Europe’s Labor Measures: Short-term Gain, Long-term Pain?

European measures applied to mitigate the effects of the pandemic have contained the unemployment rate in Europe more than in the U.S. While recognizing economic risks from the rising number of COVID-19 cases in the U.S., our forecast sees this success ratio reversing before the end of the year.

U.S. and European labor markets have displayed strikingly different performance during the crisis. From February to April, the Euro area unemployment rate rose only 10 basis points (bps) to 7.3%, while the U.S. rate (U3) rose 1,120 bps to 14.7% (Figure 1). Since then, the gap between the two regions has tightened, but remained wide overall: the U.S. unemployment rate dipped to 11.1% by June, while the Euro area unemployment rate increased slightly to 7.4% in May (latest data available).

Figure 1: Euro area vs. U.S. had different labor market reactions to the crisisImage Pop Up

Some attribute Europe’s employment resiliency to the region’s higher labor market inflexibility. Normally seen as a weakness, the more stringent hiring and firing regulation could be an advantage now as it is limiting job losses. However, we believe that the difference mostly stems from the different approach chosen by policymakers to support household incomes during the crisis: While the U.S. has focused on unemployment benefits, Europe has prioritized job protection through short-time work schemes (STWs), by which governments pay a portion of employees’ salaries (ranging from 60% to 85%) as their work time is reduced. In short, the U.S. has paid the unemployed to let the market run its course, while Europe has fought market forces by subsidizing companies. Which one is better?

Based on the unemployment data alone, Europe’s response looks more effective. However, direct comparisons are challenging. For example, within the U.S., many currently unemployed workers expect to return to their previous employer, and recent research suggests that worker expectations are strongly predictive of rehiring probabilities. This suggests that although the U.S. official unemployment rose more than in the EU, it could also fall more quickly, as the acute stage of the crisis passes. Furthermore, Europe’s STW schemes are expensive and several countries are planning to reduce their generosity through the course of the year, raising questions about their long-term success.