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Council for Economic and Social Development /
European Economic and Social Committee

BRAZIL-EU ROUND TABLE

REX/283
Social consequences of the economic crisis

Brussels, 5 June 2009

FIRST BRAZIL-EUROPEAN UNION CIVIL SOCIETY ROUND TABLE

Brussels, 7 and 8 July 2009

REPORT

SOCIAL CONSEQUENCES OF THE ECONOMIC CRISIS

RAPPORTEUR: Mário D. Soares

Member of the European Economic and Social Committee – Group II (Trade Unions)

Member of the National Council of the Portuguese General Workers' Confederation -

Inter-union (CGTP-IN)

REX/283 - DI CESE 39/2009 PT/PM/hn

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Summary and conclusions

1.1 The immediate causes of the present crisis were the bursting of the property sector bubble in the US and some European Union Member States. It also reflects a threefold process of "financialisation" of economies in the majority of developed countries, unbalanced globalisation and worsening inequalities in the distribution of wealth and income.

1.2The current situation is marked by uncertainty. There are grounds to fear that the crisis will be long-lasting, given its scale, synchronisationand depth as well as the temporary mismatches between economic activity and employment.

1.3The economic and social impact is profound: worsening labour market conditions, collapse in asset prices, a sharp slow-down in growth of consumer prices, and heavier budget deficits and public debt.

1.4 There is a real danger of an acute and protractedunemployment crisis, as experience of past systemic financial crises shows that they have lasting negative consequences in terms of unemployment.

1.5 It is crucial that the financial system be stabilised if the economy is to operate properly, but it is vital that support should be conditional upon a guarantee that the credit needed for the economy, and especially small- and medium-sized enterprises, to operate will be granted. There is a need for coordinated, wide-reaching and long-term global responsesthat aim to correct the imbalances that triggered the present crisis. However, analysis of recovery plans shows that neither employment, support for small- and medium-sized enterprises, social protection nor sustainable development are priorities.

1.6 Comparison of the resources committed to remedial measures reveals the existence in many countries, including European ones, of an imbalance between the financial efforts made to save banks and financial institutions on the one hand, and plans for the recovery of the real economy on the other.

1.7 A response to the crisis requires coordinated and timely, and at the same time monitored, action geared to employment, improving the environment and, more broadly, to a shift towards a low-carbon economy.

1.8 The key components of such a response, in addition to stabilising and recasting the financial system's architecture, must be employment, support for SMEs and social protection. Priority must be given to steps to combat inequalities and to strengthen the European social model. At the same time, the Stability and Growth Pact must be reviewed at the proper time, given the danger that applying fiscal consolidation policies, just when the EU countries' economies might be moving out of recession, could prove disastrous to economic recovery.

2.The causes of the crisis and present outlook

2.1The origin of the present crisis lies in the granting of high-risk property loans in the US, which has turned into the 21st century's first financial crisis and since expanded in a very swift and synchronised way into a world economic recession. In order to grasp the social consequences of the crisis and to recommend measures that might best reverse or minimise its effects, it is also important to take account of the less direct causes that have contributed to the present situation. Although the immediate cause is the bursting of the property bubble in the US and some European Union Member States, the crisis also reflects a threefold process of "financialisation" of economies in the majority of developed countries, unbalanced globalisation and worsening inequalities in the distribution of wealth and income.

2.2Events in the last decades of the 20th century were marked by the appearance and growth of financial capitalism, based on scarcely-regulated financial products. According to the McKinsey Global Institute, world financial assets amounted to 195 trillion dollars in 2007, representingthree and half times world GDP whereas, in 1980, the figures for the two were similar. Financial globalisation explains the high level of synchronisation of the current crisis (as revealed by looking at the proportion of OECD countries experiencing two consecutive falls in output compared with previous crises[1]), setting it apart from earlier crises.

2.3 The predominance of financial activity compared to the production of goods or services has had profound consequences on every aspect of economic and social life. A regulatory model dating back to World War II, based on sharing productivity gains and covering social risks by developing the welfare state, was challenged, giving primacy to the interests of shareholders. Applications based on short-term thinking came to the fore, to the detriment of productive activity, long-term investment, employment, economic efficiency and a better standard of living. New, highly speculative and opaque financial products emerged. Recourse to tax havens increased, especially by banks, insurance companies and speculative funds. The period was marked by financial scandals and large-scale speculation, starting at the beginning of the decade (such as Enron in the US) and coming up to the more recent instances (such as Kerviel in France and Madoff in the US).

2.4 The crisis reflects a breakdown in prudential regulation. It involved spreading financial risk by converting debts into assets that could be sold on the financial markets (securitisation), and the use of complex financial bonds bundling together different types of loan with different degrees of risk that had previously been securitised (structured products). This did not occur because these products were an ideal means for banks to avoid regulation, but rather because their complexity was such that even financial actors failed to understand the products they had acquired.

2.5However, the absence or ineffectiveness of regulation, however great, is not enough by itself to explain the origins of the crisis. It is also to be explained by a process of globalisation that is unbalanced between countries with strong trade surpluses, especially the emerging countries, and countries with high and rising trade deficits, most prominently the US. This process has produced a global glut of savings, further boosted in the emerging countries by the insufficient level social protection, meaning that families need to save more to shield themselves against social risks. This abundance of savings in the emerging countries, set against a backdrop of low interest rates and the growth of sophisticated and un- or poorly-regulated financial instruments, encouraged the search for financial applications offering high yields but entailing substantial risk.

2.6The crisis is also the result of growing inequality in the distribution of income and wealth. Added value was redistributed, with the part going to pay shrinking under the impact of pay restraint policies, and the part of profits increasing. An ILO study[2]shows that, in more than two-thirds of the countries for which data exists, the share of wages in income distribution declined over the last two decades. Executive pay, in contrast, rose steeply. In the United States, CEOs at the 15 largest firms earned 521 times more than the average salary in the firm in 2007, compared to 369 times more in 2003.Executive pay practices, substantially made up of share options, were a factor in encouraging management styles focusing on the short term, associated with increasingly risk applications. For their part, fiscal trends (rising taxation of goods and services, less taxation of income, and lower tax receipts from foreign trade) curtailed the ability of tax systems to redistribute the fruits of economic growth, making such systems more regressive. Tax rates on the highest incomes were cut.

2.7 The major inequality in income distribution, disadvantaging salaries, was one of the factors leading to excessive household debt. The relative fall or stagnation of incomes for a majority of workers spurred them to seek credit. Household over-indebtednesshas occurred in those countries where income inequality increased most[3].

2.8A crucial question for the present EESC opinion is the duration of the crisis, as the social consequences and measures in response to them must reflect this fundamental aspect. The situation is particularly uncertain at present. There are, however, grounds for fearing that, given the scale, synchronisation and depth of the crisis, as well as the temporary mismatches between economic activity and employment, it will be lasting.

2.9The European Commission's recent economic forecast (Spring forecasts) signalsa contraction in world GDP of 1.5% in 2009, and a recovery to 2% growth in 2010. For both the EU and the euro area, GDP is expected to contract in 2009 (4%) and in 2010 (0.1%), reflecting a slow recovery. Uncertainty is however great and, as the European Commission warns in its document, that it cannot be ruled out that the outlook may be worse than forecast, due in particular to:

a)a sharper deterioration in the real economy, which could aggravate the housing market corrections in some countries;

b)the risk of capital flows that could affect countries with large external financing requirements, as is the case with a number of the economies of central and eastern Europe;

c)recourse to protectionist measures.

2.10The crisis is having a profound economic and social impact: worsening labour market conditions, collapse in asset prices, a sharp slow-down in growth of consumer prices, and heavier budget deficits (21 of the 27 Member States will display deficits of more than 3% in 2009) and public debt.

2.11There is a real danger of an acute and protracted unemploymentcrisis. Firstly, because the unemployment rate was already high before the crisis, standing at 7.1% in 2007. Secondly, because study of past systemic financial crises shows that they have lasting negative consequences in terms of unemployment[4]. The decline in living standards (per capita GDP) lasts two years on average, while increased unemployment lasts for some five years.

3.The social consequences

3.1 The deteriorating situation on the labour market, and in particular rising unemployment, is one of the most striking aspects of the present crisis. This deterioration began in the second half of 2008. The unemployment rate could rise to 9.4% in 2009 and 10.9% in 2010 (11.5% in 2010 in the euro area). These are figures unseen since World War II, as highlighted by the European Commission (Spring forecasts). Some countries will experience even higher unemployment, including Spain (where it could pass the 20% mark in 2010), Ireland, Latvia, Lithuania and Estonia. The impact of rising unemployment has been cushioned in some countries (including France and Portugal) by use of partial employment schemes (suspension of employment contracts or reduced working hours, lay-offs), particularly in certain sectors such as the automotive sector.

3.2 A significant reduction in employment is also expected – between 2008 and 2010 the number of employed will fall by 8.5 million, wiping out the net job creation in the preceding two years (Spring forecasts). Higher unemployment and the lower level of employment are reflected in the downturn in the employment rate, falling from 65.4% in 2007 to an estimated 63.2% in 2010. The target set by the Lisbon Strategy of a 70% employment is out of reach for the immediate future. The crisis could have a major impact on the number of hours worked, through use of short-time working and cuts in overtime, with implications for workers' earnings.

3.3 Workers' vulnerability to the crisis varies between sectors, skill levels and type of contract. The crisis had its epicentre in the financial and construction sectors, with sectors highly dependent on credit and export business being affected subsequently, to a lesser degree. Although the crisis has spread and now affects all sectors, it is probable that the least skilled workers will make up the bulk of the unemployed. Moreover, the cuts in company workforces are having a greater impact on workers with temporary contracts or fictional service-provider contracts who, in general, have lower pay levels. Young people are heavily affected, in part because they tend to be in less secure employment.

3.4 Migrant workers are also more vulnerable to the crisis given the nature the jobs they perform, usually associated with low skill levels and greater insecurity of employment. On the tightest labour markets, with higher unemployment levels, these workers are more likely to suffer from hostile attitudes, especially in the event of prolonged crisis. Some European countries have introduced incentives for immigrants to return to their countries of origin, as in Spain, while the Italian Parliament has adopted legislation to criminalise irregular immigrants. Remittances fell worldwide in 2008 (from 2% of GDP to 1.8%) a trend that is expected to gather pace in 2009, according to a document published by the World Bank[5].

3.5 The European Commission expects pay rises in the euro area to decline in the euro area, although in real terms this may be offset in 2009 by the perceptible deceleration of consumer prices. The same may not be the case in 2010. Other factors could exert a downward pressure on earned income, particularly those relating to working hours: suspension of employment contracts, cuts in overtime, changes in work organisation (less shift working, for example).

3.6 The effects of unemployment on the income of unemployed persons are directly related to social security arrangements to compensate for the loss of earned income. Some unemployed may not be entitled to unemployment benefit, or it may not be enough to ensure a decent standard of living, depending on factors such as:

the degree of insecurity or informality on the labour markets;

duration of unemployment, which may run longer than the period of entitlement to benefits;

the restrictiveness of access to benefits, in particular during the qualification period;

complementarity between unemployment benefit and supplementary benefit schemes (different types of unemployment benefit with differing qualification periods).

These factors vary between EU countries, but it is clear that in some, a significant portion of the unemployed are not covered by unemployment benefit, as in Slovakia and Poland (only 9% and 12% respectively in 2005)[6]. According to the ILO, the percentage of unemployed people not receiving these benefits stands at 45% and 20% respectively[7].

3.7 Duration of unemployment is a crucial factor as it affects not only income but also the chances of getting back onto the labour market. The level of long-term unemployment improved between 2000 and 2007, but remains high (falling from 46.5% in 2000 to 42.5% in 2007), and it is to be feared that the crisis could lead to longer periods of unemployment.

3.8One immediate consequence of the crisis can be seen in pension fund losses following the collapse in stock market values. European countries have also been affected by the fact that a shift, albeit partial, occurred in a number of them from pay-as-you-go pension schemes, in which benefits are determined by law, to fund-based pensions. In fixed-contribution fund-based schemes, the risks are borne by individual people. The impact of the crisis on individuals depends on the degree of exposure to the stock market and losses in asset value (ranging from 8% to 50% according to a World Bank document)[8]. It also depends on the percentage of people covered by these funds. The countries of central and eastern Europe are the most heavily affected (Poland, Hungary and Latvia), but they are not alone (United Kingdom, Ireland and the Netherlands).

3.9The crisis is also having an immediate impact on people's wealth as a result of the stock market falls combined with declining house prices. Losses on the property markets vary from country to country, but the countries most affected by the property markets will be Spain, the United Kingdom and Ireland.

3.10The impact on poverty levels could be significant. Across the world, the ILO estimates that, as a result of the crisis, the number of working poor living on less than two dollars a day could increase by more than 100 million[9]. At EU level, it is difficult to predict the scale of the impact on poverty. Workers on fixed-term contracts, including temporary workers, those in the informal economy and immigrant workers are among the groups that may be worst affected by unemployment and loss of income. Other social problems may be aggravated by the crisis. One if these is payment (or non-payment) of maintenance following family break-ups, which could have an influence on child poverty.

3.11Social security finances have been hard hit, as social security operates as an automatic stabiliser. Firstly, social security is receiving less income in countries where it depends primarily on workers' contributions, given the slow-down in the rate of pay growth and the increase in unemployment. Secondly, social security systems are having to spend more as a result of both worsening unemployment and of support for employment and companies (reduction of company social security contribution to support employment, support for temporary lay-off schemes, etc.).

3.12The crisis is having an even worse effect in the developing countries due to its greater impact in countries which are, by definition, less developed and have greater social needs: the collapse of international trade, pushing down exports particularly in Asian and Latin American economies; falling oil and other raw material prices; reduced flows of capital and foreign direct investment; shrinking remittances from emigrants.

4.The most urgent challenges

4.1 Responses to the crisis initially centred on stabilising the financial system. Measures were geared to: supporting banks and businesses in the financial sector that were in difficulty, in some cases going as far as to nationalise them; support for monetary policy, with central banks injecting liquidity into the economy and reducing interest rates; and protection of deposits. These have been followed by economic stimulation packages implemented through budgetary policy aimed at bolstering aggregate demand, and by the G20 meeting on 2 April that aimed to create a new global regulatory framework for financial systems. According to the ILO, all the plans, covering 32 countries – including all the G20 ones – involve resources amounting to 1.4% of world GDP[10].