Labor Unrest in Spain

Well, they do still have to honor siesta…

The recent manifestations in Spain against a labor reform are just another symptom of the precarious situation in Europe. Even though Spain is not in the same situation as Greece (yet?), it does have a higher unemployment rate. Manifestations took place in 57 cities in Spain. But this does not only show the state of the economy in Spain, it is also a case of special interest groups trying to protect a source of income or power.

Policymakers usually confuse the cure of an economic crisis. A common thread running through different economic policies is that an increase in demand should increase the supply of goods and services when there are output gaps. But an economic recovery rests on investments being done on successful projects. Without a change in the rate of return, demand driven economic policies can only achieve to reallocate demand among different sectors, or to consume capital goods, but not genuinely and sustainable growth. It is, on the contrary, relative prices and rates of return which drive the economy; these are the areas where economic policy should concentrate. A labor reform that contributes to lower the costs associated with hiring workers and allows for a faster reallocation of labor in the market points to the right direction.

However, to pass a law labeled as “labor reform” and to do a “labor reform” are two different things. Without enough knowledge on the details of the law, and how is it going to be implemented, is hard to say if the new law goes far enough, or too far. There are, however, a few characteristics that point in the right direction, namely, to lower the cost of firing and return more flexibility on wage negotiation.

That the cost of firing employees is lowered may seem to imply that firms will be more willing to fire people and that thus unemployment will rise. But to lower the cost of firing people also lowers the cost of hiring new personnel. All business decisions and investment projects are done under uncertainty. But if it is certain that if the project does not yield the expected return the firm will not be able to set labor free, then the likelihood of new projects being begun diminishes. Projects with low uncertainty, but also lower return are the ones benefited by this law, ultimately leaving real wages to stagnate.

To increase the cost of firing workers has another important effect. Given the increase in the cost of firing employees, firms will be reluctant to hire newcomers to the labor market who have less experience and no track-record to prove their productivity and performance. The same problem faces people who have been looking for a job for a while. In other words, those who may need a job with more urgency are the ones that will have a harder time finding one. Also, since high productivity workers are employed in low return projects their real wage is not as high as it could be.

Economic policy cannot increase employment by augmenting the compensation upon firing workers anymore than investment can grow by increasing the costs associated with bankruptcy. Investments will be done in those places where investors know that they can shut down their projects if they prove not to be profitable.

Labor unions do not only oppose lowering the costs of compensation upon firing workers, they are also opposed to giving the firms higher flexibility in negotiating salaries and wages. It is no secret that when unions press for increases in minimum wages, the effect is to increase the wages of some at the expense of others. But firms are not in the same situation as are unions. Firms do have to compete with each other to hire the best employees available; and even to protect their best workers from leaving to another firm (or even the competition). It is a very rare situation to find labor unions that have to face the same challenges to keep their members under their umbrella and compete against other labor unions.

The protests in Spain are a reaction to two different issues. First, the labor unions trying to protect their group benefits; though labor reform that goes far enough, and is accompanied with market deregulation is good news for employees and investors as well. Second, the fact that the government has become oversized and cannot pursue further economic policies to increase demand and employment. The fact that government usually fail to transmit clear and concisely why certain reforms are not only needed, but also produce good results, does not help to make them pass through.

Nicolas Cachanosky is a doctoral student in economics at Suffolk University, as well as a previous Sound Money Essay Contest winner.

image: flickr.com/terry_wha

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