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The evolution of the aggregate unemployment rate conceals fairly wide differences across EU countries. In 2010, the unemployment rate remained persistently above the pre-crisis level in most of Member States, the recovery of output notwithstanding (Graph I.2.1). Unemployment started to fall in the first half of 2010 only in a few countries (Czech Republic, Germany, Belgium and Italy).

In countries hit by the bust of the housing bubbles cycle and by the effects of the financial crisis the unemployment rate kept rising to reach new historical records. In spite of the significant decline in the second half of 2010, the unemployment rate remains among the highest in Latvia, Spain and Estonia.

Overall, unemployment dispersion has increased markedly both within the euro area and the EU. A

Graph I.2.3: Changes in the unemployment rate (2008Q1-2010Q4, in pps): actual and Okun's Law prediction -2 2 6 10 14 18 LV IE EE LT EL SI _HU IT DK RO UK FI ES PT NL FR CZ LU DE SE SK BG BE AT CY MT PL Actual Predicted

(1) The bars represent changes in the unemployment rate from 2008Q1 to 2010Q4 (in pps). The predictions come from a panel estimation of the Okun's Law with dependent variable the change in the unemployment rate and the explanatory variables lagged unemployment and current and lagged GDP growth see footnote in the text.

Source: Commission services.

large share of unemployment is concentrated in relatively few countries. Spain alone, with 2 million more unemployed, accounted for respectively half and 1/3 of the increase in total unemployment in the euro area and the EU respectively. Before the recession, Spanish unemployed represented 12% of total EU unemployment, a proportion comparable to its share in total GDP. In 2010, this proportion reached 20% (Graph I.2.2), going well beyond the share of the largest Member States. An opposite evolution has been taking place for Germany, the country with the largest labour force in the EU: the German share in total EU unemployment declined from 20% in 2008 to 12% in 2010.

Graph I.2.2: Unemployment in the euro area countries: percentage share of total euro area unemployment 0% 5% 10% 15% 20% 25% 30% ES DE FR IT EL PT BE NL SK IE FI AT EE SI CY MT LU Source: Eurostat, LFS.

The rising dispersion in unemployment rates is attributable not only to the fact that the crisis hit national economies to a different extent, but also the additional economic, institutional, and policy- related factors that explain a different response of unemployment to economic activity and different risks that unemployment could become entrenched.

The Okun law predicts a relatively stable response of unemployment rates to GDP growth: each additional point of growth is expected to be associated with a less than proportional increase in the unemployment rate, according to most estimates close to 0.3%. Graph I.2.3 reports the observed change in the unemployment rate (2008Q1-2010Q4) and that predicted on the basis of country-level Okun's law estimates. (15) It appears that for most countries the increase in unemployment is lower than predicted by the Okun law. This evidence confirms the relevant role played by adjustment of working hours during the recession in a number of EU countries. However, in a few member States, notably Spain and Bulgaria, unemployment had a strong response to GDP. These different unemployment responses were to a large extent linked to the interplay between structural and institutional factors. The strong increase of unemployment in countries affected by the bust of housing bubbles was not only due to the severity of the recession but also to the fact that adjustment of working hours and labour hoarding was less present in the shrinking construction sector, while the dismissal of workers with temporary contracts more pervasive.

(15_{) The Okun's Law has been estimated with OLS and robust}

variances on a cross-section of the 27 Member States over the period 1983Q1-2008Q1 (2008Q1 is the peak quarter of GDP); the panel is unbalanced due to data availability.

European Commission

Labour Market Developments in Europe, 2011

Box I.2.1: Regional unemployment in Spain and Italy

Highly persistent regional disparities are a distinctive feature of the Italian and the Spanish labour market: regional unemployment disparities within these countries are at least of the same magnitude as that across EU countries. These disparities are also persistent, since the ranking of regions repeats unchanged over time. In spite of some improvements in the last decade, joblessness in Italy remains concentrated in the Southern regions, while Northern regions are close to full employment. A similar, pattern is observed in Spain, with

Southern regions like Andalusia and Extremadura exhibiting the highest unemployment rates, and other

regions like Navarra, La Rioja and Aragon with much lower unemployment. During the boom of the years

of the 2000s, spatial disparities declined owing mainly to the fall in the jobless rate in high unemployment regions. However, the rate of employment creation was unsustainable and mainly related to a roaring housing sector. When the burst of the housing bubble hit at the end of 2007, regional differences in

unemployment widened considerably, and in Murcia and Castilla la Mancha, where construction absorbed

about 17% of total employment before the crisis, unemployment soared to record high levels.

Large and persistent regional disparities can be explained by structural and institutional features related to i) differences in job creation linked to an unequal distribution in space of dynamic economic activities and declining sectors; ii) differences in the skill-composition of the workforce; iii) agglomeration externalities stemming from the concentration of specialised activities or from market size; iv) cultural, institutional, and policy factors that prevent mobility and the acquisition of the required skills.

Among the latter group of factors a role might be played by public employment. These factors often reinforce each other. For example, a high wage premium for public jobs in Southern regions may induce the young of the South may not only prevent mobility to the North, but would tilt education choices to the public sector, which would in turn raise the dependency on public employment (e.g. Alesina et al., 1999; Dell'Aringa et al., 2005).

The structure of collective bargaining can also foster unemployment disparities when the level at which bargaining occurs does not allow to take into account territorial difference in the levels of productivity. It is suggestive a comparison between Spain, where collective bargaining takes place mainly at provincial and industry level, and Italy where bargaining at the sectoral national level prevailed. Graph 1 suggests that in Spain regional disparities in unemployment rates are only weakly associated to differences in the real unit labour costs. This is not the case of Italy, where regions with unemployment rates higher than the national average have also unit labour costs higher than the average. Thus, the predominance of sectoral bargaining at the national level appears to be associated to a larger unemployment dispersion across regions. This phenomenon is not equally evident in Spain, possibly in light of the fact that bargaining is more decentralised, thereby allowing wages to better reflect productivity differentials between different regions.

Galicia Principado de Asturias Cantabria País Vasco Comunidad Foral de Navarra La Rioja Aragón Comunidad de Madrid

Castilla y León Castilla-la _Mancha Extremadura Cataluña Comunidad Valenciana Illes Balears Andalucía Región de Murcia Canarias (ES) 0.0 0.5 1.0 1.5 2.0 2.5 0.9 0.95 1 1.05 1.1 U n e m pl oy m ent ra te - nati o n a l a v er age =1

Real unit labour costs - national average=1

Spain Piemonte Valle d'Aosta Liguria Lombardia Bozen Trento Veneto Friuli Emilia- Romagna

Toscana Umbria Marche Lazio Abruzzo Molise CampaniaPuglia Calabria Sicilia Sardegna 0 0.5 1 1.5 2 2.5 0.9 0.95 1 1.05 1.1 U n e m pl oy m e n t ra te - nati o n a l a v er age =1

Real unit labour costs - national average=1

Italy

Graph 1:Regional unemployment and relative unit labour costs

Another factor that explains the heterogeneous unemployment response is the different degree of adjustment in wages. As reported in Chapter III, developments in nominal and real wages varied quite widely across the EU since the recession. Moreover, the adjustment of wages to the labour market slack has been taking place with lags.

Graph I.2.4: GDP and employment growth in the EU (changes over the period 2008Q2-2010Q4)

BE BG CZ DK DE EE IE EL ES FR IT LV LT LU HU NL AT PL PT SI SK FI UK -20 -15 -10 -5 0 5 10 -20 -10 0 10 GDP growth E m pl oy ment gr o w th % %

Source: Eurostat, National Accounts.

Looking forward, unemployment disparities will be linked to a relevant extent also to the capacity of countries to absorb high unemployment rates and fight structural unemployment. Although structural elements will play a major role in this respect (in particular, unemployment will be harder to absorb where linked to a relevant process of sectoral reallocation), supportive policy frameworks will also play a role. Notably, adequate and effective Active Labour Market Policies would be needed to support the search activities and re-train the long-term unemployed. In some countries, however, an effective strategy for the reduction of unemployment may require more far reaching reforms. Box I.2.1 discusses the cases of Spain and Italy, two countries where unemployment was endemically comparatively high for decades and highly concentrated in a few regions.

Box (continued)

What appears to be a distinguishing feature of regional unemployment disparities in Spain is their strong association with the use of temporary contracts. As shown in Graph 2, the larger the share of temporary employment, the higher is unemployment. A possible interpretation of this relation is that when employment is mostly temporary, real wages are less reactive to local unemployment rates. In spite of being decentralised

at the provincial level, collective agreements are automatically extended erga omnes to all workers in the

province and branch of industry to which the agreement refers. As the unionised workers that participate in collective bargaining are mostly permanent workers ("the insiders"), they will hardly accept low real wages in exchange of higher employment opportunities for temporary workers. Thus, stronger real rigidities and higher unemployment is expected in geographical areas with widespread temporary employment.

Graph 2: Regional unemployment and temporary employment in Spain (2005-2009)

European Commission

Labour Market Developments in Europe, 2011

2.3. EMPLOYMENT, PARTICIPATION, HOURS