While the global financial crisis and recession have hit all of Europe’s economies, the impact has varied considerably across countries. Output and employment, for instance, have moved quite differently in Germany, Spain, and the UK, three of the larger European countries, according to IMF research.

Fund economists Ravi Balakrishnan and Helge Berger say that Germany, Spain, and the United Kingdom have all seen a significantly larger fall in output per capita than they have in the past, which illustrates the severity of the current recession in Europe. The contrast between previous cycles and the current recession is most striking in Germany, with its massive drop in output in the current downturn (see Chart 1 above). Equally striking is the degree to which the dynamics of employment and productivity (total output divided by the number of workers) vary among countries.

As in past downturns, Spain had the steepest reduction in the employment rate, followed by the UK and Germany. However, current employment losses in Spain - - where the global crisis has coincided with the end of an extraordinary but unsustainable housing and construction boom - - have been substantially higher than in previous cycles (see Chart 2). For the UK, while employment losses are also higher than is typical at this point in the cycle, they are moderate compared to Spain. In contrast, Germany has seen fewer employment losses than in previous recessions.

The stark differences in employment responses are mirrored in pronounced differences in productivity dynamics. With little or no labour hoarding - - that is, firms holding on to workers despite a lack of demand during recessions - - Spanish productivity tends to grow more steadily and at positive rates during downturns, including the current one. In the UK, productivity usually falls during a recession, but the decline has been somewhat steeper this time around (see Chart 3 below). The very sharp drop in productivity in the current recession in Germany deviates substantially from its historical pattern of smooth productivity declines.

Labour market flexibility matters

Labour market flexibility - - particularly employment protection - - is highly relevant in explaining variations in labour adjustments to shocks. For example, across advanced economies, higher levels of employment protection tend to reduce both inflows and outflows into employment and can slow down labour reallocation after major shocks.

However, the case of Spain—which has large employment losses despite high employment protection - - illustrates that there are other factors at play, too. Spain has a very high share of employees with fixed-term contracts - - much higher than the EU average. As a result, employment adjusts relatively faster in Spain despite higher levels of employment protection, as firms let fixed-term contracts expire. And this trend has been amplified in the current recession.

In contrast, employment has adjusted more slowly in Germany and the UK in the current downturn, reflecting a mix of labour market policies and flexibility at the firm level. In Germany, “time accounts” helped smooth employment over the cycle (by offsetting shorter work hours during the recession against longer hours during the boom), but government subsidies supporting reductions in working time are a crucial factor. In the UK, while measures to support employment have been introduced recently, wage flexibility seems to have played a more important role.

According to the Paris-based Organisation for Economic Co-operation and Development (OECD), more than 20, mainly European, countries have introduced or expanded short-time working schemes during the current downturn.

According to IMF forecasts, Eurozone GDP (gross domestic product) will fall 4.2 per cent this year, against 2.7 per cent in the US.

Eurozone unemployment rose to 9.7% in September - - just 2.4 percentage points higher than at the low point in the current cycle, in February 2008. In the US, over the same period in the US, the unemployment rate rose by over 5 percentage points to 10.2 per cent in October.

Germany has about 1.5m "short-time" workers in the government-backed Kurzarbeit scheme, which helps workers and companies by making up the majority of any wages lost due to working-time cuts.