Unit 2 Unemployment, wages, and inequality: Supply-side policies and institutions

2.10 Application: Employment security and labour market flexibility in Denmark

A very different example is Denmark, where strong trade unions and employers’ organizations have cooperated to implement a novel combination of income security for workers and a freer hand for employers in hiring and firing.

The Danish economic response to COVID-19

In March 2020, the COVID-19 pandemic exploded across the world. Governments raced to contain the spread of the disease, and to minimize its economic impact. Denmark’s social and economic system was tested by the pandemic’s rapid onset. The Danish model of cooperative policymaking distinguished itself by providing an astoundingly fast and effective economic response.

Just 24 hours after the health emergency was officially declared, a national agreement between employers, trade unions, and the government was negotiated. Firms were able to send workers home on furlough with full pay instead of laying them off. The government would cover 75% of the monthly salary (up to a maximum) with the employer paying the rest. This helped protect the profits of employers as the demand for many products collapsed. It helped protect workers’ incomes and jobs. In the spring of 2020, 70,000 workers lost their jobs and 250,000 were furloughed.¹

Prime Minister Mette Frederiksen of the Social Democratic Party explained the speed and strength of the Danish response:

‘The solutions we present you with today rest on all parties contributing. The state, and thereby society, must contribute. Employees must contribute. Companies must contribute. We have a long-standing tradition of being able to do this in Denmark. The Danish model is strong, and we are now seeing its strength.’

Announcing the March 2020 response to COVID-19. From right to left: Mette Frederiksen (prime minister), Nikolai Wammen (finance minister), Jacob Holbraad (CEO, Confederation of Danish Employers), Lizette Risgaard (president of the Danish Trade Union Confederation)

Flexibility for employers and security for workers: Danish ‘flexicurity’

The tradition of cooperation between employers and employees observed in the pandemic crisis dates back to 1899 when, after three months of strikes, the trade unions and employers’ organizations agreed to the September Compromise, still recognizing their conflicts of interest but aiming for cooperative solutions. An example of the Danish model is in the labour market strategy that Denmark has followed since the 1990s, the so-called ‘flexicurity’ system—a term coined in the 1990s by then Prime Minister Poul Nyrup Rasmussen, also of the Social Democratic Party.

Under this system, employers benefit from flexibility in their hiring practices, enabling them to easily hire and fire workers. Workers therefore cannot count on job security: their job may be terminated. But they are guaranteed income security by a generous welfare system and longer-term employment security thanks to what are termed active labour market policies such as retraining programmes or job search support. This follows from the ‘right and duty’ principle underlying the Danish model: workers have the right to be supported through unemployment, but also the duty to work towards finding a new job.

The three poles of the Danish flexicurity triangle and how they are related is illustrated in Figure 2.26.

The result is that the overall economy is more efficient as workers are more easily allocated to jobs which fit them and more adaptable to changing economic conditions. Workers have the support of a strong social safety net and retraining opportunities and so do not want to prevent changes in the economy that might result in them losing their job.

Most of what matters to workers and their employers—general working conditions such as pensions, maternity and paternity leave, and wages—is negotiated between unions and associations of employers, not legislated by the government. There is no minimum wage in Denmark but average wages are among the highest in Europe and low-wage work is uncommon.

Our WS–PS model provides a possible explanation for the success of the Danish model of flexicurity in delivering real wage growth and keeping unemployment down. It suggests that this outcome may result from shifts in both curves.

• Increased labour productivity. An upward shift in the price-setting curve resulting from an increase in the productivity of labour. This is made possible by both the more cooperative relationship between employees and their employers and the flexibility that employers have in terminating the jobs of workers who are no longer needed. Taken by itself, this shift would increase the wage and the level of employment (reducing unemployment).
• A downward shift in the wage-setting curve because workers have more positive feelings (or less negative feelings) towards their employer so that keeping the job becomes more valuable to them. This means that for any given level of employment in the whole economy, the wage necessary to motivate the worker to provide the specified level of effort is now lower. The downward shift in the WS curve does not affect the wage (that is determined by the PS curve) but provides firms with a motive to hire more workers, increasing employment and decreasing unemployment.

There are two other likely effects of flexicurity on the model of the macroeconomy, and as they work in opposite directions they might cancel out. Recall from Unit 1 that the WS curve will shift up if it becomes more costly for the employer to fire a worker caught shirking or if there is a rise in the unemployment benefit or some other improvement in the prospective employee’s quality of life without the job relative to the quality of life with the job.

Danish flexicurity policies make it less costly to fire workers. This (taken by itself) would mean that the consequences of shirking on the job (not meeting HR’s work standard) would be worse for the employee, so the employer could reduce the wage and still expect the worker to work up to standard. This would be a shift down in the WS curve.

But working in the opposite direction are the generous income support for the unemployed and both governmental and trade union programmes of retraining and job search. The fact that Danish workers often move between jobs so that there is no particular social stigma associated with being unemployed also improves quality of life without a job.

As a result, while it is easier for Danish employers to fire workers not working up to standard, the quality of life (and income) of the worker without a job improved. The result could be a shift up, or a shift down in the WS curve, or no shift at all.