Economists Told Us “Flexible” Labor Markets Were a Good Thing. Now They’re Plunging the US Into an Economic Catastrophe

Richard B. Freeman

For decades, America’s “flexible” labor markets have been celebrated by economists and favorably compared to Europe’s “sclerotic” labor institutions — the products of a century of militant worker struggle. Now, thanks to that very flexibility, the US stands on the brink of an economic disaster.

A couple who both lost their jobs recently as unemployment claims skyrocket watch local news in their apartment on March 25, 2020 in Norwalk, Connecticut. John Moore / Getty

Interview by
Seth Ackerman

As the United States suffers its greatest bonfire of job destruction since the Great Depression, millions of workers in Europe who might otherwise have lost their jobs are remaining on their employers’ payrolls. In country after country, a dense web of labor laws that militant workers’ movements fought for over the course of decades — policies that restrict firing, entrench unions, and limit unilateral employer control of the workplace — have more recently made it possible to operate highly effective “short-time work” and “wage compensation” schemes, policies that have shown promise in radically reducing the incidence of mass layoffs in a depression.

To learn more about the importance of such institutions, Jacobin’s Seth Ackerman spoke with Harvard labor economist Richard Freeman, co-author of the classic study, What Do Unions Do? (1984).

Freeman spoke to Jacobin by telephone from Berlin.


SA

Right now, the US labor market is in free fall. The last time this happened, in 2008, we ended up with double-digit employment and deep economic scarring that lasted for years. But Germany also experienced a big drop in GDP in 2008 and they barely saw any increase in unemployment. How did they manage that?

RBF

Well, the biggest way the Germans dealt with this problem in 2008–9 was through short-time work. That was very successful. Rather than people being laid off, they went on “short time” — in other words a big reduction in hours. And then the government topped up their pay, so people’s incomes didn’t really go down much.

If you went on half time, for example, you would get half the pay and then the government would kick you some money so you would do better than that. So a lot of people who would have been laid off instead stayed on the payroll and didn’t even see a big a drop in their income.

SA

There are now a bunch of systems like this in Europe, no?

RBF

Yes. The Swedes, for example, have a different scheme, but there’s a lot of similarity to it. They were able to recover very quickly. It wasn’t short-time work like the Germans, but it’s the same basic idea — you’re guaranteeing to people that they can lead a reasonably normal life and don’t have to panic.

SA

None of these schemes seem to be feasible if you have an at-will employment system like in the United States. In this country, the employer can lay you off without any formal procedure. So what incentive would they have to go through the process of organizing a short-time work program or a subsidized furlough?

RBF

You’re correct. Employment protection laws over here are widely enforced. And then the employer often has to go through the works council: they have to say, look, we’re losing this amount of money. We’re not selling any of this product. We can’t keep this going.

Now, if the workers are guaranteed 60 percent of their pay from the government, you could see a company saying, well, why not keep them on; let the government pay for them. The works council would then be responsible for negotiating the new work hours. And when recovery eventually comes, they’ve kept their workers.

By the way, 10 percent of American private-sector workers work in ESOP companies (employee stock-ownership plans) where the workers are partial owners. And the research has shown that in the 2008 recession, those companies behaved almost as if they were European companies. There was no special program for them, but when the recession came they didn’t get rid of people. If you’re a worker and you own part of the company, it becomes more difficult to get rid of you.


SA

Since the 1990s, there has been a powerful orthodoxy in the economics profession and the international organizations on the subject of “labor market flexibility.” European governments are constantly berated — often by the European Union itself — for not having sufficiently flexible, US-style labor markets. Their unions have too much bargaining power, job protection laws make it too hard to fire workers, unemployment benefits run on too long, etc.

Those policies are being slowly dismantled in many countries, having long been blamed by neoliberals for Europe’s high unemployment rates — as opposed to blaming tight monetary and fiscal policies, for example. What is the logic of the flexible labor market theory?

RBF

Flexible labor markets, in the vision of some economists and ideologues, are supposed to mimic the Adam Smith supply-and-demand dynamic. So, whenever there is a shock to the economy, prices will change and some people will lose their jobs, and they’ll move quickly to another job. The key is allowing huge flexibility in wages.

Well, it turns out it’s not a good idea in almost any company to start lowering wages a lot, even from the managers’ point of view. So in practice the American approach is just to rely on people moving to new jobs very, very quickly.

These decisions by firms are always supposed to be made according to signals from the market. But when you have a big burst of unemployment, the signal from the market is very different than when you have a market where demand and supply are perfectly aligned. So in 2008, American companies did not reduce wages much, because that’s really terrible for morale. And the new firms didn’t run around creating lots of quick jobs. The flexible market worked pretty poorly.

The Europeans had built all these institutions that gave workers protection, and I would say that worked out much, much better. We finally did get back to full employment during the Obama period, but that was a long and slow and sluggish process.

SA

Did that experience have any effect on the discourse within economics and in the center-left policy world?

RBF

Well, first of all, it was shocking to many people that we were having such a big breakdown in the first place. Because it came from the financial sector, which was supposed to be the high point of capitalism.

SA

But it’s precisely when you have a big shock that you’d want to have those flexible labor markets, according to the theory. Supposedly they help the economy adjust as quickly and painlessly as possible.

RBF

That was the belief. But it runs against any understanding of Keynesian economics. My customers are the workers in your company. You laid them off; suddenly it spills over to me.

The essence of the orthodox thinking is this idea of the economy as a stabilizing, negative-feedback system: if the temperature is too high in your house, the thermostat lowers it. That’s negative feedback. But if you if you have big spillovers, like with my customers and your workers, you have a positive-feedback situation: your workers are laid off, they’re not buying my products, I lay my workers off, they won’t buy other firms’ products, and it just spills through the economy.

You know, in the stock market that’s why they put the circuit-breakers in, where they halt trading. Because once it goes down, everybody panics and they all run around selling.

SA

That’s true, job protection laws do end up playing sort of an analogous role to those financial circuit-breakers, except in the labor market. They stop, or dampen, that positive-feedback process.

RBF

That’s right. The institutions — be they works councils, unions, employment protection laws — they all force companies to move more slowly. Whereas in a flexible market, you move really quick. If you’re the only company facing a problem, it’s at least possible to argue that flexibility is better. You can deal with it more quickly. If there’s full employment and my company is really not doing well and I lay some people off, they’ll get a job very quickly.

But if everybody is laying off, it’s a herd situation and that can be economically disastrous.

I was very surprised after 2008 that center-left policies were more about getting back to, quote, “normal.” I think the Obama administration was too moderate in believing that we could get back to normal and that that would be good.

I mean, there was no great push to try to build a different labor-market system. My guess is that, if you look at the administration, it was filled with people from the Clinton administration and they shared this Wall Street idea that we can control everything through fiscal and monetary policy. That proved wrong, but they still came back.

So, I would be shocked if, after this crisis, we go back to “normal.” But then again, I was shocked the last time. I guess I just thought that this time we were really going to do the kinds of reforms we did in the Great Depression. And instead, the banks went back to doing the same stuff.


SA

It’s obviously not easy in political terms to build those kinds of institutions. Maybe parts of them have become semi-consensual in Europe after the passage of time, so that nowadays some of them are accepted even by the center-right. But when they were first pursued by the labor movement, those policies were not consensual. They required a much stronger and more confrontational labor movement to push them through.

RBF

Yes, it’s very hard to see how we could get major changes without a strong labor movement.

The Europeans had another thing we didn’t have, I would say, which was the fear of communism. In most of the countries there were various different unions and the companies would say — OK, we’re dealing with the Christian unions or the social-democratic unions. We’ve got to do something so people don’t go to the communists.

A business guy would look around and say, here’s a union I can talk with; I want to deal with a union like that. I don’t want to deal with somebody who’s being given orders from Moscow.

SA

But the business world was not happy with the labor laws those unions pushed for.

RBF

Yeah, but they didn’t have much choice. They couldn’t go to the wall fighting against them, because there was a worse alternative.

In the current situation, we do see Republicans suddenly breaking all of their supposed rules about spending. No one is going to stand up and say we can’t afford a trillion dollars to fund businesses and workers for a certain period of time so we can keep from having a Great Depression.

SA

Everyone is a Keynesian in a foxhole.

RBF

Exactly. Given the last experience we had, with the banks and the finance sector, I want to make sure that whatever bills we pass, most of the money goes to ordinary citizens. We don’t want to see things like the Goldman Sachs guy who gave himself a 19 percent pay increase last year. It would be stunning if the CEOs of these big companies got government money and started giving themselves more pay increases.

SA

Chuck Schumer and Nancy Pelosi have been pushing for more generous temporary unemployment benefits, which is certainly better than nothing.

But it may be too late. This country may have already condemned itself to a catastrophic depression, with 15 percent or 20 percent unemployment that lingers on for years. Whereas if we had had “inflexible” institutions in place beforehand, maybe it could have been limited to a 2 percent or 3 percent increase.

RBF

That’s probably true. But there is one potential saving grace in this process.

With very low interest rates and an incredible need to rebuild our economy — to deal with global warming and climate change, to rebuild our airports — there’s a massive need for labor. And on some level it is just going to have to be organized. I don’t mean a socialist setup where there’s somebody in Washington just telling people what to do. It’s got to be more consensual than that.

But usually it does require some government, somewhere, saying, “if you’re going to be polluting with this money, sorry, it’s gone.” I don’t know if they’re going to be able to build that in or not. The only story we’ve had like that that had a really optimistic outcome was World War II. We started out with massive unemployment. Then we suddenly had a national purpose and we went to full employment, immediately. I mean, very quickly.

We know we need to do things for the climate. We know now that we need to do more things on the health front. With all these things that need to be done, we should be able to create full employment.