The EU Labor Market Casts a Shadow

Harping on about disequilibrium in Europe’s labor market is hardly surprising, given high and in fact gradually rising unemployment. Even though the region should have been recovering for couple of years now, the rate for the EU-27 currently stands at 11%, with Greece and Spain displaying the worst results, with 26.9% of their labor force unemployed.

On the other hand, economies these days are much more organic, being capable of one way or another to direct resources (or excess of resources) to more productive activities that letting them sit idle. One of these ‘automatic stabilizers’ so to speak is the shadow economy.

It is true that neither Spain nor Greece had unemployment levels anywhere near to what Americans or the Japanese are used to seeing, with precrisis troughs in both countries in the low-10s.  But when the things got really tough, both unfortunately saw unemployment more than double, with other EU peers witnessing similar dynamics.

At the same time, shadow economies expanded across the region. While it does have economic costs for countries, it also relieves some social hardships for laborers. Indeed, we’ve heard and read stories about people finding some consolation in the shadow economy.

But can such a system be sufficient? Could the shadow accommodate this excess? Well, let’s look at the numbers.

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Source: Eurostat, The Shadow Economy in Europe 2013

The above scatter shows the relation between unemployment and the size of shadow economy for 27 countries in Europe. And while the direction was expected, the strength of the correlation is much weaker.

But let’s make no mistake, as Obama puts it, the data does not indicate that laborers don’t turn to shadow activity in a high unemployment environment. Rather, I think that it might hint that the shadow economy only serves as partial rescue for them. The problem is there is no other part. While they could use unemployment benefits for their income, that puts tremendous pressure on governments and in times of austerity mania, the end of allowances will return with budget cuts, meaning more social suffering. After all, it’s a zero-sum game, right?

The dynamics support the claim, especially for the cases of Spain and Greece. Even when the rise of unemployment kept its pace, the shadow economy in fact detracted among these two, albeit slowly (look at the picture below).

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Source: The Shadow Economy in Europe 2013

The above data could mean that they just made less money in the unaccounted part of the economy, but that’s even worse, right? From personal perspective, of course.

Thus, I don’t think that an excess of resources, the human capital, is deployed in the shadow economy. Europe’s labor market seems to be in very deep trouble, and even if some residents can supplement or even substitute their lost income by working in the shadow economy, the rest of the unemployed clearly cannot.

6 Responses to "The EU Labor Market Casts a Shadow"

  1. Ed Dolan
    EdDolan   July 29, 2013 at 10:50 am

    Austerity increases the supply of workers to the shadow economy, but what does it do to demand?

    Nice post, good charts, and good food for thought, for example, why does the shadow economy grow or shrink during a period of recession and austerity?

    Presumably, austerity depresses household income. That would mean less demand for producers in the both the official economy and the shadow economy, except where the shadow economy specializes in what economists call "inferior goods." Despite the name, these are not goods that are of bad quality, but simply goods that people turn to when their incomes fall. Superficially, that seems possible. People who are out of work and looking to find some way to make money would be the most likely to know what others like them need. For example, they might know that in hard times, people are more likely to get their shoes fixed rather than throw them away and buy a new pair, so they start a shadow-economy shoe repair business in their kitchen.

  2. Shaube   August 6, 2013 at 10:57 am

    Gresham's law will work? Good economy will be bursted by shadow economy in to the European O.C.A. better OIDC Optimal inflation deflation area.

    Italy isn't at the top :(

  3. @Merkliopas   August 6, 2013 at 1:44 pm

    I don't this will be the case. Rather what I wanted to point out is that job losses are real – people aren't really hiding in the shadow economy (case of Greece, Spain). Thus the longer this burden is kept – on the economies, as well as on the individuals – the bigger the harm will result.

  4. Dmitrius   August 14, 2013 at 12:24 am

    In my point of view, big wonder creates inability or unwillingness of governments to take under control costs of energy and create favorable tax enviroment for business opening. Instead high taxes, increasing energy cost, cost of leaving also increases accordingly making pressure on cost of production. Goverments only talk about austerity and tax evasion, seems the easiest part to discuss. Shadow economy is just response of the people, who want to survive. Why the one should give to govenment last pants and stay naked… Fully understand public behaveur and shadow economy growth as the only way to survive wthin poor performing goverment policies.