## _spn1018 - Executive Summary

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---

### Key findings
- "210 million people currently out of work worldwide" and official unemployment at its highest level in history.
- Analysis covers six economies: Germany, Korea, Mexico, New Zealand, Spain, and Sweden.
- Central explanatory factor: interaction between the nature of shocks (temporary vs. permanent) and country-specific labor market structures and institutions.
- Permanent shocks, particularly in construction, tended to produce the worst job losses relative to the drop in output—especially in dual labor markets and where wage rigidities existed.
- Policies to avoid job cuts were much more effective when they were well-targeted and responded to temporary shocks.
- Policies to facilitate labor movements were more appropriate following permanent shocks.

### Country-specific shocks and transmission
- Permanent vs. temporary distinction:
  - Permanent shocks: bursting of property bubbles and adjustment of over-extended balance sheets (most evident in construction employment).
  - Temporary shocks: collapse of external demand and external financing constraints (mainly affected manufacturing employment).
- Country summaries:
  - Germany: collapse in world demand for manufactured goods → contraction in export demand; shock perceived as temporary.
  - Korea: capital outflows and collapsed exports → lower asset prices, money market dislocations; external shock with temporary perception.
  - New Zealand: collapse of world commodity prices and drought → substantial drop in agricultural employment; "New Zealand’s share of employment in agriculture was about 7 percent before the crisis."
  - Sweden: domestic banks’ exposures forced credit tightening → reduced consumption and investment; large drop in manufacturing employment.
  - Mexico: multiple external shocks (manufacturing hit hardest by U.S. recession); collapse in oil prices and credit tightening magnified impact.
  - Spain: primarily domestic and permanent shocks—the bursting of a property price bubble and credit tightening.

### Macroeconomic and labor-market policy responses
- Macroeconomic support:
  - Policy rates were cut dramatically.
  - Fiscal deficits increased in all countries; fiscal response largest in the European economies.
  - Korea: smallest fiscal expansion and the only country in the sample to maintain a primary surplus.
  - Note: "The fiscal data in Figure 3 are on a GFS2001 basis... The data for Korea covers only the central government."
- Two broad labor-market policy categories implemented across all six economies:
  1. Policies to sustain labor demand: public work programs (PWP), job creation subsidies, reduction of nonwage labor costs, funding for short-time work (STW) schemes.
  2. Policies to improve employment prospects: job search assistance, training programs, job-finding and business start-up incentives, work experience programs, apprenticeships.
- Selected country measures (highlights):
  - Germany: extension of STW maximum duration from 6 months to 2 years; extension of allowance for STW to temporary agencies’ workers up to end-2010; reduction in 2009-10 of employer and employees unemployment insurance contribution rates; new subsidized training for STW.
  - Korea: temporary expansion of public sector job creation schemes; youth internship program with wage subsidies; easing STW eligibility; increased employer subsidy for STW.
  - Mexico: partial reimbursement of employer social contributions for new employees in 2009; broadening temporary PWP; temporary introduction of STW subsidies.
  - New Zealand: permanent reduction in mandatory employer retirement savings contribution; temporary job scheme to support voluntary working hour reductions.
  - Spain: reduction in employer social contribution for first two years for new employees; funding for PWPs; extension of subsidies for hiring part-time workers to those on STW.
  - Sweden: deferment of two months of employer 2009 social security contributions and taxes until January 2011; permanent increase in hiring subsidy for certain groups; shortened qualification period for hiring subsidy from one year to six months.

### Short-time work and public employment statistics
- Germany:
  - STW schemes existed pre-crisis but were made more generous in 2008–09, reaching 1.5 million workers at their peak.
  - Government provided up to 67 percent of former net wages to employees who agreed with their employers to cut working hours, partially or completely, for up to 2 years (extended from 6 months initially).
- Korea: government temporarily subsidized up to 70 percent of the wages of redundant workers retained by firms.
- Short-term public sector employment programs:
  - In 2009, such programs benefited up to 250,000 people in Korea and 700,000 people in Mexico, according to the authorities’ data.
  - Authorities’ data suggest that in Mexico about 250,000 workers benefited from short-time work schemes in 2009.

### Labor market outcomes and adjustment channels
- Employment and unemployment:
  - Employment dropped the most in Spain; remained almost flat in Germany; recovered to pre-crisis levels in Korea and Mexico.
  - Unemployment rose substantially in Spain; declined slightly in Germany; increased in all other countries (but considerably less than in Spain and from much lower levels).
- Hours worked:
  - Hours worked per person dropped in most countries, helping avoid excessive job losses.
  - Drop more pronounced in Germany, Korea and New Zealand.
  - Spain was the only country in which hours worked per worker increased, despite STW subsidies.
  - Drivers of Germany’s hours reduction (authorities’ estimates): depletion of working time accounts about 30 percent; short-time work and the lowering of regular working time by one-quarter each; reduction of overtime work by approximately one-fifth.
- Wages and contracts:
  - Korea showed exceptional downward wage flexibility.
  - Wages rose in Spain, driven by backward and asymmetric wage indexation in 2009 and rigidities from an intermediate (industry-level) wage bargaining system.
  - Authorities’ estimates: about 80 percent of the jobs lost in Spain during the crisis have been for temporary contracts.
  - In Korea, authorities’ estimates suggest that almost all job losses were for temporary employees.
- Productivity and unit labor costs:
  - Labor hoarding and the collapse in output led to a drop in labor productivity.
  - Manufacturing unit labor costs increased in most countries, particularly in Sweden, followed by Mexico; they have more than recovered in Korea and New Zealand.
- Labor force participation and composition:
  - Participation broadly flat across most countries, with slight increases in Germany and Spain.
  - Participation increased for the old and dropped for the young in many countries.
  - New Zealand authorities’ data suggest that studying accounted for about 72 percent of people between 15 to 24 years old who were not in the labor force.
- Exchange rates and migration:
  - Real effective depreciation occurred in Korea, Mexico, New Zealand and Sweden.
  - In New Zealand, outflows of workers abroad early in the crisis may have reduced unemployment impact.
  - Migration to the U.S. did not stabilize Mexico’s labor market during this crisis, according to authorities’ information.

### Modeling and empirical explanations for dispersion
- Unobserved components model:
  - Output gaps dropped across the board, particularly in Mexico and Spain, while unemployment gaps increased.
  - The ratio of the unemployment gap to the output gap varies substantially, from close to 1 in Spain to slightly negative in Germany.
- Econometric model:
  - Suggests unemployment broadly behaved as expected given the size of the shock, institutions, and policies.
- Industry-level evidence:
  - Confirms link between employment growth and shock-absorbing mechanisms: adjustment in labor costs, active labor market policies, and changes in the exchange rate.
  - Spain’s large unemployment increase is largely explained by sectoral and permanent shocks (notably construction, with high temporary employment share).
  - Germany’s better outcome reflects labor hoarding in response to external but temporary shocks.

### Policy implications and recommendations
- General principles:
  - Policies to support employment are justified during severe downturns but must be tailored to the expected duration of the shock (temporary vs. permanent) and sensitive to labor market institutions.
  - Policies are also justified to avoid increases in long-term unemployment and drops in labor force participation during severe downturns.
- Targeted policy guidance:
  - Short-time work schemes and targeted labor-demand supports are more effective in temporary-shock environments.
  - Where shocks are persistent and sector-specific (e.g., construction), policies facilitating labor mobility and retraining are more appropriate.
  - Well-targeted labor market policies (e.g., STW and hiring subsidies) can help avoid increases in long-term unemployment.
- Structural reform priorities:
  - Reduce employment protection gaps in dual labor markets to smooth adjustments and reduce abuse of temporary contracts.
  - Improve wage-setting arrangements so centralized coordination can address economy-wide shocks and firm-level bargains can address firm-specific shocks.
  - Avoid maintaining crisis-era policies over the medium term to prevent distortions; phase crisis-driven policies into broader structural reforms.
- Country-specific reform notes:
  - Spain has adopted labor market reforms expected to reduce dualism and remove some wage-setting rigidities.
  - Mexico is discussing proposals to increase contract flexibility and better link wages/promotions to productivity, if implemented.

*Source: Executive summary and excerpts from IMF staff analysis in _spn1018.*

### Executive Summary ......................................................................................................

### _spn1018 - Executive Summary ......................................................................................................

### Executive Summary
- The recent global crisis had a large human cost reflected in labor markets, with "210 million people currently out of work worldwide" and official unemployment at its highest level in history.
- The paper analyzes employment experiences of six economies: Germany, Korea, Mexico, New Zealand, Spain, and Sweden.
- Key explanatory factor: interaction between the nature of shocks (temporary vs. permanent) and country-specific labor market structures and institutions.
- Permanent shocks, particularly in construction, tended to produce the worst job losses relative to the drop in output—especially in dual labor markets and where wage rigidities existed.
- Policies to avoid job cuts were much more effective when:
  - they were well-targeted, and
  - they responded to temporary shocks.
- Policies to facilitate labor movements were more appropriate following permanent shocks.
- Policy implications summarized:
  - Policies to support employment are justified during severe downturns but must be tailored to the expected duration of the shock and the institutions in place.
  - Policies are also justified to avoid increases in long-term unemployment and drops in labor force participation during severe downturns.
  - Reforms to reduce employment protection gaps in dual labor markets could lead to smoother labor market adjustments by avoiding strict protection for regular contracts and abuse of temporary employees.
  - Wage-setting mechanisms work best when they allow for adjustment via centralized coordination for economy-wide shocks and firm-level bargains for specific ones.
  - Crisis-driven labor market policies should give way to broader structural reforms in the medium term.

### I. Introduction
- The dispersion of labor market outcomes for a given drop in output was much larger in this crisis than earlier ones (Figure 1).
- Economies with similar downturns had very different labor market outcomes, implying the collapse of growth cannot fully explain differences in labor market performance.
- The six-country sample was chosen to cover a wide range of:
  - labor market institutions,
  - policy responses, and
  - outcomes.
- Country roles:
  - Spain had the worst employment performance among OECD economies during the crisis and was hit primarily by domestic shocks.
  - Germany had the best employment performance and was hit primarily by external shocks.
  - New Zealand: advanced economy hit by multiple external shocks.
  - Mexico: emerging economy with high exposure to the U.S. economy and multiple external shocks.
  - Korea: case of a fast recovery following external shocks.
  - Sweden: case of financial sector external shocks.
- Range of institutions:
  - New Zealand: least regulated labor market.
  - Spain and Mexico: most regulated.
  - Germany, Korea, Sweden: intermediate.
  - Employment protection: relatively strict in Spain and Mexico; Spain shows rigid permanent employment coexisting with flexible temporary employment; Mexico shows rigid formal employment coexisting with flexible informal employment.
  - Wage-setting mechanisms: most rigid in Spain.

### II. The Facts

#### A. Country-Specific Shocks
- Although the crisis was global, transmission channels differed across countries; external demand declined broadly but asset-price and trade-flow collapses affected domestic and external demand to varying degrees (Figure 2).
- Shocks can be categorized as permanent (persistent) or temporary:
  - Permanent shocks: bursting of property bubbles and adjustment of over-extended balance sheets (most evident in construction employment).
  - Temporary shocks: collapse of external demand and external financing constraints (mainly affected manufacturing employment).
- Country-specific summaries of shocks:
  - Germany, Korea, New Zealand, Sweden: hit by temporary external shocks, with differing domestic demand impacts.
    - Germany: collapse in world demand for manufactured goods (consumer durables and business capital goods) → contraction in export demand; domestic demand less affected.
    - Korea: capital outflows and collapsed exports → lower asset prices, money market dislocations, spillover to domestic demand.
    - New Zealand: collapse of world commodity prices (exacerbating an earlier drought) → substantial drop in agricultural employment; tighter bank credit reduced private consumption and investment demand.
      - Note: "New Zealand’s share of employment in agriculture was about 7 percent before the crisis."
    - Sweden: domestic commercial banks’ exposures to troubled emerging economies forced credit tightening → reduced private consumption and investment demand; collapse in world demand for manufactured goods → contraction in export demand and substantial drop in manufacturing employment.
  - Mexico: hit by multiple external shocks, some potentially persistent depending on U.S. recovery; most severe shock in manufacturing due to the U.S. recession; collapse in oil prices and credit tightening magnified impact; external demand and private consumption and investment contracted.
  - Spain: primarily hit by domestic and permanent shocks—the bursting of a property price bubble and subsequent credit tightening caused contraction in private consumption and investment demand.
- Table 1 (Employment Growth Across Industries) and Figure 2 (Output Growth Decompositions, 2000–10) document sectoral and demand decomposition patterns across countries.

#### B. Policy Responses
- Macroeconomic policies were strongly supportive across the board during the crisis:
  - Extraordinary monetary policy support: policy rates were cut dramatically (by similar magnitudes, albeit from different starting points).
  - Fiscal deficits increased in all countries (Figure 3).
  - Fiscal response largest in the European economies, partly reflecting automatic stabilizers.
  - Mexico: strong starting position allowed increased spending in infrastructure investment to stimulate the economy.
  - Korea: smallest fiscal expansion and the only country in the sample to maintain a primary surplus.
    - Note: "The fiscal data in Figure 3 are on a GFS2001 basis... The data for Korea covers only the central government."
- All six countries introduced measures to support employment, particularly active labor market policies and short-time work schemes (Germany led in STW usage).
- Table 2 (Active Labor Market Policies During the Crisis) summarizes types of measures undertaken across countries.

Box 1 — Active Labor Market Policies Introduced in Response to the Recent Crisis (summarized)
- Two broad policy categories implemented across all six economies:
  1. Policies to sustain labor demand: public work programs (PWP), job creation subsidies, reduction of nonwage labor costs, funding for short-time work (STW) schemes.
  2. Policies to improve employment prospects: job search assistance, training programs, job-finding and business start-up incentives, work experience programs, apprenticeships.
- Country-specific highlights (measures listed as implemented in each country):
  - Germany:
    - reduction in 2009-10 of employer and employees unemployment insurance contribution rates;
    - easing eligibility for STW schemes by simplifying procedures;
    - extension of allowance for STW to temporary agencies’ workers up to end-2010;
    - extension of maximum duration of STW from 6 months to 2 years;
    - new subsidized training for STW.
  - Korea:
    - temporary expansion of public sector job creation schemes;
    - youth internship program for small and medium-size enterprises with wage subsidies for hiring interns at the end of the internship;
    - easing eligibility for STW schemes by reducing the proportion of workers to be reassigned and the minimum training hours to be eligible for STW subsidy;
    - increased employer subsidy for STW.
  - Mexico:
    - partial reimbursement of employer social contributions for new employees registered for social security in 2009;
    - broadening of the temporary PWP to cover all municipalities;
    - a 50 percent increase in the allowed maximum number of days for temporary work;
    - temporary introduction of STW subsidies to support working hours’ reductions negotiated by social partners.
  - New Zealand:
    - permanent reduction in mandatory employer retirement savings contribution and reduction in employee minimum contribution;
    - introduction of a temporary job scheme to support voluntary working hour reductions negotiated between social partners in some sectors.
  - Spain:
    - reduction in employer social contribution for the first two years for new employees;
    - reduction of social contributions for youth and the disabled who start up businesses;
    - funding for PWPs;
    - extension of subsidies for hiring part-time workers to those on STW schemes.
  - Sweden:
    - deferment of two months of employer 2009 social security contributions and taxes until January 2011;
    - permanent increase in hiring subsidy for recruitment of newly-arrived immigrants and those who have been unemployed or sick for more than a year;
    - shortened qualification period for hiring subsidy from one year to six months for elderly unemployed.

#### C. Labor Market Outcomes (select highlights)
- The divergence of labor market outcomes and the effectiveness of policies during the crisis is linked to:
  - the nature of the shocks (temporary vs. permanent),
  - differences in economic structure and labor market institutions,
  - presence or absence of wage rigidities and dual labor market features.
- Evidence summarized across figures and tables (Figures 4–7, Table 1) documents cross-country variation in unemployment changes, short-time work participation, hours worked, real hourly earnings per employee, share of temporary employment, and changes in labor force participation by age groups.

### III. Modeling and Explaining Dispersed Labor Market Outcomes and Assessing Policy Responses
- The analysis attributes differences in employment outcomes to:
  - whether shocks were perceived as temporary or permanent,
  - institutions such as employment protection and wage-setting mechanisms,
  - design and targeting of policy responses (e.g., STW more effective for temporary shocks).
- Empirical and modeling work (including output and unemployment gap estimates, Figure 9 and Figure 8 on real effective exchange rates) supports the role of country-specific shock composition and institutional interactions in explaining outcomes.
- Policy assessment conclusions:
  - Short-time work schemes and targeted labor demand supports are more effective in temporary-shock environments.
  - Where shocks are persistent and sector-specific (e.g., construction), policies facilitating labor mobility and retraining are more appropriate.

### IV. Key Conclusions and Policy Implications
- Policies to support employment are justified during severe downturns, but must be:
  - tailored to the expected duration of the shock (temporary vs. permanent), and
  - sensitive to labor market institutions in place.
- Avoiding increases in long-term unemployment and fall in labor force participation is a key policy objective during severe downturns.
- Structural reforms recommended:
  - Reduce employment protection gaps in dual labor markets to smooth adjustments and reduce abuse of temporary contracts.
  - Improve wage-setting arrangements so centralized coordination can address economy-wide shocks, while firm-level bargaining can address firm-specific shocks.
- Transition strategy:
  - Crisis-driven labor market policies should be phased out in favor of broader structural reforms in the medium term.

*This executive summary is from the IMF Staff Position Note summarized in the provided content.*

### 2. Policies to improve employment prospects for existing workers and those out of work

### 2. Policies to improve employment prospects for existing workers and those out of work

### Country-level policy measures (examples)
- Germany:
  - additional public employment services (PES) staffing to improve job search assistance; and
  - increased funding for training, including for the unemployed.
- Korea:
  - increase in PES staffing and expanded use of private employment agencies; and
  - increased funding for expansion of training places for the unemployed.
- Mexico:
  - increased funding for PES, including job search assistance and job matching.
- New Zealand:
  - redeployment of PES staff to increase job search assistance;
  - partnerships with employers to provide training and job placement for low-skilled youth; and
  - jobs and youth opportunities programs (wage subsidies and training for youth at risk of long-term unemployment).
- Spain:
  - increased funding for PES for job search assistance, training, and vocational education.
- Sweden:
  - increased resources for PES to expand job search assistance;
  - increase in the number of job placement schemes for the unemployed;
  - funding for practical skills development for the unemployed with previous experience and increased financial aid for those who start training; and
  - temporary regular education and training initiatives (adult vocational training/adult education, vocational colleges and universities and colleges).

### Short-time work schemes and temporary public employment
- Short-time work schemes:
  - operated through subsidies to firms for parts of the wage bill, sometimes combined with support for on-the-job training (example: Sweden).
  - in Germany, coverage and duration of benefits and subsidies were extended; participation was substantial following firm-level agreement between management and work councils.
  - participation elsewhere was more limited.
- Germany specific statistics and terms:
  - schemes existed long before the recent crisis, but were made more generous in 2008–09, reaching 1.5 million workers at their peak.
  - the government provided up to 67 percent of former net wages to employees who had agreed with their employers to cut working hours, partially or completely, for up to 2 years (extended from 6 months initially).
- Korea:
  - government temporarily subsidized up to 70 percent of the wages of redundant workers retained by firms.
- Short-term public sector employment programs:
  - Korea introduced in 2009 a program of short-term employment in the public sector for older and long-term unemployed (“Hope Work Program”).
  - Mexico expanded existing programs for short-term public sector employment in infrastructure programs.
  - in 2009, such programs benefited up to 250,000 people in Korea and 700,000 people in Mexico, according to the authorities’ data.
  - authorities’ data suggest that in Mexico about 250,000 workers benefited from short-time work schemes in 2009.

### Safety-net and PES expansions
- Sweden temporarily eased eligibility for unemployment benefits; Spain combined eased eligibility with a permanently increased duration.
- New Zealand increased social assistance for the unemployed.
- Training and job matching programs were expanded in all countries.
- PES expansions included staffing increases and funding for job search assistance, job matching, training, and vocational education.

### Employment outcomes and hours worked
- Employment trends:
  - employment dropped the most in Spain;
  - remained almost flat in Germany;
  - recovered to pre-crisis levels in Korea and Mexico.
- Unemployment rate:
  - rose substantially in Spain;
  - declined slightly in Germany;
  - increased in all other countries (but considerably less than in Spain and from much lower levels).
- Hours worked per person:
  - dropped in most countries, helping avoid excessive job losses.
  - the drop was more pronounced in Germany, Korea and New Zealand.
  - Spain was the only country in which hours worked per worker increased, despite government subsidies for short-time work programs.
- Drivers of Germany’s hours reduction (authorities’ estimates):
  - depletion of working time accounts about 30 percent;
  - short-time work and the lowering of regular working time by one-quarter each;
  - reduction of overtime work by approximately one-fifth.

### Wages, temporary contracts, and productivity
- Wage developments:
  - Korea showed exceptional downward wage flexibility.
  - wages rose in Spain, driven by backward and asymmetric wage indexation in 2009 and rigidities from an intermediate (industry-level) wage bargaining system.
  - real wages were kept broadly constant during the crisis in the other economies but have started rising more recently; compositional effects may obscure downward flexibility.
- Temporary employment:
  - countries with a large share of temporary employment saw those contracts absorb most shocks.
  - Spain had the highest share of temporary employment and experienced the largest fall.
  - authorities’ estimates: about 80 percent of the jobs lost in Spain during the crisis have been for temporary contracts.
  - in Korea, authorities’ estimates suggest that almost all job losses were for temporary employees.
- Productivity and unit labor costs:
  - labor hoarding and the collapse in output led to a drop in labor productivity.
  - manufacturing unit labor costs increased in most countries, particularly in Sweden, followed by Mexico; they have more than recovered in Korea and New Zealand.

### Labor force participation and composition
- Overall participation:
  - labor force participation remained broadly flat across most countries, with slight increases in Germany and Spain.
- Age composition changes:
  - participation increased for the old and dropped for the young, broadly offsetting each other.
  - explanations: older people may have postponed retirement or rejoined the labor market to take part in programs; younger people may have been discouraged or returned to study.
  - exceptions: Germany saw participation increase for all age groups; Mexico saw participation decline for both the young and the old but increase for other groups.
  - New Zealand authorities’ data suggest that studying accounted for about 72 percent of people between 15 to 24 years old who were not in the labor force.

### Role of exchange rates and migration
- Exchange rate movements:
  - depreciation in real effective terms occurred in Korea, Mexico, New Zealand and Sweden, which may have helped absorb shocks.
- Migration:
  - in New Zealand, outflows of workers abroad early in the crisis may have reduced the impact on unemployment.
  - migration to the U.S. did not stabilize Mexico’s labor market during this crisis, according to authorities’ information.

### Modeling, empirical findings, and explanations for cross-country dispersion
- Unobserved components model:
  - confirms substantial cross-country variation in labor market performance.
  - output gaps dropped across the board, particularly in Mexico and Spain, while unemployment gaps increased.
  - the ratio of the unemployment gap to the output gap varies substantially, from close to 1 in Spain to slightly negative in Germany.
- Econometric model:
  - suggests unemployment broadly behaved as expected given the size of the shock, institutions, and policies.
- Industry-level evidence:
  - confirms link between employment growth and shock-absorbing mechanisms: adjustment in labor costs, active labor market policies, and changes in the exchange rate.
  - sectoral shocks are key: Spain’s large unemployment increase is largely explained by sectoral and permanent shocks (notably construction, with high temporary employment share); Germany’s better outcome reflects labor hoarding in response to external but temporary shocks.
- Institutions and policy effectiveness:
  - where shocks were primarily permanent, active labor market policies focused on helping the unemployed find new jobs were more effective.
  - where shocks were perceived temporary, schemes to retain employment and avoid large sectoral adjustments (including reducing working hours) were effective.
  - countercyclical labor market institutions or policies appear to have offset transmission of supply shocks to the labor market in most countries, except Spain, where domestic labor demand shocks tended to amplify cyclical fluctuations (procyclical institutions such as prevalence of temporary contracts and wage rigidities).

### Policy implications and forward-looking recommendations
- Policy design should be tailored to the nature of country-specific shocks:
  - retain jobs following temporary shocks (e.g., short-time work schemes, labor-hoarding support).
  - support sectoral employment movements and reallocation following permanent shocks (e.g., active labor market policies that help workers find new jobs).
- Well-targeted labor market policies can help avoid an increase in long-term unemployment; examples include short-time work and hiring subsidies.
- Many crisis-era policies were temporary and are expiring or have expired to avoid creating distortions.
- Structural reforms to reduce labor market dualism and wage rigidities can improve medium-term adjustment:
  - Spain has adopted labor market reforms expected to reduce dualism and remove some wage-setting rigidities.
  - Mexico is discussing proposals that could increase contract flexibility and improve the link between wages/promotions and productivity, if implemented.

*Source: IMF staff analysis from “2. Policies to improve employment prospects for existing workers and those out of work”*

### Box 2. Shaping Labor Markets Outcomes: Institutions, Country-Specific Shocks and Policy

### Box 2. Shaping Labor Markets Outcomes: Institutions, Country-Specific Shocks and Policy Responses

### Interaction of shocks, institutions, and perceived duration
- The labor market outcomes during the recent crisis were determined by the interaction of country-specific shocks with labor market institutions and policies.
- The key factor in this interaction was the perceived duration of the country-specific shocks.

### Country case findings
- Spain
  - The shock was domestic, sectoral, and persistent.
  - Labor market was segmented and rigid.
  - Adjustment occurred primarily through reductions in temporary employment.
  - Contributing institutional features: strict employment protection for regular employees, backward and asymmetric wage indexation, and an industry-level wage bargaining system not conducive to shock absorption.
  - Labor market policies in response to the crisis proved to be ineffective.
  - The high share of temporary contracts, particularly in construction, proved to be the labor market’s weak link.
  - The drop in employment was substantially more pronounced than the OECD average, particularly in construction and manufacturing.

- Germany
  - The severe external shock from collapse in world demand for manufactured goods was perceived to be temporary.
  - Policies were well-targeted and focused on avoiding job losses and unnecessary labor market volatility.
  - Key strategy: retain jobs through subsidizing a reduction in working hours.
  - Institutional features aiding adjustment: centralized wage bargaining system and relatively inflexible working arrangements before the crisis.
  - Outcomes: Germany is the only country in the sample where construction employment rose during the crisis (reversing an unusual pre-crisis decline) and the only OECD economy in the sample where unemployment declined during the crisis.

- New Zealand
  - The shock was external and perceived as temporary but affected domestic demand substantially.
  - Flexible labor market and decentralized wage determination allowed multiple shock-absorbing mechanisms: wage restraint, declines in hours worked, some increase in unemployment (from a low level), and exchange rate flexibility.
  - Tradition of excellent cooperation between employers and employees supported outcomes.
  - Active labor market policies focused on improving flow of information and matching unemployed with potential job openings.
  - Reduction in working hours took place primarily through direct negotiations between social partners and firm-level agreements, without extensive use of government subsidies.

- Korea
  - The shock was external and temporary.
  - Labor markets are segmented but not very rigid; wage determination is relatively decentralized.
  - Adjustment channels: declines in real wages, hours worked, and temporary employment cuts.
  - Reduction in working hours occurred via both government programs and direct negotiations between employers and employees, depending on sector.
  - A program to reduce long-term unemployment through short-term government job opportunities proved effective.
  - Employment initially fell in most sectors except nonmanufacturing industry and public sector employment, but has fully recovered more recently.
  - Exchange rate flexibility, along with macroeconomic policies and financial sector support measures, may have supported the economy at the onset of the crisis.

- Sweden
  - Affected primarily by external shocks through both financial and real sectors.
  - Concentrated exposures of domestic commercial banks to troubled emerging economies forced credit tightening, reducing private consumption and investment demand.
  - Collapse in world demand for manufactured goods caused contraction in export demand and substantial drop in manufacturing employment.
  - Increased labor market flexibility from reforms in the last decade and crisis-response labor market policies muted impact.
  - Labor hoarding by firms played a role, as firms expected shocks to be temporary.
  - Exchange rate flexibility may have helped absorb external shocks.

- Mexico
  - Hit by multiple external shocks, many reflecting strong real and financial linkages with the U.S., substantial compared with most key emerging market peers.
  - Collapse of world commodity prices and credit tightening by distressed foreign-owned commercial banks magnified the impact.
  - Labor market adjusted through a number of channels, but existing rigidities pushed part of the adjustment onto the informal sector.
  - According to authorities’ analysis, the shift to the informal sector was not as large as in previous downturns.
  - Active labor market policies were strengthened, but not to the extent of some more advanced economies.
  - A weakening of the currency may have acted as a shock absorber.

### Policy implications and recommendations
- Policies to support employment are justified during severe downturns but must be tailored to the expected duration of the shock and existing institutions.
  - Short-time work programs were effective following temporary shocks, but not following permanent shocks (which require policies to facilitate sectoral labor movements).
  - Such schemes were less effective in the presence of severe wage rigidities or in dual labor markets.
- Policies are justified to avoid increases in long-term unemployment and drops in labor force participation during severe downturns.
  - These policies can avoid skill erosion and bring back into the labor force previously discouraged groups.
  - They may have helped increase labor force participation by older groups during the recent crisis.
  - Training programs and incentives to return to school could avoid loss of human capital from increased youth unemployment.
- Reforms to reduce employment protection gaps in dual labor markets could lead to smoother adjustments.
  - Avoiding strict protection for regular contracts and abuse of temporary employees can reduce vulnerability.
  - Encouraging temporary contracts pre-crisis led to fast employment growth but made temporary contracts the weak link during the crisis, causing large overall employment losses and reducing other shock-absorbing mechanisms.
- Wage-setting mechanisms perform best when:
  - Centralized coordination allows adjustment for economy-wide shocks.
  - Firm-level bargains allow adjustment for specific shocks.
  - Backward and asymmetric wage indexation and industry-level wage bargaining became binding during the crisis and led to worse employment outcomes.
- Crisis-driven labor market policies should give way to broader structural reforms in the medium term.
  - In addition to macroeconomic policies to support aggregate demand, there is scope for labor market policies early in the recovery.
  - Maintaining crisis policies over the medium term could lead to distortions.
  - Structural reforms that make labor markets work better and improve the business environment could support sustainable output and employment growth.

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2010/_spn1018.pdf_