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What are the causes of high unemployment?

10 July, 2012

**A change in expectations is needed**

By Fiona Mullen, Director Sapienta Economics Ltd

One by-product of the population census in October 2011, which led to a sharp upward revision in the estimated 2011 population from 806,800 to 862,000, is that the figures for the labour force have also changed.
Whereas the labour force in 2011 was previously estimated at 407,023, it is now estimated at 6.6% higher 434,236.
The good news is that this also means that 7.8% more people were employed than we previously thought: 398,214 in 2011 compared with a previous estimate of 375,553.
Even better news is that fewer people were unemployed: 33,951 in 2011 compared with the previous estimate of 31,470.
But that is where the good news ends.

70% of unemployed are Cypriots
The labour force survey data for the first quarter show that unemployment soared in the first quarter of 2012 to 48,166, marking a rise of 49% over the same period of 2011.
The unemployment rate in the first quarter reached an unprecedented 11.1%. Eurostat, using different methodology, reported an unemployment rate of 10.8% for May.
Only a few years ago, we were boasting unemployment rates of less than 4%.
Short -term unemployment (less than 6 months – the period of entitlement for unemployment benefit) has dropped to just over one half of the total.
More than a quarter of unemployed are aged 15-24.
And the greatest sorrow is that nearly 14% of the unemployed are seeking a first job. We are at risk of seeing an entire generation with no work skills.
Social Insurance data also indicate that some 70% of the unemployed are Cypriots, rather than other entitled EU citizens.
That is the same proportion as Cypriots on the social insurance register. But it does mean that this recession is hitting Cypriots just as hard as non-nationals.

Construction, COLA and outdated expectations
So why has unemployment shot up so much in the past few years?
A look at the data suggests some causes.
First of all, the collapse in the property market. The biggest rise in registered unemployment has been in the labour-intensive construction sector.
All over the western world, countries are realising that the high growth and low unemployment they enjoyed for so long was all based on a false premise: that low interest rates and rising property prices would last forever.
When the collapse of Lehman Brothers in 2008 made borrowing for everyone more expensive, property prices started to fall. In Cyprus and elsewhere, it led to a sharp fall in construction (on average 12.5% in Cyprus in 2009-11) and massive rise in unemployment.

Wage indexation kills jobs
But Cyprus also has its own, home-grown reasons for high unemployment. The major one (don’t shoot me) is wage indexation, also known as COLA/ATA.
Before 2004 Cyprus enjoyed a semi-closed labour market. I know from personal experience that the authorities made it very difficult for skilled or semi-skilled labour to work here.
When competition was limited by regulation, then companies had no choice but to hire Cypriots. Now they can hire anyone from the 27 EU member states. How many non-Cypriots do you know who belong to a union? So it’s a pretty safe bet that they do not get COLA. I certainly didn’t.
So Pontians, Romanians, Bulgarians and now Greeks took over the retail, construction and to some extent food and restaurant sectors because employers did not have to give them an automatic pay rise just for hanging around another six months.
This is what is so pernicious about wage indexation. If a company has to give the same pay rise to all employees regardless of performance, the employer has no money left to award the good ones for merit.
So wage indexation not only damages a company’s costs, it also gives managers no tools to raise productivity.
Yet enough people get wage indexation for it to have damaged our relative unit labour costs (the “real effective exchange rate” or REER). It is no surprise that the REER index for Cyprus is up there with the “PIIGS” (Portugal, Ireland, Italy, Greece Spain), rather than down at less than 100 for Germany.

Waiting for Daddy’s meso
The final Cyprus-born reason for the rise, I believe, especially among the young, is what can loosely be termed as waiting in the public-sector queue.
According to my own calculations, extrapolating from the rather out of date data, public-sector workers are now paid twice the rate of the private sector, at EUR 3,200 per month, compared with EUR 1,600 for the private sector.
Who in their right mind would work for the private sector under these circumstances, especially when the public sector also offers healthcare, an almost non-contributory big pension and all kinds of other benefits?
But the public sector is (at least officially) no longer hiring. So the queue of young graduates waiting for the votes of their extended family to win them a place in the public sector has been getting longer.
This queue will not get shorter until there is a realisation that the public sector is not going to provide families with the comfortable jobs of the past any more.

Time to look to the growth sectors
But there is a growth sector out there which is providing jobs.
This is the professional services sector, which has seen employment rise at an average annual rate of 3.8% per year in 2009-11 while the public sector grew by 1%.
It has also grown more than twice as fast as GDP in the past five years, at 5.1% in 2007-11, compared with 2.4% for GDP. It even grew in the first quarter of this year by 3.9% when GDP as a whole declined.
This sector will also benefit from the exploitation of natural gas, as dozens of gas support companies come in and need their services.
Sure, these companies do not pay much at entry level. But I do not know many accountants or lawyers over 40 who are short of money.
And these days, as the smarter graduates are beginning to realise, any job experience is worth far more than the pay packet that comes with it.
So it is time to readjust expectations and encourage young Cypriots to work in the sectors of the future rather than sit in a queue for the job of the past.