A vibrant European labor market with full employment

Wage income inequality is rising due to changes in the production structure

Wage inequality increased in Europe in the period 2000–2010 mostly as a result of the long-run changes in the production structure in which non-routine work became increasingly more important, whereas the relevance of routine work decreased. The changes in the production structure are illustrated by the increase in the wage premium of higher education graduates (for all OECD countries for the period 1997–2003) when the supply of graduates increased (Machin and McNally 2007). If the production structure would have remained the same, the increased supply of graduates would have led to lower wages. Tinbergen (1975) captured this as the “race between education and technology”, implying skill-biased technological change.

In particular, computers have created the technological change: less-educated and unskilled workers are pushed out of jobs by robotization; thus the demand for routine work decreases since it can be mechanized, outsourced or offshored. At the same time, the demand for non-routine work—how to make the robots—increases (Autor et al. 2003; Acemoglu 2002).

For Europe it is important to recognize that these changes in private sector labor market demand were accompanied by the expansion of the (semi-)public sector, which is far more higher education-intensive than the private sector. This contributed to a market scarcity for higher-educated workers in the private sector, adding to the upward pressure on wages of well-trained workers, while the public sector wages follow the private sector’s wage-setting. In other words, the disequalizing wage effect of the technologic change, which enhanced the relative demand for well-trained workers, was enhanced by the expansion of the (semi-)public sector in Europe. It was further enhanced by the emulation on bonuses and top earnings in the private sector.

OECD (2011) and Chusseau et al. (2008) document how increased imports from low-income countries (including outsourcing) also pushed out routine labor jobs in OECD countries. At the same time, according to these studies, the effect of the rapid rise in the integration of trade and financial markets has hardly impacted the relative shift in labor demand, in favor of highly-skilled workers.

Wage inequality has also increased in Europe due to the decrease in minimum wages in relation to median wages between the 1980s and 2008 (OECD 2011, p.30). This was a result of decreasing union power, even though the coverage of collective bargaining generally remained rather stable over time. The immigration of low-skilled workers contributes little to rising wage inequality (Heckman et al. 1998).

Income inequality

The OECD (2011, p.22) reports that income inequality in the 27 OECD countries has risen from 1975 to 2008: real household income at the bottom decile grew by 1.3% per year while growth in the top decile was some 50% higher (namely 1.9%) because the redistributive impact of taxation and transfers has decreased in the past decades and because of increased inequality in wages and in non-wage incomes.

Social cohesion

Social cohesion is a notoriously vague concept (Wilkinson 1997), despite all efforts at measurement through social capital (Putnam 2000) or otherwise. At the same time, it is used in practically every major document from EU member states as a major precondition for the functioning of European democracies. In Europe a low level of income inequality is generally viewed as a precondition for social cohesion. This is in contrast to the US, where a high level of income inequality still (irrationally) seems to signal that there is a chance for “every paperboy” to become a millionaire, presumably based on the (false) assumption that intergenerational mobility is larger if income inequality is greater; the OECD (2008, p.213) has shown that intergenerational mobility is greater when income inequality is smaller.

When launching the OECD (2011) report, the OECD Secretary General Angel Gurría, in the context of the impact of increasing income inequalities on social cohesion, said: “The social contract is starting to unravel in many countries.”

The minimum wage

In most EU member states, the wage level of workers with low education levels is mostly determined by a general minimum wage per hour for all workers. Germany has been until now one of the exceptions, although there were minimum wages for a large number of sectors organized by unions and employers, as well as some determined by public intervention; however, it plans the introduction of a general minimum wage on January 2015 (Arni et al. 2014). Minimum wage legislation aims at ensuring that a person who works full time is able to sustain himself or herself, as well as a family, with the wage income. The impact of a minimum wage on both income distribution and on employment has been an issue of considerable debate¹. The key concern is the degree of the employment loss among low-wage workers and the resulting impact on poverty levels. How much unemployment results from the introduction of a minimum wage or a raise thereof mainly depends on the degree to which workers are affected, the size of the wage change for them and the respective labor demand elasticity. Additionally, the spillover effects of an increase in wage costs on output prices might also have an effect through a reduction of general demand. And further people either non-participants or new immigrants may enter the labor force. Minimum wages only reduce poverty among households if workers living in poor households benefit from the minimum wage.

Minimum wages in the EU are often set at such low levels that only a small share of jobs is affected, and the effects on employment are negligible. The minimum wages range from about one euro per hour in Romania and Bulgaria to about 10 euro in France and Luxembourg. It is likely that these minimum wages reduce income inequality while not or hardly affecting employment. Yet high minimum wages may have a serious impact: a recent study by Cahuc et al. (2013) shows that the numerous young people out of work in France, as compared to Germany, is associated with the high French minimum wage. They show that if the French minimum wage were applied to young workers (excluding apprentices) in Germany, then it would affect the majority of young current German workers; 55 percent of young Germans now cost their employer less than the equivalent cost of the minimum wage in France (p.14). At the same time most studies done for the US (for example Teulings 2003) and for the OECD (such as OECD 2011) show that the relative decrease in the minimum wage level—as experienced in many OECD countries over the past decades—is one of the sources but not necessarily one of the causes of increased income inequality. This conclusion is drawn, for instance, without accounting for the positive impact of the decrease in the relative minimum wage on employment. Sabia et al. (2012) show that the 39 percent increase in the New York state minimum wage in 2005–2007 (from the federal rate of $5.15 to $7.15) had “substantial adverse labor demand effects for low-skilled individuals”. (p.350) and consequently had a negative effect on the income distribution.

Labor force participation and the retirement age

Labor force participation rates differ substantially between EU countries mostly due to very different social security and pension regulations. Some countries have moved the retirement age upwards, in alignment with life expectancy and demographic development (with more old-age persons relative to the working population). Others, such as France and Germany, continue to lower the pension age. Replacement rates are also substantially different among the EU member states because of differences in benefit systems for the unemployed.

Employment and happiness

For those who are employed, the quality of life at work is important. The trade-off between the level of (macro) employment and the quality of work for those who are employed then needs to be envisaged.

For the EU, Boeri and Garibaldi (2009) conclude that a permanent contract increases the probability of being satisfied by 7 percentage points from the baseline, while the importance of employment protection for happiness of permanent contract workers decreased between 2000 and 2005.

Workers’ well-being matters not only for themselves but also for firms: it is a good predictor of productivity. It is well-known that workers who are more satisfied with their jobs are less likely to quit; they are also less likely to reduce firm productivity via absenteeism or presenteeism—showing up for work but contributing little (Robertson and Cooper 2011; Cooper and Lundberg 2011).

The bottom line remains one given by Gruen et al. (2010), using the German Socio-Economic Panel:

“…we cannot identify a single job feature or a combination of such features that constitute such low quality jobs that remaining unemployed would be the better choice for the individual. On the contrary, the bulk of our evidence shows that even low quality jobs are associated with higher life satisfaction, and this effect is statistically significant for most specifications of “bad” jobs.”

Similarly, a parallel study examines the value of the large German workfare program and concludes that people’s life satisfaction rises substantially after moving from being totally out of work to being part of the program (Wulfgramm 2011).

It is likely that national happiness might decrease with a reduction in worker protection for those with permanent contracts. Yet it is equally likely that total happiness increases if the same decrease in worker protection results in increased employment.

From OECD figures Europe appears to have been an overall happy continent in the decade 2000–2010. When asked to rate their general life satisfaction on a scale from 0 to 10, people across the OECD averaged 6.7. Some countries— Hungary, Portugal, Turkey and Greece— have a relatively low level of overall life satisfaction, with average scores of less than 5.5. At the other end of the scale, scores were higher than 7.5 in Denmark, Norway, the Netherlands and Switzerland. There is little difference in life satisfaction levels between men (6.6) and women (6.7) across OECD countries. However, social status strongly influences subjective well-being. The bottom 20% of the population in OECD countries has a life satisfaction level of 6.1. This score increases to 7.3 for the top 20%.

Unhappiness is concentrated in poorer countries such as in Bulgaria. Not only do absolute happiness levels differ but their variations also differ between countries. Among OECD countries the correlation between country means and standard deviations is significantly negative (more variance when the mean is lower). Among those countries with high average scores, some have quite high degrees of equality in the distribution of happiness (Denmark and the Netherlands), while in some fairly low-ranking countries (Bulgaria and Romania) there is much more dispersion.

OECD countries with higher unemployment levels appear to be less happy, when measured by the level of happiness or the degree of dispersion of happiness (more dispersion with more unemployment). This confirms the micro findings on individual happiness and the individual (un)employment experience. More econometric research is needed to confirm the result of this casual inspection.

A vibrant scenario

A vibrant European labor market with full employment would be first and foremost the result of individual EU member countries’ policies, once the stability pact and the Banking Union have been implemented and credit flows resume pre-crisis levels. These fiscal and monetary policies have been belatedly brought to the European level as necessary complements to introducing the euro. Yet for employment and social policy, the responsibilities largely remain with the EU countries’ national governments, albeit that the European Commission (2013) wants to strengthen the “social dimension” of the Economic and Monetary Union (EMU) by using employment and social indicators as part of the “European Semester” process for economic policy coordination.

At present, public debts and budget deficits attract the most attention in the Semester process, in which EU member states’ governments have to submit their budget proposals first to the EU, before presenting them to their national parliaments. The EU gives binding criteria applied to the levels of government deficits and sovereign debt as in the stability pact for the euro.

The European Parliament (2012) has called for strengthening the EMU with a “social pact”, to be included in the Van Rompuy (2012) report, which restricted itself to four pillars of the EU: financial integration, budgetary framework integration, economic policy integration and democratic legitimacy.

“Fiscal consolidation” is the EU member countries’ commitment to comply with the Maastricht criteria in terms of government budget deficits and sovereign debt levels. It is essential in order to avoid a substantial interest claim on government income, pushing out expenditures for education, health, social transfers and the like. Yet if it leads to economic policies in which countries with substantial trade surpluses are inducing wage reductions and slowing down public investment (in infrastructure or in public R&D), then the single-minded application of fiscal consolidation may not serve its purpose, as it smothers economic growth. Likewise “austerity” should not block needed reforms in the labor market structure, nor in other markets. Vibrancy would start with adopting the policy goal of full employment, as this may serve as a reference point for “smart austerity”.

Hence we suggest: Full employment should become an EU goal to be realized by 2020. The new European Parliament should demand an employment proposal from the Commission that would have the potential to regain lasting full employment relatively soon, as well as the implications for the Maastricht criteria and the Semester process. The new European Commission (which starts in December 2020) should have a mandate to engender full employment by 2020.

The goal of full employment translates into five policies: innovation (3.1), income (3.2), mobility (3.3), immigration (3.4) and greening (3.5).

Aside from an EU-wide agreement on full employment as a policy goal, a social scoreboard might be helpful. This would be done with agreed measurements and objectives and ensure that the EU leverages both economic and social goals in EU countries. Poverty levels and social goals would be recorded next to macroeconomic and employment indicators.

Automatic stabilizers at the EU level could also be a “leveraging” European approach to help individual EU countries reach their economic and social goals. Automatic stabilizers have been amply researched (Peichl et al. 2013), for example in the form a fiscal union or a European unemployment scheme, in which a minimum level of unemployment benefits would come from a European fund for a maximum duration of one year. However, this is a difficult proposition since it involves distributional consequences as well as moral hazards.

Social goals need to be narrowed down to a small set of basic needs with a clear view on full employment as the best social policy. Too much spending on social protection will undermine competitiveness. It is critical to maintain a link between wages and productivity, allowing room for collective bargaining. Keeping this link also means that high-productivity countries should allow wages to increase.

A vibrant scenario

More public R&D, less entrepreneurial regulation, better quality education and more credit for startups can raise labor productivity in the longer run. However, R&D outcomes are not only about money; the organization of R&D plays a major role. It is clear that there are huge differences between EU states regarding the effectiveness of public R&D expenditures, whether measured in citations, patents, knowledge-based startups, or in “entrepreneurship”.

A new convergence in per capita incomes between EU member states could arise from stronger human capital and R&D positions in the poorer countries. In this respect, it is counterintuitive to notice that structural and cohesion funds—meant to bring about convergence—are hardly allocated toward universities or R&D, with the exception of Poland (see country reports in Hoareau et al. 2012).

Innovation cannot be enacted by law, nor be taught at school as to how it can be generated, even though entrepreneurship education could have a substantial impact on innovation. Policies should rather be designed to incentivize and enhance an environment for more private innovation. This is concerned with lessening bureaucracy, easing patenting, reducing costs and standardizing treatment of intellectual property rights. European education systems are typically very formal, which is arguably not the best pre-condition for future innovation, since this cannot be taught at school or university. It rather needs an education system that not only allows for but actually encourages creativity from the very beginning of (preschool) education while at the same time explicitly pays attention to entrepreneurship training.

Our following policy recommendations to stimulate innovation (as a means to generate employment) for the EU member states are then:

At the EU level, several steps could be taken:

The most radical proposal for the EU to leverage individual member states is:

A vibrant scenario

The vibrant scenario implies more innovation compared to the muddling through scenario. But this also means that the demand for well-trained workers is higher in this scenario, which if anything leads to more wage inequality as a result of the greater bargaining power of well-trained workers.

Wage inequality can be reduced by raising wages at the bottom through increased demand, like expanding the (lagging) demand for low-skilled work by developing the service sector or by creating public jobs for low-skilled workers. Currently large parts are hidden in Europe’s shadow economy, estimated to account for up to one‒sixth of GDP in Germany alone (Schneider 2003). The Belgian scheme of service checks has been helpful in creating additional demand for low-skilled workers.

Kolev and Saget (2010) address policies to mitigate earnings inequality. Regarding the low-end of the labor market, policies to reduce inequality should target the labor supply, such as providing workers with better skills and training; additionally policies also need to focus on labor demand measures, such as investment in job creation, as well as the support for institutions to ameliorate low paid workers’ salaries through paths like collective bargaining and minimum wages.

At the upper part of the wage distribution there is room for limiting the rising top earnings, along the lines of the adopted Swiss referendum (of March 2013). This referendum says: no more golden hellos, no more golden parachutes, no more bonuses linked to merging a company with another and a binding vote on executive pay by shareholders. Pension funds holding shares in a company would be obligated to take part in votes on compensation packages. Violations could result in fines equal to up to six years of salary and a prison sentence of up to three years.

A European-wide dialogue with the private sector on maximum wages (excluding the rewards of entrepreneurial work, i.e. risk taking with potential private losses) might bring about such caps on non-entrepreneurial income Europe-wide, avoiding the potential for escape by moving from one EU country to another.

The exodus of top talent by emigration to regions outside of Europe (to the US or Australia) of such a regulation is likely to be minimal, if one can generalize the findings for the US (Young and Varner 2012) for Europe. They conclude that top-income taxes in California do not lead to observable tax flight. They also studied the migration patterns of New Jersey’s millionaires before and after 2004, when the state imposed a “millionaire’s tax” that raised rates on those earning $500,000 or more to 8.97% from 6.37% and conclude that “millionaire flight” is a myth. However, Vedder (2003) finds a substantial impact of tax rate increases on out-migration from one US state to another.

Moreover, the vibrant scenario should also look for policies to combine smart growth with a return to a more redistributive tax and transfer policy (Atkinson 2013). Decreases in the bottom income tax rates, or the introduction of a luxury rate of VAT, can contribute to fiscal consolidation and help ensure that the burden of fiscal adjustment can be more fairly shared. The merits of an increase in the income tax top rate are debatable.

Perhaps the impact of a “millionaire’s tax” in Europe, if applied Europe-wide, would not lead to substantial emigration. The introduction of a millionaire tax in France in 2012 with a number of high-publicity flight cases will perhaps be a good case study, albeit that this was a tax only for residents in France thus evasion was easy by moving across the border to nearby European countries. Zoutman (2014) argues that top rates are already beyond revenue maximizing.

Limiting top incomes would have a strong impact on income inequality in the uppermost income bracket (top 1%). At the same time the possible increase in entrepreneurial income and capital income— as may be expected from a more vibrant scenario— may offset the income, reducing the impact of the top income limitation brought about by shareholder constraints.

The incentives to engage in regular work could be found in the workfare principle: there is no financial support without work or commitment to further education (Schneider and Zimmermann 2010). Rinne and Zimmermann (2012) argue that important factors that have recently contributed to the strong German employment resilience have stemmed from the 2003 Hartz market reforms, the extension of short-time work, the behavior of social partners and automatic stabilizers in social security expenditures. The impact of these reforms in Germany seems to have clearly reduced income inequality (Grabka et al. 2012).

Between country differences should be reduced by helping lower income countries to converge faster with higher income countries. This means de facto that they should quickly switch from imitation to innovation technologies. The policy described above, focusing on cohesion and structural funds for 50% for R&D and higher education, might be helpful for such a switch.

Therefore the following are policy recommendations for a vibrant scenario for EU member states:

A vibrant scenario

The vibrant scenario is defined as having increased labor mobility within and between EU countries with EU member states at the helm; this would be leveraged by the EU as a knowledge clearing house (on what works and what does not), with country specific recommendations and guidelines.

Increased labor mobility is needed because of the reduced half-life time of products, because of the creative destruction of jobs due to innovation, and because of unemployment differences between industries, regions and countries.

In the vibrant scenario the level of job protection for temporary contracts is increased while that for permanent contracts is reduced. Many different measures are needed. We distinguish between member state and EU policy.

The member states should focus on increasing mobility within their countries. The general notion is that unemployment should not occur if a job is lost, because workers anticipate the disappearance of the job and timely “hop” to another one. An incentive for anticipation is:

Other incentives are:

The EU’s role in coordination with the member states on mobility policy could be:

A vibrant scenario

As an additional measure, one could think to introduce a European social youth loan scheme, for example totaling 50 billion euro for the years 2014 and 2015. The notion would be that every young EU citizen between the age of 20 and 30 could take out a loan for a maximum of 40,000 euro at an interest rate of the government lending rate plus 2% (for default and administrative costs). It would be a personal loan that would have to be paid back according to social loan schemes. This would be similar to what some EU countries do for education loans. Basically it means one would never have to repay more than 10% of his or her income; additionally, at some point (after 20 or 25 years) if there is still a remainder of the loan, it would be written off.

The loan would have to be spent in the EU within two years following procurement (any unspent amount would be repaid immediately). It could not to be used to “play the stock market” or to save. At the same time the conditions should not be too strict in order to keep administrative costs as low as possible.

The loans should not lead to contraction of credit available for other purposes. Hence it is assumed that the European Central Bank would accommodate it in the money flow as a focused form of quantitative easing. In this way a monetary impulse is provided in spending while giving young Europeans a chance to start a business, to study, or to invest in his or her own human capital in other ways. The EU policy brief on youth entrepreneurship (2012) shows that 40% of young Europeans have an interest in starting a firm of their own. A loan scheme as proposed might help to realize this interest.

A vibrant scenario

Greening (a smaller footprint) raises prices in such a way that goods and services with a larger footprint will have the largest price increase. In this way, a shift in consumption is encouraged away from “ungreen” goods and services. The end result is an average price increase for the total basket of consumption goods. Such a price increase would in part mitigate the increase in welfare of this “vibrant scenario” policy package measures, leading to more innovation and higher economic growth.

It is unclear how additional greening efforts could impact the composition of employment. If greening is aligned with innovation, the impact on employment is positive (as is the intention of Atomausstieg).

The increased prices of “ungreen” goods and services might impede European firms’ exports and thus impact its international competitiveness. However, this need not be the case if Europe (either by Kyoto-type agreements or WTO negotiations) can create a level playing field. WTO negotiations can help create this if the EU can levy import taxes on “ungreen” goods and services to a level which would adjust the import price to include the added costs the EU bore in order to make its production greener.

A vibrant scenario

Some consideration could be given to happiness, which is a function of unemployment (negative relation), EPL (positive relation) and income, in a world with rapidly changing jobs. Overall it can be argued that the vibrant scenario is superior to muddling through as it comes closer to full employment, leads to more growth and less inequality and to more greening, while realizing that there are “happiness costs” involved in reducing employment protection and increasing labor mobility within and between EU countries.