The Danish labor market, 2000–2022 Updated

The flexicurity model

Macroeconomic development has generally been favorable in recent years, and based on standard macroeconomic indicators, the economy has consistently performed well. Employment is high, and public finances and the current account display surpluses. The period prior to the Great Recession had high growth, and unemployment fell below the structural level. There were clear signs of overheating, with a booming housing market and accelerating wage increases. This was an unsustainable situation. Economic growth was already fading when the Great Recession set in, thus bringing the economy into a deep recession. The recovery was therefore relatively slow, although steep increases in long-term unemployment were avoided. The Covid-19 crisis differs from the Great Recession not only in the nature of the shock but also in relation to the pre-existing economic situation [2]. The lockdowns had both a supply and demand component; suppliers (firms) were constrained in their possibilities to sell, and demanders in their possibilities to buy. The emergency packages allowed most firms to retain valuable job-matches and production capacity (avoiding bankruptcy), but they also protected the income of workers and hence consumers, supporting consumer confidence and avoiding steep increases in precautionary savings. Hence, two classical persistence mechanisms, namely job-matching and decreases in aggregate demand, were muted by the policy initiatives. As noted, this should be seen in the perspective that Denmark entered the Covid-19 crisis with a well-performing economy, including low unemployment and sound public finances due to previous consolidation and reforms. Public debt is about 33% of GDP, which is among the lowest within the EU and well under the 60% baseline target. Consequently, there was fiscal space to pursue rather aggressive policies in terms of emergency packages, but also more traditional fiscal policy measures.

These phenomena are seen clearly in Figure 1, displaying developments in both employment and total working hours. Employment and working hours peaked prior to the Great Recession, and subsequently plummeted to recover only more gradually. Before the Covid-19 pandemic, employment reached a higher level, but importantly without the same signs of overheating as before the Great Recession. The employment decrease due to the Covid-19 crisis was muted by the wage compensation scheme introduced, and therefore the drop in working hours is a more accurate indicator of the effect of the crisis on economic activity [2]. The recovery has been swifter than in most other countries, and employment is now at a higher level than before the Covid-19 crisis.

The Danish flexicurity labor market has received considerable attention in recent years, especially for its ability to make a relatively generous social safety net compatible with a high employment rate [1]. It should be noted that employment rates—for both men and women—are among the highest within the OECD. This is in itself an interesting observation given the extended welfare state associated with the Nordic welfare model.

While the flexicurity model is no guarantee against business cycle fluctuations, the interesting question is how the model performs in a severe recession. Lax firing rules make it likely that employment will fall drastically when aggregate demand drops, and although the social safety net provides a cushion against large income losses among the unemployed, the financial viability of the model is at risk if structural employment decreases. A prolonged decline in employment reduces tax revenues and increases social expenditures, thus putting public finances under strain.

A key property of the flexicurity model is a high level of job turnover, implying that the unemployed (including youths entering the labor market) can find jobs fairly easily, and that most unemployment spells are short. Indeed, the data bear this out, as the general level of job inflows and outflows is high. Although job inflows plummeted as a consequence of the Great Recession crisis, they soon recovered, and the gross in- and outflow rates quickly returned to pre-crisis levels or even higher (Figure 2). The Covid-19 crisis did not change this. Outflows were high, but so were inflows, and unemployment in 2021 was at a lower level than beforehand.

The resilience of the labor market can be illustrated by considering the duration of unemployment spells (Figure 3). In a normal year, 30% of unemployment spells are shorter than four weeks, and about 50% are less than three months. During crisis periods with increasing unemployment, exit from unemployment is lower, as illustrated by the 2009 numbers in the figure. But still, most durations are rather short. For 2021 the outflow from unemployment was close to (even better for long unemployment spells) what it was in 2015, which is often considered a normal business cycle year.

This high level of turnover in the labor market is also the driving force behind Denmark's comparably low levels of youth and long-term unemployment. Both are about half the EU average, during the crisis years and at other times too. High turnover rates thus effectively work as an implicit work-sharing mechanism. Equal burden sharing is important from a distributional perspective, but it is also of structural importance. The alternative would be longer unemployment spells concentrated among a smaller group of individuals, more long-term unemployed and a corresponding depreciation of human and social capital. In short, the high turnover rates reduce the negative structural potential of high unemployment.

A possible downside of the high job turnover is that it may be detrimental to firm-specific training. It is difficult for firms to protect investments in its workers’ human capital if the training is of relevance in other firms too. This may lead to a suboptimal level of investment in human capital with negative effects on productivity growth.

Flexible wages facilitate labor market adjustments

Real wage growth has been rather steady over the years, but with variations reflecting the business cycle. Most clear is the spike in wage increases, and the associated deterioration in wage competitiveness caused by the overheating prior to the Great Recession. Subsequently, wage developments have been more moderate, and real wage growth has gradually increased in response to the declining unemployment rate. The recent increase in employment has increased real wages, but only moderately. Wage flexibility—both upward and downward—has thus been relatively high by international comparison, and sluggish wage adjustment is not a key issue. This differs from labor market responses in the 1980s and 1990s, and can partly be attributed to a move from a highly centralized wage-setting system toward a model of so-called “centralized decentralization.” Collective arrangements retain their role as regulators of labor market conditions, while wage determination has become more decentralized [3]. The bargaining process follows a so-called pattern-bargaining sequence where sectors most exposed to foreign competition—industry—settle collective agreements before other sectors. For the public sector (which accounts for about one-third of total employment), wage bargaining takes place under a norm that overall public sector wage increases cannot exceed average wage increases in the private sector. The unanticipated surge in inflation with consumer prices increasing 9% in 2022 creates a new situation, and it is yet unclear whether a wage-price spiral will be triggered.

As in most OECD countries, wage inequality has followed an upward trend (Figure 4), though wage dispersion remains low by international comparisons. There are few working poor, and the number did not increase much during the crisis.

High employment rates and high share of population receiving transfers

The labor market situation can be assessed from two angles: one is the share of the working-age population in employment (as in Figure 1), and the other is the share receiving some form of public income support. The employment rate in Denmark is high by international standards, but so is the share of the working-age population receiving public transfers. The latter reflects more extended welfare arrangements, implying that most who are unable to support themselves are entitled to some form of public support. It is an immediate corollary that public finances are very sensitive to the employment rate; higher employment increases tax revenues and reduces social expenditures. Reform efforts have focused on reducing the share of the working-age population receiving social transfers. All types of social transfers have been overhauled with the aim of increasing labor supply and employment. These changes comprise both eligibility criteria and benefit levels. Several aspects of these changes are of particular interest, most notably when it comes to the youth, elderly, and immigrants.