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Economic crisis: the right time for product and labour market reforms

Written by Cemal Karakas,

DUVAL, Romain; FURCERI, Davide; TEASDALE, Anthony, ALCIDI, Cinzia; KONSTANTOPOULOS, Panayotis; KARAKAS, Cemal

DUVAL, Romain; FURCERI, Davide; TEASDALE, Anthony, ALCIDI, Cinzia; KONSTANTOPOULOS, Panayotis; KARAKAS, Cemal
© European Union 2016

How could the global, and in particular European, economy recover from the ongoing economic crisis? What kind of reforms should take place? What are the prospects for the European Union (EU) and its Member States?

On 18 April 2016, the European Parliamentary Research Service (EPRS) organised its first roundtable discussion with the International Monetary Fund (IMF). Romain Duval and Davide Furceri presented the IMF’s World Economic Outlook (WEO) chapter on product and labour market reforms and their macro-economic impact. The panel was chaired by Anthony Teasdale (Director-General of the European Parliamentary Research Service (EPRS)). Cinzia Alcidi of the Centre for European Policy Studies (CEPS), Panos Konstantopoulos of Parliament’s Directorate-General for Internal Policies of the Union and Cemal Karakas from the EPRS, commented on the IMF’s results.

Structural reforms in product markets (covering all the goods and services that people and businesses sell and buy) and in labour markets are often the subject of academic debate. However, uncertainty remains regarding the short- and medium-term economic effects of such reforms, and therefore their impact on growth, productivity, investment, employment or inflation.

Romain Duval and Davide Furceri argued that the continued weakness of GDP growth and shrinking monetary and fiscal policy space in many countries should encourage policymakers to place greater emphasis on structural reforms. High on the agenda should be reforms designed to strengthen the functioning of product and labour markets — including reducing barriers to entry in services sectors (e.g. retail), encouraging active labour market policies and/or revising unemployment benefit provisions, streamlining and harmonising employment protection legislation for permanent and temporary workers, cutting labour taxes, and implementing targeted policies to boost labour market participation among the young, women, and older workers.

FURCERI, Davide

FURCERI, Davide
© European Union 2016

According to the authors, these reforms have the potential to boost growth and jobs in many advanced economies, such as the euro area countries, over the medium term. Product market reforms might have some expansionary effect, even in the short-term, and this effect does not depend markedly on overall economic conditions. Romain Duval and Davide Furceri referred to the deregulation of the air transport and telecommunication sector during the 1990s which often led to increases in output, productivity, and quality of services. Product market reforms should also be prioritised because they boost output regardless of overall economic conditions.

In contrast, the impact of labour market reforms depends on overall economic conditions. Fiscal reforms in the labour market, such as reduced labour taxes or increased public spending on active labour market policies, have larger effects under weak macroeconomic conditions, in part because they usually entail some degree of fiscal stimulus. In contrast, reforms to employment protection arrangements and unemployment benefit systems have positive effects in good times, but can weaken aggregate demand and become contractionary when times are hard.

Commenting on the IMF’s proposals, Cinzia Alcidi stated that dynamics related to the political cycle tend to make structural reforms more likely to happen in times of downturn or crisis, which is when their costs is higher. For this reason, in the public perception, structural reforms are often associated with a difficult economic situation. Better communication and careful sequencing can not only increase reforms’ gains, but also enhance citizen support. The EU governance structure should not disregard how the impact of reforms change according to the economic regime, whether times are normal, versus crisis, and take into consideration potential short-term costs in advance of long-term gains.

ALCIDI, Cinzia

ALCIDI, Cinzia
© European Union 2016

Panos Konstantopoulos added that the IMF study puts the importance of building a mutually supportive reforms agenda, prioritising correctly the sequencing of structural reforms and incorporating enablers of growth, so as to deliver short-term gains, into perspective. In this context, complementary measures play a key role, as they solidify the reforms package and help widen the basis for citizen support. The EU may draw some lessons from this study, to help build a stronger policy-mix in support of structural reforms in times of economic growth, when reforms are easier to implement and have weaker or no adverse short-term effects.

Finally, Cemal Karakas argued in line with the IMF experts on the importance of structural reforms, but also pointed out the potential negative impact of such reforms. Labour market reforms often have distributional effects, for instance, by creating or deepening social inequalities (e.g. equal payment of women, migrants, temporary employees). Product market reforms such as privatisation and deregulation (e.g. in the telecommunication or railway sector) might have created some positive effects for consumers and job creation, but equally also demonstrated some negative economic and social effects (e.g. health, energy or the housing sector).

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