Tale of Two Countries

In the years leading up to the Great Recession, Denmark had what was arguably the most successful labor market in the world. In 2007, for example, the unemployment rate in Denmark was just 4.0 percent (compared to 4.6 percent in the United States), and a much higher share of working-age Danes were in jobs (77.1 percent) than we managed in the United States (71.8 percent). But, the Danish labor market has struggled since 2008. Most obviously, the unemployment rate almost doubled, to 7.8 percent, by 2010.

Change in unemployment rate, 2007-2009

Source: CEPR.

The same Danish labor-market institutions that served the country so well when the economy was near full employment have not been helpful in the downturn. The Danish labor market features both a high degree of flexibility –relatively low levels of legal and contractual job protection– and a high degree of income security for workers –high wages, generous unemployment benefits, and an extensive and expensive program of education, training, and job placement services for the unemployed. When there are plenty of jobs to go around, this system quickly prepares and matches unemployed workers to the available work. When the problem is that there just aren’t enough jobs, however, the Danish model is like pushing on a string (to borrow a metaphor from elsewhere in economics).

Meanwhile, the German economy has done remarkably well in the downturn. Despite experiencing a big shock to its export sector, the unemployment rate is lower today than it was before the Great Recession hit. The secret to the German success seems to be that the country’s labor-market institutions have channeled the drop in economy-wide demand into reduced hours rather than reduced employment. The average German employee works fewer hours now than before the recession, greatly reducing the need for layoffs.

We could do the same in the United States. One option (pdf) would be to follow the German example and make part-time unemployment benefits widely available. So, for example, a firm could cut its employees’ hours by 20 percent rather than laying off 20 percent of its workers. The employees on reduced hours would receive 80 percent of their pay, plus 20 percent of the regular unemployment benefit.

Another option (pdf) would be to offer a temporary tax credit to employers who increased the availability of paid time off –paid sick days, paid vacation, or paid family leave, for example. A generous “Pay for Play” tax credit could cut average hours substantially averting the need for layoffs. Such a system could also help to create a longer-term expectation for paid sick days and other forms of paid time off, something sorely lacking in the United States.

The Danish experience makes clear that focusing on the unemployed themselves –their skills, their geographic location, and their connection to the available jobs– while extremely important in the long run is unlikely to have any measurable impact in the middle of a recession. Denmark spends far more than we could ever imagine in the United States on improving the skills of unemployed workers and matching them to the available job opportunities, but the unemployment rate there has almost doubled since 2010. Precisely because Denmark’s labor-market crisis, like our own, is not a supply-side problem, but rather the result of a collapse in aggregate demand.

For more on Denmark, Germany, and the United States in the Great Recession, see my new CEPR report, just out today.

UPDATE 05/21/2011: Still no rapture, but Matt Yglesias, Mark Thoma, and Mike Konczal all blogged the paper. Zachary Roth also had a nice column citing the report.

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