Forecasts for the short term future

At the moment²⁹ it is clear that all short term economic forecasts – whether from the EU, OECD or other bodies - agree that growth in the EU is likely to be well under 1%

for 2012, and that there is a risk of growth becoming negative. On this basis, unemployment in the EU is almost certain to continue to rise, although to what extent remains highly uncertain.

In order to obtain some quantitative indication of what could happen to employment and unemployment, as and when economic confidence returns, one option is to look to the most recent experience, namely what happened in the period before, and after, the dotcom crash in 2001/2002. Given that this crash pre-dated the 2004 and 2007 enlargements of the Union to include the Member States of Central and Eastern Europe and others, this has been done just for EU-15 Member States.

In the period before the 2001/2002 dotcom crash, EU-15 experienced relatively high GDP growth - almost 3% a year on average – resulting in a reduction in the rate of unemployment from 11% in 1995 to 7.4% in 2001. In the post-dotcom recovery period from 2003 onwards, economic growth was less strong than it had been earlier – of the order of 2% a year – and, while the unemployment rate fell, it stayed at around 8% until 2007, when it dropped to 7% - the lowest rate achieved in the past two decades.

As the financial-crisis-induced recession hit, however, GDP growth began to fall - reaching a low point of -4.4% in 2009 – although growth became positive again in 2010. Nevertheless, since 2008, unemployment has remained close to 10% in EU-15.

Following their entry into the EU, labour market trends in the EU-12 Member States were less favourable than in the past, with many countries experiencing job-less growth, despite relatively high GDP growth rates, due to general improvements in productivity in this catching-up phase. As a result there was little in the way of increased employment or reduced unemployment.

Only in the years immediately before the current crisis did their labour market situations begin to improve. Moreover, because of their different economic situations, the crisis hit these countries in quite different ways with, for example, the Baltic States facing some of the most severe recessions in the EU, while Poland even managed to maintain positive GDP growth rates.

In the light of this experience, it is useful to look more generally at the relationship between GDP growth and employment in order to gauge to what extent, and with what speed, the eventual economic recovery will revive employment in the EU.

29 November 2011

Figure 19: Activity rate, unemployment rate and GDP growth for EU-15

Source: Eurostat

Between the rate of growth of GDP and changes in the unemployment rates there is, of course, a generally negative correlation. However the relationship is not one-to-one:

empirical econometric results for the EU over recent years suggest that, for each percentage point that GDP increases, the unemployment rate declines by only about 1/3 percentage points. Moreover that GDP growth must be above a threshold of about 1.5% before unemployment rates start to decline.

Though these relationships can obviously differ to some degree between Member States and over time, they suggest that, even under the optimistic assumption that GDP growth in EU-15 would reach the pre-dotcom crisis level of 3% again, the low-point unemployment rate of 7% that was achieved in 2007 is only likely to be reached after several years. Moreover, for countries that experienced the most dramatic increases in unemployment rates (such as Ireland, Spain, and the Baltic States), the period could be very long, even under favourable assumptions.

An analogous relationship holds between the growth of GDP and employment although, as Figure 20 shows, in periods of relatively strong GDP growth, the rate of growth of GDP is roughly 1-1.5 pp point higher than the growth in employment while, in periods when GDP growth declines, the growth rates of GDP and employment are much closer.

In the crisis period 2008-2010, however, GDP growth fell much more than employment growth due to the various policy measures that were taken to ‘protect’ jobs, including the use of short-time and part-time working schemes by firms. Moreover, it can also be noted that, as happened in the post-dotcom recover period 2003-2005, employment growth in 2010 lagged behind GDP growth.

Figure 20: GDP and employment growth rates in EU-15

Source: Eurostat, own calculations

This relationship between GDP growth and employment growth is volatile in the short run but, over time, the empirical findings show that, in general, GDP growth must reach 1% before employment growth becomes positive, and that for each percentage point higher GDP growth, employment growth increases by 0.4 percentage points.

Using this result, and assuming that GDP growth was only 1% for some time, then it is estimated that it could take until 2016 or 2017 to return to pre-crisis levels, unless there were very significant reductions in average working hours.^.

A further aspect that should be noted is the heterogeneous development across EU27 Member States, not just with respect to economic indicators such as GDP growth or debt ratios, as currently being addressed in the public debate, but also with respect to labour market outcomes.

Figure 21 shows the EU-15 unemployment rate alongside the variance of unemployment rates across countries and the range between countries (i.e. the maximum unemployment rate minus the minimum unemployment rate). As can be seen, these were declining over the period 1995-1999, but with heterogeneity again rising in some Eastern European countries in the 1990s.

Indicators of range and variance subsequently declined quite strongly until 2007/2008, with the range dropping from 18% to 8%, and an even greater decline in the variance – with both being particularly driven by reduced unemployment rates in Spain in the 1990s, and improvements in the labour market situation in the Eastern European countries since about 2000.

However, in the course of the crisis, diversity again increased, with the unemployment rates indicating that labour market performance is becoming more diverse across the Member States of EU-27. While unemployment rates in 2007 ranged from 3-4% to 12%, the range now goes from 3-4 % (in countries which more or less retained their pre-crisis unemployment rates) up to 20% in Spain, and more than 15% in the Baltic countries.

Figure 21: Unemployment rate heterogeneity in EU-27

Source: Eurostat, own calculations

Figure 22: Unemployment rates in EU-27, 2007 and 2010

Source: Eurostat, own calculations