Introduction

One of the biggest sources of upside surprise this year has been the strength in consumer spending across the developed world. A big reason for this is the direct fiscal support measures utilised by governments. Wage subsidy programs have worked well to offset losses to incomes as employment has fallen. Not surprisingly, the countries where wage subsidy programs have been used (Europe, Australia and New Zealand) have seen much less of an increase in the unemployment rate compared to countries that opted for other support measures like increasing unemployment benefits or providing businesses with cheap loans to pay staff (like the US).

The use of wage subsidy programs makes comparisons between global labour markets difficult at the moment. The true level of unemployment needs to reflect:

1. Those who have left the labour market (industry shut downs and mobility restrictions led to a big exodus from the labour market as people could not look for work). These people are likely to eventually re-enter the labour force once industries completely re-open and
2. Those who have been stood down, which is gauged by people working zero hours or being absent from work (these people in “normal” circumstances would have become unemployed but are being supported by wage subsidy programs).

In this Econosights we adjust the headline employment data to get a truer picture of labour market performance during the COVID-19 shock which helps in understanding the outlook.

Some background on wage subsidy programs

The premise of wage subsidy schemes is that the government subsidises employee wages to help employers retain their staff during an economic downturn. In the long-run, this should help employees (because it means less short-term unemployment which is negative for income) and employers (as once the shock runs its course they don’t need to hire new staff and manage retraining costs). In theory, it makes the downturn less severe and speeds up the recovery. But, these programs tend to be costly and limit the natural creation and destruction of jobs that normally occurs in downturns which is negative for productivity growth.

Wage subsidy programs started being used widely in Germany during the Global Financial Crisis and the sovereign debt crisis, with the rest of Europe adopting them during the COVID-19 shock, due to the success seen in prior years. European countries that adopted wage subsidy schemes during the current crisis include France, Italy, Austria, UK, Germany, Spain and Sweden. Other countries with their own wage schemes include Australia, New Zealand, Canada and Japan.

The share of workers on wage subsidy schemes across labour markets can be seen in the chart below.

At the height of the crisis, some countries were supporting 20-30% of their workers via these schemes. Many European countries have extended these wage subsidy programs until well into 2021 which would be important now given the second lockdowns imposed in many parts of Europe. Most schemes are subsidising employees at around 60% of their previous wages.

Measuring the “effective” unemployment rate

To be able to make consistent and comparable comparisons between countries around the performance of the labour market during COVID-19 we have calculated an estimate of the unemployment rate that accounts for workers absent from work and those who have left the labour market – which is known as the “effective” unemployment rate.

The US already includes stood down workers as unemployed so the only adjustment we make to the US unemployment rate is accounting for those who have dropped out of the labour market. For Australia and the Eurozone we account for these dropped out workers as well as those who are absent from work due to COVID 19 (evident in the data through those working zero hours in Australia and weekly work absence data in the Euro area).

The chart below shows the difference between the reported headline unemployment rate and our estimate of the effective rate.

In Australia, our measure of the effective unemployment rate peaked at 14.9% in April (headline was showing a much lower 6.4% unemployment rate). As at October, the effective unemployment rate had fallen to 7.8% while the headline unemployment rate increased slightly to 7.0%.

In the Eurozone, the effective unemployment rate reached a much higher peak of 32% in April (the headline unemployment rate was 7.4%) as the first wave of COVID-19 cases was much higher in Europe, along with tighter stringency. Some of the components of the Eurozone data are delayed but, on our estimates, the effective unemployment rate would have fallen to 12% in September, with the headline unemployment rate rising to 8.3%. Expect the effective unemployment rate to increase again in the Eurozone given the latest increase in mobility restrictions.

In the US, our measure of the effective unemployment rate peaked at 19.1% in April (headline rate was 14.7%). Since then the effective unemployment rate has fallen to 9.4% and the headline rate has also declined to 6.9%.

In Australia and the Eurozone, where wage subsidy schemes are being used, the actual unemployment rate is converging towards the effective unemployment rate. The longer the health crisis persists, the more concern there is that initial temporary job losses will become permanent – this is a big concern in the Eurozone now as mobility restrictions have been imposed again. It is also a risk in some US states given the start of new restrictions and as individuals choose to regulate mobility, given the extremely high US COVID-19 case count.

Implications

The strength of the labour market (usually observed via the unemployment rate) is often used as a gauge to the health of the consumer. However, the current unemployment rate across major developed countries is masking the true level of spare capacity in the labour market due to the issues raised in this Econosights. For now, any loss to consumer incomes from higher labour market spare capacity is not causing a big problem for consumers because it is being offset by a raft of government distributions and a build-up in consumer savings. But, looking ahead, lower payments for wage schemes or early termination of these programs are a risk for consumer income growth.

However, it is also not feasible for governments to keep wage subsidy programs going indefinitely. It is not good for long-run productivity growth and for the natural creation and destruction of jobs that tends to occur after a big economic shock. Government support from wage schemes needs to be withdrawn at a slow pace that matches changes in COVID-related mobility restrictions. Another option could be adjustments being made to the requirements of the schemes including: mandatory training for new skills for those on the schemes, limiting using these the schemes to those who are working very few (close to zero) hours rather than those back to “normal hours” and tougher business criteria for eligibility. There may also be a cause to transfer those on wage schemes to unemployment benefits. This still keeps jobseekers engaged in the labour force by looking for employment but can alleviate some of the long-term negative aspects of wage schemes.

Long-term use of these schemes could also create moral hazard risks. In the next significant downturn there may be pressure on governments to bring back these subsidy programs to be used again which stunts productivity growth.

In our view, unemployment rates in major developed countries are yet to peak. While the Australian employment figures have proved to be very resilient, we think the Australian unemployment rate is likely to increase after JobKeeper expires in March 2021, towards 7.5% (the same level reached in July). In Europe, numerous individual countries are extending wage schemes into 2021 (although eligibility may be tightened) but Europe’s second round of strict lockdowns is negative for employment growth, meaning that the labour market will remain weak for some time. US employment growth is slowing, and temporary job losses are turning permanent with jobless claims still very high which argues for more fiscal expenditure.

There is still a long way to go to get labour markets back to their pre-COVID shape. In the US, around 55% of jobs lost due to COVID-19 have been regained while Australia is doing better relative to the US and Europe with around 75% of jobs lost due to COVID-19 now regained. Sharemarkets tend to be forward-looking and have already priced in the COVID-19 shock to the economy and to the labour market, now rallying on better vaccine hopes, low interest rates and hopes for further US fiscal spending. However, an unexpected withdrawal of government wage scheme support and further increases in the headline unemployment rate is still a risk for economic growth and therefore sharemarkets in the medium-term.