Spanish employment growth accelerates in Q1, while use of temporary contracts grows rapidly

Employment growth remained brisk in the first quarter of 2016, when demand for labour rose for an eighth successive quarter after falling continuously since mid-2008. Total employment expanded by 3.3% year on year (y/y), or by 574,800 jobs to 18.030 million. This was the sharpest gain since the third quarter of 2007.

Firms continue to hire workers on temporary contracts

With the Spanish economy enjoying an evolving and broad-based recovery path, firms are expanding their workforces. However, reviving demand for labour is still being met predominantly by rising temporary employment, which climbed by 343,600 or 10.1% y/y to stand at 3.740 million in the first quarter. Meanwhile, firms also recruited new workers on indefinite contracts, up by a more restrained 1.8% y/y, or 197,700 to 11.195 million.

Unemployment rate notably lower than a year ago

The smaller labour force and sharp employment growth triggered yet another notable y/y fall in unemployment. Specifically, the number of unemployed retreated for a 10th successive quarter when it fell by 12.0% y/y (653,200) to 4.791 million during the first quarter of 2016. Therefore, the unemployment rate dropped to 21.0% in the first quarter, down from 23.8% in the same quarter in 2015. Youth joblessness remained at dangerous levels, with the unemployment rate for the age cohorts of 16–19 and 20–24 painfully high.

Outlook and implications

Job creation in the first quarter of 2016 was stronger than expected, and even outperformed recent survey data suggesting employment growth had peaked in line with slower overall economic growth. The demand of labour proved resilient in the face of the inconclusive general election, and policy gridlock on key issues such as labour market reform and fiscal consolidation. However, we argue that firms could begin to sit on their investment and employment plans in the face of lingering political mess, and we suggest the rapid rise in temporary contracts could be partly triggered by a cautions recruitment policy by firms wary of a future political scenario that delivers a less business friendly government.

Unemployment is falling but still presents a major risk to the recovery momentum. With unemployment standing at 4.791 million, the recent recovery in consumer confidence and spending intentions could stall, and the vulnerability is heightened by past real disposable income and housing equity losses.

Furthermore, the risk that unemployment could remain uncomfortably high for several years is acute. We continue to argue that the best hope of a significant drop in the unemployment rate is a rapid downward adjustment in the size of the labour force, which has risen exponentially in the past decade, fuelled by a steady inflow of migrants and rising female labour participation rate. Furthermore, we suspect the rebalancing economy (reducing its dependence on labour-intensive construction and real-estate sectors) will struggle to support and create sufficient jobs for its labour force that rose markedly during the prolonged economic boom.

Prime Minister Mariano Rajoy will hope that continued positive labour demand, household real income and GDP developments will sway more voters to give his government more electoral credit for navigating Spain from a near-depression to being one fastest growing Eurozone economies should the country return to the ballot box.

Rajoy will argue that the continued improvement in the labour market is further proof that his stable government is the best custodian of the recovery, while being best placed to create an environment that encourages business to ramp up their employment and investment plans. Still, a key electoral issue remains the current standard of living crisis, with household gross disposable income in real terms by end-2015 still 6.8% below its fourth-quarter peak in 2009.

Too many temporary jobs imply a new labour market crisis is never far away

The number of workers of temporary contracts continued to climb rapidly in the first quarter, outpacing the rise in new permanent jobs. Clearly, firms continue to show strong bias towards recruiting workers on temporary contracts as the recovery evolves, and this could be an increasing theme as firms tread carefully in the face of political stalemate. Reviving employment intentions primarily underpinned by the rising temporary contracts will have a less positive impact on private consumption and the housing market, with temporary workers being more risk averse and cautious spenders while being locked out of the retail mortgage market. In addition, Spain could be vulnerable to a renewed fall in employment (and a new spike in the unemployment rate) should the recovery stall or the economy begins to shrink. Firms have traditionally targeted workers on short-term contracts as a rapid response to challenging trading conditions, when times are tough rather than adjust wage levels and working hours to more appropriate levels.

Further labour market reform required but post-election political crisis a major roadblock

The dispersed political landscape after the inconclusive general election is a major barrier to deepening existing labour market reform, primarily to slow the rise in temporary contracts while encouraging greater use of permanent opportunities during the current upturn. However, the past two labour market reforms in Spain illustrate the conflicting challenges facing any government as it tries to balance the need to create jobs very quickly alongside securing a more stable and better functioning labour market in the medium term. The key conflict remains the usefulness of temporary contracts in the early phases of the recovery despite its implications for the dual labour market. But with the recovery now established, many firms are still opting for temporary contracts, suggesting that firing workers on permanent contracts still remains too costly and laborious, with severance packages standing at a maximum of 33 days' pay per year, and capped at two years' wages. It had stood at 45 days' pay for every year worked to employees deemed to have been unfairly dismissed, and capped at three and a half years. The recent change only applies to contracts issued after the law was passed, with existing contracts allowed to keep their "accumulated severance rights".

But the inconclusive general election and the ensuing political crisis suggest a difficult and much delayed path to future labour market reform. The next logical step would be a further reduction in the gap in the level of protection afforded to permanent and temporary workers by lowering severance payments for permanent contracts. Also, Spain could consider removal of differences between permanent and temporary workers by creating a universally applicable contract for new entrants. The model could mirror the Italian experience via its "Jobs Act", which has launched a new open-ended labour contract for new recruits, which limits the scope for reinstatement, introduces a fast-track settlement of dismissal disputes, while the amount of monetary compensation for unfair dismissal rises in line with length of service. Ultimately, we argue that the phase of labour-market reform needs to encourage firms to employ a greater number of young workers on more secure, indefinite term contracts.

Finally, a new general election in June 2016 is a possibility, pointing to even more delay in addressing major labour market inefficiencies at a time when the economy is enjoying a strong and broad-based recovery.