Reconnecting to Work: Policies to Mitigate Long-Term Unemployment and Its Consequences

3 - Labor market Policy in the Great Recession: Lessons from Denmark and Germany

37 3 Labor Market Policy in the Great Recession Lessons from Denmark and Germany John Schmitt Center for Economic and Policy Research The Great Recession started in the United States, but it quickly spread to the rest of the world. Although some countries fared even worse than the United States, many have weathered the crisis better. This chapter reviews the experience of 21 rich countries that are all members of the Organisation for Economic Co-operation and Development (OECD)—a group of economies that offer a standard of living roughly comparable to that of the United States—in search of possible lessons for the United States. Figure 3.1 shows the percentage point change between 2007 and 2009 in the unemployment rate across these 21 rich countries. Since national definitions of the unemployment rate vary somewhat, the figure uses “harmonized” unemployment rates prepared by the OECD. It covers a period that starts in 2007—the year just before the downturn hit most economies—and ends in 2009—the year that the economy reached its trough in most countries.1 The United States had the thirdhighest increase in unemployment (4.7 percentage points), after Spain (9.7 percentage points) and Ireland (7.2 percentage points). In the other OECD economies, the increase in unemployment was less than 2.5 percentage points. Strikingly, the unemployment rate actually fell in Germany (−1.2 percentage points). Economic theory suggests three possible reasons for the different unemployment experience. The first is that the size of the negative demand shock might have varied across these economies. It could be, for example, that Spain suffered a larger negative demand shock than the United States, which in turn experienced a worse demand shock than 38 Schmitt most of the rest of the OECD. Since we can’t directly observe demand shocks, we can never be completely sure. But all of the evidence—primarily the change in GDP—suggests that the demand shocks were large and negative across all of these economies. The shock to Germany, for example, was likely larger than the one that hit the United States: between 2007 and 2009, German GDP fell 3.8 percent, compared to a 2.6 percent decline in the United States.2 A second possible explanation for the different unemployment experiences is different macroeconomic policy responses. Even if all countries experienced exactly the same negative demand shock, countercyclical macroeconomic policy—expansionary monetary and fiscal policy—could have reduced the observed decline in GDP more in some countries than in others. Macroeconomic policy responses did vary widely across the OECD, but most analyses suggest that the United States did better than average.3 The Federal Reserve Board Figure 3.1 Change in Harmonized Unemployment Rate, 2007–2009 9.7 7.2 4.7 2.4 2.3 2.3 2.1 2.0 1.6 1.6 1.5 1.4 1.3 1.2 1.2 0.7 0.6 0.5 0.4 0.4 −1.2 −2 0 2 4 6 8 10 12 Spain Ireland U.S. New Zealand Canada U.K. Sweden Denmark Italy Portugal France Greece Finland Japan Australia Norway Switzerland Netherlands Belgium Austria Germany Percentage points SOURCE: OECD. Labor Market Policy in the Great Recession 39 lowered interest rates farther and faster in the United States than, for example, the European Central Bank did in Europe.4 The United States also implemented the largest explicit fiscal stimulus package (as a share of GDP) among the major OECD countries. Other countries passed smaller stimulus packages, and automatic stabilizers were more important parts of the fiscal response elsewhere, but, even taking all these measures into account, the fiscal response was likely faster and larger in the United States. A final possible explanation for the different international unemployment experience in the downturn is the structure of labor markets. National labor market institutions likely vary in the way that they translate a given decline in GDP into unemployment. The preceding discussion suggests that the United States experienced a negative demand shock somewhere in the middle of the OECD experience and responded in a way that partly mitigated the negative impact of that shock. If so, the large rise in U.S. unemployment suggests that U.S. labor market institutions offered a particularly harsh trade-off between falling GDP and unemployment. By contrast, Germany appears to have experienced a larger negative demand shock and responded to that...