Italy’s Regulation Choked Labor Markets

Here is another example of the normative way of how politicians deal with problems: They treat the symptoms rather than the disease.

From the Wall Street Journal,

Prime Minister Mario Monti has issued a new "growth decree" to revive Italy's moribund economy. Among other initiatives, the 185-page plan proposes discount loans for corporate R&D, tax credits for businesses that hire employees with advanced degrees, and reduced headcount at select government ministries.

Will any of this solve Italy's economic problems? Only in the sense that one could theoretically drain Lake Como with a ladle and straw. Allow us, then, to illustrate why Italy's economy stagnates.

Imagine you're an ambitious Italian entrepreneur, trying to make a go of a new business. You know you will have to pay at least two-thirds of your employees' social security costs. You also know you're going to run into problems once you hire your 16th employee, since that will trigger provisions making it either impossible or very expensive to dismiss a staffer.

But there's so much more. Once you hire employee 11, you must submit an annual self-assessment to the national authorities outlining every possible health and safety hazard to which your employees might be subject. These include stress that is work-related or caused by age, gender and racial differences. You must also note all precautionary and individual measures to prevent risks, procedures to carry them out, the names of employees in charge of safety, as well as the physician whose presence is required for the assessment.

Now say you decide to scale up. Beware again: Once you hire your 16th employee, national unions can set up shop. As your company grows, so does the number of required employee representatives, each of whom is entitled to eight hours of paid leave monthly to fulfill union or works-council duties. Management must consult these worker reps on everything from gender equality to the introduction of new technology.

Hire No. 16 also means that your next recruit must qualify as disabled. By the time your firm hires its 51st worker, 7% of the payroll must be handicapped in some way, or else your company owes fees in-kind. During hard times, your company may apply for exemptions from these quotas—though as with everything in Italy, it's a toss-up whether it's worth it after the necessary paperwork.

Once you hire your 101st employee, you must submit a report every two years on the gender dynamics within the company. This must include a tabulation of the men and women employed in each production unit, their functions and level within the company, details of compensation and benefits, and dates and reasons for recruitments, promotions and transfers, as well as the estimated revenue impact.

I earlier posted the labor markets of France and Germany compared to Spain.

Such astounding maze of regulations has been one of the major dynamics for today’s crisis. This has produced a huge bureaucracy that has been draining productive resources from entrepreneurs. This has also increased the costs of doing business. Reduced the incentives of entrepreneurs to expand. Shifted many activities to the informal or shadow economy.

Italy has one of the largest informal economies relative to the OECD nations

As well as encouraged corruption. Italy ranks as one of the most corrupt in Eurozone. Overall, such regulations has reduced Italy’s competitiveness.

So reduced competitiveness leads to diminshed output (income) – ballooning government (expense)= crisis (deficits)

And how does the Italian government intend to fix the problem?

Among other initiatives, the 185-page plan proposes discount loans for corporate R&D, tax credits for businesses that hire employees with advanced degrees, and reduced headcount at select government ministries

Gosh, 185 pages of more regulations and more bureaucracy.

Note: reduced headcount at “select” government ministries looks more symbolical and seems like a loophole.

Yet the mainstream advice of solving this problem by inflation will only worsen the situation, as this does not address the root: asphyxiation from big government.

Doing it over and over again and expecting different results only reinforces the worsening of this crisis.

Germany’s Competitive Advantage over Spain: Freer Labor Markets

When politics is involved, common sense is eschewed.

The vicious propaganda against “austerity” aims to paint the government as the only solution to the crisis, where the so-called “growth” can only be attained through additional government spending funded by more debt. Unfortunately, these politically confused people have forgotten that today’s crisis has been caused by the same factors which they have been prescribing: debt. In short, their answer to the problem of debt is to acquire more debt.

The same with clamors for crisis plagued nations to “exit” the Eurozone in order to devalue the currency. Inflating away standards of living, it is held, will miraculously solve the social problems caused by too much government interventionism that has led to inordinate debt loads.

Professor John Cochrane of the Chicago School nicely chaffs at statist overtures,

The supposed benefit of euro exit and swift devaluation is the belief that people will be fooled that the 10 Drachmas are not a "cut" like the 5 euros would be. Good luck with that.

Little has been given thought to what’s happening on the ground, particularly achieving genuine competitiveness by allowing entrepreneurs to prosper.

At the Mises Institute, Ms Carolina Carmenes and Professor Howden lucidly explains why Germany has been far more competitive than Spain, specifically in the labor markets .

Spain’s labor costs have been cheaper than Germany, yet the Germans get the jobs. Writes Ms. Carmenes and Prof Howden (bold emphasis added)

Spanish employment is now hovering around 23 percent, with over 50 percent of youths jobless. Only around 6 percent of Germans are without work, almost the lowest level in the country since reunification. This divide solidifies Spain's position among the worst-performing economies of the continent, and Germany's vaunted position as among the best.

Yet such a situation might seem paradoxical. One could, for example, look at the wage rates of the respective workers and find that low-cost Spaniards are much more affordable. Profit-maximizing businesses should be expanding their facilities to take advantage of the opportunity the Spanish crisis has provided and eschew higher-cost German labor.

While fixating on nominal labor costs might provide a compelling case for a bright Spanish future, delving into the details provides some darker figures.

Once again the German-Spain comparison shows of the myth of cheap labor

Little thought has also been given to the impact of minimum wage and excessive labor regulations which stifles investment and therefore adds to the pressures of unemployment

Again Ms. Carmenes and Prof Howden (bold emphasis added)

One of the main differences between Germany's and Spain's labor markets is their minimum-wage rates. A Spanish minimum-wage worker can expect to earn about €633 per month. Germany on the other hand enforces no across-the-board minimum wage except in isolated professions — construction workers, roofers, and electricians, as examples.

German employees are free to negotiate their salaries with their employers, without any price-fixing intervention by the government in the form of wage control. (This is not to imply that the German labor market is completely unhampered — jobs are cartelized by industry each with its own wage controls. While this cartelization is not perfect, it does at least recognize that a one-size-fits-all minimum-wage policy is not optimal for the whole country.)

As an example of the German approach to wages, consider the case of a construction worker. In eastern Germany this worker would make a minimum wage of around €9 per hour. His counterpart in western Germany would earn considerably more — almost €11 an hour. This difference allows for productivity differences to be priced separately or local supply-and-demand conditions to influence wages. Working for five days at eight hours a day would yield this German worker anywhere from €360 to €440.

It is obvious that the German weekly wage is almost as high as the monthly Spanish one. What is less obvious is why Germans do not move their facilities to lower-cost Spain.

As the old saying goes, "the more expensive you are to fire, the more expensive you are to hire." If a Spanish company decides to lay off an employee, the severance payment for most labor contracts (a finiquito in Spanish) will amount to 32 days for each year the employee has worked with the company. Although this process is not simple in Germany either, there is no legal severance requirement that companies must pay to redundant workers. The sole requirement is for ample notice to be given, sometimes up to six months in advance. If a Spanish company hires a worker who does not work out as intended, a substantial cost will be incurred in the future to offload the employee. Employers know this, and when hiring workers they exercise caution accordingly, lest this unfortunate and unplanned-for future materialize.

These factors make the perceived or expected cost of labor at times higher in Spain than in Germany, despite the actual monetary cost being lower in euro terms. This effect has been especially pronounced since the adoption of the common currency over a decade ago. As we can see below, the average cost of German labor is largely unmoved since 2000, while Spanish labor has increased about 25 percent over the same period.

When hiring a worker, the nominal wage is only half the story. The employer also needs to know how productive that worker will be. Even after we factor for the extra costs on Spanish labor, a German worker could be more costly. A firm would still choose to hire that worker if his or her productivity was greater.

As we can see in the two figures below, over the last decade a large divergence has emerged between the two countries. While German productivity has more or less kept pace with its small increases in wage rates, the Spanish story is remarkably different. Productivity has lagged, meaning that on a real basis Spanish laborers are much more costly today than they were just 10 years ago.

Of course, boom bust policies have also contributed to such imbalances. The EU integration which had the ECB inflating the system essentially pushed Spanish wages levels up substantially, thereby overvaluing Spanish labor relative to productivity and relative to the Germans and to other European nations…

In his book The Tragedy of the Euro, Philipp Bagus mentions a similar phenomenon. Bagus points to the combination of (1) the rising labor costs that result from eurozone inflation and (2) divergent productivity rates between the countries as a source of imbalance. Indeed, inflation has been one driver of rising (and destabilizing) wages in the periphery of Europe, and especially in Spain. Others include, as we have noted here, minimum wages, regulatory burdens, and severance packages that increase the potential cost of labor.

In either case the effect is the same: wage rates do not necessarily reflect the labor itself, but rather the regulation surrounding it. In Spain, this translates to noncompetitive wages. It is important to remember, though, that this does not imply that the labor itself is necessarily uncompetitive — it is price dependent after all.

Every good has its price, even labor. When prices are hindered from fluctuating to clear markets, imbalances occur. In labor markets those imbalances are unemployed people. Policies such as a one-size-fits-all minimum wage and high mandated severance packages keep the price of Spanish labor above what it needs to be to clear the market.

Until something is done to ease these policies, Spanish labor will remain uncompetitively priced. Until Spanish labor costs can be repriced competitively, Spain's masses will need to endure stifling levels of unemployment.

The only solution to the current crisis is to allow economic freedom to prevail. Of course, this means less power for the politicians and their allies which is why they won't resort to this. Their remedies will naturally be worst than the disease.

Choking Labor Regulations: French Edition

Below has been a lucid example of what plagues Europe

From Businessweek/Bloomberg, [bold emphasis added] (hat tip Dan Mitchell)

Here’s a curious fact about the French economy: The country has 2.4 times as many companies with 49 employees as with 50. What difference does one employee make? Plenty, according to the French labor code. Once a company has at least 50 employees inside France, management must create three worker councils, introduce profit sharing, and submit restructuring plans to the councils if the company decides to fire workers for economic reasons.

French businesspeople often skirt these restraints by creating new companies rather than expanding existing ones. “I can’t tell you how many times when I was Minister I’d meet an entrepreneur who would tell me about his companies,” Thierry Breton, chief executive officer of consulting firm Atos and Minister of Finance from 2005 to 2007, said at a Paris conference on April 4. “I’d ask, ‘Why companies?’ He’d say, ‘Oh, I have several so that I can keep [the workforce] under 50.’ We have to review our labor code.”

While polls show job creation and the economic crisis are the top issues for voters in the May 5 second-round vote for president, neither President Nicolas Sarkozy nor Socialist challenger François Hollande are focusing on Breton’s concern. Companies say the biggest obstacle to hiring is the 102-year-old Code du Travail, a 3,200-page rule book that dictates everything from job classifications to the ability to fire workers. Many of these rules kick in after a company’s French payroll creeps beyond 49.

Tired of delays in getting orders filled, Pierrick Haan, CEO of Dupont Medical (not to be confused with chemical company DuPont (DD)), decided last year to return production of some wheelchairs and medical equipment to France. The 150-year-old company, based in Frouard in eastern France, created 20 jobs making custom devices at a French plant—and will stop there. Faced with France’s stifling labor code, Haan probably will send any additional production of standard equipment to what he calls “Near France”—Tunisia, Bulgaria, or Romania. “The cost of labor isn’t the main problem, it’s the rigidities,” Haan says. “If you make a mistake in your hiring plans, you can’t correct it.”

There are now 2.9 million people out of work in France, almost 10 percent of the workforce and the most in 12 years. “For the 100 employees we have in France, we have 10 employee representatives, for whom we have to organize weekly meetings even when there is nothing to discuss,” Haan says. “Every time a social security contribution changes, which is frequently, we have to update software and send our HR people for training. We can’t fire anyone without exorbitant costs.

As one would note, the French dilemma has NOT been about expensive labor, but rather severely restrictive labor regulations. The byzantine regulations impedes the entrepreneurs capacity to expand, as well as, to attract additional investments. That’s aside from dealing with compliance costs, taxes and other regulations.

To argue that inflationism (through devaluation) would represent as the required solution, thus, is outrageously daffy.

This for the simple reason inflation does not deal with the disease: suffocating labor regulations. The solution here is labor reforms through liberalization or as aptly pointed out by the article “to overhaul its rigid labor laws”

Europe’s Financial Repression: How Solvency II may affect Portfolio Allocations of Insurance Firms

Governments around the world have been applying financial repression—part of which is to use new regulations to force financial institutions to funnel private savings into government debt.

We see this also happening in Europe where insurance firms are being ‘incentivized’ by new rules to invest in government debt than in equities.

From Researchrecap.com (bold highlights mine)

Fitch Ratings believes that Solvency II, the new regulatory regime for European insurers from 1 January 2013, is set to transform how insurers allocate their investments.

European insurers are the largest investors in Europe’s financial markets, holding EUR6.7trn of assets, including more than EUR3trn of government and corporate debt. Any reallocation of insurers’ asset portfolios could therefore lead to fundamental shifts in demand and pricing for several asset classes. The new rules will force insurers to value assets and liabilities at market value when determining their solvency position, and to hold explicit capital to reflect shortterm volatility in the market value of assets.

Fitch expects a shift from long-term to shorter-term debt; an increase in the attractiveness of higher-rated corporate debt and government bonds, and shift away from equity; and a preference for assets based on the long-term swap rate.

People hardly see it, but rules are being utilized to skew resource allocation for the benefit of political forces.