February 17th, 2016

Renzi’s tinkering with jobs shows a changed mood in Europe

by Enrico Colombatto Prime Minister Matteo Renzi promised to turn […]

Team AEC

Prime Minister Matteo Renzi promised to turn Italy inside out, jump-start economic growth and reduce unemployment. But during almost two years in office, he has introduced only one significant economic reform, the so-called “Jobs Act.” The outcome has been mixed, and certainly below expectations. This does not mean Mr. Renzi is on the wrong track.

Summary

Two lessons can be drawn from Prime Minister Renzi’s jobs package, which was designed to make hiring young workers cheaper and firing unneeded ones easier. The first is that it will take much more than fine-tuning to shake up Europe’s rigid labor markets and reduce unemployment, especially among the young. Reforms must cut deeper and go beyond the labor market to be effective. The second lesson from Italy’s experience is that the public is less hostile to deregulation than in the past; even with the disappointing results of the Jobs Act, there has been no backtracking. This bodes well for the future and should embolden European Union policy makers.

When the youthful, enthusiastic Matteo Renzi became Italy’s prime minister two years ago, he promised to push through key reforms in a matter of weeks, jolt the country’s political structure, and give Italians efficient government, better courts and sound public finances, along with jobs, growth and happiness. It was a tall order – and regrettably, he has not been able to deliver.

While the economy has emerged from recession – gross domestic product is estimated to have expanded by 0.7 percent last year, as opposed to contractions of 1.7 percent and 0.4 percent, respectively, in 2013 and 2014 – growth remains below the EU average. If a recovery is under way, Italians are not feeling it. Instead, they are worried about the future.

Jobs act

Over the past two years, the Renzi government has done little to help the economy rebound. Public expenditure and taxation are rising, government debt is at a record high (more than 133 percent of GDP), corruption is rampant and regulation remains extremely heavy. The centerpiece, and perhaps the only piece, of Mr. Renzi’s strategy to fix the economy is the “Jobs Act” – a series of labor code revisions adopted by Italian lawmakers in February 2015. The question is whether this attempt to alleviate Italy’s endemic high unemployment has been effective, or an example for other European countries to follow.

The Jobs Act simplifies the range of contracts available to employers and employees in the private sector. The new measures make hiring an employee cheaper, at least initially, while easing firing procedures, at least for part of the workforce. In general, employers have appreciated this reform and taken advantage of the new rules and of the tax breaks involved. However, the broad picture has not changed significantly.

Italy’s labor force participation remains the lowest in the EU. According to Eurostat surveys, 36.4 percent of the Italian working-age population neither has a job nor is looking for one. That compares with 27.6 percent for the EU as a whole, and 17.6 percent for Sweden, the best performer.

Mr. Renzi can rightly claim that the number of employed has increased and that the jobless rate has declined one percentage point over the past year, to about 11.4 percent. However, many Italians have stopped looking for work and dropped out of the official labor market – often to join the underground economy.

This suggests that the results of the Jobs Act have been far from impressive, especially when one considers the bigger picture. During the past year, the EU unemployment rate has fallen almost as much as Italy’s, from 10 percent to 9.1 percent. The Italian youth unemployment rate, at 38 percent, is double the EU average and more than five times Germany’s 7.1 percent.

Europe’s delusion

Belief that a limited reform such as the Jobs Act is sufficient can be traced to a self-delusion common in Europe. Many EU policymakers assume the unemployment problem will vanish due to faster economic growth and demographic trends. The working-age population is indeed shrinking as the baby boom generation retires and the shrunken age cohorts of the 1990’s begin to enter the workforce. Under this scenario, growth just “happens.” Jobs follow and the unemployed disappear from the statistics thanks to aging.

This vision conveniently ignores that growth actually means an increase in the production of useful goods and services. Such an increase can only take place if more working time and talent (human capital) is applied to the production process and combined with more and better equipment. Thus, the keys to job creation and growth is employees’ confidence that their willingness to adapt to the needs of production will be rewarded, and investors’ confidence that their savings will be well-remunerated and not looted by the taxman.

To make sure that market participants get the right price signals, regulations must be removed and educational systems revised. Within this context, even partial reforms are welcome. Yet they will not bring about major changes. Europe’s current economic malaise requires a more drastic overhaul.

Opportunities for change

A second approach is also possible. This scenario would be triggered by the awareness that stagnation or sluggish growth in countries featuring low productivity – such as Matteo Renzi’s Italy – will not disappear as if by magic, and that the state-managed pension systems of some EU states are not sustainable if a large proportion of young people remain jobless.

Once incumbent politicians understand that the size of their problem is not measured by decimal points, they will wake up to the reality that a healthy economy cannot tolerate unemployment rates that run consistently above 6 or 7 percent, or youth unemployment rates above 15 percent. Addressing this problem would require lawmakers to put aside their ideological blinders and make sweeping changes. Four reforms are crucial: freedom of contract in the labor market; liberalization of higher education; privatization of the pension system, and a smaller tax burden on personal incomes.

At first glance, this scenario appears to be wishful thinking. But the opportunities for change are perhaps less remote than meets the eye. The question might not be whether radical change will take place, but whether it will take place soon enough.

Mood swing

Mr. Renzi’s experiment is not important for its modest results so far. It is significant because it has shown that public opinion in Italy, and perhaps in other countries, now considers deregulation of the labor market unavoidable and is ready to accept it. The public attitude toward the Jobs Act has not turned hostile even after its disappointing early results. In fact, we can expect pressure for further deregulation to increase as Italians and other Europeans grow weary of fragile public finances and high rates of youth unemployment. The mood may have started evolving – in Italy and in countries like Greece, Spain and Portugal. Possibly even in France.

Support for liberalizing higher education is manifestly weaker. Yet, in many countries, families are already spending heavily to compensate for the deficiencies of the state-run system. To fatten up their children’s resumes, parents pay for supplementary courses and internships. In most cases, that won’t be enough. Still, it is encouraging to observe that more and more Europeans realize that a diploma does not necessarily lead to suitable job offers, and that the public sector no longer provides an automatic refuge for people with dubious job qualifications.

Pension systems are also gradually changing. The dilemma for lawmakers today is how to persuade young people to finance their own private pension schemes, while also consenting to pay for their elders who have already retired or will do so in the next few years. Not surprisingly, such proposals meet with fierce resistance. But few young people have any illusions about government budgets financing their retirements. If all goes well, those budgets may suffice to provide assistance to the poor.

Last but not least, personal income taxes are no longer increasing in most of the EU area, and in many cases the tax bite on work-derived incomes has actually decreased. It is true that this trend has been offset by a rise in indirect taxes or social security contributions, so that the overall tax burden has barely changed. Nevertheless, it is encouraging that people are less willing to accept a raid on their labor income than a reduction in their purchasing power at the moment of consumption.

One hopes that this change of emphasis reflects a growing respect for work and its fruits. That would be a promising development for Europe, provided its political leaders do not take too long to recognize the shift and act accordingly.

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