Thematic BlogSpot - Can Structural Reforms Save the Eurozone?
Structural reforms are increasingly called upon to restore solid economic growth, especially in the eurozone, where monetary policy lacks in effectiveness and fiscal space is limited. But the composition and pace of reforms, as well as their political acceptability, raise questions. Possible short-term adverse effects of structural reforms are debated. Under what conditions could structural reforms lift Eurozone GDP?
A low-growth and low-productivity context in the Eurozone
Growth projections for the Eurozone are low: 0.8% for 2014 and 1% for 2015 based on OECD numbers, while the U.S. and the U.K. have returned to pre-crisis growth rates.
This growth divergence is not new. The secular convergence in real GDP levels between the two sides of the Atlantic stopped in the mid-90s. In 2012, PPP GDP per capital was 34% lower in the EU28 than in the U.S. (OECD Factbook 2014). A key explanation factor is the divergence in productivity: as the labor productivity growth in Europe averaged 1.4% per year since the mid-90s, it stayed at 2.5% in the United States, despite the financial crisis (Van Ark). Among the proposed explanations are rigidities in labor, capital, and product markets, and a lack of productive innovation in Europe.
What are structural reforms?
Structural reforms are changes in the core structure of the economy aimed at improving aggregate supply on the longer-term. These changes may include “how prices are set, how public finance is conducted, government-owned enterprises, financial sector regulation, labor market rules and regulations, the social safety net, and institutions”, according to the IMF (“What Are Structural Policies?”, F&D, March 2013). Structural indicators capture the effective functioning of markets—like the OECD Going for Growth reports or the World Bank’s Doing Business indicator, measuring business regulations, useful to assess structural reform needs.
Different countries, different needs
Bruegel’s recommendations to the incoming EU commissioner for economic and monetary affairs note that structural reforms needs are different in every country and cover a wide array of measures such as reducing excessive regulations, administrative requirement, protectionist regulations, inefficient labor market regulations or wasteful public spending. The country specific recommendations issued by the European Council, as part of the European Semester, list possible structural reforms for each country.
To enhance convergence and reform accountability, beyond country differences, political actors like Italy’s finance minister, Pier Carlo Padoan, have pushed for a “reform scorecard” to enable a direct comparison between national reforms. Kemal Derviş, in Project Syndicate, underlines that a new social contract between Eurozone members could aim at building trust between member countries on structural reforms: reassuring Germany on effective reforms in France and Italy, and encouraging efforts in Southern Europe by greater investment throughout the region.
The hard choices: priorities, sequencing and vested interests
The EU and international organizations, using standard economic analysis, generally produce a laundry list of desirable reforms that does not tell governments where to begin, writes Jean Pisany-Ferry on Project Syndicate. Implementing structural reforms is therefore all about national governments building political acceptability for these reforms. This is where the hard choice begins.
Governments don’t tend to adopt a comprehensive approach to reforms, suggested Benoît Cœuré, but they rather avoid taking on organized vested interests (like protected sectors) and instead implement measures that affect a more diffuse group, like lowering the minimum ware or liberalizing employment protection. This is why product markets reforms are harder to implement than labor market reforms. This is also why reforms are often perceived as unfair. Taking on vested interests is a difficulty strategy and Dani Rodick (Project Syndicate), suggests that one should focus on changing the ideas by which the elites operate, instead of trying to defeat or remove vested interests. Reforming protected sectors – which are an important obstacle to productivity growth in many core European countries, including France or Italy – could for this reason be a long-term struggle.
The difficulty to implement structural reforms explains why some economists consider the very notion of “structural reform” with suspicion. Paul Krugman notes that the phrase sounds good, but could mean a lot of things. It is sometimes a convenient way, for politicians, to express the idea that something should be done to improve growth, investment and productivity in the Eurozone without providing any actual reform idea, to the point that structural reforms have become “structural excuses” or the last refuge of scoundrels when used as the universal answer to all economic problems.
The timing question
Only a few of the structural reforms result in higher growth, higher inflation, or both, says Jean Pisani-Ferry on VoxEU. Many of these reforms even have adverse short-term effects, to the point that economists and policymakers debate whether now is the right time for the Eurozone to implement structural reforms, writes David Pothier at DIW Berlin.
At the same time, it makes little sense for European countries to stop reforming now, underlines Benoît Cœuré. Many of the reforms that lead to downward price pressures and real interest rates have already been implemented, especially in Eurozone non-core countries. The reform agenda in Europe today is largely about productivity increase and boosting investment demand, and therefore less likely to have negative short-term effects.
Structural reforms need to be combined with other economic measures to avoid deflation and recession in the eurozone. The report by Henrik Enderlein and Jean Pisani-Ferry on Reforms, Investment and Growth in France, Germany and Europe (see our Warning Signals BlogSpot) underlines that action is needed on all three fronts: structural reforms, in order to strengthen potential growth and productivity; a fiscal policy support in the form of temporary public investment or immediate tax cuts; and a commitment by the central bank, provided that the reforms are real, to serve as a “backstop to government funding”, to quote Mario Draghi at the Jackson Hole conference.
If structural reforms alone won’t save the Eurozone, they are a key element to its future prosperity and therefore its sustainability over the long-term.
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