The crisis and recovery of Spain’s labour market

In the past few years Spain has been making headlines with economic growth figures of over 3 percent a year. The strong figures can be attributed to a combination of reforms, temporary tailwinds with a strong multiplier via improved sentiment, and pent-up demand after a deep crisis. In line with strong GDP volume growth, employment has substantially recovered from the large dip during the crisis years. Yet, despite the strong recovery, today still less people are at work than prior to the crisis. As much as 15 percent of the entire labour force is registered as unemployed, while more than one third of the youth is still without a job (figure 1).

In this publication we take a closer look at labour market developments since the outbreak of the crisis, the many reforms that have been implemented and what are the main challenges going forward.

The boom

Halfway 2007, just prior to the crisis, unemployment had reached a historical low. About 8 percent of the labour force was unemployed (figure 1). While that was still high in international perspective, it is much lower than the average rate of 15.5 percent in the 20 years prior to the crisis and the structural rate at that time of 14 percent. In the boom years, especially employment in the services and construction sector had grown fast. The service sector was the largest employer, employing almost 70 percent of all workers. By far most people were employed on a full-time contract, only 11 percent was working part-time early 2008 (over 18 percent on average in the Eurozone). And over a quarter of all contracts contained an end-date (14 percent on average in the Eurozone). The share of people employed on temporary contracts has always been relatively high in Spain due to the high duality in Spain’s labour market. It is much cheaper to fire people on a temporary contract than on a permanent contract, for example.

The crisis

When the crisis struck, unemployment increased rapidly. Labour market regulation at the time made it (next to) impossible to alter wages, working hours or other working conditions of existing contracts to accommodate the economic headwinds faced by firms, exacerbating the number of layoffs. In spring 2013 the unemployment rate reached its peak of 26.3 percent, with youth unemployment even as high as 55.7 percent (figure 1). Especially people on temporary contracts had to bear the brunt (figure 2), given their weak rights and the large costs involved in firing people on a permanent contract. In total more than three million jobs were lost. On top of that, data suggests that full-time jobs have been substituted by part-time jobs, which has possibly prevented even larger job losses. Mid-2014 the share of part-time jobs reached a high of 16 percent. Likely partly because of labour market reforms making part-time contracts more flexible and allowing employers to alter working conditions and hours of existing contracts to accommodate economic backlash. At that time almost 60 percent of all workers on a part-time contract wanted to work more hours, implying that the slack in the labour market was significantly larger than the headline unemployment figure suggested (figure 3).

Sector wise, employment in the construction sector has suffered the most, as in addition to the great financial crisis Spain had to deal with a burst of its housing market bubble. More than 60 percent of all pre-crisis construction jobs were lost between the pre-crisis peak and the crisis-low (first quarter 2014, figure 4).

The recovery

In mid-2013, the decline in employment came to an end (figure 5). On average, employment has grown by over 3 percent per year since 2014. In that same period, the labour force was more or less stable, leading to a significant drop in the unemployment rate. In September 2018, the unemployment rate stood at 14.9 percent, which is below the country’s average of 16.9 percent in the past three decades. Among youth the situation is still more daunting, with 34.3 percent of people below 25 years old unemployed (figure 1). Moreover, five years into the recovery, still less people are employed than at the pre-crisis peak.

As mentioned, the labour force has about stabilised in the past few years. Interestingly this happened against the background of an ageing population. Whereas ageing has had a negative impact on the size of the labour force, pension reforms such as an increase in the minimum pension age, tighter conditions for (partial) early retirement, and monetary incentives to extend the work life beyond the official retirement age seem to have had a positive impact. While the number of labour market participants of between 15 and 64 years old has slightly fallen, that of older workers has risen.

Especially in the initial years of the recovery, new jobs were of very short duration - contracts of one month were no exception for example – and many graduate students were overqualified for the jobs they could get, and accepted. In general, the largest share of jobs created since mid-2013 has been on a temporary basis. Yet the situation seems to have been turned around. In five out of six quarters up until 2018Q1 more people have been hired on a permanent contract than on a temporary contract (figure 6). This might have been supported by the labour market recovery which makes it more difficult for some businesses to attract adequate personnel (see below for remaining challenges). Yet likely labour market reforms have also played their part: the conditions for the use and renewal of temporary contracts have been made more strict, hiring subsidies have been introduced to hire people on a permanent contract, and it has become cheaper to fire people on a permanent contract and easier to adapt existing contracts to a changing economic environment.

As far as overqualification is concerned, official recent data is lacking, but anecdotal evidence suggests that the situation has improved compared to the early recovery years.

Along with the economic recovery, full-time contracts have also slowly become more popular again. And the share of involuntary part-time workers has decreased from almost 60 percent at the top in mid-2014 to 47 percent early 2018, compared to 32 percent pre-crisis (figure 3). Obviously this is still high, masking additional slack in the labour market. At the same time, other figures that can be used to estimate such slack outside the scope of official unemployment figures are rather encouraging. For example, official figures do not give any basis to believe that there are still many discouraged workers at home, i.e. people without a job that want to work but that are not seeking anymore because they think it is useless. Only around 3 percent of the (extended) labour force fits this description, the same rate as prior to the crisis.

The outlook

Looking forward, employment is set to keep growing. Yet it is expected to slow a touch from the 3.5 percent growth last year, in line with moderating economic growth. We expect the unemployment rate to fall from 17.2 percent in 2017 to slightly above 15 percent this year and around 13.5 percent next year.

The ongoing decline in unemployment supports the increase in nominal wage growth (1.7 percent in September, figure 7). The Employment and Collective Bargaining Agreement (ECBA) for 2018 until 2020 has incorporated the recent improvements in the labour market and supports our view of accelerating wage growth going forward. In short, the agreement between the country’s most important employers’ and workers’ unions signed foresees an annual wage increase of between 2 and 3 percent. This compares to 0.5 percent in 2012 and 1.5 percent in 2016 for example. We note that while firms are allowed to opt-out of collective agreements, the ECBA serves as a guideline for wage growth for most businesses. Given that we forecast inflation of around 1.8 percent next year, real wage growth will turn positive over the course of next year.

In the past years, Spain has been complimented for its reform drive during the crisis. The financial sector, government finances and the labour market have underwent the largest reforms. The labour market reforms between 2010 and 2015 seem to have helped to limit ‘unnecessary’ layoffs, support hiring and possibly to improve the international competitiveness of Spanish firms. But significant challenges remain.

Labour market reforms have supported (qualitative) employment growth

Important reforms include more firm-level flexibility to alter existing contracts to accommodate the deteriorating economic environment. They have also provided more flexibility to negotiate wage agreements on a firm level instead of a sectoral and regional level, to better match wage growth with performance and productivity growth. According to a study by the Spanish bank BBVA, greater wage flexibility is estimated to have created/ prevented the destruction of almost 1 million jobs between 2013 and 2015. Other measures to support (qualitative) employment growth include(d) incentives to hire people on permanent contracts by lowering employers’ social security contributions for permanent hires, a new permanent contract for small firms (< 50 employees) with an extended probation period of 12 months, introduction of training programs for long-term unemployed to match their skills to those asked at the jobs market, and the introduction of (fixed-term) training and apprenticeship contracts to incentivize firms to attract and train uneducated youth, by allowing them to deduct (part of) the cost of training from social security contributions.

Different governments have also implemented measures to tackle the country’s large gap between the rights of workers on temporary and permanent contracts. For permanent contracts, dismissal costs for unfair dismissals (at permanent contracts) have been reduced and the scope of criteria for fair dismissals has been broadened, made more objective and more clear. For certain types of temporary contracts severance payments have been introduced if these contracts are terminated instead of turned into a permanent contract. Furthermore, limits on the maximum duration of temporary contracts (between six months and three years, depending on the kind of contract) have been installed and employers are obliged to rollover a temporary contract into a permanent contract if an employee has been employed in the same function in the same company on two or more temporary contracts for more than 24 months within 30 months’ time.

Remaining challenges

Active labour market policy and skill mismatch

Despite all the reforms, major challenges remain. The catch up potential in labour market efficiency compared to European peers is still substantial (figure 8). Crucially, active labour market policies should be further improved. In particular, retraining unemployed, on the job training and adjusting Spain’s education system is necessary to better match the skills of the workforce with the skills required in Spain’s labour market. At above 15 percent, unemployment is still very high and with over one third of the youth unemployed the risk persists that a generation will be lost. Moreover, employer and employee surveys underscore that there is a substantial mismatch between the skills required and the skills offered. According to OECD data, for example, over one fifth of all workers has a higher degree than required for the job and over one third of all workers has a job in a different field of expertise than their own. There are several reasons.

First, there is a mismatch between the field of study students choose in high school and universities and the field of expertise the Spanish labour market is asking for. Second, Spain’s universities deliver more graduates then Spain’s labour market is in need of. Compared to European peers the share of high-skilled labour in Spain is rather low. At the same time, though, the quality of education in Spain is rather weak, with especially weak vocational training. As a result, skills related to a certain qualification in Spain are lower than in most other European countries and literacy skills for example are lowest of all OECD countries. This makes it more difficult for Spanish employers, especially for those offering high-skilled labour, to find adequately skilled workers, despite the high unemployment rate.

According to business surveys a lack of adequately skilled labour supply has not been as much of an issue for business operations in Spain since 1986 (when the series started) as it is now (figure 9), despite the large pool of unemployed to choose from. To be fair, labour shortage is still much less of an issue in Spain than in most Eurozone peers, but the surveys suggest that not all currently unemployed should expect to find a job without retraining. So it is of upmost importance that active labour market policies improve.

Wage bargaining and labour market duality

Meanwhile, firm level wage bargaining is still very much the exception rather than the rule, as legal uncertainties and costs prevent firms from diverting from sectoral and regional wage agreements. The substantial use of such agreements is one of the factors behind rather large mismatches between wage payments and performance/ productivity. Spain is among the weakest performers among EU countries in this respect (World Bank – Global Competitiveness Index). Finally, large dualities in the labour market persist. Even though, for example, severance payments on permanent contracts have been reduced, they are still high in an international perspective, while temporary contracts are allegedly still being abused.

As the recovery strengthened, the sense of urgency fell and the reform drive of Spain’s government substantially slowed. As challenges are still large, the government should yet again pick up the reform pace. Especially, in the light of an ageing population which requires higher employment rates and/ or higher productivity growth to maintain economic growth at a pace compatible with the provision of social services and the ability to service the high government debt. The current minority government led by Pedro Sanchez, officially in office until mid-2020, is unlikely to sufficiently deal with these challenges.