Tuesday 18 January 2011

Is the labour market too rigid?

In times of crisis, such as the current sovereign debt crisis, labour market flexibility is frequently mentioned as a necessary requirement for exiting the crisis. For instance, in a paper on Greece’s adjustment program, produced by the European Commission’s ECFIN, it is written that “Employment Protection Legislation has been hampering the functioning of the labour market. [...] These initiatives will increase adjustment capacity of firms, ultimately boosting employment.” (ECFIN, 2010, pp.41-42). The same recipe has been applied to Portugal.
However, the EC was vocal on the need of labour markets reforms before the current sovereign debt crisis, mentioning it in many instances as a necessary condition for making the European Union the world’s most competitive economy. In fact, in the last decade there was a significant decrease in employment protection: the OECD Employment Protection Legislation (EPL) index shows an easing of the hiring and/or firing conditions in countries with traditionally very rigid labour markets, like Germany and Denmark. Portugal, which has been one of the countries with more stringent labour market regulations, has also shared that downward trend, mainly through a reduction of the components of the index related to individual dismissals and temporary contracts.
This recent trend has made many, namely trade unionists, argue that the Portuguese labour market is already flexible enough. Moreover, there are also Portuguese corporate officials reported as saying that labour market regulations have not hindered their activities. For instance, in November 2010, Paulo Azevedo, CEO of Sonae SGPS, one of the biggest employers in Portugal, with over 30 thousand employees, mentioned on a TV interview that labour market legislation has not been a constraint on his company’s business (however he also mentioned that his colleagues complain about too much labour market rigidity).
These views suggest that actual labour market flexibility should be explored by means of adequate indicators, others than the ones based on legislation such as EPL. This hypothesis has led me and my co-authors to investigate differences in sectoral labour market flexibility, based on actual data from “Quadros de Pessoal”. We use that information to compute an index of sectoral labour market flexibility. Our sectoral labour market flexibility index shows that all sectors display a trend towards increased flexibility, resulting from the reduction of the share of workers covered by collective agreements and working full time. It also shows that the increasing trend became more pronounced after 1999. Our index lags the EPL index, which may be explained by the fact that it takes time for legislation to affect firm behavior. Although high technology sectors tend to face more flexible labour markets, there are low technology sectors among the most flexible labour markets.
However, the real issue is still to be dissected: has labour market rigidity been hindering the performance of Portuguese firms? That is, is the labour market too rigid? We are looking at that.


  1. I would suggest that the labor market does not hinder the performance of top private firms such as Sonae or Jerónimo Martins. I would say that it hinders both the performance of top formerly public firms such as PTP, CTT or EDP, and the performance of start-up companies.

    The latter is what worries me the most as it prevents entrepreneurs from risking and creating real value for Portugal and not open yet another restaurant / coffeehouse.

  2. We cannot ever be competitive through labour flexibility, that is absurd.

    Like stated we were competitive till 2000, and the markets then were less flexible. Wage adjustments cannot compensate for the appreciation of the Euro, wich is the main cause of our sudden lack of competitive conditions.

    I would eventually agree that labour costs could be a problem if the costs in Portugal were higher then in the EU, but that's not the case. We are cheaper, and still can't attract foreign investment.

    OCDE would never publish an article stating that the PIGS problems can be traced to the EURO, yet its very clear where lies the root of the problem.

    On a final note, the lack of flexibility and higher labour costs can work has an incentive to increase productivity, since we have to extract more from the resource then its cost.

    If use of the resources is flexible, we would be encouraging to continue in the path of labour intensive production, and Portuguese Economy would never transform itself.

  3. I can actually state that considering that I'm working in Germany for a year, I'm always sort of surprised to read about the working laws being rigid in Portugal. Here in germany, the companies are much more controlled and enforced certain compensatory rules when dismissing employees.. and I have to be honest I never really felt the power of the work unions in Portugal like I feel here.. open your mouth and there's ready support from them to you as an employee and the right amount of respect to their opinions by the employer. Can't tell if it's just the case for foreign companies working here in Germany, but I honestly believe this is the common case for most Germany companies.