core sector communique

Comparing Recessions in Germany, Spain, and United Kingdom

By Ravi Balakrishnan and Helge Berger
IMF Research and European Departments

November 18, 2009

• The global financial crisis has hit Europe especially hard
• Impact of crisis on output and employment varies across countries
• Institutions, policies, unusual shocks possible explanations for differences

While the global financial crisis and recession have hit all of Europe’s economies, the impact has varied considerably across countries. Output and employment, for instance, have moved quite differently in Germany, Spain, and the United Kingdom, three of the larger European countries, according to IMF research.

Germany, Spain, and the United Kingdom have all seen a significantly larger fall in output per capita than they have in the past, which illustrates the severity of the current recession in Europe. The contrast between previous cycles and the current recession is most striking in Germany, with its massive drop in output in the current downturn (see Chart 1). Equally striking is the degree to which the dynamics of employment and productivity (total output divided by the number of workers) vary among countries.

As in past downturns, Spain had the steepest reduction in the employment rate, followed by the United Kingdom and Germany. However, current employment losses in Spain—where the global crisis has coincided with the end of an extraordinary but unsustainable housing and construction boom—have been substantially higher than in previous cycles (see Chart 2). For the United Kingdom, while employment losses are also higher than is typical at this point in the cycle, they are moderate compared to Spain. In contrast, Germany has seen fewer employment losses than in previous recessions.

The stark differences in employment responses are mirrored in pronounced differences in productivity dynamics. With little or no labor hoarding—that is, firms holding on to workers despite a lack of demand during recessions—Spanish productivity tends to grow more steadily and at positive rates during downturns, including the current one. In the United Kingdom, productivity usually falls during a recession, but the decline has been somewhat steeper this time around (see Chart 3). The very sharp drop in productivity in the current recession in Germany deviates substantially from its historical pattern of smooth productivity declines.

Labor market flexibility matters

Labor market flexibility—particularly employment protection—is highly relevant in explaining variations in labor adjustments to shocks. For example, across advanced economies, higher levels of employment protection tend to reduce both inflows and outflows into employment and can slow down labor reallocation after major shocks.

However, the case of Spain—which has large employment losses despite high employment protection—illustrates that there are other factors at play, too. Spain has a very high share of employees with fixed-term contracts—much higher than the EU average. As a result, employment adjusts relatively faster in Spain despite higher levels of employment protection, as firms let fixed-term contracts expire. And this trend has been amplified in the current recession.

In contrast, employment has adjusted more slowly in Germany and the United Kingdom in the current downturn, reflecting a mix of labor market policies and flexibility at the firm level. In Germany, “time accounts” helped smooth employment over the cycle (by offsetting shorter work hours during the recession against longer hours during the boom), but government subsidies supporting reductions in working time are a crucial factor. In the United Kingdom, while measures to support employment have been introduced recently, wage flexibility seems to have played a more important role.