Simon’s Blog: America Is Having an Unemployment Apocalypse. Europe Chose Not to

The coronavirus pandemic has dramatically changed economic life across Europe and the United States. By confining people to their homes, leading them to spend far less money than they otherwise would, the West has seen a collapse in consumption, threatening the survival of a sweeping number and range of firms, from restaurants to airlines to car manufacturers. This, in turn, has produced a sudden and unprecedented collapse in demand for labor. The United States has witnessed a dramatic rise in jobless claims—a scarcely believable 10 million over the last two weeks. This is uncharted territory for labor markets, and so it is unsurprising that different countries have adopted different strategies for coping with the looming unemployment crisis.

Many European countries are cushioning the impact of the crisis on their labor markets by employing a system pioneered in Germany and Austria called Kurzarbeit (short-time working). In essence, it involves reducing the number of hours a firm’s employees work to reflect the fall in demand, but their salaries are reduced by much less than the reduction in hours, with the country’s federal labor office funding the difference. Put simply, it is a form of wage subsidy.

Which approach is most likely to limit the long-term economic damage? The U.S. one of rapid cuts in employment in order to match the supply of labor with the suddenly depressed demand for it? Or the European approach of attempting to keep as many as possible at work? This will depend to a large extent on the length of the downturn: Can we look forward to a rapid, “V-shaped” recovery and limited loss of economic activity, or are we facing a longer recession or even something akin to a depression?

German unemployment rose less than in comparable countries, enabling German firms to hold on to skilled workers, which in turn meant that they could respond more rapidly once global demand started to recover. More European countries, including France and the United Kingdom, are pushing variations on the German approach during the current crisis in the hope of limiting the long-term impact to their economies.

Kurzarbeit is especially suited to Germany and other European countries with highly regulated labor markets and generous unemployment benefits. For example, it is expensive for firms in Germany to lay off workers; the procedure is lengthy, and they often have to pay for large compensation packages. German businesses are therefore understandably keen to avoid laying people off, especially when they believe that they will soon have to rehire workers. Second, unemployment benefits are high; a German on a full-time permanent contract who has worked more than 12 months will typically receive unemployment benefits of 60 percent of their net salary for 12 months; this rises to 67 percent for someone with children. As a result, wage subsidies can be a cost-effective option for government.

There is no tradition of Kurzarbeit in the United States. When demand for labor falls, the number of workers typically falls rapidly to reflect the drop—there is no attempt to divide up the remaining demand for labor among the existing number of workers. One reason is that it is cheaper and much less complicated for U.S. firms to shed workers. Another is that unemployment benefits are traditionally low compared with those in many Western European countries, hence public subsidization of private sector wages can seem expensive.

Those in non-unionized jobs or on temporary contracts have not tended to be covered. But Kurzarbeit schemes are being rapidly expanded—the German federal labor office estimates that 2.4 million workers will soon be covered by it—and it is not an exaggeration to say that the current crisis has opened a continental chasm on labor market policy. The United Kingdom has usually been closer to the United States than the rest of Europe when it comes to labor market policies, but it has now put in place a government program to pay up to 80 percent of private sector salaries (capped at just over $3,000 a month).

Do the Europeans have it right? Much will depend on the length of the downturn. If we see a rapid economic recovery from the third quarter (July to September) of the year, then the European approach will probably be vindicated. The rise in unemployment will have been lower in Europe than in the United States, firms will have retained more skilled workers (and their loyalty), and these companies will be better placed to ramp up production quickly, much as German ones did back in 2009. By contrast, unemployment will have risen much more in the United States, and households will have suffered more financial damage, causing more corporate bankruptcies and with them pressure on the financial sector. U.S. firms will face the costly and time-consuming process of rebuilding their workforces.

This could easily happen if governments are forced to maintain the lockdowns for longer and are then only able to ease them gradually, as appears to be the case in China. Kurzarbeit is not a long-term solution for a number of reasons. First, it is costly. In countries with generous unemployment benefits, this cost initially looks manageable. But even in Germany very generous unemployment benefits do not last forever. Second, the longer Kurzarbeit goes on, the more socially inequitable it can become; those workers with full-time jobs in the sectors covered by these schemes are largely protected from the downturn, while others—many of whom are poorer—face the full brunt. Third, the longer the downturn, the greater the likelihood that consumption and investment patterns will shift and the challenge will not be to kick-start existing production capacity but to shift resources—capital and labor—into new industries. In this situation, Kurzarbeit could distort wages and hold back necessary structural changes in an economy. For example, it is possible that demand for German cars—at least the gas-powered variants—will never properly recover from this crisis. It may therefore make little sense to artificially maintain employment levels in that industry.

If we suffer a prolonged downturn and weak recovery, other factors will have a bigger impact on how economies fare than whether or not they employ Kurzarbeit schemes. Countries that succeed in ensuring that households can pay their rents and mortgages and maintain a decent level of consumption (thereby keeping a limit on corporate insolvencies), and guarantee universal access to health care will likely come through the crisis in better shape than those that do not.

The U.S. administration has certainly stepped up emergency support for businesses, while the Federal Reserve—like the European Central Bank and the Bank of England—has moved aggressively to boost liquidity in an effort to head off a financial crisis. The CARES Act passed by Congress at the end of March also increases unemployment benefits and the number of people who qualify for them. But even after these changes, which U.S. labor unemployment offices are struggling to process, most Europeans have better unemployment and welfare benefits—and, crucially, poor and jobless Europeans have better access to health care. The U.S. government could easily address these issues by spending more money. The world wants dollars, now more than ever—the yield on 10-year U.S Treasury bonds is currently just 0.7 percent. Although this would no doubt prove cheaper for the United States in the long term, there is little to suggest—at least so far—that it will significantly boost spending on social programs.

This article was published first on Foreign Policy.