Unemployment, Changes in the Labour Code, Direct Foreign Investment, and A Higher Minimum Wage In Slovakia: How are They Related?

One of the important indicators of how the overall economy of any country is doing is that country’s unemployment rate. The unemployment rate is defined as follows:

Unemployment Rate=(Number Unemployed/Number in Labor Force)*100

where the labor force consists of all people who are able and willing to work. The individuals in the labor force may be employed or unemployed. The unemployed are those people who are able and willing to work but are not currently employed.

When economists look at the unemployment rate in a country they distinguish between three types of unemployment: (1) frictional unemployment, (2) cyclical unemployment, and (3) structural unemployment.

Frictional unemployment is the unemployment that results because of a changing dynamic economic environment. In such an economy new jobs are always being created and existing jobs are being destroyed because of factors such as changes in consumer demand, changes in resource prices, and changes in technology. Consumer wants, resource prices, and methods of production are continually changing and these changes call for new types of industries and different combinations of resources and require workers to perform new kinds of jobs. Many of the individuals who lose their jobs because of these changes have the necessary skills to find another job. At the same time young persons who have finished school are searching for jobs for the first time. The individuals who are looking for new jobs do not have perfect information about where their next jobs are and so they spend time searching for a job. Usually these individuals find jobs rather quickly unless there is a high level of cyclical unemployment. Most economists consider frictional unemployment to be desirable because it is necessary if the economy is to adjust to changes in technology, resource prices, and consumer wants.

The unemployment that is caused by too little total spending or aggregate demand in the economy is referred to as cyclical unemployment. As the overall economy expands and contracts over time (the business cycle), so does the unemployment rate. When aggregate demand in the economy expands so does production, income, and employment. So the unemployment rate falls as the economy expands. When aggregate demand falls so also does production, income, and employment. And when employment rises the unemployment rate falls. The unemployment that is caused by too little total spending or aggregate demand in the economy is referred to as cyclical unemployment. Economists agree that monetary and fiscal policies are the most effective tools to use to keep the cyclical unemployment rate low.

Structural unemployment occurs when people lose their existing jobs and are unable to find different jobs at existing wage rates because either their existing skills are not in demand at current wage rates or because they would have to move to a new location to find a job at which they could be employed at the current wage rate. Factors that can cause structural unemployment include technological change, changes in resource prices, increased international trade, changes in consumer preferences, changes in the geographic location of jobs, and certain government policies such as the minimum wage and changes in work rules that make it impossible for the workers to find a different job at the current wage rate.

Economists use the term natural unemployment rate or full employment unemployment rate to represent the condition that exists when the number of qualified job seekers equals the number of job vacancies. The natural unemployment rate is the lowest unemployment rate that can be achieved by the use of macroeconomic fiscal and monetary policies. It is assumed that only cyclical unemployment can be eliminated by the use of fiscal and monetary policies. Hence, the natural (full employment) unemployment rate=frictional unemployment rate + structural unemployment rate. Frictional unemployment is considered necessary and even desirable if an economy is to make the necessary labor market changes to adjust to changes in consumer preferences, resource prices, and technology. Structural unemployment is considered to be part of the natural unemployment rate because it takes time for the structurally unemployed to develop the skills or to move to new locations so that they can become employable at current wage rates. Structural unemployment cannot be eliminated by the use of macroeconomic monetary and fiscal policies.

Current Unemployment Situation in Slovakia

Let’s now take a look at the unemployment situation in Slovakia. According to data maintained by Eurostat (2007), the unemployment rate in Slovakia in September 2007 was 11.1 percent. This 11.1 percent unemployment rate is significantly below the 19.3 percent Slovak unemployment rate of 2001, but is still the highest current unemployment rate among all European Union countries.

According to Fuentes (2007), even though the overall unemployment rate in Slovakia has declined, the number of job vacancies or unfilled jobs has actually been rising recently. He notes, for example, that, between the second quarter of 2004 and the second quarter of 2006, job vacancies have increased by 67 percent.

At the same time that employers find it difficult to fill jobs, the unemployment rate continues to remain particularly high among workers with less education and fewer skills, the young, and in certain regions of the country (Fuentes, 2007). The Slovak Spectator in the article entitled Jobless rate hits all-time low (2007) reports that in particular districts of Slovakia, such as Rimavská Sobota, Revúca, Veľký Krtíš and Rožňava, jobless rates exceed 20 percent.

A Brief Review of Labor Market Developments in Slovakia During the Decade of the 2000’s

As was noted earlier, the unemployment rate in Slovakia in 2001 was 19.3 percent. According to Rutkowski et al (2007), a combination of factors accounted for the high unemployment rates in Slovakia in the early 2000’s. In the early part of the decade small firms, primarily in the service sector of the economy, began to replace large state owned or recently privatized firms such as the large firms in the heavy industry and mining sectors. While jobs in new sectors of the economy were being created, the growth of employment in the new sectors was too small to absorb the many people who lost their jobs because of the destruction of jobs in the old sectors. Hence, more jobs were being destroyed in the old sectors than were being created in the new sectors.

Many of the people who were employable in the newly created sectors of the economy had to take a long time to find the new jobs because these new jobs had skill and location requirements that were different from the old jobs that they left. Many other individuals who lost their jobs because of the decline in employment in the old sectors simply did not have the skills to be employed in the new sectors. At the same time these individuals were offered early retirement and welfare benefits. These benefits, combined with the discouragement caused by the lack of success in finding employment, caused many to withdraw from the labor force (Rutkowski et al, 2007).

Beginning in the mid 2000’s, there began to be a net growth of employment in Slovakia. That is, newly created jobs began to exceed the jobs that were destroyed. At the same time, Slovakia began to see a decline in its unemployment rate (Unemployment Rate Total: 1995-2006, 2007). These changes were attributable to a number of developments. First, there were significant changes within Slovakia. Privatization of government owned enterprises, liberalization of the labour code, changes in the tax and welfare systems, Slovakia’s accession to the European Union, and other changes eventually led to net new job creation within Slovakia (Rutkowski, et al, 2007).

According to Rutkowski et al, (2007) “Slovakia amended its Labor Code in May 2003 and introduced the most far-reaching changes; the least rigid regulation of hiring, which placed the country next to Singapore and United States. The new Labor Code increased the working week to 48 hours (with overtime), enabled flexible part-time arrangements; introduced an allowance for indefinite repetition of fixed term contracts; a cut in severance pay; and a considerable easing of the conditions under which workers can be dismissed.”

Part of the recent job growth was also attributable to the sharp rise in foreign direct investment in Slovakia, especially by European, Asian, and American auto manufacturers. This rise in foreign direct investment was largely a result of the reforms that occurred within Slovakia that made such investment by foreign firms more attractive. According to Perry and Power (2007), foreign direct investment in Slovakia rose to a record $4.2 billion in 2006. This rise in direct foreign investment is best symbolized by the growth in the auto industry around Bratislava. Indeed, because of this growth, the area around Bratislava is now being dubbed the “Detroit of the East.” Slovakia now produces more cars per capita than any other country (Perry and Power, 2007).

Of course, the growth in employment in Slovakia was also facilitated by the strong upsurge in global economic growth that began in the mid 2000’s. This worldwide growth increased the demand for goods and services produced in Slovakia. Between 1998 and 2005 Slovakia’s export of goods and services increased by 152 percent between 1998 and 2005(Current account transactions. Exports, imports and balance, 2007). In addition, because of Slovakia’s accession to the European Union in 2005, many Slovaks were able to more easily find employment in Western Europe. According to Perry and Power (2007) about 170,000 Slovaks now work abroad.

Recent Changes in Government Policy Regarding the Labor Market

The Slovak government recently implemented several changes that will likely have an impact on employment and unemployment in Slovakia. First, a revised labour code became effective in September 2007. According to Balogová (2007b), “the revised code grants more powers to unions, limits overtime work, toughens conditions of fixed-term employment contracts and limits the use of trial periods before signing a permanent-status contract with an employee. It also bans the employer from terminating a fixed-term work contract without a legal reason and guarantees severance payments for employees who are fired due to restructuring.” In addition, small businesses with fewer than 100 union members have to grant trade union representative paid time to work on union related matters.

Slovakia has had a minimum wage since 1991 (Regnard, 2007). The minimum wage covers all employees aged 16 and over. There is both a minimum hourly and minimum monthly wage rate. The Slovak government increased the monthly minimum wage from Sk7, 600 to Sk8, 100 effective in October 2007 (Balogová, 2007a).

Thinking About It As An Economist

1. Refer to the statistics provided by Eurostat and the research by Fuentes. What do you think the full employment unemployment rate was in Slovakia in September 2007? Explain.

2. Refer to the statistics provided by Eurostat and the work by Fuentes. What do you think the cyclical unemployment rate was in Slovakia in September 2007? The frictional unemployment rate? The structural unemployment rate?

3. The Slovak Spectator article entitled Jobless rate hits all-time low indicates that in certain districts of Slovakia, such as Rimavská Sobota, Revúca, Veľký Krtíš and Rožňava, jobless rates exceed 20 percent. This is almost twice the overall Slovak unemployment rate. What accounts for the difference between the overall unemployment rate and the unemployment rate in these regions?

4. Refer to question 3 above and to the article entitled Improving Employment Prospects in the Slovak Republic: Building on Past Reforms by Fuentes. Identify four policies that you would implement to reduce the high unemployment rates in the districts referred to in question 3 above. Justify your answer.

5. Use marginal revenue product-marginal resource cost diagrams for the firm to illustrate the effect that each of the changes in the Slovak Labor Code in 2003 had on the employment of labor. Assume a purely competitive labor market in your analysis. Explain your answers.

6. What factors do you think accounted for the rise in direct foreign investment in Slovakia in recent years? Explain.

7. Use a marginal revenue product-marginal resource cost diagram for the firm to illustrate the effect that the rise in direct foreign investment had on the employment of labor in Slovakia. Assume a purely competitive labor market in your analysis. Explain your answers.

8. According to data available at Eurostat, the population of Slovakia in 2006 was 5,389,180. About 59.4 percent of that population participated in the labor force in 2006. So the labor force in 2006 was approximately 3,201, 173 individuals. Of the 3,201,173 individuals in the labor force 13.4 percent or 428,957 were unemployed. Assume that the 170,000 Slovaks working abroad had stayed in Slovakia and remained unemployed. What would the unemployment rate have been?

9. Assume that all 170,00 Slovaks working abroad are all working in England. Use labor market supply and demand diagrams for both Slovakia and England to show the effect on the wage rate and employment levels in both countries. Assume a purely competitive labor market in both countries.

10. Use marginal revenue product-marginal resource cost diagrams for the firm to illustrate the effect that the changes in the Slovak Labor Code in 2007 had on the employment of labor. Assume a purely competitive labor market in your analysis. Explain your answers.

11. Use a labor market supply and demand diagram to explain the effect of the 2007 increase in monthly minimum wage from Sk7,600 to Sk8,100 on the unemployment rate in Slovakia. Would the unemployment rate increase or decrease? If the unemployment rate increases which individuals are most likely to lose their jobs?

12. Use marginal revenue product-marginal resource cost diagrams for the firm to illustrate the effect that increasing the monthly minimum wage from Sk7,600 to Sk8,100 in 2007 had on the employment of labor. Assume a purely competitive labor market in your analysis. Explain your answers.

References

Balogová, Beata. (2007a, August 6). Lowest earners will get more. The Slovak Spectator. Retrieved October 30, 2007 from http://www.slovakspectator.sk/.

Balogová, Beata. (2007b, October 8) World Bank Pans Slovakia's Labour Code Changes. The Slovak Spectator. Retrieved October 30, 2007 from http://www.slovakspectator.sk/.

Current account transactions. Exports, imports and balance. (2007). Eurostat. Retrieved November 8, 2007 from http://epp.eurostat.ec.europa.eu/portal/page?_pageid=1996,39140985&_dad=portal&_schema=PORTAL&screen=detailref&language=en&product=Yearlies_new_economy&root=Yearlies_new_economy/B/B4/B41/dca10000.

Ďurianová, Marta. (2007, October 8). Young Slovaks struggle to find work. The Slovak Spectator. Retrieved October 30, 2007 from http://www.slovakspectator.sk/.

Euro area unemployment down to 7.3%. (2007, October 31). Eurostat. Retrieved November 3, 2007 from http://epp.eurostat.ec.europa.eu/portal/page?_pageid=1090,30070682,1090_33076576&_dad=portal&_schema=PORTAL.

Fuentes, Andres. ( 2007, September 28). Improving Employment Prospects in the Slovak Republic: Building on Past Reforms. Organization for Economic Co-Operation and Development (OECD). Retrieved November 3, 2007 from http://www.oecd.org/publicationanddocuments/0,3395,en_33873108_33873781_1_1_1_1_1,00.html.

Gwartney, James D., Stroup, Richard L., Sobel, Russell S., & Macpherson, David, A. (2006). Economics (11th ed) Mason, Ohio: Thomson Southwestern.

Jobless rate hits all-time low. Slovak Spectator. (2007, September 24). Retrieved October 30, 2007 from http://www.slovakspectator.sk/.

McConnell, Campbell R., & Brue, Stanley L. (2005). Economics (16th ed.) New York: McGraw Hill.

Perry, Joellen, and Power, Stephen. (2007, July). Shortage of Skilled Labor Pinches Eastern Europe. The Wall Street Journal Retrieved October 30, 2007 from http://online.wsj.com/public/us.

Regnard, Pierre. (2007). Minimum Wages 2007 Variations from 92 to1570 euro gross per month. Eurostat. Retrieved November 5, 2007 from http://epp.eurostat.ec.europa.eu/portal/page?_pageid=1073,46587259&_dad=portal&_schema=PORTAL&p_product_code=KS-SF-07-071.

Rutkowski, Jan, et al. (2007, September). Labor Markets In EU8+2: From The Shortage of Jobs To The Shortage Of Skilled Workers. World Bank EU8+2 Regular Economic Report PART II: Special Topic. Retrieved October 31, 2007 from
http://wwwwds.worldbank.org/external/default/main?pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&theSitePK=523679&entityID=000020953_20071016152837&searchMenuPK=64187283&theSitePK=523679.

Unemployment Rate Total: 1995-2006. (2007, July). Eurostat. Retrieved November 3, 2007 from http://epp.eurostat.ec.europa.eu/portal/page?_pageid=1996,39140985&_dad=portal&_schema=PORTAL&screen=detailref&language=en&product=STRIND_EMPLOI&root=STRIND_EMPLOI/emploi/em071.