ANNUAL REPORT 2008 - Polymer Bank Notes of the World

Box 5LABOUR MARKET DEVELOPMENTS IN THE EURO AREA IN 2008After three years of buoyant employment growth and rapidly declining unemployment, euroarea labour markets experienced a clear slowdown in 2008. Unemployment started to risein the second quarter of the year, reaching 8.1% by the end of 2008, while the annual rate ofemployment growth slowed to 0.8% in the third quarter, more than 1 percentage point below theaverage rate for the previous year. This box examines the factors behind the downturn in euroarea labour market developments.In general, developments in labour market variables tend to lag those in economic activity.Chart A shows employment growth clearly lagging economic growth. When a fall in demandfirst occurs, firms do not know whether this fall is temporary or likely to be more persistent.They therefore tend to react by maintaining production and employment levels, leading to abuild-up of inventories of unsold goods. If, over time, the fall in demand becomes more persistent,firms need to stop the excessive accumulation of inventories and start reducing production.However, they still generally maintain employment levels. When employers are uncertain aboutthe probable depth or duration of a downturn, they are likely to adjust labour input by varyingworking hours rather than the number of people employed. The reasons for this are clear: giventhe significant costs involved in recruiting, training and dismissing staff, employers are reluctantsimply to “write off” their investment in staff until they are convinced that a downturn in productmarkets is likely to persist. Consequently, firms prefer to maintain employment levels and cutproduction via a reduction in capacity utilisation (e.g. a shortening of hours worked or a declinein output per worker). While it is not immediately apparent from recent quarterly data (owingto the distortionary effect of the early timing of Easter in 2008), some slowdown in the rate ofgrowth of hours worked seems to have occurred in the course of 2008 (see Chart B). Averaginghours worked in the first half of 2007 and those worked in the first half of 2008 shows a sharpdecline in the growth rate of total hours worked (down from around 1.7%, on an annualisedbasis, in the first half of 2007 to just over 1.2% in the first half of 2008; see the dotted line).Moreover, in 2008 working hours, rather than the level of employment, seem to have played anincreasingly important role in determining developments in the growth of total hours worked incomparison with previous years.It is only when the fall in demand and the required cutback in production are expected to bepersistent and large that a significant reduction in employment levels is observed, as firmsseek to cut labour costs. A marked deterioration in labour demand is likely to hit first thosecategories of workers with more flexible working conditions, such as temporary workers, whoare less costly to lay off. There is now considerable empirical evidence that developments intemporary employment exhibit different patterns to those in permanent employment in periodsof weakening activity and economic downturn. 1 As is often the case in the early stages of aneconomic slowdown, in 2008 temporary employment growth declined more rapidly thanpermanent employment growth (see Chart C).1 See, for example, S. Bentolila and G. Saint-Paul, “The macroeconomic impact of flexible labor contracts, with an application to Spain”,European Economic Review, Vol. 36, 1992, pp. 1013-1047; B. Holmlund and D. Storrie, “Temporary work in turbulent times: theSwedish experience”, Economic Journal, Vol. 112, June 2002, pp. F245-F269.ECBAnnual Report200867