11 November 2014

An Italian train wreck


The current situation in the Italian labour market—if it can be called that—is a textbook illustration of all that can go wrong when bad economic ideas obtain a secure institutional home, from which it is impossible to dislodge them.  On that cheery note, I have no magic bullet that can dislodge labour’s political dominance backed as it by the threat of collective union power sufficient to shut down a nation.  But I can dissect how labour and socialist dogmas have provided a veneer of respectable intellectual cover for the current downward, seemingly inexorable, spiral.  Just as good ideas can save a nation, so bad ideas, widely accepted, can lead first to economic stagnation and then to political and social unrest.

In this regard, the linchpin of the Italian labour is its notorious Article 18, which provides that if a court determines that any worker in a firm with more than 15 workers who is discharged without cause is entitled to receive back pay plus reinstatement .  The niceties of “without cause” leads to endless disputes over the facts and circumstances of individual cases, all to be decided before judges who per force adopt the view that these dismissals are commonplace events.  The heavy probability of a loss, thus introduces a deadly cycle.  Firms are afraid to take the risk of dismissal, lest they be left worse off than before.  Knowing that they are unable to fire without a struggle, they cut back on hiring permanent workers.  Instead their path of least resistance is not to hire new permanent workers, so that a two-tier labour market develops in which older workers bask in union protection while younger workers, if they don’t emigrate, move in and out on the fringes the labour market, without any opportunity to acquire marketable skills or build up sufficient capital to live on their own.

Unfortunately, in politics as in war, the advantage lies with the defence. The efforts of former Prime Minister Mario Monti current Prime Minister Matteo Renzi to reform the mess has been stymied by the unions led by Susana Camusso, whose earthy truculence has proved more than a match for the professorial Monti and the youthful Renzi. The consequence is that the Italian unemployment rate has moved up to 12.6 percent in July, 2014, with no sign of it being brought back anytime soon to single digits, which it had as recently as 2011.

It is fair to ask why it is that the rates of unemployment have spiked so sharply in the past three years, when no official changes in labour policy can account for that shift.  The answer in large part depends on the synergistic relationship between labour and the stagnation in other market sectors, most notably the banking industry. As the overall economy in the European Union heads south, its pre-existing weaknesses become still more significant.  Those fortunate employees with protection become ever more determined to safeguard their prerogatives, which means that the burden of the economic slowdown is cast disproportionately on firms subject to the vagaries of consumer markets, and the employment market fringe.

What is so utterly striking about this situation is the modest nature of the reforms that have provoked so dramatic a response.  The biggest item on the table is that dismissed workers be given some form of compensation from the state which is no longer tied to their continued work at the firm.  That particular solution may ease some of the rigidities of the labour market, but at a high cost.  The first is that it will induce these workers to stay out of the labour market to collect their pound of flesh, and will therefore add to the Italian budget burden that arises whenever government seeks to pile additional transfer payments on an unproductive economy.

It is important therefore to note what a forthright and sensible reform of the labour markets should look like, if only to stress how far off base the current Italian reforms are.  For many years now I have taken the view that the only solution lies in a competitive labour market.  That competitive market is desired in labour for the same reason that it is desirable in all markets for real estate, financial services, or consumer goods.  The interplay of supply and demand does not produce some imaginary benefits that are hard to identify. Rather, the constant entry and exit of different individuals and firms in a market leads to a situation where the gains from trade are more completely realised.  Workers that do not like their current position can look around for new jobs, knowing that they will not be walled off from personal advancement by the iron gates put around other employers.  Employers will bid up wages to allow them to meet production targets for their various markets.  Socialists of all stripes assume that wages will collapse without unions to fight employers, and in so doing they forget that the only way to have across-the-board forms of social improvement is through productivity gains that only free labour markets can secure.

In my view, the need for competition is so imperative that I would resort to the traditional rule that allowed for the vast growth in English and American labour market before the desultory reforms of the early 20th century, most noticeably the Trade Disputes Act of 1906, which unleashed union monopoly power.  The correct rule is the antithesis to that act—it is, pace Camusso—to allow employers to hire only those workers who agree not to join unions while in their employ.  That tactic is the single most efficient method to limit the scope of union power.

The introduction of this system will of course cause much initial dislocation, precisely because the labour rules are so rigid and obsolete.  But there really is no other choice but to break some china. Yet it is worth noting that the damages will be far less with a strong move to open markets than with modest gimmicks of uncertain desirability.  In the 1990 I worked on labour market reform in New Zealand, which was able to bring that nation back from the brink of ruination by sharply cutting down on the number of unionised workers.  The immediate impact was a short-term decline in wages, as the monopoly protection of union workers worked its way out of the system.  But within short order the productivity gains pushed wages upward, just as the standard neoclassical theory of competition predicts, bringing in that small country 600,000 new jobs.

The ideal set of legal rules to bring about these changes depends critically on adopting a legal regime that allows that an employer, or employee, to insist on a contract at will, which allows the former to fire for good reason, bad reason or no reason at all, and conversely, provides the exact same protection to workers, who will exercise their quit option if better opportunities arise.  It is easy to point to individual cases where irrational employers will fire workers for no reason, but hard to identify these instance in practices, for the simple reason is that employers do not make money when they put the squeeze on those employees who are the lifeblood of their business.  Bad news travels fast and employers who treat their workers badly pay a very heavy price in seeking to retain their other workers or recruit new ones.  At the same time, an open labour market makes it easier for the good employee who has been displaced to find another job.  It is never an adequate response to say of any reform that it will from time to time yield bad outcomes.

The question always has to do with the relative imperfects.  On that core the choice is easy.  The huge sums of money that now go into micromanaging the system may supply substantial economic rents to union leaders like redoubtable Ms. Camusso, but they wreak havoc with the opportunities of those many part time workers who find themselves bound by her edicts.  Labour markets under contract at will experience far less abuse than the current system.

The brute truth is that either Italy reforms its labour markets or the downward spiral will continue.  There is no way that any fancy stimulus program can miraculously offset the structural imperfections in the labour markets.  Even under ideal circumstances these programs never work, for while they supply cheap credit for businesses, they reduce the willingness of individuals to lend out capital for such puny return.  Two wrongs never make a right, so either the labour reforms are undertaken or the so-called financial reforms will prove useless or worse.  Either Italy faces down its own unions or it will continue to stagnate.  Margaret Thatcher, where are you now when the Italians need you so desperately?

Richard Epstein is the Laurence A. Tisch Professor of Law at the New York University School of Law, The Peter and Kirsten Bedford Senior Fellow at The Hoover Institution, and the James Parker Hall Distinguished Service Professor of Law Emeritus and Senior Lecturer at the University of Chicago.