IZA Newsroom

IZA – Institute of Labor Economics

Covid-19 scrambled European country ranking of labor market performance

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How did the labor market get through Covid-19 year 2020 in Europe? Broadly speaking, without much damage, according to a recent IZA Policy Paper by Stijn Baert (Ghent University). The percentage of unemployed among the 25 to 64-year-olds in the EU-27 rose 0.2 percentage points (pp) from 4.8% to 5.0%. By comparison, between 2009 and 2010, when the labor market digested the Financial Crisis of 2007–2008, this number increased by 1.3 pp at the EU-27 level.

This average obviously hides differences between EU countries. Most strikingly, in the Baltic states, the increase in percentage of unemployed is more than 1.5 percentage points and therefore substantial: Estonia (1.7 pp), Latvia (1.8 pp) and Lithuania (1.7 pp).

Among the other countries, only Romania (1.0 pp) and Sweden (1.2 pp) exhibit growth in their unemployment-to-population ratios in excess of 1 pp. Thereby, Sweden, often seen as a ‘model country’ even drops to 23rd place by unemployment (out of 27 countries).

Inactivity rose more sharply in Southern Europe

But what happened to the percentage of inactive people in 2020? While unemployed search for a job, this is not the case for inactive people. Did some of the unemployed become discouraged, partially masking the shift from employment to unemployment with a parallel shift from unemployment to inactivity?

Overall, the increase in inactive persons at the EU-27 level also remained rather limited. In 2019, 20.0% of the population was inactive; in 2020, that percentage rose to 20.3%—an increase of 0.3 pp. This rather small number still implies an increase by about 720,000 persons.

Again, we see important differences between countries. Inactivity rose more sharply in Southern Europe: Spain (1.1 pp), Italy (1.5 pp), Portugal (0.6 pp) and Greece (1.0 pp). Bulgaria (0.8 pp) and Ireland (0.8 pp) are also close to 1.0 pp increases in inactive persons.

Overall, the labor market of Poland experienced the most favorable evolution: despite the crisis, both the percentage of unemployed and inactive fell.

Germany’s position remains rather stable

Germany, the largest EU country by number of citizens, is not mentioned in the above discussion. This is because Germany remained fairly stable in terms of its position in the ranking of European countries.

Between 2019 and 2020, the percentage of unemployed among 25-64 year olds increased by 0.5 pp (i.e. from 2.4% to 2.9%). Admittedly a bit more than the European average, but because Hungary and Romania experienced a stronger increase, Germany rose from 7th to 5th place of best-performing countries in terms of unemployment.

The percentage of inactive persons rose even less, i.e. from 15.6% to 15.7%. This does mean, however, that Germany drops from 5th to 6th place as Latvia saw its inactivity percentage decrease despite Covid-19.

Overall, Germany is stable within the best quarter of European countries for both parameters.

What about 2021 and 2022?

Does the small overall effect of Covid-19 year 2020 mean that the ominous reports at the start of the crisis should be classified as misconceptions?

Stijn Baert:

“Not necessarily. The labor market almost always follows the pattern in economic growth at some distance. During the Financial Crisis, unemployment peaked about a year after the deepest decline in economic growth. If the current downturn in economic activity continues, it might not be possible to sustain the current level of labor hoarding, especially if support measures are removed. Much also depends on how the European countries deal with their accumulated debt: hard savings can be expected to deal an extra blow to the labor market, while well-considered investments could, through their multiplier effect, provide stimuli.”

Higher minimum wage lowers enrollment in academic programs at universities

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While much research has been done on the employment effects of minimum wages, little is known about their effect on human capital accumulation. A new IZA discussion paper by Diana Alessandrini and Joniada Milla finds a strong impact of higher minimum wages not only on individuals’ schooling decisions, but also on the type of human capital acquired by students.

Using Canadian longitudinal data, the authors explore 136 minimum wage amendments across provincial jurisdictions. Canada provides a unique test case because community colleges play a large role in post-secondary education in Canada and because they often provide occupation-specific training rather than general academic training. This allows for potential important interactions between minimum wages and the type of education that individuals pursue, in addition to effects on overall education levels.

Shift towards occupation-speci fic training

The study finds that high minimum wages stimulate the accumulation of occupation-specific human capital at community colleges but discourage enrollment in academic programs offered by universities. Quantitatively, a 10% increase in the minimum wage increases community-college enrollment by 6% and reduces university enrollment by 5%.

At the same time, high minimum wages strengthen the link between parental background and children educational attainment, worsening the university participation gap between individuals with high and low parental education. The increase in the opportunity cost of education caused by the minimum wage appears to discourage enrollment among students with lower-educated parents.

Lower drop-out rates

Finally, minimum wages also affect whether students drop out of post-secondary education or return to school later in life as mature students. The data show that the positive effect on community-college enrollment is driven by older students. As minimum wage hikes may increase competition in the labor market, students already enrolled in community college are less likely to drop out, and workers who separate from their job are more likely to return to community college to advance their studies.

These novel results an inform policymakers regarding the spillover effects of minimum wage regulations on human capital accumulation and the unintended consequences on educational attainment. Given substantial government spending on post-secondary education, it is important to know whether a minimum wage policy works against or in favor of concurrent education policies.

Relative comparisons affect performance and choices in college

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When making choices about one’s educational career, students face considerable uncertainty about their own ability. Am I sufficiently prepared to pass the exam? Am I good enough to pursue a college education? A young person might have difficulties in answering these questions right away and will have to form beliefs about their own ability.

More often than not, this will be done by comparing oneself with friends or fellow classmates. A student who is a big fish in a little pond, outperforming their classmates, tends to be more confident and might believe that they are more capable than an otherwise identical student who happens to be in a group with higher ability peers.

Such social comparisons may be of particular importance in the first year of university, which for many students is a daunting experience. Coming from the familiar environment of high school, where they shared classrooms with the same classmates for many years, they suddenly interact with students from all over the world. This drastic change in one’s peer group may also change students’ beliefs about their own ability.

In a new IZA discussion paper, which is now accepted for publication in the Economic Journal, Benjamin Elsner, Ingo Isphording and Ulf Zölitz show how social comparisons affect the choices and performance of first-year students who are randomly assigned to first-year tutorials at a Dutch business school.

Rank matters!

The authors measure a student’s relative ability through their ordinal rank within their teaching section. The ordinal rank measures whether a student is ranked first, second, third and so on, based on the grades they had received before being assigned to their new section. Different mechanisms explain why a higher ordinal rank may affect choices and performance: a more highly ranked student may perceive herself as more competent in general (the big-fish-in-a-little-pond effect), and it might affect how teachers or fellow students interact with them.

In line with this idea, the authors find a strong effect of a student’s rank on contemporaneous performance. Students with a higher rank have a lower risk of dropping out of a course and receive higher grades in standardized exams that are anonymously graded. The effects of rank on expectations about future grades and satisfaction with fellow students suggest that a higher rank leads students to believe that they are more capable than their peers. Thus, being a big fish in a little pond in your first-year tutorial boosts performance by shaping a student’s beliefs about own ability.

Students react to good news only

A student’s rank appears to be especially important at the very beginning of the first year, a period characterized by particular uncertainty in a completely new environment. But how students react to their rank depends on the information the rank conveys: Students respond asymmetrically to changes in their rank. An increase in the rank relative to the previous period significantly improves performance, whereas a decrease in the rank has no effect.

The authors interpret this as evidence for the good-news-bad-news effect, which means that people respond to positive but tend to ignore negative signals. Only if a rank in a tutorial indicates that a student became better over time will it affect their performance.

Persistent effects of rank

The authors also show that the effects of one’s rank in a first-year tutorial are persistent. Students with a high rank in a particular first-year course are more likely to choose a related follow-up course in higher years: A student who was highly ranked in a statistics course is more likely to specialize in statistics later on. A student who was highly ranked in marketing rather specializes in marketing. The ordinal rank in first-year courses appears to shape students’ perceived comparative advantages in one subject over the other and have a lasting effect on students’ choices.

The results provide important insights into the decision-making of college students. Whether or not someone is a big fish in a little pond is to a large degree a matter of luck. Yet, when making important career decisions, students appear to put considerable weight on relative comparisons to other students – a factor to be kept in mind when helping students to make better-informed career choices.

“I will have to discuss this with my family”

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People work only slightly more when they can earn high wages than they do at other times. Does this mean that people respond only weakly to wage incentives? This would have important consequences for economic policy. For example, tax cuts would only to a very limited extent induce people to work more. Similarly, government stimulus packages could be expected to have little effect if firms, when demand for their products is high, are unable to achieve a significant increase in hours worked through paying higher wages.

However, there are several arguments against such a view. Progressive tax systems or the pursuit of promotions can weaken the measured relationship between hours worked and pay, even if workers are in principle willing to work more for more money. A recent IZA discussion paper by Christian Bredemeier, Jan Gravert and Falko Juessen points to another reason: Changes in one family member’s income alter the balance of power in the family’s decision-making processes, and this can affect how much each family member works.

The study builds on a large body of scientific literature that has demonstrated that families respond differently to a given amount of income depending on which family member earned that income. A change in a family member’s income appears to alter that member’s influence in the family’s decision-making processes. A career setback, for example, tends to lead to having less say in the family. One can then try to restore one’s old position in the metaphorical “family council”, for example, by working (paid) overtime, even if, as a single person, one would rather wait to do so until one’s work is paid better again.

Consumption patterns reveal family members’ influence

The authors develop a statistical method that deducts the changes in intra-family bargaining positions caused by wage changes when measuring the willingness of employees to work more if they are paid more. The method uses information on families’ consumption patterns, i.e., what goods and services are purchased, to infer which family member currently has a large influence on family decisions.

The results of the study indicate that workers are willing to work about 7% more if their earnings per hour are 10% higher. For a full-time worker, this amounts to just under three hours of (paid) overtime per week. This figure is discernibly larger than the results of most previous studies, which do not factor out the effect of wage changes on intra-family bargaining positions.

Factoring out this effect is instructive for assessing the consequences of policies that similarly affect the earnings of different family members and therefore have no substantial effects on intra-family bargaining positions. According to the authors, temporary tax cuts or increases in the general wage level could indeed induce employees to increase their working hours by clearly relevant, albeit moderate amounts.