Explaining Unemployment in Spain: Structural Change, Cyclical Fluctuations, and Labor Market Rigidities

Explaining Unemployment in Spain: Structural Change, Cyclical
Fluctuations, and Labor Market Rigidities by Jeffrey Franks

This paper explores the characteristics and causes of unemployment in
Spain and provides a brief discussion of recent labor market reform measures
and their likely impact. Three characteristics distinguish the Spanish
unemployment problem: (i) its magnitude (over 24 percent in early 1994);
(ii) its persistence (above 15 percent since late 1981 despite a major
economic boom in 1986-91); and (iii) the strength of the cyclical variation
in unemployment (nearly 9 percentage points in the last cycle). The roots
of the unemployment problem lie in a rapid demographic transformation over
the past 15 years that has produced a large increase in female labor force
participation and a substantial reduction in agricultural employment.
Although the job creation record in Spain in the 1980s compares favorably
with that in other European countries, it was insufficient to absorb the
increasing nonagricultural labor force.

Two sets of explanations for high and persistent unemployment are
explored. The first, called market-clearing explanations, looks at
reasons why the reported unemployment rate would be high despite well-
functioning labor markets. Little evidence is found in support of
equilibrium business cycles theories, but between 6 and 12 percentage points
of Spanish unemployment could be attributed to workers voluntarily
unemployed owing to generous unemployment benefits and to those reportedly
unemployed but really working in the underground economy.

The second set of explanations, denominated market-failure theories,
looks at unemployment caused by rigidities in the labor market. Legal
restrictions on hiring, firing, and employment mobility have created a labor
market extremely unresponsive to fluctuations in the unemployment rate.
Econometric estimates demonstrate that the unemployment rate has a unit
root--an extreme manifestation of persistence that constitutes evidence in
favor of unemployment hysteresis. A simple error correction model of wage
determination shows evidence that the wage rate in Spain does not moderate
when unemployment increases and does not respond positively to improvements
in productivity.

The paper concludes with a brief discussion of recent reforms in the
labor market introduced by the Spanish government. While a number of
positive steps have been taken, particularly in reducing the generosity of
and ease of eligibility for unemployment benefits, it is likely that
additional reforms will be necessary if unemployment is ever to fall below
10 percent.