How big is structural unemployment in Latvia?

IMF estimates suggest it is quite high, around 12% (see this presentation, slide 18), which is not much below the actual unemployment rate of 14.1% (among the 15 – 64 year old, 4th quarter 2012). The policy implication of this is that there is not all that much room for lower unemployment before bottlenecks will appear and wage increases will accelerate in some sectors of the economy leading to higher inflation in the overall economy and a rerun (though not of the epic proportions) of 2004 – 2007. 

Solution: Fight high structural unemployment with retraining measures etc., which, however, is a slow measure – but it’s about what one can do.

This view was challenged during a seminar on 1 March by Mihails Hazans, Professor at University of Latvia and Alf Vanags, Director of BICEPS, Baltic International Centre for Economic Policy Studies, see their presentations (pdf) here. They claim that structural unemployment was reduced during the boom and that job-creating policies are therefore both useful and welcome.

So where is the truth? The seminar did not provide an estimate and in a sense fair enough: One is trying from one number, the actual unemployment rate, to deduce two numbers namely structural unemployment, i.e. unemployment stemming from mismatches in terms of skills needed in the labour market and skills supplied by the unemployed and by geographical mismatches, and cyclical unemployment, i.e. unemployment due to too low demand in the overall economy for goods and services and thus for labour to produce those goods and services.

I cannot point to a figure either although I (still) lean towards a quite high figure i.e. something closer to the IMF estimate. My little addition here is typical for a blog: A bit of back-of-the-envelope calculations. Not particularly scientific but not completely useless either.

The Latvian labour market has always been rather dysfunctional by EU standards, as also pointed out in this paper from Bank of Latvia. In Figure 1 I show how Latvian unemployment has ranked in terms of size (1 = highest rate in the EU, 27 = lowest rate in the EU). The Latvian unemployment rate has never been lower than the 6th lowest in the EU27 except for 2006 and 2007, the years of extreme overheating of the labour market as witnessed by the ultra-high wage increases of those years, see Figure 3. In other words, even when the labour market was overheated in the extreme, 15 countries, a majority of EU countries, still provided lower unemployment rates. This speaks of a very high level of structural unemployment.

Figure 1: Latvia’s ranking in EU27 in terms of unemployment rate. 1 = highest unemployment rate, 27 = lowest unemployment rate, 1998 – 2012

Source: Eurostat and own calculations

A second way to illustrate this is seen in Figure 2 where I portray unemployment rates in Denmark and Latvia. Denmark is also suffering from the aftermath of a property and credit boom gone bust, although not of Latvian magnitude (no country is…). Even at its most overheated, Latvian unemployment remained well above Danish unemployment, as it always has been, suggesting significantly higher structural unemployment.

Figure 2: Unemployment rates in Denmark and Latvia, quarterly, 1998 – 2012

Source: Eurostat

Figure 3: Growth of average net wages in Latvia

Source: Central Statistical Bureau of Latvia

Could that high level of structural unemployment ‘just’ have come down rapidly during the boom as otherwise structurally unemployed people found a job and became attached to the labour market?

Wages are growing again in Latvia (see Figure 3) but moderately and possibly just in line with productivity growth or so, thus not suggesting imminent overheating – but neither the IMF nor Hazans-Vanags suggest that we are in such an overheating situation, of course, so the macro data cannot reveal who might be right at the moment.

Personally I find it hard to swallow that the Latvian labour market ‘just’ transformed itself all that much but let us see what happens when (if…) unemployment hits 10 or 9 or 8 per cent. Will wages then take off or not? That should tell us who might be right.

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga