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Building competitiveness

Insider aiding

Europes labour markets have favoured older workers at the expense of younger ones. The

latest in an occasional series on structural reform

Feb 25th 2!2 " from the print edition

#F $%% the euro &ones many problems'

youth unemployment is perhaps the most

distressing. (oblessness among young

workers is around )* in +ortugal and

nearly 5* in ,pain. $bove-average

unemployment is the norm for young

people' even in more liberal markets like

$mericas. ut ,pains youth

unemployment rate /umped by nearly 2

percentage points between 20 and

21' compared with a rise of seven

points in $merica. %abour-market

regulations take much of the blame while

hard-to-fire older workers luxuriate on

permanent contracts' the young are

typically hired temporarily and are easier

to sack.

,uch 3dual4 labour markets arethemselves products of reform. $lthough

$merican unemployment uickly dropped

following the troubles of the !10s and

early !16s' European /oblessness

remained stuck at high levels. %eaders

recognised the need to in/ect more

flexibility into the labour market but

powerful trade unions headed off a full-

frontal assault on workers rights. The

answer was to create a less-protected

class of employees.

,pains experience is instructive. $s the

unemployment rate approached 2* in

the mid-!16s' the government

introduced fixed-term contracts of

between six months and three years'

which were sub/ect to lower dismissal

costs than those for workers on open-

ended contracts. $t the end of a three-

year contract firms could either convert a

worker to permanent employment or send

him packing. The reforms got results.

7nemployment fell from nearly !6* when

they began in !168 to around !8* six

years later.

ut the reforms had unintended

conseuences too. Temporary contracts

surged' soon accounting for close to a

third of ,panish employment. 9orkers

churned from /ob to /ob /ust :* of

temporary contracts were converted to

permanent employment during the mid-

2s. 9hen the economy turned down

employees were shed in larger numbers

and the unemployment rate rose fasterthan before. Those more likely to be

employed on temporary contracts' such as

the young' bore the brunt of the pain. The

euro &ones long expansion from the mid-

!11s until the crisis of 26 disguised

many of these problems. $ construction

boom helped ,panish unemployment back

below !*' even as immigration soared.

ut the crisis has exposed old weaknesses

again.

;olatility is but one cost of dual labour

markets. Freuent /ob turnover makes

households finances less certain' making

it harder' for example' to save regularly

for old age.

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employment discourages firms from

investing in their workers. The cost to an

employer of converting an expiring

temporary contract into a permanent one

is uite high because of a discontinuous

/ump in the cost of sacking the worker. ,othere is an incentive to get rid of him

when his contract ends and to invest little

in training him.

This systematic underinvestment drags

productivity inexorably downward. $ 2!!

study by (uan =olado of 7niversidad

>arlos ??? de

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$nd attractive as the Aerman model is

now' across decades $merican /obless

rates are tough to match. The $nglo-

,axon preference for little or no

employment protection may be the most

effective at herding workers from declining

industries to growing ones' driving /ob

creation and innovation. =yspeptic bond

markets are now pushing ,pain and

others towards reforms that make it

easier and cheaper to lay off workers

again. Cot before time.

The euro crisis

Europes Achilles heel

Amid growing risk of a Greek exit, the euro zone has et to face up to the task of

saving the single currenc itself

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second election looming in Areece' where

parties are struggling to form a

government. ?f a ma/ority of Areeks again

vote to re/ect the spending cuts and

reforms that go with their countrys bail-

out' then euro-&one governmentsJin

particular' AermanysJwill face a drastic

choice.

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wages stagnate. Dow wonderful it would

be if a cut in interest rates' :' extra

teachers and some new roads could spare

the French from all this. ut that growth

fairy does not exist.

"and the stories the #elieve

$cross Europe the pattern repeats itself.

?n ?taly the half-truth is that the country

can escape its dysfunctional politics by

entrusting hard choices to a technocrat.

?ts prime minister'

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$aluing %ace#ook

&ucker#ergs rocket, read for lift'off

=espite the hype as it prepares to launch its ?+#' the giant social network still has plenty toprove

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This fren&y is further proof' if any were

needed' that Facebook has become a global

internet idol. Facebulls reckon the flotation'

which could raise almost G!2 billion with

about half going to shareholders selling upH'

will help transform the social network into aweb powerhouse in the same way that

Aoogle used the riches from its 28 ?+# to

spread its tentacles across the web. $nd

they confidently predict that Facebooks

shares will start trading well above the

range of G26-)5 that the firm has set for

themJa range that would value Facebook

at G00 billion-1: billion. Editors 7pdate

:55 A

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,uch sums of money are impressive given that

Facebook was only launched in the same year

that Aoogle went public. ut the networks rise

also raises several important uestions that

investors would do well to ponder. The first of

these is whether Facebook can become a partof the fabric of a more social web' rather than

simply a destination on it. 9ithin five years'

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probably the single most powerful platform out there right now for targeting consumers'4

says =ick @eed of (ust

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maturing into an exceptional technology leader. ut if something were to go badly wrong at

Facebook in future' its shareholders will be able to do little more than give him a big thumbs

down.

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Income ine(ualit

)ho exactl are the *+

The ver rich in America increasingl work in finance, marr each other and care

passionatel a#out politics

(an 2!st 2!2 " from the print edition

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The average household income of the !* was G!.2m in 26' according to federal tax data.

The ultra-rich skew that average upwards admission to the !* began at G)6' in 26.

The >ongressional udget #ffice puts the cut-off lower' at G)80' in 20' or G252'

after subtracting federal taxes and adding back transfers. ollege and two

others' !:* of the top !* were in medical professions and 6* were lawyers shares thathave changed little between !101 and 25' the latest year the authors examined see

chartH. The most striking shift has been the growth of financial occupations' from /ust under

6* of the wealthy in !101 to !).1* in 25. Their representation within the top .!* is

even more pronounced !6*' up from !!* in !101.

,teve Baplan of the 7niversity of >hicago thinks finance explains much of the rise in

ineuality. 7pdating a series developed by Thomas +iketty and Emmanuel ,ae&'

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$lthough the !* have been gaining share in most countries' a recent #E>= report shows

that the trend began sooner' and has gone further' in $merica. ,ome scholars' noting that

ineuality has risen more in English-speaking countries' think social and political values may

play a role in mainland Europe and (apan' corporate governance' tax laws and unionisation

have tended to lessen income disparities. ut the relatively large role of the financial sector

in English-speaking countries could also be a factor even more of the top !* work in

finance in ritain than in $merica.

ommon Aood' a group of rich people who back #ccupy 9all ,treet. Der

father used to give his occupation as 3capitalist4. 3? grew up believing that QcapitalistsR were

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making the world a better place'4 she says. 3The capitalism we have has left us with

degraded infrastructure' threats to our health' and global warming.4

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fed up bank investors have become with

their returns.

Co wonder. etween 20 and the end of

last year shareholders in banks globally have

lost almost !* of their investment each

year' according to the oston >onsulting

Aroup see chart !H. ehind this

international average lie some truly horrible

losses. ?nvestors who stuck it out in =utch

banks saw the value of their holdings fall by

almost 26* a year. Dolders of French'

Aerman and ,wiss banks suffered average

annual losses of close to 2*. Those in$merican and ritish banks lost !8* and

!:* a year respectively. 3The little secret to

doing wellShas been /ust dont hold banks'4 says (acob de Tusch-%ec' a fund manager at

$rtemis.

$ fall in the price of an asset is usually a good signal to consider buying it. ut those

investors who thought that they had timed the bottom of the market have been proved

wrong again and again. 3?ve been dipping in and out of ?talian banks but am keeping very

uiet about it'4 says one fund manager. 3%ast year when ? told an investor Qin my fundR that

? was holding some he got up and left the room.4

,uch sharp falls in shareholder value are not /ust distressing for investors. They should also

worry the businesses and households that need a healthy banking system to keep credit

flowing. ?f the shares and debt issued by banks are uninvestible' then over time the banking

system will have to shrink or be nationalised.

There are three reasons why the banks have been such a bad bet. The first is weakness in

9estern economies' which has led to elevated losses' subdued demand for credit and

deleveraging by the banks themselves. 9ith returns on assets remaining largely unchanged

this is a tough time to charge customers moreH' the industrys total profits are likely to

keep falling.

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$ second reason is worries about sovereign

defaults. ?n the second half of last year

European banks sold virtually none of the long-

term bonds that they use' alongside deposits'

to finance loans. These markets have thawed

slightly since the European >entral ank E>Hprovided more than ! trillion G!.) trillionH in

three-year loans to European banks. ut they

are still fragile' partly because banks have

pledged collateral to the E>' leaving less to

repay bondholders if a bank were to go bust.

,imon ,amuels' an analyst at arclays' points

out that almost five years since the start of the

financial crisis' European banks are more

dependent on state support than ever. 39hat

we have' in effect' is nationalisation via the

debt markets'4 he says. 3?f you cant get a private-sector debt model to work then there isno real investible euity.4

The weak economy and worries over the euro area are' with some luck' transient problems.

Met weighing on investors minds is a third concern the impact that regulation will have on

banks long-term profitability and the safety of their debt. @eturns on euity have fallen

precipitously' from about !5* before the crisis to below !* now. ritish banks returns

have slipped from almost 2* to about 5* last year see chart 2H.

$ big reason is that banks have to hold much more euity as a buffer against losses. ,imple

arithmetics dictates that returns must fall. #ther regulations to make banks safer also have

a cost. anks will have to hold many more liuid assets' which can be uickly sold. They are

also being forced to stop profitable if riskyH activities such as proprietary trading.

@ules aimed at ring-fencing retail banks' 3bailing in4 bondholders and making banks easier

to wind up if they fail are also pushing up banks funding costs and depressing returns. They

are doing little to encourage investors to buy bank bonds. 3?f regulators told European

banks to raise bail-in debt there would be a resounding clatter of pennies at the bottom of

the tin but no folding money at all'4 says the chairman of a large bank.

For all the gloom' most big banks are still forecasting or at least aiming forH returns on

euity of !2-!5*' which would handily cover the cost of their capital. That would also be

respectable by historical standards $utonomous @esearch reckons that over the long term

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banks returns have averaged !* in ritain and 1* in $merica. ut it invites two

uestions.

The first is whether banks can attract investors with a combination of utility-like returns and

bank-like volatility. @egulators hope better-capitalised banks will be less volatile and moreattractive. onsulting Aroup

reckons that investment banks can uickly cut !-!5* of fat in areas such as market data

and exchange fees. =eeper savings can be made by reducing layers of management and

title creep it found that almost half of the staff in second-tier investment banks had the

title of director or managing director compared with 2-)* among the better firms.

ut banks do not have a great record as beancounters. European lenders have managed to

reduce their overall cost-to-income ratio only to about :2* from :1* since the mid-!11s'

an average improvement of .)* a year. Their current targets assume an average

improvement of 2.0* a year over the next three years' a figure