Bad news Barney. It looks like this neo-liberal orthodoxy of the past three decades could be another victim of the economic crisis.

Who says so? That socialist rag the Financial Times (22 January 2010), looking at the uber-flexible labour markets in the US :

(Giving full quotes as you can’t link to FT, you have to register)

“Something weird is happening to labour markets in the rich world. The link between depth of recession and rise in unemployment is broken. And for the first time in a generation, Europeans can bask in the knowledge that their unemployment would have to rise in order to approach US levels.

In some countries – the US stands out – the decline in output has not been so terrible but the employment shake-out has been brutal. Many more American jobs have been lost than in other countries – and many more than in the past.”

And this is backed up by Trots at the OECD and Harvard:

“The failings of flexibility

Macroeconomics has learnt the art of eating humble pie. Since the onset of the financial crisis, long-cherished predictions, theories and rules of thumb about the way whole economies work have fallen by the wayside. Is it now the turn of microeconomists to taste some of the same medicine when it comes to the labour market?

For years, it has been the settled view in economics that, in most cases, flexible labour markets are best. More jobs might be lost in a downturn, but this cost was far outweighed by the benefits of flexible pay and the ease of reallocating jobs from dying industries to dynamic ones. No body was more closely aligned with such recommendations than the Organisation for Economic Co-operation and Development, the Paris-based club of developed nations.

But now the OECD is modifying its view. “We have been promoting flexibility, not for the sake of it, but for economic performance and for workers to get into new jobs,” says Stefano Scarpetta, the OECD’s head of employment analysis.

This motivation is allowing a change of view. “Judging from the outcomes so far, short-time working schemes seem to have been rather successful in containing the job haemorrhage,” he says, adding that even his organisation is “a little bit more positive on public works programmes: we argue that as part of a labour market approach, they might be worthwhile”.

While this is not a wholesale repudiation of the OECD’s former views, it reflects the fact that, according to the organisation’s own analysis, the gains in employment flexibility of recent years have failed to protect employees from the economic crisis. “There do not appear to be any clear grounds for concluding that workers, generally, are any better or worse prepared to weather a period of weak labour markets than was the case for the past several recessions,” the OECD concluded in its latest Employment Outlook.

Some top economists argue that the theory of superiority of flexible labour markets applies only at full employment. It will not work well when there has been a large shock to demand, output is well below potential and jobs are effectively rationed. In these circumstances, German-style institutions that cushion and spread the pain are probably superior.

For professor Richard Freeman of Harvard University, the problem is simpler. Microeconomists and policymakers spent much too much time fiddling with the work incentives of poor people. “If the unemployed person or the welfare mother… doesn’t do quite as much work as we would like them to do, or as they should, that’s a very small cost to society; when a big banker takes excessive risks, it can bring the whole system to a disaster….so we took the eyes off the ball of the really risky part of capitalism.”

As an aside, while I am critical of Labour on a number of points, I have to say that there achievement in making the labour market more flexible seems to be paying substantial dividends. Hats off to them, and I hope it continues. And lets hope we don’t double-dip…

What is true is that since the end of the commitment to full employment, unemployment has had the potential to dramatically increase very quickly, while it takes a longer time to drop.