Spain versus Ireland
Another example that highlights the heterogeneity within the European labor markets is Spain versus Ireland.
Spain and Ireland both experienced large employment destruction in the construction sector after the Lehman shock. However, they fared differently during the sovereign debt crisis. Ireland’s unemployment stabilized and then fell. In Spain it increased until January 2013. From 2011 to 2013, structural unemployment increased by ~0.5% in Ireland. It increased by more than 2.5% in Spain.
The difference could be attributed to the citizens’ migration from the country in search for employment. However, it’s mainly the difference in the labor markets’ flexibility in Spain and Ireland. This has led to the difference in unemployment rates between the two countries.
Ireland’s flexibility versus Spain’s rigidity in labor markets
Ireland entered the crisis with a relatively flexible labor market. It adopted more labor market reforms under its European Union (or EU) International Monetary Fund program that started in November 2010. In contrast, Spain entered the crisis with strong labor market rigidity. Labor reforms only started in Spain in 2012.
The firms’ ability to adjust to the new economic conditions has already been impacted in Spain. As a result, nominal compensation per employee continued to increase in Spain until 3Q11. This was despite a more than 12% increase in unemployment during that time. In Ireland, the downward wage adjustment started in 4Q08. It proceeded quicker.
The Irish labor market controlled labor costs through downward wage adjustment. The Spanish labor market forced firms to reduce total labor costs by reducing employment. In Spain, this burden was concentrated on a less protected group. It concentrated on people who were employed on temporary contracts. This accounted for around one-third of all employment contracts in the country before the crisis.
Reforms have had a positive impact on Ireland’s economy. This is also reflected in the performance of exchange-traded funds (or ETFs) that invest in Ireland like the iShares MSCI Ireland Capped ETF (EIRL). Since 2013, the EIRL has even outperformed the iShares MSCI EAFE ETF (EFA). The EFA invests in Europe. It also invests in stocks like Novartis AG (NVS), Toyota Motor Corp. (TM), and HSBC Holdings Plc (HSBC).