April 29, 2004

Can labour market institutions explain unemployment rates in new EU member states?

Reforming labour market does not provide the solution for high unemployment in Poland and the Slovak Republic

Press release
Reforming labour market institutions will not suffice to battle high unemployment in Poland and the Slovak Republic. The serious problems in these countries call for more profound measures, e.g. improving regulatory quality and law enforcement in both countries, as well as modernising the agricultural sector in Poland.

Labour market institutions already are relatively flexible, and reforming these may only reduce unemployment in those countries modestly. Poland and the Slovak Republic are two of the ten countries acceding the European Union on May 1st. In the other countries joining the European Union, unemployment is lower and reforming labour market institutions may contribute relatively more to further improving the labour market performance. Lowering the tax wedge could contribute to reduce unemployment in Hungary, for instance.

These are some of the conclusions from the CPB Document Can labour market institutions explain unemployment rates in the new EU member states?, published today by CPB Netherlands Bureau for Economic Policy Analysis (CPB). In this publication, CPB investigates labour market institutions in the new EU member states and compares them with institutions in the fifteen already existing members of the EU. The report tries to answer to what extent differences can form an explanation for high unemployment in some of the new member states.

Vast differences in unemployment exist among the new member states
We are on the verge of a historic moment: on the 1st of May, the European Union will be enlarged by ten new member states. These countries, Poland, Hungary, the Czech Republic, the Slovak Republic, Slovenia, Estonia, Latvia, Lithuania, Malta and Cyprus, display much diversity on a number of aspects. Unemployment rates, for instance, vary between 4.4% in Cyprus to 19.2% in Poland. Cyprus is not the only country with fairly low unemployment; unemployment rates in the Czech Republic, Hungary, Slovenia and Malta are also below the EU-15-average. However, Poland and the Slovak Republic struggle with unemployment rates far above rates in any of the present member states in the EU-15. These large differences make it clear-cut the new member states can not be put in one box.

Labour market institutions in the new member states are not less rigid than in the present member states
The importance of flexible labour market institutions is widely acknowledged. It is generally agreed upon that generous unemployment benefits and a high tax wedge lower the incentives for labour market participation. High unemployment rates in Europe, compared to those in the United States, are often attributed to the relatively rigid European labour market comprising high employment protection and generous social security facilities. Many fear that the situation will not improve in an enlarged European Union. After all, some fifteen years ago, most of the new member states were centrally planned economies having fairly rigid labour markets.

However, major changes have occurred in Central- and East- Europe in their run-up to accessing the European Union. Unemployment benefits have been cut, in level as well as duration, and are now markedly below the average in the current member states. Employment protection legislation has been moderated and is comparable to what is usual within the current member states. The level of wage negotiations has been on a decentralising trend and nowadays, most bargaining takes place at the firm level. After years of reforms, labour market institutions are on average not less flexible than those in the current EU member states.

Reforming labour market institutions in the new EU member states may be useful...
Labour market reforms are a tested recipe for suppressing high unemployment rates. Similarly to the current EU-15, the new EU member states could benefit from specific measures. Lowering the tax wedge, the difference between employers' labour costs and the sum the employee is left with, may have a significant effect on unemployment in Hungary. Rising spending on active labour market policies in a number of new member states may enable certain groups of unemployed people to re-enter the labour market. This is in line with a recent advice published by the European Commission. However, this does not suffice.

...but does not suffice for solving labour market problems in Poland and the Slovak Republic
Focusing on labour market reforms alone would be an unwise decision. Extremely high unemployment in Poland and the Slovak Republic can only be attributed marginally to their labour market institutions. Other elements play a far larger role. In their run-up to accession, both countries have exercised a tight monetary policy combined with structural reforms of large sectors, such as coal mining in Poland. Combining these two measures has led to increasing unemployment. Restructuring has not come to an end: Poland's large agricultural sector is in strong need of restructuring, which is likely to cause more unemployment. In the Slovak Republic, poor law maintenance, administrative barriers to job creation, and a large general government in need of restructuring are the main problems. In comparison with these measures, labour market reforms only provide a minor contribution to improving labour market performance.

Read also the accompanying press release.

In five out of ten new member states, unemployment rates lie above average unemployment in the fifteen existing members of the European Union (EU-15). The study finds labour market institutions in the acceding countries are less rigid then in the EU-15.

Labour market institutions explain only a minor part of unemployment in the new EU member states. This does not mean that these countries have no labour market problems. Just as in the EU-15, a great deal of heterogeneity exists between the acceding countries. In some of them, labour market reforms could prove a key issue in improving employment performance. The main worry is poor labour market performance in Poland and the Slovak Republic, where unemployment has risen to almost 20%. The main reasons for this growth are (i) postponed restructuring in combination with tight monetary policy; (ii) poor governance; and (iii) an increasing labour force.


Laura Thissen
S. Ederveen