Global Daily – A large amount of slack has built up in the labour market

The eurozone labour market has deteriorated rapidly during the pandemic, despite the wide use of government subsidised short-time work schemes (STW). STW is designed to allow companies to temporarily reduce the number of working hours of employees (often to zero) while keeping them on the payroll. The government reimburses the companies what they have paid to these employees, which often is around 70-80% of their normal hourly pay. According to the methodology used by national statistics bureaus, all persons that are in STW are recorded as being employed, even when working zero hours. Despite the use of STW, employment dropped by 2.2% (equal to 3.6 million jobs) during the period 2019Q4-2020Q3.

Compared to the drop in employment,  the rise in unemployment (by around 1.8 million people) was relatively limited during the first wave of the pandemic. The gap between job losses and the number of unemployed can largely be explained by a 1.1 million rise in the people that have become marginally attached to the labour market during the first three quarters of 2020. These people do not meet the strict criteria for unemployment that is used by statistical bureaus in the eurozone and by Eurostat (people that are without work, and are available to start working within the next two weeks and have also actively searched for work in the last four weeks), but are very close to officially being registered as unemployed. Including these marginally attached to the official eurozone unemployment rate would lift the unemployment rate by around 1 percentage point.

Finally, slack in the labour market has built up due to the fact that a large number of people have become inactive, meaning that they have withdrawn from the labour market (around 1.7 million people, which is equal to around 1% of the active population). They are a source of future labour supply, which will prevent the labour market from becoming tight when employment growth does eventually pick up.

We expect another drop in employment during the second wave of the pandemic in 2020Q4-2021Q1, when GDP is expected to contract. The unemployment rate will probably rise again during this second wave and extra labour market slack is expected to build up. On top of that, a proportion of the people that are in a STW are at risk of losing their jobs when the government withdraws support as lockdown measures are eased (likely later this year). The graph below shows that in Germany and France a significant proportion of employees still was in STW by the end of 2020. It seems that this – at least partly – reflects hidden unemployment, which will result in a rise in actual unemployment when government subsidy is withdrawn.

For instance, industrial production in France and Germany has rebounded sharply after April 2020 and has not been hindered by new lockdown measures since then. In France, manufacturing output was merely 3% below pre-pandemic levels in November and in Germany around 3.5%. Still, in France 19% of all employees in the transportation industry and 15% of employees in other industrial companies still were in STW in November. In Germany 8.5% of all employees in manufacturing still were in STW (see graph below).  In Germany’s metal industry more than 15% of all employees were in STW in December and in mechanical engineering 15% as well. The fact that STW schemes were still widely used in these parts of Germany’s manufacturing sector, suggests that the use of the STW represents some hidden unemployment. This means that there is a high probability that a significant proportion of these employees will lose their jobs after all if the STW schemes are scaled back. All in all, we expect the unemployment rate to rise to around 10% by the end of 2021.

As declines in labour market slack tends to be sluggish compared to increase in economic activity due to hysteresis effects, it will take a while before slack in the labour market diminishes. This will probably keep wage growth and inflation subdued in the next few years.