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Unemployment in Spain: Causes and Remedies

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1995
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UNEMPLOYMENT, a serious problem in many European countries, is especially pressing in Spain, where nearly one fourth of the work force has been jobless since 1994. Spanish unemployment is notable for its persistence as well as its magnitude. What are the causes, and is there a remedy?

Spain has the most severe and intractable unemployment problem of all the industrial countries. Unemployment grew steadily from the late 1970s through the mid-1980s; the share of the labor force without jobs rose from less than 5 percent in 1977 to 21.6 percent in 1986 (see chart). Since 1982, the unemployment rate has not dropped below 15 percent, even during periods of strong economic growth, such as the one sparked by Spain’s accession to the European Community in 1986. GDP grew an average 4.5 percent per year from 1985 to 1990; although this expansion fueled employment growth averaging 3 percent per year, the unemployment rate fell only modestly. In 1992, the unemployment rate rose sharply as the economy slipped into recession, reaching a record 24.6 percent in early 1994 before beginning to decline as economic growth returned.

Unemployment has risen for virtually all categories of workers, but the rise has been particularly sharp for certain groups—women, the young, and the long-term unemployed. The share of women in the unemployed labor force rose from 36 percent in 1980 to over 50 percent in 1994. In 1994, more than 45 percent of people between the ages of 16 and 24 were jobless, and this group accounted for nearly one third of all unemployed workers. As in other European countries, increases in the duration of unemployment and in the number of long-term unemployed were responsible for part of the rise in unemployment during the late 1970s and 1980s. In 1977, only 20 percent of the unemployed had been out of work for more than one year. By 1994, that proportion had soared to 55.8 percent—2.1 million people.

Spain: unemployment rate, 1976–95

Source: Bank of Spain.

There is no single explanation for Spain’s unemployment problem. A number of factors interacted to produce the extraordinary unemployment rates of the 1980s and 1990s. Demographic trends produced a sharp increase in the number of workers. At the same time, rapid modernization of the Spanish economy led to large declines in employment in agriculture and traditional basic industries. There was an increase in “voluntary” joblessness because of Spain’s large underground economy and the generosity and coverage of unemployment benefits under the socialist government of Felipe Gonzalez. In addition, severe labor-market rigidities affecting hiring and firing, wages, and employment contracts contributed to the stickiness of real wages and inhibited the creation of stable, permanent jobs. Much-needed reform of Spain’s labor markets began in 1993, but it will take years to turn the situation around.

Structural issues

Long-term sociodemographic trends are at the root of the current problem: the growth of Spain’s population and the entrance of women into the labor market have generated increases in the economically active population averaging 1.2 percent per year since 1980 (see table). The number of women in the labor force grew by a striking 3.1 percent per year, while the annual growth rate for men was a negligible 0.2 percent because of early retirement schemes and a drop in the number of young men in the work force. As a result, the share of women in the Spanish labor force rose significantly, from 28 percent in 1981—the lowest rate of any country in the Organization for Economic Cooperation and Development (OECD)—to 36 percent in 1994, although it still lags behind most West European countries.

Changes in the economic structure of Spain as it moved into the ranks of the highly developed countries and opened its economy to the world have led to the elimination of jobs in agriculture and basic industries over the past 15 years. As recently as 1979, 20 percent of workers in Spain were employed in agriculture, compared with 5.8 percent in Germany and 2.7 percent in the United Kingdom. Since then, more than 1.1 million agricultural jobs have disappeared. The number of workers in basic industries fell from 3.4 million in 1977 to 2.6 million in 1985, a loss of 800,000 jobs. After a partial recovery during 1986-90, industrial employment dropped below 2.5 million in 1994. Much of the decline can be attributed to redundancies in industries such as coal, steel, shipbuilding, electrical appliances, and textiles. Although current employment levels are particularly low in the aftermath of the 1992-93 recession, Spain’s industrial structure has been changed permanently. As a result, industrial employment is likely to remain below 3 million—indicating a permanent loss of at least 500,000 jobs.

Spain: economic growth and the labor market, 1988–94
1988198919901991199219931994
(percentage change)
Size of the labor force2.21.41.40.40.51.11.0
Employment3.64.12.60.2-1.9-4.3-0.9
Real wages1.50.52.12.31.82.2-0.2
Real GDP5.24.73.72.20.7-1.12.0
(percent)
Unemployment rate19.517.316.316.318.422.724.2
Source: Bank of Spain.
Source: Bank of Spain.

Because of the expansion of its non-agricultural labor force, Spain needs to create more jobs to reduce unemployment than other European countries. Even if the distortions in the Spanish labor market were no worse than in other European countries, Spain’s employment problems would still be more severe because of the increase in its female labor force and the loss of jobs in both agriculture and traditional industries. Indeed, Spain was unable to grow its way out of high unemployment in the 1980s and early 1990s despite a relatively favorable record of economic growth and job creation.

Distortions and rigidities

Demographics and structural changes alone do not explain why the Spanish economy has been unable to generate enough jobs to prevent an explosion in the unemployment rate. Other countries have successfully gone through the same types of transitions without significant increases in unemployment. It was the combination of a rapid transition and distortions and rigidities in the labor market that caused unemployment rates to jump from 1 in 20 workers in 1977 to nearly 1 in 4 workers today.

Underground economy. One distortion of the labor market commonly mentioned as an explanation for the country’s high reported unemployment rate is the existence of a substantial underground economy that employs a large number of people formally listed as jobless. The Spanish press is full of critical commentaries on official unemployment statistics and anecdotes of fraud and employment in the so-called shadow economy; however, reliable studies on the subject are scarce. Such evidence as does exist is of two sorts—statistical studies that attempt to calculate the level of underground economic activity from indicators like the use of money (especially cash) and other “causal” variables (like tax rates, unexpected changes in participation rates, etc.); or studies that have attempted to directly measure the level of clandestine work or fraud in unemployment benefits.

Statistical studies in the late 1970s and early 1980s estimated that the shadow economy accounted for between 2.5 percent and 6.5 percent of GDP. The weakness of these studies is that estimates in terms of output do not directly translate into unemployment rates, since some underground economic activity is likely carried out by people who do not figure among the officially unemployed. Furthermore, there are no recent estimates on the underground economy that could explain the huge rise in unemployment during the 1980s and 1990s.

Studies on underground employment have been conducted directly through surveys, examination of fraudulent use of unemployment benefits and other public services, and scrutiny of tax records. The data suggest that between 7 percent and 30 percent of all unemployment claims are from people working in the underground economy. This means that anywhere between 1.8 and 7.3 percentage points of unemployment in 1994 could be explained by the underground economy—a wide margin of error.

Unemployment benefits. A second important distortion in the Spanish labor market arises from its overly generous unemployment benefits, which encourage people to remain unemployed for longer than they would otherwise, or to enter the labor market when they are not truly hunting for a job. Overly generous unemployment benefits might also exacerbate the unemployment problem by pushing wages up, thereby discouraging firms from hiring more workers. Both the coverage and the generosity of unemployment benefits increased substantially in Spain during the 1980s.

Before reforms were introduced in 1992-94, unemployment benefits were nontaxable and were paid on a declining scale as a proportion of previous income: 80 percent for the first six months, 70 percent for the next six months, and 60 percent for the second year of unemployment. Workers receiving nontaxable unemployment benefits equivalent to 80 percent of their former salaries could theoretically get a higher net income from unemployment compensation than from working. OECD calculations suggest that, among the industrial countries, Spain’s gross replacement ratios (ratios of benefits to wages) during the first year of unemployment were second only to Sweden’s.

The proportion of unemployed workers receiving benefits has also risen substantially over the past decade, from 25 percent in 1983 to nearly 70 percent in 1993. This increase reflects government policy as well as the changing composition of the labor force. Government decrees extended coverage to temporary workers (1984), employees of cooperatives (1985), and incorporated workers in other sectors previously covered by special unemployment regimes (1986, 1987). The decline in the proportion of self-employed workers in the labor force has also indirectly increased the coverage rate.

A recent study (Alba-Ramirez and Freeman, 1990) suggests that generous unemployment benefits in Spain may contribute to the high unemployment rate by encouraging eligible workers to extend the average duration of unemployment by 4-6 months, compared with workers who are ineligible. There is a significant increase in workers’ exit from unemployment during the months immediately before and after the expiration of their eligibility for benefits. Longer periods of unemployment for workers covered by benefits may have been responsible for as much as 25 percent (roughly 5.5 percentage points) of total unemployment before reforms were implemented.

Structural rigidities. The Spanish labor market, which has been rigid for several decades, became even less flexible during the 1980s, when it evolved into an amalgamation of the corporatist system of the Franco era and the modern welfare state. Many of the restrictions on functional and geographical mobility, as well as regulations requiring high severance payments, in place before 1975, were retained in the 1990s, when new regulations—such as those guaranteeing generous unemployment compensation and strengthening collective bargaining rights—were adopted. Statutory restrictions have had important effects, hampering the efficient operation of the market in three general areas: hiring and contracts, the flexibility and cost of using labor, and termination of employment. In each of these areas, the restrictions increased the costs of employing workers and thus reduced incentives to hire.

By law, the state employment office (INEM) traditionally had a monopoly on job placement, undermining efficiency in this area. Strict regulations governed hiring under permanent labor contracts, and part-time employment was discouraged. Restrictions on hiring fixed-term, or temporary, workers were relaxed considerably in 1984, creating a sharp distinction between permanent workers and temporary workers on contracts of up to three years. This artificial distinction between temporary and permanent workers doing the same jobs is a form of labor-market dualism, giving different pay and working conditions to employees performing similar tasks. This distorts hiring decisions, leads to inefficient use of labor in the production process, and also distorts relative wages.

By restricting functional and geographical mobility, basic labor legislation exacerbated employment problems. There were tight controls on the length of the working day, the number of permissible overtime hours, and minimum vacation time, among other things. Employers were required to negotiate with unions and obtain government approval for any substantial modifications in these areas.

Finally, the regulations governing labor shedding in Spain have been stringent, and the costs of dismissing workers have been high. Redundancies required administrative approval and could be appealed to legal authorities. In practice, approval has rarely been granted without the agreement of the unions, which are able to extract a premium for their cooperation. Dismissed workers are granted generous lump-sum benefits. The legal minimum compensation is 20 days’ salary per year worked but, in practice, the average benefit is about 50 days’ salary per year worked. Furthermore, redundant workers are eligible for full unemployment compensation from the first day of unemployment, regardless of whether they received a severance package.

These legal restrictions have been a major contributing factor in the unresponsiveness of real wages to high unemployment. Recent empirical studies provide evidence that wages in Spain are extremely rigid and do not drop in the face of high unemployment. At the same time, there appears to be significant inertia in wages, which continue to increase in real terms even when economic conditions are weak and unemployment is high. These facts reinforce the impression that deep structural problems in the labor market are responsible for the persistence of unemployment.

Insider-outsider effects. Another source of wage rigidity is the “insider-outsider” effect of collective bargaining. Insider-outsider theory argues that when wages are set in a bargaining process between employers and unions in circumstances where the unions place more emphasis on raising wages for current workers than on expanding employment, the result is higher-than-market-clearing wages for employed insiders and more unemployment for outsiders. Furthermore, once workers lose their jobs and become outsiders, they are no longer taken into account by the bargaining unions and employers and hence are less likely to regain employment. This means that unemployment shows “hysteresis,” since reductions in unemployment levels resulting from unanticipated shocks tend to become permanent. Research has shown that insider-outsider effects can occur even in the absence of explicit union bargaining.

Evidence of insider-outsider unemployment in Spain is strong. Structural rigidities make it possible for current workers to demand, and receive, higher wages without worrying about being replaced by the unemployed. Furthermore, the creation of permanent jobs is inhibited by the existence of a large pool of temporary workers in Spanish firms, combined with high dismissal costs for permanent workers.

Recent reforms

As the unemployment rate began to climb again in 1991 and 1992, the need for a major overhaul of labor-market regulations became increasingly clear. Beginning in 1993, the Government responded with a series of reforms designed to decrease distortions and rigidities.

Unemployment compensation was one of the first areas to be tackled by labor-market reforms. Steps were taken to tighten eligibility requirements and to reduce both the level and the average duration of benefits. The minimum period of work required to become eligible for benefits was raised from six months to one year, and the ratio between the time worked and the duration of benefits was raised from 2:1 to 3:1, thereby shortening the eligibility period. The minimum and maximum levels of unemployment benefits were lowered, and payments were made partially subject to taxation and social security contributions.

Labor-market reforms introduced several modifications in the hiring process and terms of employment for workers. INEM’s statutory monopoly over job placement was abolished, and temporary employment agencies were authorized for the first time. Measures were taken to encourage part-time employment, which is much less common in Spain than in most other industrial countries.

The Government took steps to make working conditions more flexible. Reforms included provisions to increase functional mobility, granting employers more latitude in the use of labor in the workplace. There were also measures to relax restrictions on the length of the working day and overtime hours. The requirement for administrative approval of geographical mobility was eliminated.

Attempts were made to correct the labor-market structures that led to insider-outsider behavior and perpetuated the rigidity of real wages. Reforms included modifications in the regime governing temporary contracts—designed to curb the number of temporary hires—in an effort to reduce labor-market dualism. Regulations governing collective bargaining were also modified. The reforms contained provisions for decentralizing collective bargaining and reducing legal restrictions on the content and scope of contracts to make the bargaining process more flexible.

Additional measures needed

Spain’s reforms appear to be bearing fruit. As the economy emerged from recession in 1994, employment began to rise both earlier and at a faster rate than after previous recessions. Between the first quarter of 1994 and the first quarter of 1995, total employment grew by 1.9 percent. As expected, there was particularly strong growth in jobs affected by the reforms, particularly in part-time work and newly introduced apprenticeship contracts. The unemployment rate fell from 24.6 percent to 23.5 percent over the same period. Real-wage growth also became more moderate, which may have reflected greater wage flexibility.

Despite these encouraging signs, there are indications that more reforms may be needed to bring Spanish unemployment down to the levels of the rest of Europe. Even if employment were to grow by 3 percent per year (as in the late 1980s), it would take nearly a decade of uninterrupted growth to drive the unemployment rate below 10 percent.

Two areas, in particular, remain of concern. First, the reforms did little to reduce the high dismissal costs that raise the cost of employing workers and make the labor market less flexible. The restrictions on temporary contracts that were part of the reforms may have made it harder to dismiss workers, because temporary workers are no longer allowed in every type of job, and it remains costly to hire permanent workers. Second, collective bargaining remains highly centralized and overly conflictual, resulting in Europe’s highest level of work lost to strike activity, perpetuating wage rigidity, and impeding the efficient and productive use of labor. Thus, while Spain has taken important steps to attack the problem of high and persistent unemployment, it will take years of sound economic growth—and more reforms may be necessary—before the problem can be considered solved.

Suggestions for further reading: Alfonso Alba-Ramirez and Richard B. Freeman, Jobfinding and Wages When Long-run Unemployment Is Really Long: The Case of Spain, National Bureau of Economic Research Working Paper No. 3409, August 1990.

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