What policies can help mitigate the impact of financial crises on employment? In an ambitious paper presented at the World Bank seminar series of the Chief Economist of the Middle East and Northern Africa Region, IMF colleagues Davide Furceri, Dominique Guillaume and Lorenzo Bernal-Verdugo provide a partial answer to what is arguably one of the most pressing questions confronting policymakers across the globe today.
Using historical data, they demonstrate that, in the short run, increases in unemployment are associated with financial crises. In addition, such increases tend to persist, albeit abated, in the medium run. However, policy choices drive substantial differences in how financial crises reverberate through labor markets. Countries with relatively rigid labor regulation suffer lower initial increases in unemployment. But at a price: their recovery is protracted, and, more worryingly, only partial. By contrast, countries with more flexible labor regulations experience sharper increases in unemployment in the short-run, yet such increases wither away fully in the medium run. Thus, adopting flexible labor regulation seems crucial to avoiding lasting damage. Still, this comes at the cost of having to incur higher short-term employment losses. Since even short-lived shocks can have irreversible detrimental effects, for example by hampering investments in human and physical capital, flexible labor regulation needs to be complemented with social protection policies.
The results outlined in the study illustrate the thorny trade-offs that might arise between minimizing short-term damage and maximizing prospects for long-run recovery that were also highlighted in a recent review of policies to offset the adverse labor market consequences of crises. Policies that focus on mitigating immediate impacts may aggravate systemic problems and thus backfire in the longer term. In Indonesia, for example, the 1997-1998 crisis sparked pro-labour pressures that led to better compliance with minimum wages and to the introduction of severance pay and dismissal regulations. While these measures protected workers’ earnings and limited initial job losses, they also led to severe rigidities in hiring and firing, which then hampered job creation and prospects for recovery. Conversely, policies that are conducive to long-run growth, when implemented incautiously, may do unnecessary damage in the short run. Thailand’s recovery from the Asian crisis is a case in point. While the Thai Government introduced reforms conducive to long-run growth, the adjustment programme proved to be too harsh, leading to an unnecessarily sharp decline in output.
Whereas some policy options involve tradeoffs, others are utterly undesirable. For instance, increasing public sector wages is plainly a bad idea. While this might marginally enhance social stability, it proves costly and does not protect those most exposed; public sector employment is usually the most stable type of employment during times of crisis. Moreover, it is undesirable from a distributional point of view since those employed in the public sector typically earn more than others. Expanding public sector employment is not appealing either, since newly created jobs are difficult to dislodge after the crisis and may stifle competiveness. Indeed, the experience of MENA in the early 90s suggests that the creation of “deficit financed” public sector jobs may stunt private sector job creation in the medium-run. It is worrying, therefore, that the governments of Morocco, Jordan, Egypt, Bahrain, Kuwait, Algeria and Saudi Arabia have recently resorted to increasing public sector wages or employment.
The challenge for policy makers is thus to identify cost-efficient, feasible policies that are beneficial both in the short and the long-run. Examples of ad-hoc policies that have worked well in previous crises include 1) credit-market policies that reallocate funds from inefficient to efficient firms, thus minimising credit misallocation; 2) temporary public-works programmes that target the poor and vulnerable and yield productivity-enhancing infrastructure; and 3) targeted self-employment assistance.
Despite the success of such programs, the most important conclusion from the review is that there is no substitute for being prepared and instituting sound structural policies. Countries with policies that facilitate resource reallocation across firms, prudent fiscal management and effective stabilisers in place before crises hit, tend to suffer less than countries that lack these. Policies that govern firm dynamics appear to be particularly crucial determinants of the depth and duration of crises, which perhaps should not come as a surprise, since firms are the creators of jobs.
Join the Conversation