment is preferable to employment adjustment because the former helps distribute the burden more equitably, while the latter negatively affects human capital and the potential growth rate.
References
Bakker, B., and C. Klingen, eds., 2012, How Emerging Europe Came Through the 2008/09 Crisis: An Account by the Staff of the IMF’s European Department (Washington: International Monetary Fund).
Ball, L. M., D. Leigh, and P. Loungani, 2013, “Okun’s Law: Fit at Fifty?” NBER Working Paper 18668 (Cambridge: National Bureau of Economic Research).
Banco de España, 2013, “Spanish Non-Financial Corporations’ Debt since the Start of the Crisis. A Disaggregated Analysis,” Economic Bulletin, January 2013 (Madrid).
Bassanini, A., and R. Duval, 2006a, “Employment Patterns in OECD Countries: Reassessing the Role of Policies and Institutions,” OECD Social, Employment and Migration Working Papers No. 35 (Paris: Organisation for Economic Co-operation and Development).
Bassanini, A., and R. Duval, 2006b, “The Determinants of Unemployment across OECD Countries: Reassessing the Role of Policies and Institutions,” OECD Economic Studies No. 42, 2006/1 (Paris: Organisation for Economic Co-operation and Development).
Bassanini, A., and R. Duval, 2009, “Unemployment, Institutions, and Reform Complementarities: Reassessing the Aggregate Evidence for OECD Countries,” Oxford Review of Economic Policy, Vol. 25, pp. 40–59.
Boeri, T., 2011, “Institutional Reforms and Dualism in European Labor Markets,” in O. Ashenfelter and D. Card (eds.), Handbook of Labor Economics, pp. 1173–1236 (Amsterdam: North Holland)
Cahuc, P., O. Charlot, and F. Malherbet, 2012, “Explaining the Spread of Temporary Jobs and Its Impact on Labor Turnover,” CEPR Discussion Papers No. 8864.
Central Bank of Ireland, January 2011, Central Bank Quarterly Bulletin (Dublin).
European Central Bank, “Integrated Economic and Financial Accounts by Institutional Sector,” available at http://sdw.ecb.europa.eu/reports.do?node=1000002340_ALLPDF
International Monetary Fund, 2010, “Chapter 3. Unemployment Dynamics during Recessions and Recoveries: Okun’s Law and Beyond,” World Economic Outlook, April 2010 (Washington).
Koo, R., 2008, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession (Singapore: John Wiley & Sons (Asia) Pte. Ltd.).
Lamont, O., 1995, “Corporate-Debt Overhang and Macroeconomic Expectations,” American Economic Review, Vol. 85(5), pp. 1106–17.
Organisation for Economic Co-operation and Development (OECD), 2006, OECD Employment Outlook (Paris).
Organisation for Economic Co-operation and Development (OECD), 2012, “Chapter 2. What Makes Labour Markets Resilient During Recessions?” OECD Employment Outlook (Paris).
