FREEING UP EUROPE'S RIGID LABOR MARKETS IS A TRICKY BUSINESS
The standard prescription to cure the high unemployment afflicting Europe is to loosen its highly restricted labor markets by making it easier and less costly to hire and fire new workers. Such a change would presumably encourage job creation and weaken the bargaining power of entrenched employees--eventually resulting in more competitive wages that make possible still greater employment growth.
Sometimes, however, the cure worsens the disease. In the latest issue of Economic Policy, economists Samuel Bentolila and Juan Dolado examine the impact of a law passed in Spain in 1984 that significantly eased regulations on the hiring of workers for temporary periods. The law apparently improved labor-market flexibility in several respects. About one-third of all workers now hold temporary jobs. Employment has become more variable over the business cycle, and labor-market turnover has increased. But researchers found that instead of dampening the wage growth of the core of permanent employees, the law actually tended to enhance it.
The apparent explanation is that permanent employees felt freer to bargain for wage increases because they knew that any dismissals caused by their demands would affect temporary workers first. An analysis showed that the interests of highly paid permanent workers weighed far more heavily in labor contracts than those of their lower-paid temporary co-workers.
Such findings don't mean that reforming Europe's constricted labor markets is a bad idea. But they do suggest that reform measures need careful planning and can sometimes backfire.GENE KORETZ