## _sdn1302

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---

### I. Introduction
- Paper examines IMF labor market recommendations for advanced economies since the beginning of the crisis, drawing on theoretical and empirical literature on labor market design.
- Focus questions:
  - Between 2007 and 2010, unemployment in advanced economies rose from 5.4 percent to 8.3 percent, and by end-2012 it had declined to only 8.0 percent—how much is cyclical vs. structural?
  - Adjustment in euro area periphery must come largely from competitiveness improvements; short-run adjustment requires relative decreases in nominal wages and prices—how best to achieve this?
  - Can labor market reforms lower the natural rate of unemployment and materially raise potential growth?
- Organizing concepts:
  - Micro flexibility: ability to reallocate workers to jobs that sustain productivity growth.
  - Macro flexibility: ability to adjust to macroeconomic shocks while protecting workers and maintaining investment incentives.
- Paper summarizes literature (no new theory or empirical evidence) and assesses IMF positions relative to literature lessons.

### II. Micro flexibility — Key findings
- Productivity growth requires constant reallocation: entry of high-productivity firms, exit of low-productivity firms, and faster growth of efficient producers.
- Good institutions achieve reallocation while limiting welfare costs for transitioning workers.
- Cross-country evidence shows wide variation in unemployment inflows and duration; similar unemployment rates can mask very different reallocation dynamics (example: 1980s–1990s Portugal vs. United States).
- Two central labor market institutions for reallocation:
  - Unemployment insurance (UI): reduces welfare cost of unemployment but can raise reservation wages and increase unemployment duration; design (benefit decline with duration) and active labor market policies (ALMPs) matter more than benefit level alone.
  - Employment protection (EP): trade-off between mobility and stability; some EP can encourage firm-specific skill investment and internalize social costs of layoffs, but excessive or complex EP hampers reallocation and likely reduces productivity growth and welfare.

### II.A Unemployment insurance and employment protection — Findings from literature
- Unemployment insurance:
  - Provides social insurance where private markets fail.
  - Higher UI can increase reservation wages and unemployment duration; effects depend on benefit design and ALMP quality.
  - Empirical evidence highlights the importance of benefit tapering over duration and conditionality tied to job search/training.
- Employment protection:
  - Excessive EP or complex judicial/administrative layoff procedures reduce reallocation and productivity.
  - EP increases bargaining power of employed workers, can raise wages, increase firms' costs, reduce hiring, and lengthen unemployment duration.
  - Dual systems (high protection for permanent contracts, light rules for temporary contracts) often yield ambiguous efficiency and welfare effects: low investment in temporary workers, high insecurity for youth, and broader social costs (e.g., mortgage access).

### II.B Regimes and trust
- Stylized cross-country typology:
  - "Anglo-Saxon" model: low EP + low UI → large flows, short unemployment duration, low unemployment.
  - "Nordic" model: medium/high EP + generous but conditional UI + strong ALMPs → allows reallocation with low unemployment ("flexicurity").
  - "Continental" model: high EP + generous UI + limited ALMPs → limited reallocation and high unemployment.
- Trust between firms and workers is a strong explanatory variable for unemployment outcomes.
  - Trust often reduces the estimated impact of specific institutions in multivariate regressions.
  - Evidence suggests trust influences the design and functioning of labor market institutions and that trust can be increased over time (example: Ireland increased trust since mid-1980s, though it fell somewhat since the crisis).
  - Dialogue and negotiated commitments between social partners help build trust.

### II.C Tentative conclusions (Micro) — Policy orientation and prescriptions
- Preferred orientation: "protect workers, not jobs" (flexicurity).
- Policy prescriptions:
  - Protect workers primarily via unemployment insurance rather than high employment protection.
  - Unemployment benefits can be generous if coordinated with effective ALMPs and conditionality (reported job search, training, job acceptance).
  - Adult vocational training coordinated with UI is essential; retraining programs have mixed empirical success and must be well-designed and funded.
  - Employment protection should:
    - Be limited and linked continuously to tenure (increasing with length of employment), avoiding threshold effects of dual systems.
    - Avoid excessive judicial uncertainty; EP should function more like a financial transaction (severance) than a complex, uncertain judicial process.
  - Dual EP systems should be avoided; temporary workers suffer insecurity and firms under-invest in them.

### III. Macro flexibility — Overview and key institutions
- Macro flexibility: ability to maintain low unemployment on average and limit unemployment fluctuations in response to shocks.
- Key institutions influencing macro flexibility: minimum wage, tax wedge, and collective bargaining structure.
  - Minimum wage and tax wedge primarily affect the average level of unemployment.
  - Collective bargaining affects both the level and responsiveness (fluctuations) of unemployment.

### III.A The minimum wage and the tax wedge — Findings
- Minimum wage:
  - Distributional objective: ensure low-skill workers earn a living wage.
  - Empirical evidence suggests within a range the employment effect is small.
  - Complement: a low minimum wage plus negative income tax may achieve redistribution without pricing low-skill workers out.
- Tax wedge:
  - High in Europe; often correlated with higher unemployment in cross-country regressions.
  - Not all payroll taxes equally harmful—some (e.g., retirement contributions) are deferred benefits.
  - Incidence may fall mostly on workers, but when minimum wages or UI prevent wage adjustments, tax wedge raises labor cost to firms and can increase unemployment.
  - Shifting tax mix away from labor may be desirable.

### III.B Collective bargaining — Effects and trade-offs
- Level effects (unemployment):
  - Centralized bargaining: ambiguous effects—may weigh more for unemployed welfare (lower unemployment) but can increase union bargaining power (higher wages).
  - Centralized bargaining criticized when it fails to accommodate regional productivity differences.
  - Intermediate (sectoral) bargaining may raise union bargaining power relative to firm-level bargaining and place less weight on unemployed welfare.
  - Extension agreements (sectoral coverage) can be useful where many small firms exist but depend on bargaining quality and representativeness; risk of reduced union legitimacy when coverage is high but membership low.
  - Extension agreements should include flexibility tools (top-up agreements, temporary opt-outs) to handle firm-level heterogeneity and adjustment needs.
- Fluctuation effects (responsiveness of wages to shocks):
  - Not all macro shocks require wage adjustment; monetary offsets can address some demand shocks.
  - Wage deflation can be harmful in a liquidity trap (higher real interest rates when nominal rates at zero).
  - For competitiveness shocks in currency unions, centralized bargaining can facilitate coordinated nominal wage reductions across firms without disrupting relative wages and can help firms commit to pass cost reductions into prices.
  - Centralized bargaining can solve coordination problems when coordinated wage reductions are necessary.

### III.C Tentative conclusions (Macro)
- Reforms of bargaining structure require caution—institutions are rooted in history and social norms.
- Desirable system: allow decentralized (firm-level) wage setting for spatial/firm heterogeneity while retaining coordination mechanisms for macro adjustment.
  - Combination of national and firm-level bargaining attractive: firm agreements adjust to firm conditions; national agreements set floors and help large-scale adjustments.
  - Historical examples: Wassenaar Agreement (Netherlands, 1982) and Moncloa Pact (Spain, 1977).
  - Coordination can also be achieved via sectoral leadership (e.g., tradable-sector wage leadership in Germany).
- Success depends on details and trust; workers must trust firms to reflect cost decreases into prices and firms must be able to credibly commit.

### IV. IMF recommendations during the Great Recession — Overview
- Reassesses:
  - Cyclical vs. structural nature of higher unemployment.
  - Need for competitiveness improvements in euro area periphery.
  - Potential for labor market adjustments to lower the natural rate and improve growth.

### IV.A Unemployment — IMF stance and actions
- IMF view: high unemployment largely cyclical with substantial unemployment gaps in most countries; sustaining aggregate demand remains essential.
  - Evidence cited: relative stability of the Beveridge curve and mismatch measures that returned to normal after initial rise.
  - Inflation behavior attributed to anchored expectations and a decreased effect of the unemployment gap on inflation.
- Early crisis recommendation: strong fiscal stimulus given risk of demand collapse and the zero lower bound on monetary policy.
- Later recommendation: shift from stimulus to fiscal consolidation once collapse was averted, to avoid unsustainable debt and sovereign default risk.
  - Consolidation should proceed gradually where financing conditions permit, backed by credible medium-term plans; offsetting measures to support growth recommended (unconventional monetary policy, improved financial intermediation, trade balance improvements).
- Labor-market-specific measures supported by IMF:
  - Support for extension of UI in severe recessions (example: United States).
  - Support for UI expansion in program countries (Iceland: spending on unemployed quadrupled during 2008–10; Greece: UI expansion on pilot basis).
  - Support for reducing benefits where judged excessively generous and materially disincentivizing reemployment (example: Portugal).
  - Recognition of hysteresis risks from prolonged unemployment—targeted measures for young, low-skilled, and long-term unemployed: registration expansion, retraining, subsidized hiring, study programs (Iceland opened secondary schools to anyone below 25 in 2011 and promoted work-related education).
  - Short-time work schemes (Germany experience) mitigated unemployment increases early in crisis; IMF advised phasing out to avoid impeding reallocation.
  - Recommendations to reduce dual employment protection in countries with severe youth/unemployment concentration (Italy, Portugal, Spain), with smooth transitions and grandfathering to avoid short-term unemployment spikes; reduce EP on new permanent contracts to stimulate future stable hiring.

### IV.B Competitiveness — IMF stance and guidance
- For euro area periphery at fixed nominal exchange rates, competitiveness can be restored only by:
  - Cutting relative nominal wages (short run), or
  - Improving productivity (long run and preferable but slow).
- Reversing competitiveness gaps in a currency union implies relative inflation differentials: to meet a 2 percent euro-area target, inflation must be lower than 2 percent in the South and higher than 2 percent in the North.
  - Thus, northern countries must accept higher inflation for southern adjustment—IMF emphasized this point.
- Best short-run method: national wage-cut agreements via common assent (tripartite social pacts).
  - Problems: workers may not perceive need for cuts and may not trust that firms will pass cost reductions into lower prices; enforcement/verification of price cuts is difficult.
- IMF recommended national agreements informally or formally in several euro-area countries, but such agreements were often hard to achieve or did not occur.
  - Ireland: tradition of tripartite agreements from 1980s; negotiations turned contentious in crisis; government undertook unilateral pay and pension cuts before a 2010 agreement with unions.
  - Spain: social partners unable to reach a national wage agreement when inflation fell at start of 2009 and economic climate worsened.

### Wage-setting, competitiveness, and country cases
- Greece: real wages in 2009 increased (incorporating inflation expectations that turned out to be too high), raising household incomes but worsening competitiveness as wage growth outstripped the euro average.
- Latvia: adjustment included a sharp reduction in public sector wages, improving the fiscal position and—together with high unemployment—placing downward pressure on private sector wages.
- Serbia: public sector wage freeze in 2009–10 with relief payments for lower-income workers to align public wages more with private sector wages.
- IMF advice where intermediate-level bargaining was insufficient (Greece, Portugal, Spain): facilitate opt-out clauses from collective agreements and move toward decentralization of collective bargaining to the firm level.

### Policy options when national agreements are absent
- Greater flexibility in wage-setting:
  - Allow firms and workers to set wages that reflect firm-level productivity to restore competitiveness.
  - Encourage decentralization of collective bargaining and opt-out provisions where intermediate bargaining fails.
- Decreasing public sector wages:
  - Improves fiscal position directly.
  - Can exert downward pressure on private sector wages depending on initial public/private wage gaps and pass-through.
- Decreasing the minimum wage:
  - Can be effective when wage distribution is compressed and many wages move with the minimum.
  - Justified only when the minimum wage is clearly out of line.
  - IMF recommended cutting the minimum wage in Greece (to bring it back toward 40 percent of the median wage).
  - IMF recommended a freeze of the minimum wage in Portugal after rapid increases during 2007–10.

### Fiscal devaluation
- Concept: shift from direct taxes (e.g., social contributions) to consumption taxes (e.g., VAT) so lower labor costs reduce export prices while higher VAT does not affect exports.
- Potential impact:
  - Can accelerate current account adjustment, but at most achieve "a couple of percentage points of devaluation" because large changes in social contributions and VAT are not feasible.
- IMF stance and experience:
  - IMF supported the idea in countries including France, Italy, and Portugal.
  - Despite much discussion, fiscal devaluations were not implemented during this crisis.

### Growth in the medium term: product and labor market reforms
- Product market reforms
  - Priority: lower barriers to entry to increase competition, curb incumbent rents, raise activity and labor demand, and boost total factor productivity over the medium term.
  - Empirical evidence: product market reforms lead to increases in total factor productivity and declines in average unemployment.
  - Short-term effects:
    - Increased competition can cause job shedding in some sectors and possibly decrease overall employment unless aggregate demand increases proportionally.
    - Largest productivity gains tend to be in nontradables where demand is relatively inelastic, possibly reducing employment in the short run.
    - In tradables, productivity gains are more likely to raise employment but potential gains are typically smaller.
  - IMF caution: product market reforms are essential but may have adverse short-term employment effects and should be chosen carefully given limited macro policy space and high unemployment.
- Labor market reforms
  - Objectives: lower the natural rate of unemployment, improve incidence for particular groups, and increase productivity via better reallocation.
  - Key institutional reforms recommended:
    - Reform employment protection to reduce duality.
    - Increase labor force participation—especially among women and workers aged 55 and older—by reducing the secondary-earner tax wedge, lowering marginal tax rates, or using targeted in-work tax credits.
    - Replace high unconditional family income support with programs that give higher benefits to those in work (e.g., childcare subsidies for working mothers).
    - Raise effective retirement ages and statutory retirement ages where low and adjust pension benefits toward actuarially fair levels.
    - Tighten disability benefit rules: link benefits to work capacity and strengthen attachment to the labor force through ALMPs.
  - Romania example: pension law increased retirement age, re-indexed pensions, tightened early retirement and disability pensions starting in 2011; changes implemented gradually while leaving minimum pension thresholds unchanged to protect the poorest pensioners.

### Country-specific labor-market measures and findings
- Iceland:
  - Spending on unemployment increases, mostly through cash benefits.
  - Job retraining, subsidized hiring and study programs.
  - Automatic salary increases frozen; public firms can align contract terms to those in private sector.
- Ireland:
  - Strengthened labor activation and training for job seekers, particularly long-term unemployed.
  - Targeted fiscal policy and investment projects to foster job creation.
  - Revised regime for sectoral wage agreements (Registered Employment Agreements and Employment Regulation Orders).
  - Substantial wage (including pay rate and allowances) and personnel cuts; further reductions to public sector wage bill through improved rostering and longer working hours; increased redeployment possibilities within the public sector.
- Latvia:
  - Emergency public works program to help unemployed.
  - Substantial wage (and price) cuts.
- Portugal:
  - UI benefit reduced (from very high levels).
  - Steps to improve education and training for long-term and youth unemployed.
  - Reduction in protection (including cut in severance pay).
  - Reform of overtime regime.
  - Change in regime for firm-level agreements and extension of collective bargaining to ensure significant representation before extension to whole sector.
  - Substantial wage cuts (including elimination of 14th month salary).
- Romania:
  - Reform of working time regime and fixed-term work arrangements.
  - Minimum wage raised (from initially low levels).
  - Change in collective bargaining regime aimed at promoting decentralization of wage setting.
  - Temporary cuts in public wages (reversing increases during 2006–08) and scaling back employment; new public wage law.

### Cross-cutting policy themes and implications
- Labor activation and training:
  - Emphasis on job retraining, activation, and targeted programs for the long-term unemployed and youth.
- Wage and public-pay adjustment:
  - Policies included freezes on automatic salary increases, substantial wage cuts, elimination of special pay (e.g., 14th month salary), and temporary public wage cuts to restore fiscal sustainability.
- Collective bargaining and decentralization:
  - Reforms altered sectoral and firm-level bargaining regimes to broaden scope for firm-level agreements and to ensure representation before extending agreements to entire sectors, with a trend toward decentralization of wage setting.
- Employment protection and contractual flexibility:
  - Reforms reduced protection (including cuts in severance pay), revised overtime and working-time regimes, and changed rules for fixed-term work arrangements to increase labor market flexibility.
- Active labor-market policies and public works:
  - Emergency public works and subsidized hiring were used to mitigate unemployment spikes.

### Conclusions on flexibility and policy stance
- Two types of flexibility needed:
  - Micro flexibility: ability to reallocate resources and generate productivity growth. Promote protection via unemployment insurance rather than high employment protection ("flexicurity").
  - Macro flexibility: ability to adjust to macro shocks. Collective bargaining structures should allow decentralized wage setting while retaining coordination for macro adjustment.
- Recommended collective bargaining structure:
  - Combination of national and firm-level bargaining: firm-level agreements adjust to firm-specific conditions; national agreements set floors and help adjust wages/prices in major macro shocks.
  - IMF notes implications of alternative bargaining structures are poorly understood and advises caution in policy recommendations; trust among social partners is as important as structures.
- Short-term IMF advice given cyclical rise in unemployment:
  - Maintain aggregate demand to the extent possible.
  - Share the burden of lower demand via extension of unemployment insurance benefits.
  - For countries needing competitiveness improvements while in currency unions or pegs: greater wage-setting flexibility (e.g., opt-out clauses) and public sector wage cuts have featured in IMF-supported programs, despite controversy.

*Italic source: Excerpt from the IMF PDF chapter/section "_sdn1302" (provided content).*

### 1. Unemployment Rate, Inflows, and Duration .........................................................................6

### 1. Unemployment Rate, Inflows, and Duration .........................................................................6

### Major sections
- "1. Unemployment Rate, Inflows, and Duration" — page 6
- "2. Unemployment Duration and Employment Protection" — page 7
- "3. Unemployment and Trust" — page 9

### Supplementary material
- "Endnotes" — page 21
- "Annex: Advice on Labor Market Issues in IMF-Supported Programs in Europe" — page 24

*Source: _sdn1302 - 1. Unemployment Rate, Inflows, and Duration; https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2013/_sdn1302.pdf*

### References .............................................................................................................

### _sdn1302 - References .............................................................................................................

### I. INTRODUCTION
- Paper examines IMF labor market recommendations for advanced economies since the beginning of the crisis, informed by theoretical and empirical literature on labor market design.
- Focus questions:
  - Between 2007 and 2010, unemployment in advanced economies rose from 5.4 percent to 8.3 percent, and by end-2012 it had declined to only 8.0 percent—how much is cyclical vs. structural?
  - Adjustment in euro area periphery must come largely from competitiveness improvements; short-run adjustment requires relative decreases in nominal wages and prices—how best to achieve this?
  - Can labor market reforms lower the natural rate of unemployment and materially raise potential growth?
- Organizing concepts:
  - Micro flexibility: ability to reallocate workers to jobs that sustain productivity growth.
  - Macro flexibility: ability to adjust to macroeconomic shocks while protecting workers and maintaining investment incentives.
- Paper summarizes literature (no new theory or empirical evidence) and assesses IMF positions relative to literature lessons.

### II. MICRO FLEXIBILITY — Key findings
- Productivity growth requires constant reallocation: entry of high-productivity firms, exit of low-productivity firms, and faster growth of efficient producers.
- Good institutions achieve reallocation while limiting welfare costs for transitioning workers.
- Cross-country evidence shows wide variation in unemployment inflows and duration; similar unemployment rates can mask very different reallocation dynamics (example: 1980s–1990s Portugal vs. United States).
- Two central labor market institutions for reallocation:
  - Unemployment insurance (UI): reduces welfare cost of unemployment but can raise reservation wages and increase unemployment duration; design (benefit decline with duration) and active labor market policies (ALMPs) matter more than benefit level alone.
  - Employment protection (EP): trade-off between mobility and stability; some EP can encourage firm-specific skill investment and internalize social costs of layoffs, but excessive or complex EP hampers reallocation and likely reduces productivity growth and welfare.

### II.A Unemployment Insurance and Employment Protection — Findings from literature
- Unemployment insurance:
  - Provides social insurance where private markets fail.
  - Higher UI can increase reservation wages and unemployment duration; the pattern depends on benefit design and ALMP quality.
  - Empirical evidence highlights the importance of benefit tapering over duration and conditionality tied to job search/training.
- Employment protection:
  - Excessive EP or complex judicial/administrative layoff procedures reduce reallocation and productivity.
  - EP increases bargaining power of employed workers, can raise wages, increase firms' costs, reduce hiring, and lengthen unemployment duration (Figure 2 shows sizable effect).
  - Dual systems (high protection for permanent contracts, light rules for temporary contracts) often yield ambiguous efficiency and welfare effects: low investment in temporary workers, high insecurity for youth, and broader social costs (e.g., mortgage access).

### II.B Combinations? — Regimes and trust
- Cross-country typology (stylized):
  - "Anglo-Saxon" model: low EP + low UI → large flows, short unemployment duration, low unemployment.
  - "Nordic" model: medium/high EP + generous but conditional UI + strong ALMPs → allows reallocation with low unemployment (flexicurity).
  - "Continental" model: high EP + generous UI + limited ALMPs → limited reallocation and high unemployment.
- Trust between firms and workers is a strong explanatory variable for unemployment outcomes (Figure 3 shows a strong bivariate relation between a trust measure and unemployment).
  - Trust often reduces the estimated impact of specific institutions in multivariate regressions.
  - Evidence suggests trust influences the design and functioning of labor market institutions and that trust can be increased over time (example: Ireland increased trust since mid-1980s, though it fell somewhat since the crisis).
  - Dialogue and negotiated commitments between social partners help build trust.

### II.C Tentative Conclusions (Micro)
- Preferred orientation: "protect workers, not jobs" (flexicurity).
- Policy prescriptions:
  - Protect workers primarily via unemployment insurance rather than high employment protection.
  - Unemployment benefits can be generous if coordinated with effective ALMPs and conditionality (reported job search, training, job acceptance).
  - Adult vocational training coordinated with UI is essential, but retraining programs have mixed empirical success and must be well-designed and funded.
  - Employment protection should:
    - Be limited and linked continuously to tenure (increasing with length of employment), avoiding threshold effects of dual systems.
    - Avoid excessive judicial uncertainty; EP should function more like a financial transaction (severance) than a complex, uncertain judicial process.
  - Dual EP systems should be avoided; temporary workers suffer insecurity and firms under-invest in them.

### III. MACRO FLEXIBILITY — Overview
- Macro flexibility: ability to maintain low unemployment on average and limit unemployment fluctuations in response to shocks.
- Key institutions influencing macro flexibility: minimum wage, tax wedge, and collective bargaining structure.
  - Minimum wage and tax wedge primarily affect the average level of unemployment.
  - Collective bargaining affects both the level and responsiveness (fluctuations) of unemployment.

### III.A The Minimum Wage and the Tax Wedge — Findings
- Minimum wage:
  - Distributional objective: ensure low-skill workers earn a living wage.
  - Empirical evidence suggests within a range the employment effect is small.
  - Complements with negative income tax: a low minimum wage plus negative income tax may achieve redistribution without pricing low-skill workers out.
- Tax wedge:
  - High in Europe; often correlated with higher unemployment in cross-country regressions.
  - Not all payroll taxes equally harmful—some (e.g., retirement contributions) are deferred benefits.
  - Incidence may fall mostly on workers, but when minimum wages or UI prevent wage adjustments, tax wedge raises labor cost to firms and can increase unemployment.
  - Shifting tax mix away from labor may be desirable.

### III.B Collective Bargaining — Effects and trade-offs
- Level effects (unemployment):
  - Centralized bargaining: ambiguous effects—may weigh more for unemployed welfare (lower unemployment) but can increase union bargaining power (higher wages).
  - Centralized bargaining criticized when it fails to accommodate regional productivity differences.
  - Intermediate (sectoral) bargaining may place less weight on unemployed welfare than centralized bargaining and may raise union bargaining power relative to firm-level bargaining.
  - Extension agreements (sectoral coverage) can be useful where many small firms exist but depend on bargaining quality and representativeness; they may reduce undercutting but can reduce union legitimacy if coverage is high yet membership low (example: France).
  - Extension agreements should include flexibility tools (top-up agreements, temporary opt-outs) to handle firm-level heterogeneity and adjustment needs.
- Fluctuation effects (responsiveness of wages to shocks):
  - Not all macro shocks require wage adjustment; monetary offsets (interest rate changes) can address some demand shocks.
  - Wage deflation can be harmful in a liquidity trap (higher real interest rates when nominal rates at zero).
  - For competitiveness shocks (e.g., loss of competitiveness in currency area members), centralized bargaining can facilitate coordinated nominal wage reductions across firms without disrupting relative wages and can help firms commit to pass cost reductions into prices.
  - Theoretical view: centralized bargaining can solve a coordination problem when coordinated wage reductions are necessary.

### III.C Tentative Conclusions (Macro)
- Reforms of bargaining structure require caution—institutions are rooted in history and social norms.
- Desirable system: allow decentralized (firm-level) wage setting for spatial/firm heterogeneity while retaining coordination mechanisms for macro adjustment.
  - Combination of national and firm-level bargaining attractive: firm agreements adjust to firm conditions; national agreements set floors and help large-scale adjustments.
  - Historical examples credited with improvements: Wassenaar Agreement (Netherlands, 1982) and Moncloa Pact (Spain, 1977).
  - Coordination can also be achieved via sectoral leadership (e.g., tradable-sector wage leadership in Germany).
- Success depends on details and trust; workers must trust firms to reflect cost decreases into prices and firms must be able to credibly commit.

### IV. IMF RECOMMENDATIONS DURING THE GREAT RECESSION — Overview
- Revisits three issues from introduction and assesses IMF recommendations against literature conclusions:
  - Cyclical vs. structural nature of higher unemployment.
  - Need for competitiveness improvements in euro area periphery.
  - Potential for labor market adjustments to lower the natural rate and improve growth.

### IV.A Unemployment — IMF stance and actions
- IMF view: high unemployment largely cyclical with substantial unemployment gaps in most countries; sustaining aggregate demand remains essential.
  - Evidence cited: relative stability of the Beveridge curve (no clear rightward shift indicating a higher natural rate) and mismatch measures that returned to normal after initial rise.
  - Inflation behavior attributed to anchored expectations and a decreased effect of the unemployment gap on inflation, not necessarily a small unemployment gap.
- Early crisis recommendation: strong fiscal stimulus given risk of demand collapse and the zero lower bound on monetary policy.
  - Later recommendation: shift from stimulus to fiscal consolidation once collapse was averted, to avoid unsustainable debt and sovereign default risk.
  - Consolidation should proceed gradually where financing conditions permit, backed by credible medium-term plans; offsetting measures to support growth recommended (unconventional monetary policy, improved financial intermediation, trade balance improvements).
- Labor-market-specific measures:
  - Support for extension of UI in severe recessions (e.g., United States) and program countries (Iceland: spending on unemployed quadrupled during 2008–10; Greece: UI expansion on pilot basis).
  - Support for reducing benefits where judged excessively generous and materially disincentivizing reemployment (example: Portugal).
  - Recognized risk of hysteresis from prolonged unemployment—young, low-skilled, and long-term unemployed require targeted interventions (registration expansion, retraining, subsidized hiring, study programs; Iceland measures in 2011 included opening secondary schools to anyone below 25 and promoting work-related education).
  - Short-time work schemes (Germany experience) shown to mitigate unemployment increases early in crisis; IMF reassessed such policies and their eventual phasing out to avoid impeding reallocation.
  - Recommendations to reduce dual employment protection in countries with severe youth/unemployment concentration (Italy, Portugal, Spain), with caveats: smooth transitions and grandfathering to avoid short-term unemployment spikes; reduce EP on new permanent contracts to stimulate future stable hiring.

### IV.B Competitiveness — IMF stance and policy guidance
- For euro area periphery at fixed nominal exchange rates, competitiveness can be restored only by:
  - Cutting relative nominal wages (short run), or
  - Improving productivity (long run and preferable but slow).
- Reversing competitiveness gaps in a currency union implies relative inflation differentials: to meet a 2 percent euro-area target, inflation must be lower than 2 percent in the South and higher than 2 percent in the North.
  - Thus, northern countries must accept higher inflation for southern adjustment—IMF emphasized this point.
- Best short-run method: national wage-cut agreements via common assent (tripartite social pacts).
  - Problems: workers may not perceive need for cuts and may not trust that firms will pass cost reductions into lower prices; enforcement/verification of price cuts is difficult.
- IMF recommended national agreements informally or formally in several euro-area countries, but such agreements were often hard to achieve or did not occur.
  - Ireland: tradition of tripartite agreements from 1980s, but negotiations turned contentious in crisis; government undertook unilateral pay and pension cuts before a 2010 agreement with unions.
  - Spain: social partners unable to reach a national wage agreement when inflation fell at start of 2009 and economic climate worsened.

_Italic source: Excerpt from the PDF chapter/section titled "References" in the IMF document _sdn1302._

### 2009. However, in February 2010, a new three-year agreement was signed that

### _sdn1302 - 2009. However, in February 2010, a new three-year agreement was signed that

### Wage-setting, competitiveness, and country cases
- Greece: real wages in 2009 increased (incorporating inflation expectations that turned out to be too high), raising household incomes but worsening competitiveness as wage growth outstripped the euro average.
- Latvia: adjustment included a sharp reduction in public sector wages, improving the fiscal position and—together with high unemployment—placing downward pressure on private sector wages (magnitude of pass-through is debated).
- Serbia: public sector wage freeze in 2009–10 with relief payments for lower-income workers to align public wages more with private sector wages.
- IMF advice where intermediate-level bargaining was insufficient (Greece, Portugal, Spain): facilitate opt-out clauses from collective agreements and move toward decentralization of collective bargaining to the firm level.

### Policy options when national agreements are absent
- Greater flexibility in wage-setting:
  - Allow firms and workers to set wages that reflect firm-level productivity to restore competitiveness.
  - Encourage decentralization of collective bargaining and opt-out provisions where intermediate bargaining fails.
- Decreasing public sector wages:
  - Improves fiscal position directly.
  - Can exert downward pressure on private sector wages depending on initial public/private wage gaps and pass-through.
- Decreasing the minimum wage:
  - Can be effective when wage distribution is compressed and many wages move with the minimum.
  - Justified only when the minimum wage is clearly out of line.
  - IMF recommended cutting the minimum wage in Greece (to bring it back toward 40 percent of the median wage).
  - IMF recommended a freeze of the minimum wage in Portugal after rapid increases during 2007–10 (level not too far out of line with the EU average).

### Fiscal devaluation
- Concept: shift from direct taxes (e.g., social contributions) to consumption taxes (e.g., VAT) so lower labor costs reduce export prices while higher VAT does not affect exports.
- Potential impact:
  - Can accelerate current account adjustment, but at most achieve "a couple of percentage points of devaluation" because large changes in social contributions and VAT are not feasible.
- IMF stance and experience:
  - IMF supported the idea in countries including France, Italy, and Portugal.
  - Despite much discussion, fiscal devaluations were not implemented during this crisis.

### Growth in the medium term: overview
- Advanced economies, and several European countries in particular, face very low potential growth and in some cases a high natural rate of unemployment.
- Higher potential growth and lower natural unemployment facilitate fiscal adjustment and reduce needed relative wage adjustments for competitiveness.
- Achieving these outcomes requires structural reforms in product and labor markets.

### Product market reforms
- Priority: lower barriers to entry to increase competition, curb incumbent rents, raise activity and labor demand, and boost total factor productivity over the medium term.
- Empirical evidence: product market reforms lead to increases in total factor productivity and declines in average unemployment (references to empirical literature).
- Short-term effects:
  - Increased competition can cause job shedding in some sectors and possibly decrease overall employment unless aggregate demand increases proportionally.
  - Largest productivity gains tend to be in nontradables where demand is relatively inelastic, possibly reducing employment in the short run.
  - In tradables, productivity gains are more likely to raise employment but potential gains are typically smaller.
- IMF caution: product market reforms are essential but may have adverse short-term employment effects and should be chosen carefully given limited macro policy space and high unemployment.

### Labor market reforms
- Objectives: lower the natural rate of unemployment, improve incidence for particular groups, and increase productivity via better reallocation.
- Key institutional reforms recommended:
  - Reform employment protection to reduce duality (avoid excessive protection for permanent workers while temporary workers have little protection).
  - Increase labor force participation—especially among women and workers aged 55 and older—by:
    - Reducing the secondary-earner tax wedge where family taxation applies (examples cited: France and the United States).
    - Lowering marginal tax rates or using targeted in-work tax credits for secondary earners.
    - Replacing high unconditional family income support with programs that give higher benefits to those in work (e.g., childcare subsidies for working mothers; noted as relatively low in Austria and Portugal).
  - Raise effective retirement ages and statutory retirement ages where low (examples cited: France, Greece) and adjust pension benefits toward actuarially fair levels.
  - Tighten disability benefit rules: link benefits to work capacity and strengthen attachment to the labor force through active labor market policies (recommended for Greece, Ireland, Portugal).
- Romania example: under its program, pension law increased retirement age, re-indexed pensions, tightened early retirement and disability pensions starting in 2011; changes implemented gradually while leaving minimum pension thresholds unchanged to protect the poorest pensioners.

### Conclusions on flexibility and policy stance
- Two types of flexibility needed:
  - Micro flexibility: ability to reallocate resources and generate productivity growth. Promote protection via unemployment insurance rather than high employment protection ("flexicurity").
  - Macro flexibility: ability to adjust to macro shocks. Collective bargaining structures should allow decentralized wage setting while retaining coordination for macro adjustment.
- Recommended collective bargaining structure:
  - Combination of national and firm-level bargaining: firm-level agreements adjust to firm-specific conditions; national agreements set floors and help adjust wages/prices in major macro shocks.
  - IMF notes implications of alternative bargaining structures are poorly understood and advises caution in policy recommendations; trust among social partners is as important as structures.
- Short-term IMF advice given cyclical rise in unemployment:
  - Maintain aggregate demand to the extent possible.
  - Share the burden of lower demand via extension of unemployment insurance benefits.
  - For countries needing competitiveness improvements while in currency unions or pegs: greater wage-setting flexibility (e.g., opt-out clauses) and public sector wage cuts have featured in IMF-supported programs, despite controversy.

*Italic: Source — _sdn1302 (excerpts provided from the IMF PDF content unit)*

### conclusion of

### conclusion of

### Country-specific labor-market measures and findings
- Iceland
  - Spending on unemployment increases, mostly through cash benefits.
  - Job retraining, subsidized hiring and study programs.
  - Automatic salary increases frozen; public firms can align contract terms to those in private sector.
- Ireland
  - Strengthened labor activation and training for job seekers, particularly long-term unemployed.
  - Targeted fiscal policy and investment projects to foster job creation.
  - Revised regime for sectoral wage agreements (Registered Employment Agreements and Employment Regulation Orders).
  - Substantial wage (including pay rate and allowances) and personnel cuts; further reductions to public sector wage bill through improved rostering and longer working hours; increased redeployment possibilities within the public sector.
- Latvia
  - Emergency public works program to help unemployed.
  - Substantial wage (and price) cuts.
- Portugal
  - UI benefit reduced (from very high levels).
  - Steps to improve education and training for long-term and youth unemployed.
  - Reduction in protection (from high levels), including cut in severance pay.
  - Reform of overtime regime.
  - Change in regime for firm-level agreements (broadening the scope for conclusion of agreements with work councils and workers‘ representatives); change in regime for extension of collective bargaining agreements (ensuring significant representation before extension of agreements to whole sector).
  - Substantial wage cuts (including elimination of 14th month salary).
- Romania
  - Reform of legislation governing working time regime and fixed-term work arrangements.
  - Minimum wage raised (from initially low levels).
  - Change in collective bargaining regime aimed at promoting decentralization of wage setting.
  - Temporary cuts in public wages (reversing increases during 2006-08) and scaling back employment; new public wage law.

### Cross-cutting policy themes and implications
- Labor activation and training
  - Many countries emphasized job retraining, activation, and targeted programs for the long-term unemployed and youth.
- Wage and public-pay adjustment
  - Policies included freezes on automatic salary increases, substantial wage cuts, elimination of special pay (e.g., 14th month salary), and temporary public wage cuts to restore fiscal sustainability.
- Collective bargaining and decentralization
  - Reforms altered sectoral and firm-level bargaining regimes to broaden scope for firm-level agreements and to ensure representation before extending agreements to entire sectors, with a trend toward decentralization of wage setting.
- Employment protection and contractual flexibility
  - Reforms reduced protection (including cuts in severance pay), revised overtime and working-time regimes, and changed rules for fixed-term work arrangements to increase labor market flexibility.
- Active labor-market policies and public works
  - Emergency public works and subsidized hiring were used to mitigate unemployment spikes.

* _sdn1302 - conclusion of*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2013/_sdn1302.pdf_