Labour Economics 41 (2016) 32–46

Contents lists available at ScienceDirect

Labour Economics

journal homepage: www.elsevier.com/locate/labeco

Learning from the Great Divergence in unemployment in Europe during

the crisis☆
Tito Boeri a,⁎,1, Juan F. Jimeno b,c,d
a
Bocconi University, Italy
b
Banco de España, Spain
c
CEPR, United Kingdom
d
IZA, Germany

a r t i c l e i n f o a b s t r a c t

Article history: Since the mid-2000s there has been an increasing divergence in unemployment rates across EU countries and age
Received 2 February 2016 groups. We argue that this divergence has to do with labor market institutions when account is made of their
Received in revised form 24 May 2016 interactions with the magnitude and nature of the shocks from the Great Recession and the Eurozone debt crisis.
Accepted 26 May 2016
New macro and micro evidence is provided highlighting the importance of these interactions in explaining cross-
Available online 28 May 2016
country differences in labor market adjustment to shocks. Having identified the labor market institutions respon-
JEL classification:
sible for this increasing unemployment divergence, we consider what can be done at the EU level to promote
J64 institutional convergence. In particular, we discuss a “positive conditionality” approach that could operate also
J66 in good times, and not only under recessions, when conditionality is strong, but some reforms may backfire.
© 2016 Elsevier B.V. All rights reserved.
Keywords:
Unemployment
Labor market institutions
Demand and financial shocks

1. Introduction
The unemployment response to the Great Recession and to the
subsequent events associated to the European debt crisis has been
extremely heterogeneous across Europe and population groups. The
dispersion in EU national unemployment rates reached in 2014 histori-
cal peaks. In most countries, notably in Southern Europe, unemploy-
ment has also been heavily concentrated among youngsters, with
youth unemployment rates well above 40%, and up to four times as
large as for the other age groups. Identifying the causes of this heteroge-
neous response of unemployment is very important for a better under-
standing of labor market dynamics. The lessons that one can draw from
this experience are also important for an evaluation of the EU policy-
coordinated approach to macroeconomic stabilization and microeco-
nomic conditionality.
Although the Great Recession and the events associated with the
European debt crisis implied demand and financial shocks of different
☆ This paper draws from presentations at the ECB Forum on Central Banking, Sintra
2015, and at the Festival of Economics in Trento. We are grateful to the editor and a
referee for helpful comments.
⁎ Corresponding author at: Bocconi University, Economics, via Roentgen 1, Milano, Italy.
E-mail address: tito.boeri@unibocconi.it (T. Boeri).
1
Currently President of the Italian Social Security administration (INPS), is Professor of
Economics at Bocconi University.
nature, size, and timing across countries, these differences cannot fully
account for unemployment divergence in Europe. In this paper we
argue that the roots of this increasing heterogeneity in unemployment
are in the interactions between the several shocks that hit EU countries
since 2007, the nature of these shocks, and the labor market institutions
present in these countries at the outset of the Great Recession. The role
of institutions in asymmetric labor market response to shocks could
have been greater than under previous recessions because the introduc-
tion of the euro reduced the scope for macro stabilization policies at the
national level. Put it another way, more reforms of labor market institu-
tions would have been needed to reduce the impact of the crisis on
unemployment in several countries.
Unfortunately, our analysis suggests that EU policy co-ordination
failed to achieve the type of institutional reforms that would have
been required to improve the functioning of labor markets, and actually
in several cases imposed reforms that backfire during recessions. We
therefore develop proposals to improve the role of supranational
authorities in reforming sub-optimal institutions, by exerting condition-
ality not only during downturns, but also at normal times. In particular,
we propose to increase the coordination of the main guidelines of
employment policies in European institutions, and to implement some
programs at the European level. In this regard, we call for European
employment policies to complement national policies in the areas of
employment protection legislation, and unemployment insurance.
Allowing countries to benefit from these complementary institutions,

http://dx.doi.org/10.1016/j.labeco.2016.05.022
0927-5371/© 2016 Elsevier B.V. All rights reserved.
 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46
conditional on carrying out structural reforms, would establish the type
of positive conditionality that is needed. In addition to exerting positive
conditionality, such supranational labor institutions would obviate to
the limitations of national stabilization policies imposed under a mone-
tary union. The fact that these complementary institutions target EU cit-
izens rather than governments or local administrations or
intermediaries, make them more transparent and socially acceptable.
We also consider a policy enforcement mechanism for these European
institutions, which is based on a stronger cross-country co-ordination
of social security administrations in monitoring entitlements of those
moving across jurisdictions. In particular, we propose to introduce a
European social security number or identifier, which would allow for a
stricter control at the EU level over the implementation of these pan-
European programs. It would also contribute to encourage more mobil-
ity of workers in Europe, making social security entitlements fully
portable across jurisdictions.
Our approach is eclectic and tries to draw evidence from different
sources. By using macro data and digging into Okun's type relationships
we show that the relative impact of shocks on GDP and unemployment
was dissimilar across countries. We also highlight that the rise of unem-
ployment and the increasing differences of unemployment across
countries and socio-demographic groups are not unrelated phenomena:
there is a positive correlation across countries, and across time between
the average unemployment rate, and the dispersion of unemployment
across population groups. We complement this macro evidence with
new data coming from a survey on firms carried out by the ESCB Wage
Dynamics Network (WDN) that provides information on their responses
to different shocks (demand, finance, costs-push) along several
dimensions (employment, wages, working hours). The country
differences in this regard provide further insights as to the interactions
between labor market institutions and shocks that are at the roots of
the EU unemployment divergence. We conclude that the Great
Divergence arises from a triple interaction: between magnitude of the
macroeconomic shocks, nature (financial vs. real) of these shocks, and
labor market institutions conditioning firms' adjustment to those
shocks. This implies that coping with it is not simply a matter of
macroeconomic stabilization at the EU level, but also of institutional
reform.
After having laid out the facts, we evaluate the institutional
reforms sponsored by EU supranational authorities during the crisis.
We begin by surveying the recent relevant literature on the impact of
labor market institutions during financial recessions, and at different
phases of the business cycle. Then we compare these results with the
actual recommendations developed by EU supranational authorities
during the crisis, and argue that EU conditionality to a large extent
failed to take into account the main conclusions from this literature.
Since we are aware of the political resistance to comprehensive labor
market reforms, and of the fact that EU-conditionality is stronger
under bad times, we advocate a “positive” conditionality that could
also operate under normal business conditions to induce institution-
al reforms.
We structure the paper as follows. We first document, in Section 2,
the main facts about country-specific unemployment trajectories, and
the differences across socio-demographic groups within each country,
paying particular attention to youth unemployment. To gauge the rela-
tive role of shocks and institutions, we first focus on outliers in Okun's
equations, and, secondly, present some new microeconomic evidence
on how firms adjusted wages, hours and employment in response to
demand and financial shocks, and how those responses are related to
cross-country changes in unemployment. Based on this analysis of the
interactions between shocks and institutions, we look, in Section 3, for
theoretical mechanisms that could possibly explain our findings,
drawing on the still rather limited literature on finance-labor interac-
tions, and on the optimal timing of labor market reforms over the
business cycle. Finally, in Section 4 we conclude with an assessment of
the EU-wide policy response to unemployment, and provide some
33
examples of how positive conditionality could operate to promote insti-
tutional reforms in the EU.2
2. Characterizing the heterogeneity in unemployment
2.1. Some key facts on the Great Divergence in unemployment in Europe
Figs. 1 and 2 illustrate the main unemployment facts that motivate
our analysis. Fig. 1 plots the three country groupings resulting by
disentangling different unemployment trends throughout the crisis:
i) countries whose unemployment rate was barely affected by the crisis
(Belgium, Czech Republic, Germany, Hungary, Malta, Austria, Poland,
Romania and the UK)3; ii) countries that experienced a rise of unem-
ployment below the EU average, mostly followed by a fall in 2013–
2014 (Denmark, Estonia, France, Luxembourg, Netherlands, Slovakia,
Finland, and Sweden); and iii) countries that experienced an increase
of unemployment larger than the EU-28 average (Bulgaria, Latvia,
Lithuania, Slovenia, Ireland, Greece, Croatia, Italy, Cyprus, Portugal,
and Spain).4 Fig. 2a displays a range of unemployment rates within
the Euro area. The difference in the average unemployment rate
between the top and the bottom quintile is 15 percentage points (in rel-
ative terms they differ by a factor of four). A similar comparison in the
United States, between the averages of the ten states with the highest
and ten states with the lowest unemployment rates, yields a gap of
less than 5 percentage points.5
Admittedly, unemployment dispersion, both across countries and
across regions, rises during recessions. However, its recent increase
across countries in Europe is not merely a cyclical phenomenon: the
observations for the 2012–14 period lie well above the 95% confidence
interval of the linear regression of the standard deviation of unemploy-
ment rates on GDP growth during the period 1984–2014 (Fig. 2).6
A main driver of European cross-country unemployment divergence
is youth unemployment. On average, youth unemployment was in 2014
about 25% both in the EU and in the Euro-zone and stands above (often
well above) 40% in Southern Europe while remaining at single-digit
levels in Austria and Germany. The standard deviation of youth unem-
ployment across European countries is at its highest level since the
mid-nineties Table 1a).7 The increase in dispersion is also noticeable
when we consider overall unemployment. Both the youth and the over-
all unemployment rates have a marked national dimension. As shown in
Table 1b, when decomposing cross-country and within country disper-
sion in unemployment, the fraction explained by differences in NUTS-2
EU regions within each country declined substantially in recent years.
The rise of unemployment and its increasing dispersion across socio-
demographic groups are two interrelated phenomena. Fig. 3 documents
the positive correlation, across countries and over time, of the standard
deviation of the unemployment rate (defined over gender and 5-years
2
To “develop concrete mechanisms for stronger economic policy coordination, conver-
gence and solidarity” and “to prepare next steps on better economic governance in the eu-
ro area” are nowadays issues at the top of the economic policy agenda. See Juncker et al.
(2015).
3
In these countries the increase of the unemployment rate was at most 1 pp.
4
Casado et al. (2015) looking at worker flows in a smaller sample of European coun-
tries, also find similar groupings.
5
However, unlike the United States, Europe has not experienced a decline in participa-
tion rates. Also, in stark contrast with previous recessions, where soft-landing schemes to
retirement were widely used by firms attempting to downsize, employment rates among
older workers actually increased in most European countries throughout the Great Reces-
sion and the euro area debt crisis. For more details, see Boeri and Jimeno (2015).
6
The sample is composed of EU countries for which harmonized measures of annual
unemployment rates exist since 1984.
7
Another illustration of the degree of cross-country heterogeneity regarding the inci-
dence of unemployment across socio-demographic groups is provided by Casado et al.
(2015), who show that in those countries where unemployment rose, job losses were
highly concentrated among younger workers. Thus, the explosion of youth unemploy-
ment was, unlike in previous recessions, not only related to a hiring freeze, but also to
the heavy destruction of jobs held by young people, with the dissolution of temporary con-
tracts, while, at the same time, employment rates among older workers were increasing.
34 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46

Fig. 1. Unemployment rates (%) in EU countries, 2000–2014.

 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46 35

age groups) and the aggregate unemployment rate. The time series cor-
relation between both variables is stronger in Eastern and Southern
Europe, where unemployment differences across groups are also higher.
The cross-country correlation significantly increased since 2007.

2.2. Heterogeneous responses to shocks

The unprecedented divergence in unemployment rates was there-

fore driven by national trajectories, as opposed to within country
regional variation. As labor market institutions typically vary by country
rather than by region, this fact points to the importance of institutional
factors in the unemployment response to the Great Recession and the
Eurozone crisis. Another explanation is that shocks differed in magni-
tude and nature (e.g., the presence of housing bubbles in the pre-crisis
period and the depth of financial markets) across countries. In this
section, we first evaluate the role played by the size of the shocks in
national unemployment trajectories. Next, we look at the nature of
shocks by producing new evidence from the last wave of a survey of
European firms across 25 countries, carried out by the ESCB's Wage
Dynamics Network.8
Fig. 4 plots the annual change in GDP (horizontal axis) and in the
unemployment rate (vertical axis) over the 2008–2013 period for
the 28 EU countries (plus Iceland, Norway, the US as well as the
EU28, and the Euro-zone aggregates). The slope of the regression line
(−.377) is akin the so-called β coefficient of Okun's Law, that is, the
percentage decrease in unemployment associated to a one-per-cent in-
crease in GDP. Changes in output explain 55.7% of the cross-country
dispersion in unemployment. When we allow for separate β-
coefficients for negative and positive changes in GDP, we obtain that
the elasticity of unemployment to output is −.43, when GDP falls, and
−.29, when GDP rises, while the corresponding R2 are, respectively,
54.2% and 14.6%. Additionally, Fig. 5 shows that the Okun's coefficient
(estimated in this case at quarterly frequencies over the 1995–2013
period, pooling together country groupings based on the share of de-
pendent employment with fixed-term contracts in the initial year) is Fig. 2. a. Dispersion of unemployment rates in Euro-zone countries. b. Time series
significantly higher in those countries with dual Employment Protec- association between GDP growth and the standard deviation of unemployment across
tion Legislation, where reductions in employment can be accommodat- some European countries. In display also regression lines and 95% confidence intervals.
ed by not renewing temporary contracts at their expiration, and hence
are less costly for employers. growth: i) a term related to the participation margin (d ln (LF)), ii) a
We are clearly aware that the labor market plays a crucial role in the component related to productivity per hour worked (d ln (Y/H)), and
transmission of shocks, so that unemployment, and GDP are jointly iii) a component related to the intensive margin, that is, hours worked
determined. However, since the crisis originated outside the labor mar- per employee (dln (H/N)).9 As shown by Fig. 6, which plots this decom-
ket, one can, at a first approximation, consider the magnitude of the position, EU countries behaved very differently in the way these three
output fall as something exogenous to the labor market. With this cave- components accommodated the response to shocks. This heterogeneity
at in mind, we interpret the large fraction of changes in unemployment in the use of the intensive and participation margins also points to the
not explained by changes in output (close to 45%), as well as the differential role played by labor market institutions across European
asymmetries in the responses to negative and positive output shocks countries during the Great Recession and the Euro area crisis.
as indications that, beyond the shocks associated to the Great Recession
and the European debt crisis, there are other factors at play.
2.3. Microeconomic evidence on the adjustment to shocks
There are indeed marked differences in the way countries adjusted
their labor market to the output shock. Some countries largely activated
The WDN dataset, compiled from an ad hoc survey of firms, provides
the intensive (hours worked per employee) and the participation
microeconomic evidence on the sources of shocks as perceived by firms,
margins, while others concentrated all the adjustment on unemploy-
as well as their responses, in terms of employment, wages, hours
ment. This can be illustrated by a simple decomposition. Given that
worked and other potential adjustment mechanisms. In particular, the
u ≈ − ln (e),where u denotes the unemployment rate, and e the ratio
survey focuses on demand, finance and cost shocks, hitting European
of employment (N) to the labor force (LF), then
firms during the 2010–2013 period, and elicits information as to how
employers adjusted wages, working hours, and the labor force.10
du ¼ d ln ðLF Þ−d ln ðN Þ ¼ −d ln ðY Þ þ d ln ðLF Þ þ d ln ðY=H Þ Given the nature of the recent European crisis, we focus on product
þ d ln ðH=NÞ ð1Þ
demand and financial shocks, distinguishing between access to external
finance and financing costs, and neglect other cost-push shocks. Fig. 7
with Y being GDP and H hours worked. Hence, the change in the plots the (employment-weighted) average size of the demand and
unemployment rate is the result of three additional terms besides output
9
We take OECD data for GDP, unemployment rate, labor force and GDP per hour
8
Detailed information about it can be found in: worked, and obtain hours worked per worker as the residual of the Eq. (1).
10
https://www.ecb.europa.eu/pub/economic-research/research-networks/html/ See the Appendix for the precise wording of the questions of the WDN survey
researcher_wdn.en.html concerning the incidence of shocks and firms' responses to them.
36 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46

Table 1a
Youth and total unemployment rates (average and standard deviations across countries, %).

Euro-zone EU

Youth (15–24) Total (15–64) Youth (15–24) Total (15–64)

Average Standard Deviation Average Standard Average Standard Average Standard

Deviation Deviation Deviation

1995 21.3 13.1 10.5 5.7 20.5 11.7 10.0 4.9

2000 14.7 10.0 7.2 3.9 17.9 10.1 9.1 4.8
2005 17.0 5.6 7.6 2.3 18.6 6.9 8.4 3.3
2010 20.4 9.4 9.0 4.2 23.2 8.8 10.2 4.4
2014 25.6 13.5 11.4 6.1 24.5 12.0 10.6 5.3

Table 1b
Regional dispersion of unemployment rates. EU regions (NUTS-2 level).

Youth unemployment(15–24 years of age) 2005 2014

% Dispersion explained by differences across regions within countries 37.1% 21.8%

% Dispersion explained by differences across countries 62.9% 78.2%

Adult unemployment (over 25 years of age) 2005 2014

% Dispersion explained by differences across regions within countries 34.7% 28.8%
% Dispersion explained by differences across countries 65.3% 71.2%

m rk m r u
Note: This is the well-known decomposition of the Theil index, that is T ¼ ∑K¼1 ð uk
u
ÞT k þ ∑K¼1 ð k k Þ lnðuuk Þ
r r u
⏟ Twithin ⏟ Tbetween
where m is the total number of EU Member States, r is the total number of NUTS-2 regions, rk is the number of NUTS-2 regions in country k, u is the average youth unemployment rate in the
EU,uk is the average youth unemployment rate of NUTS-2 regions in country k and Tk is the Theil index of country k. The first component, Twithin, is the weighted average of the Theil indexes
of each sub-group of NUTS-2 regions, which is the dispersion rate of youth unemployment due to the variability within countries of unemployment rates at the regional level. The second
component, Tbetween, captures inequality between EU countries, basically computing the Theil by using the countries' mean values of regional unemployment rates.

financial shocks against, GDP growth and changes in unemployment in
the countries in the sample, together with the associated linear regres-
sion and the 95% confidence bands.11 This suggests that there are
statistically significant and economically meaningful associations be-
tween the average size of the shocks and the aggregate changes in
GDP and unemployment. It is also noteworthy that financial shocks
(access to finance and financing costs) seem to be more closely associ-
ated to cross-country changes in unemployment and GDP than demand
shocks, which signals the importance of understanding the links
between financial conditions and labor market performance, as
highlighted by our review of the literature in Section 3.1.
In order to evaluate how firms adjusted to the shocks, we
implemented a two-step procedure. At first, for each firm we estimated
the probability of reducing wages (either the base wages and
performance-related pay), permanent employment, temporary em-
ployment, and working hours per worker, conditional on receiving a
given shock, controlling by firm's size, sector of activity and whether
or not the firm was a multi-establishment unit, and allowing the coeffi-
cients of these covariates to change across countries by using a probit
specification. We did so for two types of shocks: i) a negative demand
shock, identified as firms declaring that they had suffered a “strong
decrease“ in demand during the period 2010–2013, and ii) a negative
financial shock, that is, firms declaring that either they suffered a
“strong decrease” in access to external financing or a “strong increase”
in financing costs. Next, we aggregated up the estimated probabilities
country by country, using the employment weights provided by the
WDN survey.
Tables 2a and 2b provide the size of the shocks computed this way
for the countries in the WDN sample (with the exception of Malta for
which the number of observations was too small to implement the
estimation). In a nutshell, the adjustment probabilities are higher in
response to the negative demand shocks than to the negative finance
shocks. As for cross-country differences, these estimates suggest that
11
The scale of the shocks comes from the simple average of the qualitative responses,
going from 1 (Strong decrease) to 5 (Strong increase) with 3 being no change and 2 and
4 being moderate decrease and moderate increase, respectively.
firms in Eastern European countries (especially in the Baltic countries)
and in Ireland had a higher probability of reducing wages, both base
wages and their flexible components, while in Southern European
countries (most notably Portugal and Spain) and in Slovenia, Croatia
and the Czech Republic, they had a higher probability of reducing
temporary employment. The probability of adjusting along the
intensive margin (working hours per worker) after a negative demand
shock was higher in Belgium, Luxembourg, Greece, Slovakia and the
UK, while responses to negative financial shocks were larger in
Belgium, Ireland, Italy, and the Netherlands.
How relevant are at the macro level these differences in the adjust-
ment of firms to shocks? How much do they contribute to explaining
unemployment divergence across the EU? To highlight the role of the
margins of adjustment to shocks we compute three indexes for each
country. The first one [flexibility of wages = probability of reducing
base wages multiplied by the probability of reducing working hours]
measures to what extent wages and working hours adjusted. The
second one [flexibility of employment = probability of reducing tempo-
rary employment times the probability of reducing permanent employ-
ment] is a proxy for the degree of employment flexibility. Finally, a third
index [duality = probability of reducing temporary employment times
(1 - probability of reducing permanent employment)] indicates to what
extent employment adjustment relies on temporary contracts as
opposed to permanent contracts, and, hence, to what extent there is a
dual labor market structure.
Table 3 reports the results from simple OLS regressions of changes in
the unemployment rate during 2010–2013 period on the size of the
shocks and firms' responses to them, as characterized by the three
indexes described above. We exclude from the sample Greece and
Cyprus, which were under formal rescue programs and, as seen in Fig.
7, were hit by very negative demand and financial shocks, and are sig-
nificant outliers regarding the fall in GDP and the rise of unemployment
during this period. Results show that our indexes contribute to explain
cross-country differences in changes in unemployment rates. Overall,
countries with higher wage flexibility registered lower increases of
unemployment, while, on the contrary and as should be expected in a
recession, countries with higher employment flexibility registered
 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46
Fig. 3. Correlations across countries and across time between the standard deviations of unemployment rates across 5-year age groups and gender and the overall unemployment rate.
higher increases of unemployment. Also, dualism seems to be associat-
ed with a higher increase of unemployment during this period.
3. Insights from the literature: a quick review
Let us summarize the evidence produced so far. The great divergence
of unemployment in Europe is not only the consequence of asymmetric
shocks. It is true that shocks were of varying intensity and nature across
countries, but even after controlling for these differences, the labor
market responses appear to have been different across countries.
Some countries used the intensive margin of labor market adjustment
more, while others concentrated their response on the extensive mar-
gin. Some countries had bargaining structures that allowed for nominal
wage cuts preventing mass lay-offs, while others could not use wage
reductions as an alternative to dismissals. These institutional differences,
in a context where the inactivity margin was not used as a shock absorb-
er in many countries – the labor force increased also in countries
experiencing huge employment losses (Fig. 6, top panel), unlike in previ-
ous recessions – turned out to be very important in the differential rise in
unemployment. Another important factor was labor market segmenta-
tion between temporary and permanent contracts, concentrating the
adjustment on the former. Thus, the labor market response to the shocks
was clearly affected by the country-specific design of labor market insti-
tutions. The nature of shocks was also important: as documented above,
there is evidence that financial crises involve a different labor market
37
adjustment than pure demand shocks requiring more adjustment of
wages and temporary employment than ordinary recessions.
These triple interactions (institutions, size and nature of shocks)
deserve to be investigated more thoroughly, not lastly because there
are many alternative combinations of interest. While there is a wide
literature on the effects of the main labor market institutions (unem-
ployment benefits, employment protection legislation, working hours
regulations, collective bargaining institutions, active labor market
policies) on unemployment, and there is some literature on the interac-
tions between labor market institutions and macroeconomic shocks
(Blanchard and Wolfers, 2000), much less is known about the way
labor market institutions operate under financial shocks, and along
the business cycle. Needless to say, these interactions are also very im-
portant in evaluating the timing of reforms of labor market institutions.
Before providing an assessment of the employment policy response at
the EU level during the crisis, it is therefore important to briefly review
the recent literature on labor-finance interactions as well as on reforms
of labor market institutions over the business cycle. This is the task set
out for this section.
3.1. The literature on the interactions between finance and labor
After the Great Recession, involving a very large financial shock at
least judging from financial market spreads or asset prices, various
papers contributed to the understanding of the interplay between
38 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46
Fig. 4. Annual GDP growth (dlnY) and change in unemployment rates (dU), 2008–2013. Note: The simple includes the 28 countries of the EU, Iceland, Norway, the US, and the aggregates
for the EU28 and the Euro-zone. The balck line is the regression line for all the observations; the red l(blue) line is the regression line corresponding only to negative (positive) values of
dlnY.
labor and finance. Pagano and Pica (2011) studied the effects of financial
market imperfections on labor adjustment in the context of a perfect
labor market. Their model and empirical findings point to a “dark side
of finance”: during banking crises employment losses are greater in
the industries that are more dependent on external finance, and those
located in the more financially developed countries. Monacelli et al.
(2012) investigated the interaction between the firms wage policy
and its financial structure in imperfect labor markets drawing on an
original intuition by Michelacci and Quadrini (2005, 2009) on the
interactions between debt position of firms and bargaining power of
employers. In their model, borrowing is used as a bargaining tool, reduc-
ing workers' claims over the surplus. This adds a new transmission
mechanism to the negative effects of credit restrictions on employment,
notably via a weaker position of employers at the bargaining table, and
hence higher wages. This theoretical mechanism is not fully consistent
with our findings that point to a stronger effect on downward wage
Fig. 5. Unemployment responsiveness to output changes in countries with different
degrees of dualism. Note: GDP variation is shown on the x-axis, while variation in
unemployment is shown on the y-axis, both in percentages.
Source: Authors' calculations on OECD data.
adjustment of financial shocks as opposed to demand shocks. A few
papers addressed specifically the link between financial market frictions
and labor market volatility using the Mortensen–Pissarides general
equilibrium model of the labor market. Petrosky-Nadeau and Wasmer
(2013), providing an extension of the double search frictions of
Wasmer and Weil (2004), found that financial frictions create an
additional entry cost to productivity, increasing the elasticity of labor
market tightness to productivity shocks by a factor of five. Petrosky-
Nadeau (2014) focused on the financing of vacancy costs in a model in
which firms accumulate net worth, and showed that these financing
constraints generate persistence in market tightness. Boeri et al.
(2015) investigated the effects of financial crises on job creation
calibrating their model to the US labor market, attributing to large finan-
cial shocks an increase of unemployment of up to 60%. Kuehn et al.
(2014) also established a link between search theory and asset pricing
where the causation, however, goes from search frictions to asset prices.
More on the empirical side, Bentolila et al. (2015) exploited a unique
dataset on bank balance sheets to evaluate the consequences of credit
restrictions on employment, finding that attachment to weak banks ex-
plains a sizeable component (up to 36%) of aggregate job losses. Hall
(2014) and Kehoe et al. (2014) looked at the labor market impact of
deleveraging finding that this contributed significantly to employment
(and vacancy) losses in the US. Eckstein et al. (2015) and Christiano
et al. (2015) examined the business cycle implications of financial
shocks through corporate borrowing. Consistently with Jermann and
Quadrini (2012), they find that financial shocks amplify cyclical
fluctuations in hours worked. Braun and Larrain (2005); Boeri et al.
(2015) as well as Giroud and Muller (2015) found that it is highly
leveraged firms to have experienced the largest employment losses in
the aftermath of the financial recession of 2008–9. Pratap and Quintin
(2011) considered the effects of financial crises on emerging markets,
documenting that they involved large productivity and earning losses
for workers moving across industries.
A common implication of this flourishing literature is that aggregate
shocks to finance have much different effects on firms depending on
whether or not they have a liquidity buffer, and can borrow from
workers by adjusting wages, and not only employment levels. This sug-
gests that micro wage flexibility, allowing for different wage policies of
firms even within narrowly defined industries, is even more important
than macro wage flexibility under these circumstances.
 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46
Fig. 6. Role of intensive, extensive and participation margins in unemployment to output
response (2008–2013). a. Demand shocks, as perceived by firms, GDP growth and changes
in the unemployment rate, 2010–2013. b. Access to External Finance, as perceived by
firms, GDP growth and changes in the unemployment rate, 2010–2013. c. Financing
costs, as perceived by firms, GDP growth and changes in the unemployment rate, 2010–
2013.
3.2. The literature on labor market institutions over the business cycle12
The rather scant literature on the cyclical implications of labor
market institutions has focused on the following set of institutions:
unemployment benefits, working hours, employment protection legis-
lation, and wage setting. We now summarize its main findings from a
normative standpoint.
3.2.1. Unemployment benefits
Unemployment benefits are usually extended during recessions.
There are some recent studies addressing the optimal design of unem-
ployment benefits over the business cycle by drawing on the extension
12
This sub-section draws extensively on Boeri et al. (2015).
39
of potential duration of unemployment benefits in the US during the
Great Recession. According to the theory, the optimal level of benefits
can be established by considering the tradeoff between the incentive
to search for work, the objective of smoothing consumption between
periods of employment and unemployment, and the fiscal externalities
associated with the provision of unemployment insurance (see Boeri
and van Ours, 2013, Chapter 11, and Cahuc et al., 2014, chapter 13 for
an overview). According to this literature, the optimal level of unem-
ployment benefits is inversely related to the magnitude of the elasticity
of unemployment duration with respect to the level of the benefits.
Hence, the focus of the empirical literature on evaluating how this
elasticity varies with the unemployment rate.
Kroft and Notowidigdo (2014), on the basis of data on the unem-
ployment rates in different states of the US between 1985 and 2000,
find that this elasticity is weaker when the local unemployment rate is
high: a one standard deviation increase in the unemployment rate (an
increase of 1.3 percentage points from a base of 6.2%) reduces the
magnitude of the duration elasticity from 0.563 to 0.304 (a decline in
magnitude of 46%). This provides empirical support to the decision of
US Government to lengthen the duration of unemployment benefit
during the Great Recession. Similar are the results by Landais (2015),
using administrative data from the Continuous Wage and Benefit
History Project (CWBH) about unemployment spells in five US states
from the late 1970s to 1984, who finds a somewhat smaller elasticity
than Kroft and Notowidigdo (2014). However, also according to Landais
the elasticity is procyclical: it is 0.38 when the state unemployment rate
is at 4.5% (the minimum in the CWBH data) and 0.25 when the unem-
ployment rate is at 11.8% (the maximum in the CWBH data).
Jung and Kuester (2015), using a general equilibrium model of the
labor market (with matching frictions and risk-averse workers)
calibrated to the US economy conclude that not only the replacement
rate (or the duration which is the same in net present value terms) of
unemployment benefits, but also hiring subsidies and layoff taxes,
should rise in recessions. With a similar model structure Mitman and
Rabinovich (2015) find that, when wages adjust rapidly to macroeco-
nomic shocks, the response of benefits to a negative shock should be
non-monotonic: unemployment benefit should be raised in the short
term (4–6 weeks after the shock) in order to provide short-run relief
to the unemployed and stabilize wages, but subsequently it should be
brought back down to below its pre-recession level in order to speed
up the subsequent recovery.
3.2.2. Short-time work
Subsidized short-time work (STW) proved rather effective during
the Great Recession. Boeri and Bruecker (2011) and Cahuc and Carcillo
(2011) found that under severe recessions, STW contribute to save
jobs. However, the number of jobs saved is generally smaller than the
number of persons involved in the schemes, and deadweight costs are
likely to rise substantially at milder recessions. Burda and Hunt
(2011), looking specifically at the German experience, also found that
working time accounts were very important in promoting adjustment
of hours rather than outright dismissals.
3.2.3. Employment protection
Flexicurity countries, providing relatively low protection against job
loss in terms of severance and firing taxes, are generally found to
promote the adjustment mostly via the extensive margin of job losses
(Andersen, 2014). The short run impact effect of reform reducing
employment protection during a recession is likely to be mostly on
the job destruction side, amplifying the responsiveness of unemploy-
ment to output changes. This is consistent with estimates of Okun's
law “beta” coefficients during downturns (IMF, 2010). Gnocchi et al.
(2015) also find that reforms reducing EPL involve an increase in the
volatility of employment. They also report a lower correlation between
real wages and productivity in the aftermath of the reform, which may
be harder to explain.
 40
T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46
Fig. 7. a. Demand shocks, as perceived by firms, GDP growth and changes in the unemployment rate, 2010–2013. b. Access to External Finance, as perceived by firms, GDP growth and changes in the unemployment rate, 2010–2013. c. Financing costs,
as perceived by firms, GDP growth and changes in the unemployment rate, 2010–2013. In display also regression lines and 95% confidence intervals.
 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46 41

Table 2a Table 3
Probability of reducing wages, employment and working hours in response to a negative OLS estimates of impact of shocks and adjustments in changes in unemployment rates
demand shock. across countries (2010–2013).

Strong decrease in demand and probabilities of reducing: (1) (2) (3) (4)

Permanent Temporary Working hours Base Flexible Demand shock

employment employment per employee wages component Size of shock −1.56 .61 −.99 −1.34
of wages (2.7) (1.5) (1.7) (2.9)
Flexibility of employment 23.86 29.63
AT 0.465 0.161 0.213 0.106 0.162
(2.9) (4.3)
BE 0.636 0.312 0.369 0.021 0.044
Flexibility of wages −32.3 −49.80
BG 0.710 0.386 0.277 0.251 0.331
(2.0) (4.4)
CY 0.522 0.322 0.242 0.626 0.585
Duality 24.53 9.4
CZ 0.633 0.417 0.275 0.230 0.465
(1.9) (1.0)
DE 0.414 0.168 0.215 0.097 0.136
R2-Adjusted .223 .082 .066 .605
EE 0.497 0.272 0.132 0.427 0.515
ES 0.532 0.463 0.270 0.130 0.285 Finance shock
FR 0.588 0.251 0.155 0.021 0.228 Access to external finance −4.49 −8.75 −6.33 −5.88
GR 0.782 0.278 0.435 0.791 0.703 (2.3) (4.5) (3.3) (3.5)
HR 0.800 0.408 0.066 0.556 0.538 Financing costs 3.40 8.10 4.81 4.56
HU 0.583 0.350 0.193 0.281 0.372 (1.8) (1.8) (2.6) (2.8)
IE 0.561 0.366 0.435 0.379 0.451 Flexibility of employment 22.23 19.35
IT 0.481 0.296 0.342 0.022 0.278 (2.9) (2.4)
LT 0.573 0.240 0.270 0.474 0.709 Flexibility of wages −67.88 −91.93
LU 0.673 0.218 0.399 0.067 0.476 (1.8) (3.1)
LV 0.660 0.311 0.260 0.623 0.407 Duality 18.98 12.73
NL 0.840 0.305 0.203 0.254 0.595 (1.8) (1.2)
PL 0.432 0.205 0.045 0.071 0.204 2
R -Adjusted .532 .441 .435 .678
PT 0.498 0.448 0.215 0.125 0.329
RO 0.690 0.279 0.186 0.197 0.358 Note: N = 24 (22 when excluding Greece and Cyprus). t-Stats in parenthesis.
SI 0.592 0.528 0.249 0.367 0.585
SK 0.771 0.208 0.398 0.141 0.236
UK 0.810 0.350 0.507 0.214 0.354 finds that part of the differential in the increase of unemployment
between the two countries was due to the larger gap between the dis-
missal costs of permanent and temporary contracts and the less restric-
Table 2b tive rules regarding the use of the latter contracts in Spain, and that
Probability of reducing wages, employment and working hours about 45% of the surge in Spanish unemployment could have been
in response to a negative finance shock.
avoided had Spain adopted French employment protection legislation
Strong decrease in access to external finance or strong increase in financing costs before the crisis started.
and probabilities of reducing:

Permanent Temporary Working hours Base Flexible 3.2.4. Wage setting

employment employment per employee wages component The dis-employment costs of minimum wages and collective
of wages
bargaining tend to be stronger during recessions. Clauses extending
AT 0.219 0.056 0.063 0.004 0.057 the coverage of collective bargaining beyond union density tend, in
BE 0.492 0.224 0.246 0.014 0.009 deflationary environments, to increase downward wage rigidity, put-
BG 0.354 0.211 0.145 0.101 0.252
CY 0.500 0.206 0.150 0.459 0.509
ting more adjustment burden on employment levels (Addison et al.,
CZ 0.394 0.181 0.143 0.069 0.211 2015). By contrast, countries not allowing for extended coverage of
DE 0.123 0.122 0.134 0.066 0.078 collective agreements experienced relatively widespread nominal
EE 0.097 0.074 0.095 0.122 0.131 wage reductions (Doris et al., 2013). While collective bargaining gener-
ES 0.530 0.447 0.236 0.080 0.309
ally takes into account business conditions, as the trade unions moder-
FR 0.333 0.222 0.119 0.020 0.131
GR 0.544 0.266 0.195 0.725 0.550 ate their wage requests during downturns, the setting of the minimum
HR 0.635 0.482 0.022 0.375 0.410 wage may not internalize macroeconomic constraints when political
HU 0.266 0.219 0.071 0.087 0.208 decisions, and hence electoral cycles are involved. Reforms of collective
IE 0.384 0.281 0.270 0.250 0.308 bargaining, notably those inducing more decentralization in wage
IT 0.319 0.306 0.347 0.069 0.147
LT 0.227 0.176 0.171 0.250 0.219
setting appear to increase the correlation of wages with labor productiv-
LU 0.305 0.342 0.225 0.023 0.042 ity over the business cycle (Gnocchi et al., 2015).
LV 0.203 0.147 0.116 0.156 0.123 Fiscal costs of minimum wages and collective bargaining tend also to
NL 0.593 0.275 0.254 0.139 0.485 be particularly pronounced during downturns, as displaced workers
PL 0.242 0.159 0.042 0.068 0.134
draw for a relatively long time unemployment benefits before finding
PT 0.393 0.394 0.145 0.140 0.254
RO 0.409 0.235 0.090 0.096 0.227 alternative employment.
SI 0.467 0.498 0.150 0.249 0.415 Overall, this literature suggests that it is desirable to increase the
SK 0.211 0.088 0.083 0.056 0.065 generosity of unemployment insurance and to enhance short-time
UK 0.232 0.222 0.142 0.054 0.124 work during downturns. However, governments and social partners
should take care to commit to a rule-based system, with automatic
clause consistent with a fiscal budget balanced automatically over the
As for dual labor markets, the literature has identifies many effects business cycle (Andersen, 2014). Experience-rating and co-financing
on employment, wages, worker turnover, and productivity.13 An inter- by the employers of a significant share of the costs of short-time work
esting quantitative study comparing employment adjustment in are also very important in making sure that these schemes are down-
France and Spain during the Great Recession (Bentolila et al., 2012b) scaled as soon as macroeconomic conditions improve. The literature
also suggests that reforms of EPL should be made cyclically responsive.
Reducing severance pay during downturns may backfire also because
13
For a survey, see, for instance, Boeri (2010) and Bentolila et al. (2012a). it involves significant fiscal externalities as the provision of insurance
42 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46
against labor market risk falls almost entirely on unemployment
benefits.
4. Assessing labor market reforms in Europe during the Great
Recession
The above suggests that policies aimed at bringing unemployment
down should address the institutional failures highlighted by the crisis,
learning from the best (and worst) performers. At the same time, they
should pay great attention to the interactions between macroeconomic
and financial conditions, aggregate demand management, and institu-
tions. Institutional reforms are particularly needed in the Euro area as
the monetary union reduces the scope of macroeconomic stabilization
policies at the national level. At the same time, the optimal design of
institutions is not independent of the underlying cyclical conditions.
As suggested by the above literature review and the evidence produced
in this paper, some badly needed institutional reforms aimed at restor-
ing competitiveness can have undesirable effects in severe downturns.
If stabilization policies reducing the risk of these reforms backfiring
are not feasible under a monetary union, there are only two possible
ways out. On the one hand, institutional reforms should be as much as
possible carried out under better macroeconomic environments; this
requires that the EU conditionality is strengthened during cyclical
upturns. On the other hand, labor market institutions themselves may
have to be designed in such a way as to have counter-cyclical properties,
which requires giving some fiscal leeway to countries hit by asymmetric
shocks in a monetary union. Both options are discussed in some detail in
the following section.
4.1. EU conditionality during the crisis
During the recent crisis in the EU, coordination of fiscal policies
relied upon an idea of conditionality that placed a great deal of emphasis
on labor market reforms, and not so much on product market reforms.
Even when the diagnostics of dysfunctional labor markets were
right,14 the key lessons from the international experience of labor
market reforms were lost in translation, and adjustment programs did
not directly address the main determinants of poor labor market perfor-
mance. Recommendations from international institutions were trans-
lated into reforms that backfire during recessions, ignoring the issue of
contractual dualism, overlooking best practices in subsidizing short-
time work, and not addressing the key issues related to the reforms of
collective bargaining and pension systems. We offer below four exam-
ples, drawing on the Italian, Spanish, Greek, and Portuguese experiences
throughout the crisis.
In the case of Italy, fiscal consolidation forced the government to
reduce the duration of the income support schemes for the unemployed
at the same time as a pension reform was increasing the retirement age.
In the midst of a major recession, this left many older workers displaced
during the Great Recession without the soft landing scheme that had
been internalized in the collective dismissal agreement (the so-called
“esodati” problem), forcing the government to adopt a number of ad
hoc (and costly) measures to deal with this problem. As older workers
are more protected than young workers, the phasing out of any escape
route to retirement also helped concentrate even more employment
adjustment on youngsters. While in normal times there is no “lump of
labor” and youth unemployment generally declines as employment
among older workers increases, increasing retirement age and phasing
out any bridging scheme to retirement in the midst of a major recession
may concentrate all the adjustment on young people.
In Spain, a strong case was made for wage moderation (as opposed
to microeconomic wage flexibility). The request was also for a stricter
control of the budget execution of regional governments and for more
14
See, for instance, Blanchard et al. (2014).
transparency, timeliness and detail in the publication of monthly and
quarterly government finance statistics. In fact, during the execution
of the financial sector rescue program in 2012 the Spanish Government
implemented comprehensive labor market reforms to provide firms
with more flexibility in adjusting their labor force by reallocating
workers internally, reducing working hours and altering other employ-
ment conditions, modifying wages for incumbent workers and allowing
for more decentralization in wage setting. A pension reform aimed at
slowing down the rise of pension expenditures was also carried out. Al-
though it seems evident that these labor market reforms may have been
instrumental in delivering faster wage adjustment and a realignment of
competitiveness in the Spanish economy, they did not successfully
address contractual dualism and only mildly affected wage flexibility
at the microeconomic level. As for the pension reforms, they were far
from guaranteeing the actuarial neutrality in pension systems that
was needed to adjust the labor force smoothly in times of recession
and very far from restoring the long-term sustainability of Spanish
pensions.
In the case of Greece, Memorandums of Understanding asked for
fiscal austerity and welfare cuts to consolidate public accounts, and
wage reductions to restore competitiveness. This was done by cutting
the coverage of unemployment and health benefits, reducing the
minimum wage by between one-third and one-quarter and increasing
the retirement age. No reference was made to measures promoting
economic efficiency and productivity enhancing. The imposition of
these policies on an economy with such profound structural weak-
nesses as Greece exacerbated the social impact of the crisis by harming
in particular the less protected segments of the population and spread-
ing poverty in a country where levels of wage, income and wealth
inequality were already high (Matsaganis, 2013).
Finally, in Portugal labor market reforms were key ingredients of the
adjustment program. They reduced employment protection legislation,
diminished the coverage and relevance of sectoral collective bargaining
for wage-setting, froze minimum wages, and cut the replacement rates
and duration of unemployment benefits. This was the most comprehen-
sive reform package in the four examples that we have reviewed, and
the one that appears to have produced most favorable outcomes (see
Martins, 2016). Nevertheless, the dimensions in which the adjustment
program was most successful were other than employment develop-
ments, the wage-setting system still needs to be further reformed, the
tax burden on labor remains excessively high, and support for low
wage earners should be increased (Portugal, 2015).
Overall, within the four cases reviewed above, the key policy actions
were i) wage moderation, ii) reductions in severance pay and, more
broadly, the strictness of employment protection, and iii) increases in
retirement age. References to either contractual dualism or to schemes
inducing more adjustment along the intensive margin, such as short-
time work or working-time accounts, were either less emphasized in
the recommendations by international institutions or “lost in transla-
tion” when national governments acknowledged these recommenda-
tions. The possibility of introducing actuarial reductions to early
retirement rather than forcing a rapid increase in the retirement age
was also overlooked, and, in any event, prevented by the objective of
obtaining immediate reductions in public pension outlays.
In summary, there are reasons to believe that labor market reforms
were generally implemented without learning from the heterogeneity
in labor market responses to shocks in the euro area, and not taking
into account the fact that fiscal measures and labor market reforms
that are effective in normal times may not be desirable during major
recessions.
A final lesson learnt from the recent experience is how to use the
fiscal constraint as a device to induce institutional reforms. Relaxing
the fiscal constraint during a recession was deemed to exacerbate
moral hazard problems in a monetary union. A typical (and topical)
concern when discussing the implementation of labor market reforms
is indeed that governments are less willing to do so without being
 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46
constrained by a strong fiscal restriction. However, our analysis suggests
that this argument is ill suited for a number of reasons.
First and foremost, the effects of structural reforms are not indepen-
dent of cyclical conditions. Some reforms may be desirable only during
upturns and would deliver higher unemployment than in a no-reform
scenario during downturns. This is particularly the case for employment
protection legislation, but unemployment benefit and retirement plan
reforms should also be fine-tuned to take into account cyclical
fluctuations.
Second, the types of reforms that are desirable during downturns are
typically those that involve higher public expenditure. This is the case,
for instance, for the short-time work schemes used in Germany to
mitigate the effects of the Great Recession. Many countries, including
the United States, also made their unemployment benefit systems
more generous, a reform that is not within the realm of possibilities
for countries forced to carry out a major fiscal consolidation in the
midst of a recession. By the same token, flexicurity reforms that substi-
tute employment protection (involving severance payments by firms)
for unemployment benefits (paid out of social security contributions
and general government revenues during recessions) require some
fiscal room, particularly during a recession. Finally, reforms operating
on the intertemporal budget constraint, which is relevant for pension
systems, are inconsistent with fiscal consolidation targeting short-run
yearly deficit levels.
Third, although the institutional framework put in place in the EU to
deal with policy coordination has been somewhat enhanced during the
crisis, there is still a long way to go to make its implementation more
efficient. A better way to exert EU conditionality is to go directly to cit-
izens and promote best-practice institutions.
There is still a lot of ground to cover in improving labor market insti-
tutions in Europe, and supranational authorities have a crucial role to
play in this reform process. The cross-country divergence in unemploy-
ment evolutions is not a reason to strengthen the country-specific
dimension of employment policies. Quite the opposite; the difficulties
faced by governments in introducing best-practice institutions highlight
the resistance to reforms by powerful interest groups favoring the status
quo.15 In this context, more active involvement of the European
Commission in the design and implementation of labor market policies
is essential. At the same time, these reforms have strong effects on
income distribution and may require those losing out to be compensat-
ed. Thus greater involvement of the EU would be acceptable to govern-
ments of Member States only if it goes hand in hand with adequate
funding from European employment programs. This supranational
funding, if well designed, could also lessen the institutional shortcom-
ings of some of the countries, and play a stabilizing role across the
euro area. As is the case with access to fiscal leeway, it is more about
using the carrot than the stick.
4.2. Towards positive conditionality
There are three key lessons that can be drawn from the European
experience during the crisis and that are particularly relevant from the
policy standpoint, notably for EU policies. The first is that some labor
market institutions react better than others to macroeconomic shocks.
For instance, the German setup in terms of regulations on working
hours adjustment, would seem to have outperformed other institution-
al settings at least under a temporary, but strong demand shock such as
the collapse of world trade during the Great Recession. A second lesson
is that different types of shocks tend to induce adjustment along differ-
ent margins. For instance, demand shocks induce more adjustment of
quantity (hours and workers) while financial shocks more adjustment
of prices (wages). This suggests that it is important to have in place
institutions allowing for adjustment along all of these margins, and
15
On this topic it is very enlightening to read Fornero (2013).
43
not shutting down any of them. These institutions could then be
expanded (as in the case of short-time work schemes) depending on
both, the size and the nature of shocks. A third lesson is that some insti-
tutional reforms which are good under normal conditions, during
downturns may backfire, by involving high adjustment costs, and creat-
ing strong constituencies against the reform process that may eventual-
ly reverse it.
This third lesson is the one which is more troubling from the stand-
point of a EU employment policy because it ultimately states that EU
conditionality imposing institutional reforms to reluctant Governments
is bound to fail precisely when it is most effective. Indeed EU condition-
ality exerts its influence only over Governments of countries under
severe distress and in needs of financial assistance.
The key issue to be addressed from a normative standpoint is there-
fore as follows: are there policy tools to be activated at the EU level
capable of exerting a sort of “positive” conditionality operating also
under “normal” conditions? Positive conditionality involves a political
dividend for reforming Governments and for the EU institutions as
well. Three desirable properties of these policy tools are as follows:
i) they should operate by funding complements to existing national
programs, rather than forcing their dismantling, ii) they should reduce
moral hazard of Governments by conditioning this funding to the access
to best practice rules for institutions, and iii) they should not imply
permanent transfers across countries.
We provide below a few examples of potential positive conditional-
ity tools. They have a common denominator in involving a gradual in-
troduction of individual accounts, so that the benefits of implementing
the programs go directly to the workers, rather than to governments,
so-called social partners and other intermediaries. As a result of such
benefits being fully portable across national jurisdictions, they would
be perceived as EU-wide entitlements provided by supranational
authorities to national Governments undertaking reforms converging
to EU institutional standards. By doing so, these portable individual
entitlements would also reduce some major barriers to transitory
labor mobility, which could also play a role as a stabilizer in the event
of asymmetric shocks.
4.2.1. The European employment contract for equal opportunity
Labor costs, including high and uncertain firing costs, are often
singled out as the main reason why employers refrain from hiring
workers under the regular full-time/open-ended employment contract.
This is particularly true in the countries where EPL reforms progressed
“at the margin”, not by changing employment conditions for the regular
contracts, but by introducing other types of “atypical” contracts, usually
either part-time or fixed-term contracts. The inefficient turnover gener-
ated by this reform strategy seriously impedes productivity growth
(Bassanini et al., 2016; Boeri et al., 2014).
Facing similar problems (and an acute pension funding problem),
Austria successfully implemented an EPL reform in 2002 by introducing
individual savings accounts. In the new regime, severance pay does not
depend on the reasons for terminating the contract, and is covered by
the employers' contributions (1.53% of the salary) into a fund. In the
case of dismissal after three years of tenure, the employee can choose
between either receiving the funds accumulated in their account or
saving them for a future pension.16 This is important, as breaks in career
are the single most important reason of potential inadequacy of pen-
sions (OECD, 2015).
The reform experience during the European crisis shows that no
significant improvements were achieved in the reform of inefficient
EPL or in the correction of labor market segmentation, even when EPL
reforms were mandated under a formal rescue program. Perhaps an
alternative strategy, based on the Austrian system, could have been
more successful.
16
For more details, see Hofer et al. (2011).
44 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46
Let us examine how it could work. The European Commission would
design a new single open contract with severance pay gradually increas-
ing with worker tenure, mimicking the new open-ended contract intro-
duced in Italy, effective since March 2015. The contract comes with
individual saving accounts into which both employers and some
European funds (Structural Funds combined with the European Social
Fund) contribute. Employers get some reduction in severance pay
obligations and some reduction in labor costs (as European contribu-
tions also play the role of deferred wage subsidies). Workers gain
from more stable jobs (and from the wage subsidy). Additional
European funding to be put towards active labor market policies or
unemployment insurance could also be implemented through contribu-
tions to the individual accounts.
4.2.2. The European unemployment insurance program
The lack of automatic stabilizers operating at the EMU level has been
evident throughout the crisis. At the same time, “solidarity” and the
promotion of social and economic cohesion among Member States are
explicitly stated goals of the European Treaties. Thus, unemployment
insurance implemented at the central level could be an attractive devel-
opment, insofar as it could deliver on both fronts (i.e. the absorption of
asymmetric shocks and the promotion of economic convergence).17
However, current unemployment insurance schemes in many European
countries are far from optimal as there is inadequate management
of moral hazard issues on both sides. On the one hand, the search activity
of insured workers may be affected by entitlements. On the other hand,
the financing of benefits does not always make employers internalize
the social costs of unemployment. Moreover, introducing an EMU-wide
unemployment insurance scheme when labor market performance and
institutions are as heterogeneous as highlighted in previous sections
may be counterproductive.
Nevertheless, there is a simple way to overcome these problems —
by making the unemployment insurance scheme available only to
those countries that achieve substantial progress towards a better de-
sign of labor market institutions. As in the case of the European employ-
ment contract, the implementation of this scheme could be eased by the
introduction of individual accounts that could make unemployment
benefits portable across countries, complementing the national insur-
ance schemes. This European unemployment benefit could also be
operated in conjunction with the equal opportunity contract in order
to improve employment incentives (Brown et al., 2008) and introduced
as a partial complement to national unemployment schemes. As shown
by Dolls et al. (2014), with proper contingency and claw-back
mechanisms this European unemployment insurance scheme does
not need to imply substantial permanent transfers across countries,
while it does preserve some redistributive and stabilizing properties.
Experience-rating forcing Governments that receive more to contribute
more could be designed in such a way as to phase-out any cross-country
redistribution in the medium-run (Brandolini et al., 2015).
4.2.3. A proper enforcement mechanism
These programs require a proper enforcement mechanism and
one that reduce abuses, minimizing opportunistic behavior in cross-
country redistribution. Workers moving repeatedly across borders
may take advantage of failures in tracking working and non-working
spells of individuals across EU borders. There are documented cases of
workers claiming unemployment benefits in one country while work-
ing in another EU country. Contributions paid in the country of origin
by posted workers are also rarely verified, and there is a serious risk
that some contractual restrictions, e.g., on working hours, are not
enforced once the worker is posted elsewhere.
A harmonized social security archive covering all workers operating
within the EU borders could be very useful in improving the
17
References to previous proposals along these lines include Delpla and Gourinchas
(2014) and Claeys et al. (2014).
effectiveness of the European entitlement programs. Public administra-
tions could agree in using a European social security identifier (like the
National Insurance Number, NIN, in the UK) and regularly exchange in-
formation. This European Social Security Identification Number (ESSIN)
would draw on the existing country-specific identifiers. It would
contain a country identifier (e.g., the first three digits) tracking the
country of the first job, and be combined with national fiscal identifiers.
A European social security identifier would also make people aware
of the public good associated to being part of the Union, while, at the
same time, repressing the illegal flows of workers from one country to
the other. The EU social security number will be granted only to
workers, who have been paying regularly social security contributions
during their employment spells.
5. Final remarks
Unemployment in Europe is getting more and more country-
specific. Looking at the impact of the Great Recession on labor markets,
at least three different patterns can be discerned across Europe. There is
a group of countries where unemployment, both in levels and distribu-
tion among socio-demographic groups, remained relatively constant
throughout the whole period. A second group of countries experienced
a mild increase in unemployment that was somehow unevenly distrib-
uted across socio-demographic groups. Finally, there are the countries
where unemployment skyrocketed and its burden was mainly concen-
trated on young workers. Asymmetric shocks, in terms of both size and
nature (financial vs. real), combined with cross-country institutional
differences, resulted in highly heterogeneous responses of national
labor markets to the Great Recession. It is difficult to foresee a united
Europe and a properly functioning Economic and Monetary Union
with so much cross-country divergence in labor market conditions,
and very limited instruments to insure unemployment risks across
countries.
As documented in this paper, the European unemployment
divergence ultimately has to do with differences in labor market institu-
tions across countries, notably the way in which these different institu-
tions reacted to the macroeconomic and financial shocks that are at the
roots of the crisis. In many European countries labor market institutions
are far from the “optimum” and, even when reformed during the crisis,
there are noticeable gaps to be closed.
European supranational institutions throughout the crisis over-
emphasized the realignment of external competitiveness by relying on
wage reductions, not realizing that these reductions are most costly
when they have to be achieved by nominal wage cuts (given the low in-
flation rate), households are highly indebted, and governments had to
reduce public consumption, investments and transfers to consolidate
public debt. When structural reforms were implemented, either at the
initiative of national governments or of countries under formal adjust-
ment programs, they focused on reducing the costs of dismissals and
forcing across the board downward wage adjustments in the middle
of a recession, rather than on removing structural impediments to
productivity growth in poorly regulated labor markets. The internation-
al institutions with the capacity to apply some of their own initiatives to
change the orientation of reforms and employment policies (for
instance the European Commission) did very little in this respect and
failed to design new programs at the supranational level.
In this paper we offered some proposals to change this state of affairs,
looking forward to an enhanced role for European supranational institu-
tions in improving the functioning of labor markets. To do so we propose
to increase the coordination of the main guidelines of employment poli-
cies in European institutions and to implement some programs at the
European level. In this regard, we call for European employment policies
to complement not substitute national policies in the areas of EPL and
unemployment insurance. They would be introduced under positive
conditionality, offering different (and we believe more effective) incen-
tives for national governments to introduce badly needed structural
 T. Boeri, J.F. Jimeno / Labour Economics 41 (2016) 32–46 45

reforms. And, finally, they would target EU citizens, possibly monitored rather than governments or local administrations or intermediaries,
in their access to these schemes by using a EU social security number, meaning they would be more transparent and socially acceptable.

Appendix A

Detailed information about the nature, characteristics, questionnaire and country-specific results of the Wage Dynamics Network, from which data
were used in Section 2.3 of this paper, can be found in:
https://www.ecb.europa.eu/pub/economic-research/research-networks/html/researcher_wdn.en.html.
Below we reproduce the parts of the questionnaire from which we took information to compute the size of the shocks and the firms' responses
to them:

C2. Changes in the economic environment

This section aims at assessing the main changes your firm experience during 2010–2013 with regard to the economic environment. When answering the questions please refer
to “the most significant changes” taking place over this period.
C2.1 — To what extent has your firm been affected with respect to each of the following aspects? Please choose an option for each line
Strong increase Moderate increase Unchanged Moderate decrease Strong decrease
Demand for your firm's products/services □ □ □ □ □
Volatility/uncertainty of demand for your firm's products/services □ □ □ □ □
Access to financing your firm's activity through the usual financial channels □ □ □ □ □
Customers' ability to pay and meet contractual terms □ □ □ □ □
Access to supplies from your firm's usual suppliers □ □ □ □ □
C2.3 Please indicate how was the change in each one of the components of total costs listed below. Please choose an option for each line
Strong increase Moderate increase Unchanged Moderate decrease Strong decrease
Total costs □ □ □ □ □
Labor costs □ □ □ □ □
Financing costs □ □ □ □ □
Costs of supplies □ □ □ □ □
Other costs (please specify______________________) □ □ □ □ □
C2.4- Please indicate how was the change in each one of the components of labor cost listed below. Please choose an option for each line
Strong increase Moderate increase Unchanged Moderate decrease Strong decrease
Base wages or piece work rates □ □ □ □ □
Flexible wage components (bonuses, fringe benefits, etc.) □ □ □ □ □
Number of permanent employees □ □ □ □ □
Number of temporary/fixed-term employees □ □ □ □ □
Working hours per employee □ □ □ □ □
Other components of labor costs □ □ □ □ □
(please specify________________________________)

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