The Covid-19 pandemic is wreaking havoc on the economy as governments around the world are imposing strict confinement measures, bringing social life and economic activity to a halt in order to slow the spread of the virus. Labour markets are suffering an unprecedented shock with International Labour Organisation estimates saying that 81 per cent of the global workforce is currently being affected by full or partial workplace closure. The labour market impact and responses to the economic crisis in Europe and the United States provides a roadmap for future developments. In addressing the labour market shock, policymakers should try to craft a balance between flexibility and security.

As the Covid-19 pandemic tightens its grip on the world economy, governments and central banks have been scrambling to find effective tools to offset the economic fallout. Measures taken in response to the outbreak may push the global economy into the sharpest downturn since the Great Depression. Policymakers find themselves facing a classic economic trade-off: social distancing and confinement measures are critical to reducing the spread of the virus; however, efforts to contain it keep workers away from work and prevent consumers from spending, thus reducing overall economic activity. Nonetheless, it is important to mention that economic consequences are, and should be, secondary to health consequences.

Prematurely abandoning or relaxing social distancing would see infection rates surging back and, consequently,  worsen public health conditions which would lead to even greater economic loss. The IGM Forum, part of the University of Chicago Booth School of Business, recently surveyed prominent economists and found that 80% believed abandoning drastic lockdown measures now would lead to worse damage in the long-term. 

The economic fallout is already evident in the dramatic changes happening in the world of work. Initial indications from US and European labour markets show that as many people have fallen out of work in the first weeks of the Covid-19 crisis as during the entire Global Financial Crisis (GFC). Governments and central banks around the world have reacted with large fiscal and monetary stimulus packages to buttress workers’ incomes and offer liquidity and guarantees to banks and firms. In the labour market, initial responses focused mainly on switching to alternative working arrangements such as labour hoarding measures meant to increase employment retention. Labour hoarding refers to the practice of retaining excess labour in spite of decreased demand through policies such as short-time working (STW) schemes. This essentially entails sending people home or slashing work hours substantially while keeping them employed at reduced pay. The government then replaces part of an employee’s lost income from reduced working hours. Such programmes have been at the centre of policy proposals and actions to tackle the economic contraction caused by the pandemic.

The labour market responses in Europe and the US are a test case for contrasting social and growth models. Several continental European nations allow distressed companies to tap government funds through programmes such as Germany’s Kurzarbeit, chômage partiel in France, and Italy’s cassa integrazione guadagni in order to stave off unemployment. Anke Hassel, professor of public policy at the Hertie School, says such policies are particularly well­-suited for countries where companies invest a lot in improving the skills of their workforce and place a greater emphasis on vocational education, such as Germany. Because of these arrangements, industrial relations are more oriented towards long-term employment contracting. Such companies do not want to risk losing valuable know-how and would prefer to avoid the costly process of re-hiring and training new employees. Workers with industry- or firm-specific skills may find it harder to find employment elsewhere and may even suffer a wage penalty if they switched to another industry. 

STW schemes have proven to be a valuable tool in helping to prevent mass lay-offs in the aftermath of the GFC. Other European countries with large welfare states and highly regulated labour markets also rely on such measures to help mitigate the effects of economic shocks. In addition, the European Commission will tap into international markets to fund STW schemes in the EU’s stricken economies; however, unemployment levels vary considerably across the Union. The effectiveness of STW schemes may vary as well based on the composition of the economy and labour market structures.

In contrast to most continental European countries, labour market arrangements in the US and the United Kingdom (UK) rely more on flexible labour markets, weaker job protection legislation, and limited welfare provisions. Companies rarely feel like retaining workers in a downturn because labour can be recruited, laid off, and redirected with relative ease. In consequence, fluid labour markets encourage individuals to invest in general skills that are easily transmissible between industries. There is no surprise that STW schemes in those countries tend to be weaker and take-up rates are lower. High labour market flexibility explains the record surge of unemployment in the US compared to Europe.

Nonetheless, interest for STW schemes has increased as they lend themselves particularly well to the circumstances of the Covid-19 crisis. In this context, the UK has adopted a strategy more akin to continental European countries with the government covering up to 80% of the wage for workers on leave. While flexible labour markets can adjust more rapidly to economic shocks, widespread lockdowns may impede this process. Adjustment through unemployment could actually worsen the recession and slow down recovery because job losses tend to lag growth. Laid off workers could leave the labour force or even lose their skills. The US is particularly vulnerable in this regard as mass unemployment would face workers not only with the prospect of lost wages, but also fragile safety nets to fall back on.  

Unless the economic downturn lasts for a very long period, it may be better and cheaper for companies and workers to maintain ties and allow for a quicker recovery once the virus is contained. If jobs are retained when there is no demand, however, STW subsidies can reduce the reallocation of jobs to sectors in dire need of workers. There is a sharp fall in labour demand in sectors that involve physical interaction such as proximity services, hospitality, and manufacturing. At the same time, other parts of the economy such healthcare, retail and wholesale services, as well as delivery and e-commerce, are experiencing significant labour shortages. 

Heavy travel restrictions in Europe have already led to a shortfall of agricultural workers, prompting Germany to lift the ban on seasonal workers entering the country and France scrambling to recruit from employees on temporary lay-offs. In Sweden and the UK, airlines are offering their suspended workers fast-track healthcare training in order to staff hospitals. Professor of Macroeconomics at the Hertie School, Dennis J. Snower, warns of a “Great Economic Mismatch” between labour supply and demand. He argues that instead of making up for wages, governments should be subsidising the movement of workers from contracting sectors into expanding ones. 

Under these conditions, the ideal policy response is twofold: (1) preserving existing employment and relieving workers of unemployment anxiety to facilitate a prompt recovery once the virus is contained, while also (2) facilitating reallocation of workers from temporarily shutdown sectors to those facing labour shortages. During a temporary shock, it might be more desirable to hoard labour. At the same time, STW schemes should not interfere with labour reallocations in some sectors. Therefore, policymakers should look to craft a balance between security and flexibility in their response.

Governments could actively encourage restructuring by facilitating worker loans between firms and offering hiring and retraining subsidies. A temporary labour market restructuring may even turn permanent in some parts of the economy. Evidence from France during the GFC shows that hiring subsidies reduce the costs of firms and have a positive effect on job creation and employment. Support programmes targeting new hires can be a strong complement to rescue packages for existing jobs. 

Expanding STW schemes and facilitating labour reallocations will not be enough to stave off mass unemployment. The crisis is particularly punishing for the precariously employed, independent workers, and the self-employed. Some forms of insurance may be tied to the workplace or workers may lack eligibility altogether as a consequence of precarious work arrangements. It is important to extend unemployment insurance, income relief, and social protection to people who will not be able to make ends meet. Extending welfare provisions will require additional resources, but the costs of not taking action could be even higher. The Covid-19 pandemic is an impetus for policymakers to expand social protection systems around the world.