Benito Arrunada on the need to reform the Spanish labor market

This EALE blog invites many kinds of postings, concerning both theoretical and policy related issues. The idea is to become a forum for the exchange of wide-ranging ideas touching upon (European) law and economics. Here is a posting concerning the need for labor reforms in Spain. Please feel free to send me something. - Henrik (hl.ino@cbs.dk)

`Labor reform as an ethical imperative´

Prof. Benito Arrunada, Dept. of Economics & Business, Univ. Pompeu Fabra

Spain has the most restrictive labour law of all developed countries. As a result, it also has the highest unemployment.

The rules that weigh down industrial relations today stem from those laid down formulated under Franco. Why are they still alive 34 years after the death of the dictator?

Some people may think that the labour laws are wrong but well-intentioned. I do not believe this. The State, in its zeal to protect workers, is unlikely to have forgotten that a contract is only possible when all parties agree. The problem does not lie in the State’s paternalistic myopia but in the unequal way it treats its citizens.

In Spain, there are two types of worker. On the one hand, the élite which enjoys “placements” in the public sector and large corporations. On the other, temporary workers—mostly young people, women and immigrants—as well as marginal, self-employed workers.

This duality is apparent throughout the Spanish labour market, especially in access to long-term, stable jobs.

More than ever, we need stable jobs, in which workers can gain experience and accumulate knowledge. But stability is reserved for the labour élite. Today’s permanent contracts do not promote long-term relations because employers are obliged to continue paying their workers, whatever their productivity and attitude.

Obviously, employers take precautions. Firstly, they avoid long-term employment, replacing work by capital and long-term by short-term work. When they have no alternative and they have to hire long-term workers, they choose people they can trust, who will be productive even when they have a contract in which abuse is possible. So the people they hire are those able to signal that they will be cooperative in the future. And such signals, considering the calamitous state of education in Spain, are only within the reach of the well-off and the well-connected.

Entrepreneurs are being criticised for not hiring more workers. But it is no coincidence that there are few Spaniards who want to be entrepreneurs, and even fewer who want to be employers. This vocational crisis can be seen even in schools of Business Administration in regions that once proclaimed their entrepreneurial spirit. This is not just because entrepreneurs are viewed with suspicion: in a society that worships money, the fact that young people do not wish to be entrepreneurs suggests that business is not very profitable.

Temporary contracts are also a tool for inequality—not because they are temporary, but because they cannot be extended. This restriction prevents them from being used for long-term relations without the risk of opportunism. Long-term relations are thus reserved for the labour élite which is able to offer the right signals.

What’s more, there is tremendous hypocrisy regarding temporary contracts. Their fiercest critics are often the first to use them for their own employees, as has occurred with some trade unions.

And employers’ organisations are not free from blame. They say they are in favour of making contracts more flexible, but seem to be less than enthusiastic about an equally necessary measure, that of liberalising the negotiation of collective agreements. Perhaps they are afraid of undermining their raison d’être.

The crisis is exacerbating discontent, and these inequalities will end up being intolerable. The privileged half of the country cannot continue to live at the cost of the other half. If it wants to keep its standard of living, it will have to work for it. It is time for popular sovereignty to do away with privileges, and restore the forgotten values of justice and equality of opportunity. Labour reform is an essential first step to achieve the fair and open society that we all want.

Europe Needs A Sovereign Bankruptcy Procedure

By Hans-Bernd Schäfer

The bailout for Greece has spoiled the reputation of Chancellor Angela Merkel so much, that almost nobody in Germany wants her in charge when the next crisis unfolds. First she was not far sighted enough to see the upcoming danger and when the danger was clear and present she was not courageous enough to fight for the right decisions. First she subordinated the problem to internal affairs like a provincial election and insisted that this is only a problem between Greece and its creditors. Later she was overrun by coordinated efforts of banks and other creditors to grant a complete bailout.
What went wrong? The fathers and mothers of the EURO simply ruled out the possibility that a member of the Euro-Zone might default. Had they studied financial history they would have known that sovereign bankruptcies are in the long run as numerous as snowflakes. The Greek crisis would have been swiftly solved without any impact on the credibility of the Euro, had a sovereign bankruptcy procedure been in place, as it already exists for cities in the United States. When in the USA a large city goes bankrupt that does not even cause headlines around the world, let alone affects the strength of the dollar. Greece however, with an economic weight of 2.6% of the Euro area’s GNP could send the Euro into decline, because no orderly procedure existed to deal with the crisis.
A well-ordered method for sovereign bankruptcy should observe in particular the following four objectives, including the appropriate legal instruments. First of all, after the government of the debtor nation has declared sovereign bankruptcy, the creditors – just as with normal insolvency proceedings – should remain inactive to generally prevent the draining off of foreign currencies. This limits the effects of the crisis on the real economy. Secondly: the proceedings should create incentives for the debtors and creditors to keep from carelessly or even thoughtlessly increasing the foreign debt. These proceedings also allow outsiders to impose harsh terms and reforms on all offers of help to the nation whose debt is to be restructured. It includes prescribing a haircut for creditors by reducing interest payments or writing off a part of the debt and reduce it to a sustainable level. When this occurs, the insolvency proceedings cast a long shadow on the behavior of the creditors and debtors at the time the loan was given. It leads to ex ante efficiency of insolvency proceedings. Thirdly, the conditions of the economic policy in the debtor nation should ensure minimum standards for the maintenance of essential public services. Fourthly, an independent person or committee, who neither follows personal interests nor is dependent on the interests of third parties and is in the position to weigh the interests of all parties and make reasonable judgments, should coordinate the proceedings, for instance a European or International sovereign insolvency court.
If well-regulated insolvency proceedings had been established, Greece would have declared sovereign bankruptcy when mature bonds could no longer be refinanced. Greece could have then submitted an application to open proceeding to restructure its debt at an institution created for just this purpose. The application would have lead to a moratorium that would have prevented a sudden reduction of Greek debt by seizing foreign assets and the following notorious hemorrhaging. In official proceedings the application would have then been examined to determine which sanctions could be imposed on the nation. The state would receive a bridging loan or other help. The loan could either come from the IMF, other European countries or state banks. The holders of government bonds as well as bank loans would be called to pay for and receive a so-called haircut. If such a haircut would have endangered certain banks, which are too big to fail, the governments could have come to rescue the banks but not the equity capital of their owners. These proceeding would not have endangered the stability of the Euro. In fact, it would show that a difficult financial crises can be surmounted by the use of a well-ordered and legally conceived proceeding. The rules of crisis management would stem the danger of future crises and not expand them.
In the absence of any legal framework the governments of the Eurozone agreed on a complete bailout, which gives the wrong incentives to creditors. For a period of three years all Greek loans, which become due are replaced with credits from governments of the Euro Zone. After 3 years one third of all Greek debts will be shifted to the taxpayers in the Euro Zone without any burden to the creditors themselves. This is a bailout, giving creditors even more incentives to careless lending and spending resources to receive government support. And this is not even the end of the story. Even though Greece can replace all its due capital payments with new loans from the bailout package, the European Central Bank has started to buy huge amounts of Greek government bonds.
At best the bailout package has bought three years of time. After 3 years the Greek debt will be higher than today, then about 150 per cent of the national product. The huge reforms within Greece will have disrupted the economy, as the public sector will shrink and it takes more than three years for the private sector to provide almost a million of new jobs. To send Greece back to the capital markets after 3 years will most probably not work. Latest then a debt restructuring including a sizable haircut for Greek’s debtors will be unavoidable. It is to be hoped that the governments of the Euro zone come to realize this and invest their time into drafting a debt restructuring procedure which works and does not lay the foundations of more crises in the future.

Why is Law and Economics more influential in the US?

After reading the excellent article referred to below by Professors Martin Gelter and Kristoffel Grechenig on the reasons why European legal thought has embraced law and economics much less than American legal thought has, I asked them if they would write a posting about it.
Feel free to comment on this posting by Prof. Grechenig (you can comment, or send a longer posting to me at hl.ino@cbs.dk). - Henrik

Some History of Legal Thought and Its Influence on Law & Economics

by Kristoffel Grechenig, Dr., LL.M., University of St. Gallen, Switzerland & Max Planck Institute for Research on Collective Goods, Bonn, Germany

I widely agree with H.-B. Schäfer, when he says that the impact of law and economics on legal scholarship is increasing (blog post, 30/5/09). In order to understand why there are still differences between U.S. legal scholarship and German-tradition legal scholarship with regard to law and economics, it is essential to understand the historical development of German "legal science". I believe that there are two main factors for this transatlantic divergence: First, legal realism enjoyed great success in the U.S., whereas the German free-law movement failed to leave a lasting impression. While legal realism transformed American legal thought and opened up the discourse to policy arguments, the predominant German legal theory for a long time emphasized and still emphasizes the internal coherence of the legal system; it assigns only a limited role to external elements. Second, the different philosophical roots and attitude towards utilitarianism and consequentionalist thinking in general had an impact on legal scholarship such that a resistance to consequentialism in Europe implied a resistance to law and economics. To be clear, quite a bit has changed in the past due to the work of the people who have posted on this blog and many others. The point is that a general and widespread acceptance will depend, among other factors, on how well the historical basis of legal doctrine has been understood. For more on the historical development please see the article by Martin Gelter and myself published in the Hastings International and Comparative Law Review, Vol. 31, No. 1, 2008, http://ssrn.com/abstract=1161168).