Is Labour market flexibility really so bad?

Paul De Grauwe’s recent assertion in the Financial Times (Flexibility is out: now we see rigidity’s virtues, 23rd February), is deeply flawed in its argument that labour market rigidity is a virtue in the current downturn. Rigidity may indeed provide a circuit breaker which delays any labour market shake-out but that is not the end of the story. Companies shed labour because they need to reduce their cost base. Preventing them from reducing their payroll costs now merely increases the subsequent corporate sector deficit. A larger corporate deficit in turn risks an even greater spike in future unemployment.

In the current financial crisis, characterised by credit rationing, do we really believe it is virtuous to place companies in a position of even greater reliance on capital markets?

Surely one of the lessons we have learned over recent decades is that more labour market regulation means less GDP and employment growth. If Professor De Grauwe’s circuit breakers do click in, they could well result in a lag until an even greater labour market shake-out occurs. When recession ends and recovery begins, high regulation economies could then see even greater reluctance to raise employment levels. Once bitten, twice shy.