Wednesday, March 28, 2012

Tackling the scourge of youth unemployment

A fifth of young people in the EU are not in employment, education or training – a measure tagged with the ungainly acronym ‘NEET’. The problem is not confined to the usual suspects, like Spain (49 per cent) or Italy (29 per cent). Nearly a quarter of people under 25 are jobless or not in education in France, Sweden and the UK. Politicians are sounding the alarm. The EU’s Employment Commissioner, László Andor, recently stated that “without decisive action at EU and national level” we will create a “lost generation”. French president Nicolas Sarkozy condemns a “vicious cycle” of worklessness and deteriorating skills.

Are governments’ fears justified? The ‘NEET’ measure is not very accurate. It lumps together recent graduates, who face much shorter periods of unemployment than the low-skilled, with those who leave school at 16 with no qualifications and who may struggle to find work for the rest of their lives. Overall, young workers tend to be unemployed for shorter periods than older ones. And on average they have more family resources to rely upon than older unemployed people: many can live at home, and be bankrolled by their parents.

However, there is no doubt that prospects look bleak for Europe’s youth. They have fewer marketable skills than older workers on average, and hence find it hardest to get work in periods of high unemployment, not least because redundant workers with more skills ‘trade down’ to lower paid jobs. As Europe’s economic stagnation continues – it is already into its fourth year with no end in sight – more people will join the ranks of the long-term unemployed. The longer someone is out of work, the harder it is to get them back in: they lose motivation; they lose the skills they have through lack of use; and they are more likely to succumb to mental illness, alcoholism and drugs, and crime.

Politicians are right to demand that something must be done. But what? The best way to deal with unemployment is to get economies growing again. Easing up on the pace of fiscal austerity would alleviate pressures on labour markets. But governments have turned their backs on this solution.

Instead, many are continuing to deploy cheap policies that are unlikely to work in a downturn. In recent years, governments have turned to ‘work first’ policies to try to get workers to supply their labour, or employers to demand it, or both. The UK, for example, has started to demand that unemployed people do work experience or subsidised work in exchange for welfare benefits. But the evidence from a similar programme in Germany suggests that this approach raises average employment prospects only marginally, and actually reduces it for people aged under 25.

France has raised the percentage of young people large firms must employ if they want to avoid a penalty tax, while Spain is offering tax breaks to small enterprises to take on young people. Such schemes are unlikely to help much: they are limited to particular sizes of companies, in order to keep the costs low for the taxpayer, and so will only lead to jobs for a fraction of the jobless youth. Moreover, they have unintended side-effects. For example, firms have an incentive to switch older workers for younger ones, which will make no difference to the overall unemployment rate. France’s penalty tax may make firms less productive, by forcing them to take on more low-skilled young people. More importantly, ‘work first’ policies are ineffective in tackling cyclical unemployment, when demand for labour is depressed. When cyclical unemployment is high, there are more applicants than jobs, and pushing people to supply their labour while trying to coax or force employers to hire them will not work.

The best way to tackle youth unemployment in a slump is to invest in people’s skills. Investment in skills does two helpful things: it removes some young people from the labour market, making it easier for others to get jobs, and it improves the stock of skills the economy can draw on once demand recovers, which can help boost growth.

Participation rates in vocational training and university education among 18 to 24 year olds are low in many of the European countries struggling with youth unemployment. Between 40 and 43 per cent of young people in the UK, France, Spain and Portugal are in some form of education, compared to 53 to 60 per cent in Germany, the Netherlands, Denmark, Norway and Finland. The latter countries have much lower levels of youth unemployment than the European average.

If France boosted the proportion of young people in education and training to 50 per cent, the NEET rate would fall to 16 per cent. This would require the creation of 400,000 places. Such a move would reduce the number of young applicants per job by nearly a third, helping to ease pressure on the youth labour market during the slump.

Improving young people’s skills will also help Europe’s economy to be more productive in the longer term, and reduce structural unemployment. The returns on investment in human capital are very large, on average, which shows that training leads to more productive workers and thus higher wages and more employment. University graduates across the OECD earn €123,000 more than non-graduates over their lifetime, well above the €35,000 cost of their education. People who complete high school or take vocational courses make €43,000 more than those who do not, with the education costing an average of €19,000. A proportion of these extra earnings will eventually flow back into government coffers through higher taxes and reduced unemployment benefits. Furthermore, these costs do not take into account unemployment benefits and other social costs, which make the case for action even more compelling. At present, governments are currently paying vast sums in unemployment benefits, and young people are losing skills and motivation. Ongoing unemployment depletes the economy’s stock of human capital, reducing growth potential.

For countries that cannot or will not risk their public finances, there is an alternative. The cost of education can be passed on to students themselves, with the government providing the finance. This means that the cost of increasing the proportion of young people in either training or education need not endanger the government’s balance sheet directly. The UK may be a model to follow. It has introduced higher tuition fees with upfront loans to cover the costs of both university and vocational qualifications. The loan is repaid through the tax system once graduates and trainees are working and are earning more than a certain wage threshold. There is a low interest rate attached. However, the UK has not increased the number of places available, which is crucial for such a model to act as a safety valve for youth unemployment.

Europe faces a choice. It can continue to fiddle with small-scale, ineffective labour market policies for young people. Or it can invest in their human capital. It should choose the latter. Such a policy would open the way for stronger productivity growth once the current crisis has been overcome. In the interim, it would prevent young people from losing skills and motivation, and joining the ranks of the long-term unemployed. It would also make it easier for those that cannot or will not take up more education and training to find a job.

John Springford is a research fellow at the Centre for European Reform.

Friday, March 23, 2012

Oh no, Orban clone? The EU ponders Slovak elections

Hungary's Prime Minister Viktor Orban is the leader least beloved by EU governments and institutions. The European Commission thinks him too spendthrift and has launched proceedings against Hungary for breaching rules on budget deficits. The Venice Commission, a constitutional advisory body affiliated with the Council of Europe, has accused the government of amassing too much power and violating human rights. Orban has done little to win friends abroad: he called the European Commmission's action "extremely stupid" and compared the EU to the Soviet Union. So should European governments and officials be concerned that Hungary's neighbour Slovakia has just elected another firebrand, former Prime Minister Robert Fico, to lead its government? Is Orban a sign of a broader trend – is the economic crisis lifting populists to power in Central Europe?

At first glance, the two situations are similar. Much as Orban in Hungary, Fico will exert a dominant influence: SMER won a controlling majority in the Slovak parliament; for the first time in the country's history a one-party government will rule (SMER fell just short of winning enough votes to be able to unilaterally change the constitution). In his previous stint in power, in 2006-2010, Fico's ministers earned a reputation for corruption and poor stewardship of the economy: Slovakia's debt increased by one-third under his rule, and this was only partly due to the crisis (fiscal discipline crumbled even before the economy soured). Relations with the neighbours suffered too: under Fico, the Slovak National Party (SNS) – one of the three members in the prime minister's coalition – openly railed against 'the Hungarian enemy'. Little wonder that media in the region have been alarmed at Fico's return and are warning of 'Orbanisation' of Central Europe.

But on closer inspection, the differences between the two countries' political situations outweigh the similarities. In contrast to Orban's euroscepticism, Fico ran on a platform of turning Slovakia into a responsible EU citizen. This may have been partly a tactical ploy (to implicitly criticise some of the smaller centre-right parties of the outgoing government, which opposed the EU's bailout of Greece). But having made good relations with the EU a centrepiece of his candidacy, Fico seems intent to deliver. In one of his first post-election appearances on TV, the prime minister-designate agreed to be accompanied by the Slovak vice-president of the European Commission, Maroš Šefčovič – this appears to have been a calculated signal to Brussels that Slovakia will take the EU seriously. Fico also nominated the respected Miroslav Lajčák, currently one of the managing directors in the European External Action Service, to the post of foreign minister (which he already held in 2009-10). The odds are that the new government will be broadly supportive of commonly agreed solutions to the economic crisis though not necessarily contributing many ideas of its own – like other smaller new member-states, Slovakia has struggled to formulate original proposals on improving the way the EU works.

There are few signs for now that SMER is planning to build a one-party state, as many suspect Orban of doing in Hungary. Throughout the campaign, Fico stressed 'stability', implicitly rejecting radical reforms, political or otherwise. In keeping with the tradition, the prime minister-designate has offered two deputy chairmanships as well as a number of key committee chairmanships in the parliament to the opposition. Fico said that he would seek no changes to the constitution, which disperses power between the prime minister, parliament and the president. Granted, Fico controls the first two institutions and is friendly with the president. SMER alone also lacks the votes to change the constitution; it would have to ally with one of the centre-right opposition parties. The true test of Fico's tolerance for political diversity may come after 2014, if an opposition candidate wins the presidency. The outgoing but popular Prime Minister Iveta Radičová is rumoured to be considering a run, and if she wins, Fico may be tempted to tinker with the constitution to curb the president's powers. But for now, the prime minister-designate has gone out of his way to demonstrate that he is committed to pluralistic democracy.

As for relations with neighbours, Fico will have the benefit of ruling without the nationalists from the SNS – in fact, their party failed to clear the 5 per cent barrier necessary to enter the parliament, as has the Slovak Hungarian Coalition (SMK), which represents radical Hungarians in Slovakia and is close to Viktor Orban. For the first time in the country's recent history none of the nationalist parties will have deputies in the parliament. Instead, a newish party called Most/Hid ("bridge" in Slovak and Hungarian), which campaigns to improve ties between the two ethnic groups and fielded both Slovak and Hungarian candidates, has won seats in the legislature for the second term in a row. So Fico is well positioned to continue the outgoing government's policy of pursuing good neighbourly relations with Hungary. Whether he will do so is another matter; there is a lot of potential for trouble. The two countries disagree on Budapest's policy of giving passports to ethnic Hungarians living in Slovakia. Viktor Orban has publicly regretted the poor showing of the SMK, arguing that only 'ethnicity-based parties' can represent the interests of Hungarians in Slovakia. His rhetoric could sharpen further: Hungary holds parliamentary elections in 2014 and Orban faces opposition from the ultra-nationalist Jobbik party, which is gathering strength, especially among young voters. Sensible Hungarians worry that the prime minister may move even further to the right to fend off the challenge, which may include criticising the Slovak government's treatment of ethnic Hungarians. How Fico will respond is anyone's guess: in opposition, he has been more critical of Orban than Iveta Radičová, at one point calling Hungary "an extremist country". There is a possibility that Slovak-Hungarian relations will deteriorate amidst tit-for-tat accusations. 

People familiar with the prime minister-designate's thinking say that he wants the respect and recognition of his EU peers, and fears that his past record and Orban's presence across the border will taint him. Whether by agreeing to share some power with the opposition or by selecting respected Eurocrats for ministers, Fico is signalling that he is not Orban, and Slovakia is not Hungary. Despite these positive moves, it is too early to be conclusive: his government has not even formally assumed power yet. Among other things, the new administration will have to cut benefits and raise taxes to comply with the EU's new fiscal compact, so political opposition to SMER is likely to grow – and with it will the temptation to reach for populist rhetoric. The party's shady past may yet catch up with the prime minister-designate: SMER's financial backers will expect lucrative government contracts, so corruption could rise and fiscal discipline falter. But for now, Robert Fico seems intent to demonstrate that he is wiser and more respectable than he was in 2006-2010. And Viktor Orban in Hungary appears not to be a harbinger of a broader trend towards populism in Central Europe but a one-off.

Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.

Tuesday, March 13, 2012

Eurozone policy-makers place a big bet

Have eurozone policy-makers finally managed to lance the boil? They can certainly point to lower borrowing costs in Italy and Spain as evidence of stabilisation. Many of them argue that this demonstrates the success of the strategy of fiscal austerity and structural reforms. The more thoughtful among them acknowledge that borrowing costs in Spain and Italy have actually come down because of the ECB’s long-term refinancing operation (LTRO) – it has lent almost unlimited amounts of money in cash to the region's banks at 1 per cent, who in turn have bought Italian and Spanish debts. But they will then argue that this has carved out sufficient breathing space for structural reforms and fiscal austerity programmes to boost confidence and lift economic growth. There is no doubt the ECB has bought the eurozone time, but that time is not being used constructively. And the LTRO is storing up trouble for the future.

The ECB cannot support the banking system (and hence) the bond markets indefinitely. Its balance sheet has risen to close to 30 per cent of eurozone GDP. At some point the ECB will have to reverse its liquidity measures. To do this, the banking systems and bond markets of the struggling eurozone economies will need to have stabilised, and the banks will need to be in a position to start paying back the loans. This will require economic recovery. And here is the rub. Eurozone policy-makers base their confidence in the current strategy on the belief that the private sectors of the hard-hit economies are going to ride to the rescue. Indeed, they believe that austerity and structural reforms will make more households and firms confident to spend and invest. The problem with this analysis is that both households and business are hugely indebted and face a long period of deleveraging and/or face a very unfavourable economic environment. It is far from clear, for example, why already-indebted Spanish firms would suddenly start to invest in the teeth of falling demand. Nor is it clear why households – facing unprecedented unemployment – would increase spending. There is no reason to expect the private sector to pick up the baton.

The experience elsewhere in the eurozone's periphery demonstrates that tightening fiscal policy in the teeth of a recession is very dangerous. It can push highly indebted countries into a spiral that is tough to get out of. Nor are structural reforms any kind of panacea. Too many policy-makers and commentators attribute Greece's difficulties to the Greek authorities' failure to push through sufficient structural reforms over the last two years. This, they argue, has destroyed business confidence and investment in the country. There is no doubting the need for structural reforms in Greece, but the collapse in investment reflects the fact that firms cannot access capital and foreign businesses and banks are now loath to do business with their Greek counterparts because of the risk of default. Despite having pushed through a series of structural reforms over the last two years, Portugal is only a few months behind Greece. Business investment is collapsing and the country remains firmly shut out of the capital markets. Private sector forecasts expect the economy to contract by at least 5 per cent this year, with the economy sliding further into a debt trap.

There is scant reason to expect fiscal austerity to be any less destructive in Spain than in Greece or Portugal. Fiscal austerity of the order required by the EU will simply push the Spanish economy into a slump, which in turn will worsen the debt position of the private sector, amplifying the required amount of deleveraging, and ultimately how much private debt ends up on the state's books. Italy is in a stronger position than Spain, in that the country has much lower levels of private sector indebtedness. But if Spain slides into a depression, Italy will not escape contagion. The country's borrowing costs will remain very high, further weakening its public finances and pushing up borrowing costs for the private sector (public sector borrowing costs are the benchmark for the private sector).

In the circumstances, the Spanish government is absolutely right to spurn EU demands that it cut Spain’s budget deficit from last year's figure of 8.5 per cent of GDP to 4.4 per cent this year. But even the compromise target of 5.3 per cent (falling to 3 per cent in 2013) will undoubtedly prove impossible and result in an even deeper recession than the country already faces. Most forecasters already expect Spanish GDP to contract by 2 per cent this year, implying a big jump in the ratio of public debt to GDP. The current strategy is the worst of both worlds: it does little, if anything, to bring down public deficits but leads to a dramatic worsening of debt trajectories as the volume of debt relative to GDP rises rapidly. In short, it risks a repeat of Greece and Portugal.

Could exports come to the rescue? The solution propagated by 'austerians' is a so-called internal devaluation. Austerity and private sector wage cuts will lower inflation and costs and bring about improved trade competitiveness within the eurozone. This might just about be possible if German inflation were to surge, enabling these peripheral countries to improve their competitiveness without deflating nominal GDP. But this will not be allowed to happen. The ECB will raise rates to ward off the threat of higher inflation in Germany. In the run-up to the financial crisis, the ECB held rates too low for the needs of the eurozone as a whole in an attempt to boost the then ailing German economy, in the process helping to inflate the bubbles in the periphery. The perceived needs of the German economy will almost certainly take precedence again. And for obvious reasons. If the ECB allowed German inflation to surge, political support for euro membership in Germany could disintegrate.

The eurozone crisis is to a large extent an economic growth crisis and the ECB's LTRO does very little to address that. It will not slow the pace of bank deleveraging across the eurozone. It does little to deal with the aftermath of the asset price collapse or of massive misalignments in real exchange rates. Without a return to economic growth, the banks will not keep buying sovereign debt and will not be able to pay back the ECB. Indeed, the LTRO may ultimately make things worse, because it further concentrates risk in the struggling economies. Their banks have had to place decent collateral with the ECB in return for the money they have borrowed. In place of this capital they now have more of their own countries' sovereign debts. So the LTRO could actually worsen the rather poisonous nexus between sovereigns and banks.

The eurozone needs Monti, Rajoy and François Hollande (assuming he wins the upcoming French presidential election) to steer Europe away from the current dangerous course. The Italian and French governments have a strong vested interest in supporting the Spanish government, as a full-blown crisis in Spain would engulf Italy and ultimately France. However, the obstacles to such an alliance are formidable, not least the differences between Monti and Rajoy on the one side and Hollande on a range of economic and social issues. The Italian and Spanish leaders would have to persuade Hollande of the case for market-led reforms. Only then could they hope to overcome German opposition to debt mutualisation. However, much of the French policy elite fears that any open criticism of the German position would undermine the Franco-German alliance, in the process weakening French power and influence in Europe. The problem they face is that their current strategy of managing the eurozone crisis is bringing about the loss of influence they hope to prevent. 

Simon Tilford is chief economist at the Centre for European Reform.