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Christina Vasilaki: The vicious circle of deflation and labour market reforms

The vicious circle of deflation and labour market reforms

Eurozone inflation fell to 0.5% in May, down from 0.7% in April and well below the European Central Bank’s 2% target. In response to that, the ECB has announced a series of measures to help boost economic growth in the euro area and prevent it from becoming the “next Japan” in terms of deflation. The first step was a lowering of the benchmark interest rate to a new record low. The refinancing rate was cut from 0.25% to 0.15%.

Despite these well-received actions, the conditions necessary for long-term deflation have already been stabilised in the Eurozone. The continued high unemployment rate resulting in weak consumer demand is reflected in the eurozone’s weak growth rate, with the bloc’s economy expanding by just 0.2% in the first three months of the year.

EU leaders are keen to announce a downward trend in the EU unemployment rates. Nevertheless some 18.75 million were still unemployed in April.

Whilst there is a growing consensus on the fact that unemployment -especially persistent structural youth unemployment- is a time bomb waiting to explode, the actual fight against it risks becoming the Eurozone’s next “systemic bubble” with severe consequences in its macroeconomic future.

In other words, the unprecedented rise of unemployment rate in the EU has been unanimously and massively condemned by policymakers on the national and international scene, the world’s most influential economic thinkers and institutes as well as the European intelligentsia and labour movements across the continent. Yet this consensus has failed to bring the EU closer to the crisis’ substantial resolution. The reason lies on the opposing approaches, which serve different interests -not always those of the unemployed.


Governments and businesses appear lately “determined” not to permit young, jobless Europeans to become Europe’s “lost generation.” They agree that this would end up in social unrest and eventually in the collapse of the single currency, the maintenance of which has proved to be their fist and foremost priority.

The so far approach of addressing chronic levels of unemployment could be summarised in the following phrase: making dismissals easier makes hirings less difficult. On the same line, the Outlook on the Global Agenda 2014 prepared by the influential World Economic Forum (WEF) stresses the need to tackle the employment crisis while “resisting tendencies toward protectionism.” The so-called German model of successfully reducing unemployment by means of structural reform can be easily translated to a well-planned scheme of deregulation of the labour market by means of deterioration of the European welfare state.

In terms of numbers this seems to work. Austria, the country with the lowest unemployment rate in the Eurozone (currently at 4,8% according to Eurostat) is also the country which maintains the level of an OECD indicator called “Protection of permanent workers against individual and collective dismissal” at 1,94 in 2013, the lowest in the Eurozone and significantly lower than the average (2,29 in the OECD countries).

In this context and in order to tackle record high unemployment, crisis-hit Spain introduced in 2012 a labour market reform, which provoked a significant decrease in the employment protection indicator (2,28 in 2013 compared to 2,69 in 2008). As an OECD report assesses, “the labour market reform has improved the de jure flexibility of the collective bargaining system” and it “has significantly reduced the rigidity of the Spanish legislation on dismissals.”

According to the European Trade Union Confederation, more types of non-standard employment relationship are being created or have seen a sharp increase in their use, such as zero-hour contracts and employee shareholder status (UK), youth contract (Greece), service contracts (Germany, Poland), agreements on work performed outside the employment relationship (Slovakia) and the three year training contract (Spain).

The role of central bankers

There is no doubt that central bankers and their conviction that labour market regulation leads to inflationary hikes, hide behind this obsession with “flexibilisation”. In other words, for the European Central Bank price stability prevails over labour stability. However, as Bernadette Segol, General Secretary of the European Trade Union Confederation, marks: “Stability of nominal wages also function as an anchor for the entire economy. If the nominal wages building cannot come crushing down, neither can prices, and the economy cannot get caught in a spiral of falling wages and falling prices. This should be a prime concern of any central bank.”

Economic recovery away from austerity

Unemployment, deflation and recession are all mainly driven by the harsh austerity measures imposed to crisis-stricken countries. An alternative remedy proposed by progressive economic thinkers aims to beat the Japanese-style stagnation of European economies by increasing public investments in the EU with 2%, a year in the years 2015 to 2019. The directions for investment should be taken from past EU and EIB (European Investment Bank) priorities, putting back on the agenda the EU 2020 objectives.

According to data provided by the European Council of the Labour Movement (ECLM), the above investment plan would increase employment by more than 1,7 million people in 2015 rising to nearly 6 million people in 2019. Also, in 2019 the GDP level can be increased by almost 5% compared to a scenario without the investment plan.

In the long-term the effect of the investment plan, as representatives of the labour movement claim, will also have an impact on the value of elasticity as the economy will converge towards a less energy intensive economy. Using the methodology of the European Commission, the investment plan will create between 7,2 and 11 million full-time jobs all depending on the value of multiplier. Furthermore the increase in GDP due to the investment plan is estimated to lie between 312 to 390 billion Euros. Likewise the tax revenue and social security contributions will increase substantially.

All in all, as EU’s political leaders agree that “the worse of the Eurozone crisis is behind us”, yet “there is still a lot of work to be done” -meaning more austerity and brutal fiscal consolidation-, EU’s youth is struggling between hopelessness and chronic unproductivity. At the same time, insisting on this approach means that the Eurozone risks falling in decades of economic stagnation, whereas past experience has shown that a policy stance more favourable to employment does not come de facto at the expense of price stability.