Spanish unemployment stands at 24 per cent, and there are grounds for believing that on its current path, the rate is unlikely to fall below 20 per cent at any point soon. Roughly one in four Spanish workers is unemployed, twice the rate in the rest of the European Union.

There are at least three general reactions to this problem. Some sceptics argue that the figures are unrealistic, and that a widespread underground economy makes high unemployment just a statistical artefact. Unfortunately, it seems clear that correct accounting for the underground economy will only reduce the unemployment rate by up to a maximum of 3 or 4 points.

Alternatively, there is an 'apocalyptic view’ of unemployment which argues that there is no other solution but a drastic reorganization of labour markets, based on work-sharing and 'new forms of production’. But apart from unemployment, Spain's economic position is in many ways fundamentally sound. Income distribution, at least between capital and labour, is just about right, and there is wide scope for investment to take place at existing, historically high profit levels.

Lastly, policy-makers, obsessed by meeting the nominal convergence requirements of the Maastricht Treaty, expect significant reductions in unemployment only as a side-effect of improving economic conditions. In the Spanish case, that is interpreted as meaning massive unemployment remaining into the next century.

But there is not necessarily a contradiction between convergence and reducing unemployment as long as the domestic conditions are right. In fact, Spanish unemployment is nothing less than the acutest symptom of a common European disease, as a CEPR research team argues in a recent Report. The malaise is caused by serious supply side problems compounded by restrictive demand policies. Reducing unemployment can be achieved, and it must be done sooner rather than later, the researchers urge.

The Report contends that one path could lead to considerable improvements. Roughly four million jobs are needed to reduce unemployment significantly. On the anticipated path of future productivity growth, this requires 5 per cent annual GDP growth sustained over the course of a decade. This can be achieved with real product wages increasing at roughly the rate of productivity growth, and without strong inflationary pressure. But it is essential to implement two types of measures to attain this goal.

On the supply side, there is no need for drastic deregulation of the labour market. For the most part, the market's institutions serve the goals of efficiency and equity simultaneously. Nonetheless, government-enforced firing costs, in dismissals for economic reasons, are too high. At the same time, ill-designed collective bargaining practices tend to have an inflationary bias, hindering the efficient allocation of labour. These two features of the Spanish labour market are the primary causes of its inefficient functioning, and must be tackled at once.

On the demand side, it is important to note that greater demand will not come simply from supply side reforms. But the mix of expansionary macroeconomic policies must be changed. At the current rate of accumulation of public debt, more fiscal toughness is essential, leaving only one alternative for demand expansion, that is, more relaxed monetary policies.

Realistically, such policies will produce a depreciation of the exchange rate, an impossible condition if Spain is to be a founder member of a European monetary union. But if sustained growth requires currency depreciation, then it must be allowed to happen.

It is also important to realize that demand and supply policies reinforce each other. The supply reforms advocated by the CEPR team are easier, from an economic policy point of view, when the labour market is buoyant. Demand expansion can produce economic growth instead of inflation if the sources of wage inflationary pressure are eliminated or reduced.

At present, there is an unproductive tug of war between the central bank and the unions. The central bank restricts money, fearing inflation, while the unions refuse to accept reductions in firing costs without significant job creation.

The solution to this conflict is the coordination of demand and supply policies, a 'two-handed' strategy to be achieved with credible social pacts. Despite the failure of such pacts in the past, the current income distribution makes the outlook much more promising. In this way, the authors of this Report believe, Spanish unemployment can be reduced at low cost.

Would the diagnosis be different for other countries? Should the same cure be advocated for the European disease? There are wide variations in macroeconomic constraints and labour market institutions across European countries. Hence, the details of a package to reduce unemployment in each of these countries should be country-specific.

Overall though, a two-handed approach is the only solution to European unemployment. Without reforms in labour market institutions, supply constraints will limit the scope for growth. And without demand, there will be no growth at all, and supply reforms will not be feasible because of policy constraints. But as the preceding article makes clear, whether policy-makers will attempt to cure the disease in this way, instead of just aiming to reduce the pain is another question altogether.

Spanish Unemployment: Is There a Solution? was written by a team of researchers from Spain, France, the UK and the US:

Olivier Blanchard (MIT)

Juan Francisco Jimeno (Universidad de Alcalá de Henares and FEDEA, Madrid)

Javier Andrés (Universidad de Valencia)

Charles Bean (LSE and CEPR)

Edmond Malinvaud (INSEE, Paris)

Ana Revenga (World Bank)

Gilles Saint-Paul (DELTA, Paris, and CEPR)

Dennis J Snower (Birkbeck College, London, and CEPR)

Robert Solow (MIT)

David Taguas (Ministerio de Economia y Hacienda, Madrid)

Luis Toharia (Universidad de Alcalá de Henares)

Preparation and publication of the Report was supported by Consejo Superior de Cámaras de Comercio, Industria y Navegazión, and a Spanish version appeared in December 1994, El paro en España: Tiene solución?, published by FEDEA, Madrid. (check)

Available from CEPR

Unemployment: Choices for Europe

Monitoring European Integration No. 5

ISBN 1-898128-14-6

Spanish Unemployment: Is There a Solution?

ISBN 1-898128-18-9