When the economy falters, flexibilization of the labor market, pruning rules and more market forces are the recipe of many economists. The IMF swears by it.
The EU and the ECB have also been calling for years that southern European countries must reform their economies, which is a euphemism for more flexible layoffs, greater wage differentiation, meager benefits and more incentives to work. Only then will the coins of the zeuro countries again be in line with those of the neurostates.
But this may be putting the cart before the horse. On the economists site Me Judice emeritus professor Alfred Kleinknecht puts a finger on the sore spot. Labor market reforms slow down innovation. Wherever major labor market reforms take place, productivity growth weakens. In many rich OECD countries, productivity growth since the Second World War has never been as low as in the last 15 years. The neoliberal reformers expected the opposite. It’s a strange paradox: despite robotization, digitization and artificial intelligence, productivity growth is declining.
Various ‘rigidities’ such as protection against dismissal, centrally negotiated collective agreements, or strong unions may be harmful to the economy from a neoclassical point of view, but they are actually useful for innovation. Because markets are now more competitive, they actually work worse.
One of the reasons is that smoother dismissals give more power to management. Sun kings can therefore create a culture of fear that leads to risk-averse behavior in the workplace. Flexible-to-dismissal workers then avoid risky, but potentially highly profitable options. In addition, increasing mobility also leads to less loyalty to the company. As a result, companies invest more in supervision and control to prevent, for example, the leakage of trade secrets. The management bureaucracies not only lead to higher overhead costs but can also limit the autonomy of creative people. With more mobility, investments in company-specific training also pay less. ‘Long-term commitments to a company are an abominable labor market rigidity for economists. But they are actually useful for innovation. That is why the US, with its flexible labor market, has done so poorly in its ‘old’ economy, as witnessed by the American ‘Rust Belt’, according to Kleinknecht.
In a traditional economist’s view, central wage-setting – and collective labor agreements – are also a rigidity in the labor market. But the advantage is that this rigidity forces laggards to modernize, while in decentralized negotiations they can demand wage sacrifices as an alternative to modernization. Innovative companies need the prospect of market entry barriers and monopoly profits as an incentive to accept the risks and uncertainties of innovation. And to be able to absorb losses from failed projects.
In short, the neoliberal model has helped many people (especially low-paid) work with better functioning markets, but has also undermined innovation and productivity growth. As a result, the cake that we can divide extra each year hardly grows anymore. The old-fashioned model with a rigid labor market, more rules and less market forces is better for innovation.
Maybe it’s time to think seriously about that.