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Towards the end of March this year, the weekly jobless claims in the United States increased by 1000% during the first bout of the pandemic. As of June, the country has reported an unemployment rate of 11.1%, which is an improvement in comparison to its previous peak rate of 14.7% in April but it is still a stark contrast to the impact the pandemic has on Europe. Based on the latest CEIC data, the Netherlands currently has a 4.3% unemployment rate, and Italy, arguably one of the worst-hit European countries, is at 7.82%.

The most significant cause for such a difference is the variation in the approach taken. While American employers are quick to hand out pink slips, European firms are relying on the government during this chaotic time. Most European countries participate in schemes where the government takes responsibility for some of the wage costs. For instance, the Germans have the Kurzarbeit, the French have their chômage partiel, and the Italians rely on cassa integrazione—thus allowing European firms to retain their employees, albeit at reduced pay.

Though the latter appears to be more advantageous, is it the most strategic choice to Europeanize American firms in the long term? The answer is not necessarily clear cut, with both economic and humanitarian factors coming into play.

At first sight, the American approach seems to be harsh. After all, why punish employees for something entirely out of their control? Work ethic and performance are not the driving factors of the mass dismissals. However, it seems to partially follow what is advocated by Schumpeter, a renowned economist.

In 1947, Schumpeter introduced the free-market approach. He claims that the most efficient economy will be the one that is unregulated and determined by the invisible hand, also known as the supply and demand forces. A free market will result in theoretically zero or the least amount of externalities possible, and thus maximizes the benefits for society. Concerning the current topic at hand, due to a significant health threat, the demands of the consumers have changed seemingly overnight. We can compare abandoned restaurants, clubs, and airlines to declining or obsolete firms. At the same time, online shopping, specialized medicine and healthcare, and food are the emerging firms in an in-demand industry. When the forces are free to play, the declining firms should replace the newer ones, creative destruction can ensue, and the market will continuously improve.

In a free efficient market, as demand increases for one good, the supply will, in turn, increase. The opposite should also hold – as demand falls, the supply should decrease as well. Theoretically, this is possible if those in the declining industries lose their jobs, and then almost immediately find employment opportunities in the newly growing sectors. But this course of action is inhibited by the European intervention. Partially compensated employees will stay in the declining industries rather than fulfil what the invisible hand wants the market to do. Resources will remain stuck in inefficient places, whereas, without intervention, will be more appropriately allocated.

It is important to note that the American approach is also not purely Schumpeter-esque, but is closer to his ideas than the European one. The American government has also temporarily inflated the unemployment benefit budget to USD $2 trillion and crafted a USD $350 million stimulus package to keep smaller firms afloat. Those interventions may inhibit shifts to a more profitable industry, and create less motivation and incentive to look for (temporary) jobs in other sectors.

Coming back to the issue, if the free market is the most efficient form of the economic approach, why are countries choosing to deviate? Efficiency is, in general, defined as achieving maximum results with minimum wasted effort. For the economy to be efficient is ideal, but it is not a well-rounded indication of success. The well-being of one’s citizens is a huge factor in making political decisions. Sudden dismissals can cause people to be responsible for large debts such as mortgages suddenly. The accumulated “wasted effort” that occurs to ensure stability may be worth the trade-off. This current degree of security is where Europe’s overall choice excels, and could potentially lead to a faster “bounce back” effect in the post-pandemic era. Europeans are, for the most part, still receiving some compensation. As a result, though salaries are not as high as they were a few months ago, cutting back on spending is likely not to be as much as if they were entirely out of a job. And though both America and Europe will see a decrease in overall consumption, European domestic consumption will most likely be higher, and fear of reduced spending lower than in the United States. Of course, neither will be able to negate the effects of the pandemic fully, but can only hope to minimize them as much as possible. As with everything, there are some exemptions. Europeans in specific industries, such as tourism, will still get hit hard, especially when the summer touristic season proves to be disappointing and government schemes stopped. In this case, the full effects are postponed rather than lessened or avoided altogether.

Furthermore, the free market approach fails to consider the barriers of entry in certain industries. Though yes, resources (including labour) may move to in-demand sectors, most people do not have the qualifications to do so. To move from hospitality to healthcare is neither an easy nor quick transition; specialized knowledge that takes years to cultivate is a requirement. Even if this happens over time, what happens during the transition phase when they are out of a job? In real life, to have a truly unregulated market could potentially lead to a degree of chaos and simply not the best route to take. The fact that the economy will eventually recover should also not be overlooked. Sectors that seem irrelevant now will ultimately be needed again, and thus should not be rendered obsolete just yet.

The solution isn’t clear, but some American firms have recently undertaken decisions that to some extent, will benefit their employees while cutting costs (and indirectly following the free-market approach). There is a rising trend for employees to be furloughed instead of fired in more prominent American companies who can afford to do so. Furloughing was a technique commonly used in Europe during the 2007-2009 financial crisis. Furloughed employees are on unpaid leave, but can return to their positions once circumstances have stabilized. Using this strategy can even benefit the firms in the post-pandemic era as they can get back to business much quicker. An example is the Hilton hotel group, who is taking it one step further and helping their furloughed employees find jobs in e-commerce, an in-demand sector with fewer barriers to entry, in the meantime.

Both unemployment responses are different and come with their own set of advantages and disadvantages. Crafting the perfect response remains challenging, especially during times where circumstances change from day to day. Policies should strive for an optimal combination of flexibility and stability (for the sake of employees) is what policies should strive. A handful of Americans has taken adoptions of the European-style responses, but only time will tell if it will produce the results hoped.