Free Lunch: The good, the bad and the ugly in structural reform

Δημοσιεύθηκε: 15 Απριλίου 2015 - 10:52

Not all reforms are created equal

"Not helpful" was then-commissioner Olli Rehn's reaction a few years ago when the International Monetary Fund realised - and duly publicised - that it had underestimated the harm fiscal austerity inflicted on growth. The rest of us may beg to differ: it's a good thing when a large economic research and policy institution improves our knowledge and even better if policies improve as a result. The implication of the new take on fiscal multipliers was that the eurozone and the IMF had made the recession worse by overdoing the fiscal belt-tightening.

The IMF is being helpfully unhelpful again. There is a lot of interesting stuff in the fund's World Economic Outlook, in particular its Chapter 3, which analyses the worldwide fall in productivity growth. But the most interesting bits were only hinted at in chief economist Olivier Blanchard's presentation on Tuesday. A blog post by Francesco Saraceno proves that it pays to read until the end of the WEO Chapter 3. Tucked away in the last pages (Box 3.5, p104), is a short study on how productivity is affected by structural reforms.

To point out the obvious, this is particularly relevant to the eurozone, where structural reforms are imposed on the weakest members, bought from stronger countries in return for extended deadlines on deficit reduction, and insisted on by the ECB as the counterpart for its doing the monetary heavy lifting. So you might think Europeans would be particularly keen to find out if reforms achieved their promise.

The IMF estimates the effect of labour market reforms and product market reforms separately. Product market liberalisation - reforms that increase competition in the sale of goods and services - have a positive effect on productivity, especially in the service sectors, but the short-term effect is negative. Meanwhile, labour market deregulation does not help productivity at all, and even has negative effects in the short run. The figure below summarises the findings:

I'll write that again. Product market liberalisation is good for productivity in the long run but costly in the short run. Labour market deregulation shows only bad effects on productivity. Blanchard's euphemism is that "structural reforms are no miracle cure - the effects are very often uncertain". Indeed. You might think that in a rational world, better knowledge about what works and what doesn't would inform policy decisions and help us move on from the generic call for "reform". You might even hope that it would inform the current stand-off in Greece, whose government says it is keen to weaken product market monopolies but undo some of the labour market reforms (on collective bargaining and minimum wages) enforced by creditors.

This nuance on the benefit of structural reform follows a spurt of research showing that the impact of structural reforms in a deflationary environment, in particular when monetary and fiscal policy do not stimulate aggregate demand, is ambiguous at best. The Bruegel blog has a good round-up of the academic findings. The general idea is that by pushing prices down, reforms worsen whatever bad effect disinflation and deflation may have. Intuitively, however, one can see how this would be worse for labour market deregulation than for product market liberalisation, as per the IMF results. More competition in product markets lower prices by expanding production as more competitors fight for market share. So the price fall is accompanied by a directly expansive effect. Labour liberalisation, however, works in the first instance by reducing wages, which may well have a redistributive and demand-depressing effect before any output growth is seen.

There is more. As the chart above shows, the IMF also looks at the labour tax wedge - the difference between the price paid for the product of labour and the reward ultimately received by the worker. No surprise there: reforms that shrink the tax wedge are good for productivity. So wouldn't you think countries under pressure to reform had made a priority of shrinking the labour tax wedge, whether by shifting the tax burden elsewhere or cutting spending?

If so, you'd be wrong. The OECD's latest "Taxing Wages" report, which was also published on Tuesday, reveals that most OECD countries are raising not lowering taxes on work. The average labour tax wedge has increased by a full percentage point since 2014. And which country has the biggest tax wedge on one-earner families with children? Greece, after five years of troika tutelage.