Another Lesson from Bastiat: So-Called Employment Protection Legislation Is Bad News for Workers

Frederic Bastiat, the great French economist (yes, such creatures used to exist) from the 1800s, famously observed that a good economist always considers both the “seen” and “unseen” consequences of any action.

A sloppy economist looks at the recipients of government programs and declares that the economy will be stimulated by this additional money that is easily seen, whereas a good economist recognizes that the government can’t redistribute money without doing unseen damage by first taxing or borrowing it from the private sector.

A sloppy economist looks at bailouts and declares that the economy will be stronger because the inefficient firms that stay in business are easily seen, whereas a good economist recognizes that such policies imposes considerable unseen damage by promoting moral hazard and undermining the efficient allocation of labor and capital.

We now have another example to add to our list. Many European nations have “social protection” laws that are designed to shield people from the supposed harshness of capitalism. And part of this approach is so-called Employment Protection Legislation, which ostensibly protects workers by, for instance, making layoffs very difficult.

The people who don’t get laid off are seen, but what about the unseen consequences of such laws?

Well, an academic study from three French economists has some sobering findings for those who think regulation and “social protection” are good for workers.

…this study proposes an econometric investigation of the effects of the OECD Employment Protection Legislation (EPL) indicator… The originality of our paper is to study the effects of labour market regulations on capital intensity, capital quality and the share of employment by skill level using a symmetric approach for each factor using a single original large database: a country-industry panel dataset of 14 OECD countries, 18 manufacturing and market service industries, over the 20 years from 1988 to 2007.

One of the findings from the study is that “EPL” is an area where the United States historically has always had an appropriately laissez-faire approach (which also is evident from the World Bank’s data in the Doing Business Index).

Here’s a chart showing the US compared to some other major developed economies.

It’s good to see, by the way, that Denmark, Finland, and the Netherlands engaged in some meaningful reform between 1994-2006.

But let’s get back to our main topic. What actually happens when nations have high or low levels of Employment Protection Legislation?

According to the research of the French economists, high levels of rules and regulations cause employers to substitute capital for labor, with low-skilled workers suffering the most.

Our main estimation results show an EPL effect: i) positive for non-ICT physical capital intensity and the share of high-skilled employment; ii) non-significant for ICT capital intensity; and (iii) negative for R&D capital intensity and the share of low-skilled employment. These results suggest that an increase in EPL would be considered by firms to be a rise in the cost of labour, with a physical capital to labour substitution impact in favour of more non-sophisticated technologies and would be particularly detrimental to unskilled workers. Moreover, it confirms that R&D activities require labour flexibility. According to simulations based on these results, structural reforms that lowered EPL to the “lightest practice”, i.e. to the US EPL level, would have a favourable impact on R&D capital intensity and would be helpful for unskilled employment (30% and 10% increases on average, respectively). …The adoption of this US EPL level would require very largescale labour market structural reforms in some countries, such as France and Italy. So this simulation cannot be considered politically and socially realistic in a short time. But considering the favourable impact of labour market reforms on productivity and growth. …It appears that labour regulations are particularly detrimental to low-skilled employment, which is an interesting paradox as one of the main goals of labour regulations is to protect low-skilled workers. These regulations seem to frighten employers, who see them as a labour cost increase with consequently a negative impact on low-skilled employment.

There’s a lot of jargon in the above passage for those who haven’t studied economics, but the key takeaway is that employment for low-skilled workers would jump by 10 percent if other nations reduced labor-market regulations to American levels.

Though, as the authors point out, that won’t happen anytime soon in nations such as France and Italy.

Now let’s review an IMF study that looks at what happened when Germany substantially deregulated labor markets last decade.

After a decade of high unemployment and weak growth leading up to the turn of the 21th century, Germany embarked on a significant labor market overhaul. The reforms, collectively known as the Hartz reforms, were put in place in three steps between January 2003 and January 2005. They eased regulation on temporary work agencies, relaxed firing restrictions, restructured the federal employment agency, and reshaped unemployment insurance to significantly reduce benefits for the long-term unemployed and tighten job search obligations.

And when the authors say that long-term unemployment benefits were “significantly” reduced, they weren’t exaggerating.

Here’s a chart from the study showing the huge cut in subsidies for long-run joblessness.

So what were the results of the German reforms?

To put it mildly, they were a huge success.

…the unemployment rate declined steadily from a peak of almost 11 percent in 2005 to five percent at the end of 2014, the lowest level since reunification. In contrast, following the Great Recession other advanced economies — particularly in the euro area — experienced a marked and persistent increase in unemployment. The strong labor market helped Germany consolidate its public finances, as lower outlays on unemployment benefits resulted in lower spending while stronger taxes and social security contribution pushed up revenues.

Gee, what a shocker. When the government stopped being as generous to people for being unemployed, fewer people chose to be unemployed.

Which is exactly what happened in the United States when Congress finally stopped extending unemployment benefits.

And it’s also worth noting that this was also a  period of good fiscal policy in Germany, with the burden of spending rising by only 0.18 percent annually between 2003-2007.

But the main lesson of all this research is that some politicians probably have noble motives when they adopt “social protection” legislation. In the real world, however, there’s nothing “social” about laws and regulations that either discourage employers from hiring people and or discourage people from finding jobs.

P.S. Another example of “seen” vs “unseen” is how supposedly pro-feminist policies actually undermine economic opportunity for women.

Read Full Post »

The Role of Unions in a Free Society

Labor Day is a good opportunity to consider whether unions help or hurt ordinary workers in America.

The answer is yes and no, depending on circumstances, but that’s actually the wrong question. The real issue, at least from a public policy perspective, is whether government should be a neutral referee in labor matters.

The union bosses reject that approach. They want the government to tilt the playing field, which is why the Obama Administration is using the National Labor Relations Board to promote the interests of Big Labor.

In this short interview on Larry Kudlow’s CNBC show, I argue that government should not have a thumb on the scale.

To elaborate, here’s what I wrote last year about labor unions and the role of government.

In a free society, people obviously should be free to join unions and companies should be free to negotiate with unions. But that also means that companies should be free to resist union demands and hire non-union workers. There is no right or wrong in these battles, just as there is no right or wrong when McDonald’s decides to sell french fries for a particular price. The market will reward good decisions and penalize bad choices. The only appropriate role for policy in this area is to enforce contracts and protect public safety.

I then make what should be an obvious point about what happens if unions use the coercive power of government to push wages – when adjusted for productivity – above a competitive level.

…above-market wages (at least in the private sector) are not sustainable in the long run. Workers ultimately get paid on the basis of what they produce and if it costs $25 per hour to employ a worker and that worker produces $23 per hour of output, that ultimately is a recipe for unemployment. A good example is the American auto industry, which has declined in part because of a compensation system that is not matched by productivity. This does not necessarily mean that wages are too high. It could mean that productivity is too low. Some of that, to be sure, is the fault of government policies such as a corporate tax system that penalizes investment (thus making it more difficult for workers to boost productivity). But unions also have used their government-granted power to insist on absurd workforce practices.

The important point in that passage is that unions may be hurting workers, not with demands for unsustainable wages, but instead by imposing work rules that undermine productivity.

That’s an empirical issue, to be sure. But here’s the bottom line. Government favoritism may help workers in the short run by temporarily pushing wages higher, but may hurt them in the long run by making companies – or, as I mentioned in the Kudlow interview, entire industries – uncompetitive.

Read Full Post »

Funny…but Sad…Look at How the Minimum Wage Destroys Opportunity

My Cato colleague, Mark Calabria, recently explained how the minimum wage destroys jobs, and I’ve written on several occasions why government-mandated wages can create unemployment by making it unprofitable to hire people with low work skills and/or poor work histories. And I’ve attacked Republicans for going along with these job-killing policies, and also pointed out the racist impact of such intervention.

But this cartoon may be a more effective argument for getting government out of the business of interfering with market forces. It’s simple, direct, and gets the point across. I’m not sure that always happens with my writing.

My former intern, Orphe Divougny, also did a very good job in explaining why politicians shouldn’t interfere with the right of workers and employers to enter into labor contracts.

Read Full Post »

According to Census Data, People Vote with their Feet for Less Government

The world is a laboratory and different nations are public policy experiments. Not surprisingly, the evidence from these experiments is that nations with more freedom tend to grow faster and enjoy more prosperity. Nations with big governments, by contrast, are more likely to suffer from stagnation.

The same thing happens inside the United States. The 50 states are experiments, and they generate considerable data showing that small government states enjoy better economic performance. But because migration between states is so easy (whereas migration between nations is more complicated), we also get very good evidence based on people “voting with their feet.” Taxation and jobs are two big factors that drive this process.

Looking at the census data and matching migration data with state tax systems, here’s what Michael Barone wrote. He finds (not that anyone should be surprised) that the absence of a state income tax is correlated with faster growth, which attracts people from high-tax states.

…growth tends to be stronger where taxes are lower. Seven of the nine states that do not levy an income tax grew faster than the national average. The other two, South Dakota and New Hampshire, had the fastest growth in their regions, the Midwest and New England. Altogether, 35 percent of the nation’s total population growth occurred in these nine non-taxing states, which accounted for just 19 percent of total population at the beginning of the decade.

And here’s Diana Furtchtgott-Roth, writing for Realclearmarkets.com. She uses the presence of right-to-work laws (which prohibit union membership as a condition of employment) as a proxy for the degree to which big government and big labor are imposing restrictions on efficient employment markets. Not surprisingly, the states that have a market-friendly approach create more jobs and therefore attract more workers.

The American people have been voting with their feet, the Census Bureau announced on Tuesday, leaving states with heavy union influence and choosing to live in “right-to-work” states with higher job growth where they cannot be forced to join a union as a condition of employment. …As a result of geographic shifts in population uncovered by the 2010 Census, nine congressional seats will move to right-to-work states from forced unionization states. Some winners are Texas, Florida, Arizona, Georgia, and South Carolina, while losers include New York, Ohio, Michigan, Illinois, and New Jersey. Over the past 25 years job growth in right-to-work states has been over twice as high as in unionized states.

This leaves us with one perplexing question. If we know that pro-market policies work for states, why does the crowd in Washington push for more statism?

Welcome, Instapundit readers. Since many of you might not be regular readers of International Liberty, the important lesson to learn from the Census data is that federalism is good because state governments have to compete against each other, and this helps restrain the greed of politicians. The same principle operates at the international level, which is why tax competition is such a powerful force for liberty.

Read Full Post »

Greetings from Tampa

I”m in Florida for a speech tomorrow to the National Workforce Association.

This will be a Daniel-in-the-Lion’s-Den moment, since I’ll be arguing to a bunch of folks from federally funded organizations that the federal government should have no involvement in workforce issues. Wish me luck.

Read Full Post »