Europe's Labor Market Problem

While the continent may have lower unemployment rates than the U.S., its economic recovery will be less robust.

Back in January Paul Krugman wrote a column about the surprising comeback of the European economy. He argued that Europe had overcome its lags in IT investment and addressed many of the labor market rigidities that had saddled it with very high rates of unemployment, particularly among younger workers.
He was quickly corrected by economist Greg Mankiw and others who pointed out that Europe still lags significantly in economic wellbeing measured by per-capita GDP adjusted for purchasing power parity. For the 15 original members of the European Union (the E.U. 15) per-capita GDP is about $34,900. For the U.S. it is about $47,500--more than one-third larger.


Since I am currently working in Italy for a few months it has been interesting to get more of a European perspective on these issues from my colleagues here. It is clear that Krugman was correct in one sense. Coming into the recent economic crisis Europeans did feel that their economies were more vibrant and flexible than they had been previously. And as the crisis took hold they expected to come out of it a lot better.
After all, with the exception of Spain and Ireland, most European countries had not had a housing market bubble as the U.S. did. Also, the financial sector problems were not as ubiquitous--although certainly the U.K., Switzerland and the Netherlands were big participants.

But many Europeans now express frustration that their experience has not been very good. GDP in the E.U. 15 economies declined by 4.1% in 2009 and is projected to increase by a very sluggish 0.7% in 2010, according to the latest statistics from Eurostat.

The unemployment rate in the E.U. 15 has increased to 9.9%, still not as high as in the U.S. Krugman's column observed, "In particular, in the prime working years, from 25 to 54, the big gap between European and U.S. employment rates that existed a decade ago has been largely eliminated." Apparently so, but this misses the deeper reality of European labor markets.

Consider the following data I took from David Altig's superb Macroblog site. The first chart shows the response of employment in the U.S., the E.U., Canada, the U.K. and Japan since 2007, the beginning of the financial crisis. The losses have been far more dramatic in the U.S.--something I have emphasized in previous columns. Bad for us, good for them, right? Not necessarily.