Tuesday, 1 February 2011

Unemployment: a ticking time bomb ?

Here is another post with some historical reference but this time the flashback is really brief, so don’t worry. It’s not that I am obsessed with history it is just that I believe that we can learn a lot from what happened in the past, since human nature (the driver behind everything) never changes. I hope you don’t get bored…

In the late 80s – early 90s, Finland faced a severe recession. Deregulation in the banking sector during the 80s, made loan financing cheaper and brought a massive influx of capital. Corporate and household lending exploded and as is usually the case, lending standards were lowered in order not to lose or to gain market share. Of course, this is never wise and the final outcome is almost always predictable: a banking crisis…

The banking crisis happened pretty much the same time as in the other Nordic countries (Norway and Sweden). But I don’t want to focus on the banking crisis or its resolution in this post, I want to focus on the rebalancing that the Finnish economy went through these days.

The trigger that set off the banking crisis was a mixture of events going on at about the same time each of them adding further pressure. Efforts to defend the Finnish Markka (the national currency back then) peg, as well as the German unification in 1990 led to a rise in interest rates in Finland. This made debt more difficult to service. The collapse of Finnish exports towards the Soviet Union after its collapse in 1991 made a large part of the over-leveraged corporate sector unable to cope and corporate defaults surged. The result was a sky-rocketing unemployment rate and a deep recession.

The unemployment rate from about 3% exploded to 18%. Well, that’s what a really severe recession will do to you.

source: Bank of Finland

Another point that I want to highlight is that the crisis was followed by a rebalancing in the Finnish economy during which traditional sectors such as forestry and paper industry were overtaken in importance by more high-tech sectors such as electronics and biotechnology (while forestry and paper industry remain important).

This was a pretty dramatic shift since the “new” sectors had nothing to do with the older ones. This is where structural unemployment comes in. A lot of the people fired because of those sectors waning in importance and financial health will maybe face difficulties finding employment in the “new” sectors since the skill-sets required are completely different.

Some of these people will retrain and find jobs in different sectors or maybe will seek employment in less knowledge – intensive sectors. But not all of them will, those who don’t are now part of the structurally unemployed.

In Finland, even 10 years after the recession broke out, unemployment stood at almost 10%, a proof that these things certainly take time. The lowest that unemployment got was 6%, just before the present crisis, still double the rate it was before the 1990 recession. It seems that some of the workers fired back then never managed to become part of the new economic reality.

What I find particularly interesting are the analogies that can be drawn with Greece. Because of the crisis, the Greek economic model is being altered too. It mainly consists of state employment (which for now is not being affected, apart from temporary workers), employment in the retail trade sector and employment in the construction sector (the problem with this particular sector is that I don’t how much of its workers were there through formal contracts and how many through informal ones). Two out of the three pillars of the present model are being hit especially hard because of the crisis.

I think that unemployment is much higher than what the figures show for a multitude of reasons: unemployed people not being registered, informally employed people now being unemployed etc.  

source: statistics.gr

Below there is a graph showing employment in a couple of sectors as a percentage of the total labour force. (the de-industrialization of Greece is obvious)

source: statistics.gr, own calculations

For a little while I expect the share of retail trade in total employment to remain almost constant at these levels (as a %) but sooner or later it has to decline, especially if public sector lay-offs materialize.

The only sector where employment is rising is agriculture. To tell you the truth, this is something that I expected to happen but not that soon, maybe a bit down the line seemed more likely to me. I don’t know if this is a temporary hick-up but I expect this trend to strengthen in the not so distant future since this is one of the few sectors that maybe Greece has a comparative advantage. When unemployment in cities becomes rampant I think that some people will flee back to their hometowns or home-villages and get employed in more traditional lines of business like agriculture. Also, in the short term, when there is no way for the Greek economy to rebalance, I expect more Greek people to do jobs that were until recently looked down on and in most cases taken by foreign immigrants.

Now look at a chart about long-time unemployment (the y-axis displays 000s of unemployed workers). These are the people more likely to get discouraged from looking for a job.

source: statistics.gr

With the economic boom of the 00s long-time unemployment declined but it has started to rise at an alarming pace. I expect this to go on for a long time as falling demand feeds through the economy. My view is that especially high long-term unemployment is likely to cause several social problems, such as homelessness, a potential rise in criminality and many more. Maybe then a rise in unrest down the line, when people start to become desperate and outraged over their situation. So the fact that we don’t see unrest right now doesn’t mean that we are not going to in the future. Maybe it takes more the form of higher criminality than protests but to be honest I really don’t know. I just hope to be proved awfully wrong, since this is not going to be pleasant…

When thinking about this post my intention was to argue that elevated levels of long-term unemployment over a long time usually lead to this unemployment becoming structural. Data from Finland support this since unemployment rate there never got quite that low as before the 1990s recession. Keep in mind here that we are talking about a model rebalancing and still structural unemployment soared after the crisis. I have to say that I am not able to picture any rebalancing taking place in Greece and I shiver in the thought of how high will structural unemployment be after we exit this crisis…

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