A 'J-curve' for the eurozone periphery: the prospects for labor market reform.

• Author: Zimmermann, Klaus F.

Remember the international trade debate of the 1980s and 1990s? Much of the international discussion about the global economy back then was shaped by references to a rather obscure term, the "J-curve." The term sought to capture the fact that, as nations sought to improve their economic fortunes by devaluing or depreciating their currencies, there was a time lag before any improvement would show up in that nation's trade balance.

Now, amidst the debate about economic reforms in Europe, another kind of J-curve effect is upon us. Crisis-ridden countries such as Italy, Spain, and Portugal have embarked on a healthy diet of labor market reforms, but even under the best of circumstances it will take some time before this tough medicine yields improvements in these nations' employment and growth statistics.

The current effort seeks to pass laws to bring these nations' labor market policies into line with those of other, more successful economies. As important as these steps are, they are but a first step in the reform process. They increase employers' readiness to hire more people only very gradually.

If those measures had been taken earlier, well before the onset of the global financial crisis, they could have yielded positive effects by now. The German case, where unemployment is at lows not seen in thirty years, shows the benefits of deploying such strategies early. The fact that Italy and Spain waited so long does have significant consequences. Employers' hiring calculations are currently not just handicapped by excessive job protection policies, but by a prolonged recessionary environment. The longer confidence in the smooth workings of market mechanisms has been lost, the harder it is to regain.

But that makes these measures all the more crucial. They include the reduction of often excessive, multi-year payouts which employers in those countries have to pay in case they need to lay off people. And they include curtailing a routine use of the courts to contest individual layoffs in trials regularly stretching over several years.

These societies need to sort out some very basic questions. None is more important than this: Having high levels of job protection always sounds desirable, until one realizes that it means that an entire generation of young people is basically denied access to full-time jobs, as we currently witness in Spain.

Weighing down companies with overly generous severance pay obligations for employees (witness Italy) or a...