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The following OECD assessment and recommendations summarise chapter 3 of the Economic survey of Denmark published on 19 February 2008.
The economic boom has led to wider labour-market inclusion, but this could be lost if a wage spiral is now set in motion
Following strong economic growth during 2005 and 2006, unemployment reached a 30 year low in mid 2006 and has fallen further since then. Private-sector agreements concluded in early 2007 implied relatively moderate wage growth of 4 to 4.5% a year, but local agreements now have started to react to the labour shortages. GDP growth has slowed recently, but with a large positive output gap, capacity constraints are set to continue. Inflationary pressures are strengthening, and there is a real risk that the achievement of low unemployment could be spoiled in the coming years. Marginal groups, such as immigrants from non-western countries, have benefitted most from the recent strength of the labour market, but to secure a foothold in employment, these groups will need time and stability. It is therefore vital to avoid policies that put the current expansion at risk. Crucial in this respect is to reach a reasonable settlement during the renewal of public-sector wage agreements in early 2008. Demands are currently aired for wages to grow considerably faster than in the private sector, but if met, these wage increases might well spill over into an economy-wide wage spiral with increased inflation to follow.
Why has the record low unemployment not generated inflationary pressure until very recently?
These potential risks have to be assessed against changes in the structural rate of unemployment, the NAIRU, and changes in the structure of employment. There is growing evidence that the NAIRU – the rate of unemployment consistent with a non-accelerating inflation – has fallen in Denmark as a result of a combination of factors: benefit reforms and active labour market policies, including greater efforts to mobilise people outside the labour market; hysteresis, as the length of the expansion provides opportunities for the former unemployed to develop work skills; increased supply of low wage workers from the new EU member states; and possibly more decentralised wage bargaining.
Structural unemployment has declined steadily
However, the decline in the NAIRU cannot fully explain the wage moderation observed until recently. Indeed, actual unemployment has been below any empirically-based estimate of the NAIRU for a while, and the unemployment gap is currently large. The observed wage moderation at the aggregate level can also be partially explained by significant changes in the industry structure towards sectors with relatively low labour intensity. Indeed, wage settlements have already begun to outrun productivity gains in some sectors, but this has not yet emerged at the aggregate level in part because changes in industry structure have helped to contain the overall development in wages relative to labour productivity. In the absence of further major changes in the industry mix, it is likely that the current very tight labour market conditions will strengthen the upside risks to wages and prices.
Labour supply should be boosted now– in ways that also help fiscal sustainability
With the recent strength in job growth, actual employment is well above the structural targets envisaged in the 2015 Strategy. However, this cyclical rise will only be sustained if it is supported by measures to increase durably the labour supply and further reduce structural unemployment. The government’s recent job plan recognises this, proposing measures to enhance activation as well as measures to reduce reliance on disability and sickness benefits. A number of these measures could be implemented quickly. Others may require more time, for example those aimed at strengthening the capacity of job centres to implement stronger activation requirements. Rather, measures should be pursued in ways that also help the long-run challenge of fiscal sustainability. These include:
Refine activation programmes to make them more cost effective. Ensuring more counselling with job-centre staff and better matching of activation programmes to individual needs should be considered, while putting less time and resources into training which has proven not to be cost effective. In cases where it is cost-effective, compulsory activation could be brought forward to speed up the transition back to employment. Also, training programmes should be structured so that they ensure continued jobs search. Continued evaluation of labour-market programmes is essential given their high cost.
Activation programmes should focus more on older workers close to moving into early retirement. A special focus on such workers in activation policies, as is the case for young people, might reduce unemployment amongst older workers and possibly even reduce the flow into early retirement.
Ensure that unemployment benefits support activation. It is important to have benefits early on so that the unemployed can spend time on job search. At the same time, it is important that if the unemployment spell is prolonged, eligibility to benefits becomes gradually tighter with requirements to search for jobs in other areas or to consider changing profession. In particular, for full-time unemployment benefit recipients who had low income and so face a very high replacement rate (up to 90%) for four years, the incentives to consider moving to another part of the country for work are quite limited, since such a move would leave the person with less disposable income than if they stayed unemployed where they are. Reducing the unemployment benefit replacement rate during the period of unemployment should be considered, as has recently been introduced in Sweden. In addition, shortening the duration of part-time unemployment benefits would help promote search for full-time work.
Policies to promote immigration of workers, which is also a focus of the government’s job plan, should contribute to easing the current labour shortages. However, Denmark does not have a good track record of integrating immigrants, especially from non-western countries, into the labour market. The gap between the employment rates of native born and foreign born individuals is the largest in the OECD, partly reflecting immigrant characteristics, including their country of origin. Weak integration and the redistributive features of taxes, benefits and publicly funded services imply that low-skilled immigration does not generally improve fiscal sustainability. High-skilled workers may also be discouraged from staying for long in Denmark by the high income tax rates. Accompanying reforms would therefore be needed to ensure also long term benefits from higher migration flows, including policies to encourage high skilled immigrants to stay in Denmark and policies to enhance the skills and employment prospects of low skilled immigrants.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.The complete edition of the Economic survey of Denmark 2008 is available from:
For further information please contact the Denmark Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat's report was prepared by Jens Lundsgaard and David Turvey under the supervision of Stefano Scarpetta. Research assistance was provided by Lutécia Daniel.