Flexible labour, flexible production and innovation-by-agreement: international comparisons contesting the Lindbeck-Snower insider-outsider thesis and 'structural reforms' in the European Union.

• Author: Oliveira, Teresa Carla
• Position: Report

Introduction

Since the onset of the financial crisis of 2007-08, 'structural reforms' to achieve more flexible labour markets have been demanded by the 'Troikas' of the IMF, the European Central Bank and the European Commission of weaker and mainly peripheral EU member states. This paper submits that the case for them is unfounded. It does so first by citing rethinking by the IMF in a study that finds no link between employment protection and inefficiency. Also a questioning of structural reforms by Benoit Creure, a member of the executive board of the ECB.

It then critiques the insider-outsider theory forwarded by former Nobel economics committee member Assar Lindbeck and the British economist Denis Snower on the grounds that their flexible labour market case, though influencing claims for structural reforms, was entirely theoretical, with no supporting evidence. It contrasts this with the flexible production model in Japan, where failures in flexible labour markets in the early 20th century gave rise to lifetime employment for core workers, and illustrates how this enabled the kaizen of continuous improvement and achievement of some of the most competitive companies in the world. It relates this to western theories of psychological contract and social contract and. demonstrates that recommendation of this flexible production model, with the principle of work-life balance, was made to and endorsed by the European Council in the Lisbon Agenda 2000. It also summarises some implications in relation to feasible policies to recover employment in Europe.

1. Deflation, Flexible Labour Markets and Structural Reforms,

   Flexibilisation of labour markets has been integral to the case for 'structural reforms' which have been demanded of several EU member states since the onset of the financial crisis of 2007-08. Such reforms assume that increased economic efficiency, and innovation, depend on a reduction of social protection of labour. If business did not need to engage employees on the basis of long-term contracts, or any contracts, and could fire them easily, then new and innovative firms would be able to attract the new workers they need to expand their business (Janssen, 2015).

   Yet recent research by the IMF has found there is no evidence that deregulation of labour markets increases economic efficiency. This is highlit in a text box in the IMF's World Economic Outlook of April 2015 recognising that productivity in terms of output per worker can be increased by using more highly skilled labour and information and communications technology, and by investing more in research and development. But, in a survey of OECD countries, does not find any statistically significant negative effects on productivity, and thus economic efficiency that result from defence of employee rights through protective labour market legislation (IMF, 2015a).

   In addition, in November 2015, an IMF Staff Discussion Note published findings that 'beggar-thy-neighbour' wages policy through 'structural reforms' was not a condition for recovery through increased competitiveness but was deflationary (IMF, 2015b). Unlike the 'crowding out' hypothesis of Milton Friedman, the IMF also has found that there is no evidence that public spending drains rather than sustains the private sector (Abiad, Furceri and Topalova, 2015). In effect, EU 'structural reforms' are not working at a macroeconomic level. Rather they are imposing massive social and political costs in terms of high levels of unemployment which is encouraging political extremism (Holland, 2015b).

   In parallel, in statements in 2014 and 2015, Benoit Creure, French Member of the Executive Committee of the ECB, questioned the case for structural reforms and the obsession with competitiveness at the cost of demand. As he put it

   'I want to stress that we need to enhance our understanding of the supply side so we can better appreciate its interactions with demand. For instance, we know too little about which policies will extend the benefits of micro-level reforms to the macroeconomy ... The empirical debate is also still raging over the short-term impact of such reforms on output ... And the optimal pace of supply side reforms has not been established empirically ...' Coeure, 2015).

   Adding also that

   'Structural reform' is a term that policymakers like to utter, but it is often too vague to be meaningful. In particular, my hope is that work in this area can help policymaking escape the obsession of 'competitiveness' which, when narrowly defined, focuses on export market shares, real exchange rates and unit labour costs (Coeure, 2014)'.

   We suggest that the research on lifetime employment in Japan cited in this paper could help at least some policy makers challenge such obsessions. Not least in that it demonstrates precisely the link between micro level and macroeconomic and social outcomes that Creure laments has been missing in much of the presumption of the need for structural reforms in Europe.

2. Insider-Outsider Theory

   The case for more flexible labour markets and for structural reforms was influenced by the 'insider-outsider' thesis of former Nobel economic committee member Assar Lindbeck and the British economist Dennis Snower who claimed that Europe only can be competitive by reducing the right of strongly unionised 'insider' employees to defend high wages and benefits against outsiders who would be prepared to work for less. Their claim was powerfully influential in Germany where it was held to justify the Hartz employment reforms reducing insider rights (Holland, 2015b).

   Lindbeck and Snower's (1988) analysis is replete with algebra, a priori reasoning and generalisation but entirely lacking in any empirical support for the claim that insiders necessarily are less efficient that outsiders would be if they took their jobs. There is no evidence for such a claim (OECD, 1999, Esping-Andersen and Regini, 2000; Kelly, 2005; IMF 2015b).

   Recent evidence from the Bundesbank and from the German statistical office also shows that the argument that a minimum wage will destroy jobs and create unemployed 'outsiders' has not been supported since the introduction in 2014 of a minimum wage of 8.50 [euro] an hour in Germany--50% of the median German wage. This refutes pessimistic predictions in a spring 2014 forecast from the Ifo research institute in Munich which warned of 200.000 jobs being destroyed and predicted an immediate increase in unemployment from January 2015 onwards. Whereas, from January to July 2015, unemployment in Germany fell by 250.000. The outcome was higher wages in general, substantially higher wages for the lowest paid and many temporary jobs being replaced by regular ones (Bundesbank, 2015; Janssen 2015).

   Implicit within the Lindbeck-Snower insider-outsider case are differences in how western mainstream economics conceptualise 'the firm and industry' and how Japanese economists and management do not. A foundation of western microeconomics is a Cobb-Douglas (1928) production function, which assumes that production is a function of combining capital and labour, plus some other residual factors such as technical progress. The premise of this is that capital is a fixed cost and labour is a variable cost and therefore disposable in the event of an economic downturn.

3. Japanese Lifetime Employment

   With lifetime employment in Japan since the early 20th century this logic was reversed. With a commitment to long term employment, labour became a fixed factor of production, meaning that Japanese manufacturers had to gain continually better use of it. In leading Japanese firms flexible production and innovation are integral to the labour process through continuous improvements in work methods--kaizen (Yamaguchi, 2004; Moriguchi & Ono, 2004). Western microeconomics assumes that firms cannot grow beyond at a point at which their marginal costs will rise to meet price. Japanese producers have constantly been reducing marginal costs through continuous improvement (Womack & Jones, 1996; Colenso, 2000).

   It was because of 'insider' commitment to lifetime employment that Japanese producers had to find more efficient methods of work operation to increase and sustain their competitiveness. For Toyota, and what then became known as The Toyota Production System, economies of scope or doing more with the same, rather than more of the same, was vital for its survival after WW2, since there was insufficient demand for vehicles for it to achieve economies of scale.

   Kaizen style 'continuous improvement', with the need to cut costs after the impact of the 1973 oil shock, was the driving force behind high efficiency lean production that, by 1982, had enabled both Toyota and Honda to double output per worker whereas US auto producers hardly increased it at all (Ohmae, 1982). These differences between flexible production and flexible labour markets are contrasted in Figure 1.

   There has been a widespread presumption that lifetime employment in Japan relates to a Confucian group culture and is not translatable to other societies (e.g. Sparrow & Marchington, 1998). Yet this misses that it was the outcome of the failure of flexible labour markets in Japan in the early 20th century. Japanese industrial firms had been training engineers, at considerable cost, but then found that they quit to accept higher pay offers from others. As a result most of them introduced annual wage increases or 'seniority pay' to retain them as insiders as well as 'lifetime employment' to the age of at least 55 for 'core' workers (Yamaguchi, 2004; Moriguchi & Oo, 2004).

   Lindbeck and Snower (1988) not only did not consider how the loss of trained labour with flexible labour markets caused Japanese employers to offer 'insider' lifetime employment. They neither refer to it, nor to Japan, nor to any actual labour market. When this was put by one of us to Dennis Snower on the launch in London of his and Lindbeck's insider-outsider thesis, he...