Wednesday, June 26, 2013

Spain and Florida

Paul Krugman argues that the key difference maker in the economic fortunes of Spain and Florida is Florida's membership in a fiscal union. Scott Sumner notes that Krugman is correct, but that supply side factors play a large role as well.

This reminds me of an IMF paper on Spain's labor market that concluded:

"Spain stands out by the structure of its collective bargaining, which takes place at the intermediate level and greatly constrains wage flexibility, and by the very high severance payments for permanent workers, which accentuate the insider-outsider problem."

and:

"The unemployment rate could be substantially reduced by effectively decentralizing collective bargaining, thereby reducing excessive wage demands and allowing more wage flexibility. Reducing unemployment benefits and lowering the tax wedge would also help reduce unemployment by lowering the cost of labor. Finally, deregulating product markets reduces unemployment including by boosting activity and labor demand."

Europe is suffering from low aggregate demand, which accounts for high cyclical unemployment. The ECB, not fiscal austerity, is almost entirely to blame for this.

Still, well before the cyclical downturn, many European economies had chronically high unemployment, thanks to bad labor market policies. As Scott Sumner often points out, Europe has both demand side and supply side problems that both need to be addressed if we are ever to see a real labor market recovery in places like Spain (and France, Italy, etc).

PS: The main reason the USA has weathered the recession better than Europe is better monetary policy (albeit still inadequate), but our more flexible labor markets are part of the story as well.
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