TCS Daily

Reform the Works

By Johnny Munkhammar - July 17, 2006 12:00 AM

EU leaders say they want higher economic growth and more jobs. They talk the talk about the need for reform. But in most of western Europe, they have failed to walk the walk. This is especially true when it comes to the single most important reform: freeing up the labor market.

At the start of the current Finnish EU presidency, Finland's Prime Minister Matti Vanhanen set out his priorities for the next six months. "The key challenge is to identify the basis for economic growth in Europe," he said. "Finland's answer includes innovation, energy solutions, quality of work and productivity, openness of global trade, immigration and well-functioning social protection system."

Indeed, one of the first working groups of the presidency brought together EU labor ministers, on 7 July. They describe many of the challenges correctly - such as the demographic situation and the globalized economy - but are vague on what to actually do about them.

The most recent statistics from Eurostat show that unemployment in the EU has dropped somewhat, to about 8 percent. The drop is limited, though, and the level will rise again when the current good business cycle is over. The total rate is of course much higher, if hidden unemployment in various government labor market programs, sick-leave, early retirement, etc., are added. Youth unemployment remains very high, at almost 18 percent.

The problem is serious. But its causes are simple, really, and so are the solutions.

The first thing we should consider when discussing the labor market is that it is - or should be - a market. And the core principle of a market is free exchange. Every market is founded on that freedom. Free exchange, free prices and free competition. The labor market should not be any different.

Freedom brings on constant improvements. Innovators and entrepreneurs compete to satisfy consumers. Free exchange in a town is good, in a whole country it is better and all over the world even greater. More minds, more ideas, more people that want to create something new. Never before have so many people been part of a global economy and had such high living standards as they enjoy today.

Some say a free labor market will lead to a race to the bottom. Wages and other working conditions will be pushed down. But this is basically a Marxist notion of capitalism, which economic history proves false.

Wages are ten times higher today than a hundred years ago because our productivity is that much higher. We produce, per person, ten times more value. If wages in a free market are set below productivity, a competitor will make a profit by offering higher wages. Employers compete, too. Why else would wages be the highest in the world in the US, where the labor market is relatively free and only some ten percent of the labor force are members of trade unions? Why else would multinational companies voluntarily pay workers in, for example, China on average four times more than old, local, companies do?

Nevertheless, many countries have created complex policies to replace the free exchange of labor. The results of this in the EU are clear. The share of the population between the age of 15 and 64 in employment in the EU is only 64 percent. Between 1970 and 2003, employment in the US increased by 75 percent. In France, Germany and Italy, it increased by 26 percent.

Comparisons with the US may be unpopular these days. And to be fair, from a free-market perspective, the US is far from perfect. But its state interventions in the labor market are smaller than in Western Europe. The US employment rate is 72 percent. In 2004, 51 million people left their jobs while 54 million were hired. The old jobs are replaced with new and better ones.

The most telling comparisons can be made within Europe. Denmark has an employment rate of 76 percent but Poland is at 53 percent. Youth unemployment is above 20 percent in Greece, Italy, Sweden, France, Belgium and Finland, and between 5 and 8 percent in Ireland, The Netherlands and Denmark.

In my country, Sweden, the situation is bad. Total unemployment is estimated at 15 to 20 percent. Employment grew at the fourth lowest rate in the EU-15 between 1995 and 2004. Youth unemployment is the fifth highest in EU-25 at 23 percent. The number of early retired under the age of 30 has almost doubled since 1999 and is now over 20,000.

What is the difference between the policies of the countries that succeeded and the others? First of all, labor markets are substantially freer in countries that succeed in creating new jobs. Second, payroll and income taxes are more than ten percentage points lower in the five best ones compared to the five worst ones. Third, the levels of contribution from the state for unemployment and sick-leave are lower in the successful countries.

Change is needed in Europe and the path is clear. EU countries could act now to free their labor markets by:

- Having a real single market in services, unleashing a great potential for new jobs.

- Allowing private initiatives in health care, education, elder care, child care and social security.

- De-regulating the labor market both in terms of job protection, minimum wages and trade union privileges.

- Abolishing the pension age, allowing people to work for as long or as short as they like and letting people invest their pension as they wish.

- Reducing payroll and income taxes, making work more profitable and hiring cheaper.

These liberating steps would create a strong boost of employment in Europe. All that is needed to achieve change is political boldness and determination. There will be real results - and reality is, after all, what counts in the end.

The author is the Program Director of the Timbro think tank in Sweden.


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