Reforms and employment performance in Portugal since the labour market reforms

A closer look at OECD numbers

The latest OECD Economic Survey of Portugal published today calls for labour market reforms but also admits to the fact that the country is suffering from “ the most unequal distributions of income in Europe. Recent efforts to step up the guaranteed minimum income scheme are welcome.”

One of the key messages from OECD preliminary assessment of labour market reforms in Portugal over the 2011- 2015 period, which was released two weeks before the country survey, is that unemployment is falling more sharply than predicted on the basis of pre-reform data.

Based on a regression explaining changes in quarterly unemployment in terms of (lagged) changes in quarterly GDP growth rates, the OECD observes a much sharper drop in unemployment rates from the second half of 2013 on than would have been expected (see graph). With growth recovering to 0.9% over 2014, the unemployment rate should have stopped increasing. In reality, however, unemployment dropped sharply in 2014 (by around 2pp).

While the OECD in a text box admits that high flows of emigration and a large increase of unemployed participating in active labour market programmes can also play a role, the report still claims that “these finding are at least consistent with what one would expect”, in other words corresponding with the assumption that reforming job protection and collective bargaining systems would produce a faster labour market recovery from recession.

A closer look at the numbers reveals things that do not add up

First, the numbers behind the OECD graph, in particular the employment numbers, turn out to be questionable. With a growth rate of merely 0.9% in 2014, the total number of jobs in Portugal in 2014 suddenly jumps up by 72.000. This corresponds with a growth rate of 1.6%. In other words, employers in this first year of moderate recovery have been hiring workers twice as fast as their activity was expanding. Growth became labour intensive to such an extent that it begs belief.

Second, looking at the sectors where these jobs were created adds more doubts. While the contraction of employment in manufacturing continued in 2014, the OECD statistics report that tens of thousands of new jobs were added in manufacturing, retail, ITC and finance. In terms of percentage changes, these numbers imply a rate of job creation of 16 to 18% in finance and ICT. These are big numbers and, in the case of finance, they imply a return to the pre-crisis level number of jobs.

Explaining the numbers

The OECD labour market reform report unfortunately does not try to understand what is really happening here. There are at least three possible underlying explanations.

One is that the number of unemployed that are being mobilised through active labour market programs (internships, integration of long term unemployed) started to increase substantially exactly in the year 2014. The increase, 28.000 persons, boils down to almost half of the total of 70.000 new net jobs that appeared in the statistics that year.

A second explanation, not raised by the OECD report, is that the Portuguese labour market reacted the opposite way in the period before the recovery. As can be seen from the first graph, the increase in the observed unemployment rate was more pronounced than is predicted by the OECD model. What may be at work here is that firms, constrained in their access to finance during the unfolding of the euro crisis and related banking credit squeeze, reduced job levels more intensively than otherwise would have been the case. When the economy (weakly) recovered in 2014, two years after the president of the ECB launched the promise to do ‘anything it takes’ to save the euro , finance conditions for business had presumably improved sufficiently enough to produce the inverse effect of companies creating more jobs than usual in order to bring staff levels back up to speed.

Finally, when bringing wages into the picture, it appears that the trend change in 2014 also took place along this dimension. After several years of real wage cuts for workers in the private non-agricultural business sector (excluding real estate)), real wages in 2014 suddenly jumped up by 2.7%. (see table below, taken from OECD report).

The numbers from the table imply that jobs disappeared more quickly than GDP was shrinking in parallel to real wages going down (2011–2013), whereas more jobs were added in relation to the economic recovery in the year 2014, when real wage dynamics displayed signs of a recovery. This stands in opposition to what is to be expected under the traditional theory of labour market flexibility where downwards wage pressure is expected to lead to more (and not less) jobs.

Conclusion

An in-depth look at the job numbers as well as the corresponding wage trends reveal that what is happening here is not consistent with the theory of ‘easy firing’ and ‘downwards wage flexibility’. It would be interesting for the OECD to delve deeper in these matters and numbers in order to come up a more convincing explanation.