“Labour hoarding is still high,” summarised European Stability Mechanism economists in a on Wednesday 30 October 2024, emphasising that the broad employment landscape and its economic consequences represent the “euro area’s Achilles heel.” This situation is particularly concerning for the ESM, as labour hoarding--where firms retain more employees than economic activity necessitates--has emerged as a critical issue for the euro area’s economic future. Carmine Gabriele, Katarina Gumanova and Michael Kühl, all from ESM’s economic and market analysis team, have forewarned that labour hoarding, coupled with structural and persistent low growth, could become a vulnerability for the euro area’s economy.

Historical patterns

Historically, the euro area has exhibited a close relationship between economic activity and employment, contributing significantly to productivity growth. Over the past few decades, productivity increased steadily as economic activity outpaced employment growth, allowing firms to produce more goods per employee. Notably, the industrial sector exemplified this trend, achieving nearly three times the productivity growth of other sectors during the two decades leading up to the covid-19 pandemic.

However, this traditional dynamic has shifted. During the pandemic, euro area employment remained high due to job retention schemes even as economic activity dropped, creating an unusual decline in productivity per employee. While productivity per hours worked remained steady, the number of hours worked and total employment in the euro area diverged significantly from the level of economic activity. This trend has persisted beyond the pandemic, as the energy crisis also caused a sustained decoupling of economic activity from employment growth.

Since mid-2022, employment and hours worked have outpaced economic activity, particularly in the industrial sector. “At the same time, the unemployment rate in the euro area reached historical lows, with firms hoarding workers,” noted the ESM economists. They pointed out that labour shortages further exacerbated this phenomenon. Surveys indicated record numbers of job vacancies, pointing to a persistently tight labour market despite economic pressures.

Sectoral impact

The extent of labour hoarding across the euro area is measurable. According to the ESM team’s estimates, labour hoarding has inflated “current employment levels 2.1% higher than they would have been otherwise,” keeping approximately 3.6m additional workers across the euro area employed as of the second quarter of 2024. Without these surplus employees, the economists estimated that the unemployment rate would be around two percentage points higher than current figures.

Labour hoarding differs among euro area countries and across various economic sectors, significantly affecting the industrial and construction industries, noted the ESM blog. In this sector, employment exceeded economic activity-predicted levels by 9.3% as of Q2 2024, accounting for 1.3% of total euro area employment.

The economists reported that labour hoarding in the services sector amounted to 2.3% of employment in that sector. Country-specific data also reveal disparities in labour hoarding, with Germany and France identified as primary contributors. Without labour hoarding, employment levels in Germany and France would likely be 7% and 5% lower, respectively.

Contributing factors

The economists’ analysis identified both cyclical and structural drivers behind labour hoarding. Cyclical factors, such as profit growth in recent years, have provided firms with temporary financial buffers to absorb the costs associated with maintaining high employment levels. These buffers, in turn, support continued labour hoarding, enabling firms to retain staff even amid low productivity levels. The economists noted that this trend may ease if economic growth picks up, as increased productivity could naturally diminish labour hoarding over time.

Structural factors, including an ageing population and labour shortages, may also motivate firms to maintain high employment levels. With fewer available workers in the euro area, employers may be inclined to hold onto their workforce even in the face of economic slowdown, as replacement workers are more difficult to secure.

Risks

Despite expectations of economic recovery, the ESM economists cautioned that growth projections remain modest, with risks of prolonged labour hoarding persisting. If economic activity proves weaker than forecasted, higher labour costs and diminishing profit buffers may compel firms to adjust employment levels downward. Should this scenario unfold, “labour hoarding could then translate into increased unemployment.” The economists emphasised that such a scenario could harm aggregate demand, put strain on public finances and potentially impact financial stability. As unemployment rises, demand for social support would grow, pressuring public budgets further. Financial stability could also be undermined by increased credit risks among banks due to potential household and corporate defaults.

Policy implications

The ESM economists highlighted labour market developments as a key concern for policymakers. They pointed to two critical challenges: addressing structural issues in the euro area labour market, exacerbated by the pandemic and recent inflationary pressures, and enacting labour market policies to facilitate workforce reallocation to more productive sectors. Recent reports by and have offered medium-term strategies to tackle these issues, noted the economists.

According to Gabriele, Gumanova and Kühl, policies aimed at labour market reallocation could gradually reduce labour hoarding, support economic growth and bolster financial stability. Although labour hoarding has temporarily cushioned the euro area from higher unemployment, they argued that these policies are essential to prevent an impending employment shortfall. With strategic interventions, the euro area can mitigate the impact of labour hoarding, protect public finances and ensure long-term financial stability, concluded the ESM economists.