Structural reforms and macroeconomic policies: some thoughts on a complex relationship

Presentation to ETUC conference ‘Labour market reforms and macro-economic policies in the Lisbon agenda’

Brussels, 20-21 March 2005

Andrew Watt

European Trade Union Institute for Research, Education and Health and Safety

http://www.etui-rehs.org

Overview of presentation

Some empirical puzzles

Mainstream views of macro/structural link

Problems with mainstream views?

Some real-world experiences

Policy conclusions: coordinating a two-handed strategy

No shortage of market-oriented structural reform

Labour market reforms

Product market reforms

Pension reforms

Single market programme/Competition policy

Network industries

Trade liberalisation

Lisbon Strategy

4

Substantial PMR – especially in EU

5

Same is true of LMR

6

Substantial PMR – especially in EU

Data source: IMF (2004): 11

Labour productivity growth, annual rates in %

0.6

1

0.4 0.4

1.6

1.6

1.2

0.8

0.2 0.3 0.40.6

1.2 1

1.7 1.4

2.2

2.6

1.6

1.2

1.41.3

2.1 2.1

0

0.5

1

1.5

2

2.5

3

1980-90 1990-95 1995-2000 1995-2003 1980-90 1990-95 1995-2000 1995-2003

EUR12 Capital deepening TFP

US Capital deepening TFP

Data source: O’Mahony and van Ark (eds.),(2003): 29

EU-US labour productivity, 1995-2001

-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6

Agriculture, Forestry and Fishing

Distributive trades

Financial Services

Manufacturing

Total Economy

Transport

Business Services*

Other community, Soc. & Pers. Services

Construction

Public Admin., Edu & Health

Communications

Mining and quarrying

Electricity, gas and water supply

* includes real estate

Data source: Eurostat (2005), New Cronos, Labour Force Survey

Unemployment rates EU 25 & EU 15(% of labour force 15/64)

0

2

4

6

8

10

12

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

EU25 EU15

Data source: OECD Economic OutlookData source: OECD Economic Outlook

Productivity down instead of up

0

0.5

1

1.5

2

2.5

3

3.5

Av

era

ge

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

Labour productivity, EURO area

Data source: OECD Economic OutlookData source: OECD Economic Outlook

Sharp decline in potential output, rise in NAIRU merely arrested

1.7

1.9

2.1

2.3

2.5

2.7

Av

era

ge

19

84

-86

Av

era

ge

19

94

-96

20

04

20

05

20

06

20

07

7.1

7.3

7.5

7.7

7.9

8.1

8.3

8.5

8.7

Potential growth NAIRU

12

Mainstream view: MOSR => growth

Unclear view of role of macro policy

Pure supply side (ECB?) view

Macro policy keeps inflation anchored, MOSRs raise the potential growth rate which automatically (from the supply side) leads to higher actual growth while maintaining price stability

Greenspan is God view

God-like central banker spots that potential output of economy has risen and keeps policy expansionary

Unclear view of role of macro policy

Layard/Nickell-type view

MOSRs reduce power of wage and/or price setters (ceteris paribus), leading to disinflation, macro policy can be more expansionary, leading to higher growth/employment

Competitiveness (employers’/Commission?) view

MOSRs raise 'competitiveness': higher growth and employment come though expanding market share/export-led growth

Assumptions of/problems with mainstream views

MOSRs are efficiency enhancing (LMI and PMR have no net positive role, higher competition reduces costs)

Efficiency-enhancing effects of MOSRs not offset by, e.g. negative demand/stabilisation effects

Inflation not prevented from falling by inflation floor or offset by other factor (inflation good indicator of excess supply, higher inflation elsewhere)

Central bank reacts in a timely fashion and can stimulate demand through interest rate policy (disinflation initially raises real interest rates)

Assumptions of/problems with mainstream views

Export channel is effective (external market relatively large, exchange rate does not offset, no trade retaliation)

Distributional outcomes of MOSRs are neutral or positive for growth and employment

Central bank is god-like

Investors decisions are guided by supply-side (cost) concerns rather than demand-side considerations

-> all are essentially supply side views in which macro policy is neutral in all but the very short run (investment losses reversible, no labour market hysterisis)

Mainstream 'political economy' view an exception?

The mainstream political economy view (OECD, IMF, Saint Paul etc) is centrally concerned with ensuring that MOSRs take place , in the face of the 'imperfections' of the political system, by means of accommodative macro policy. Only in that sense is macro policy not 'neutral'.

But in this view macro policy is a condition of the implementation of MOSRs (which are what actually generate the improved outcomes), not a condition of their effectiveness.

So it is predicated on the idea of 'inadequate' MOSR, leaving aside the issue of why such poor outcomes despite the considerable amount of MOSR

Specific problems in EMU

One central bank but 12 agents of MOSRs

ECB unlikely to react to national MOSRs, even ex post

Fiscal policy constrained by SGP

SGP prevents most (large) EMU countries from accompanying MOSRs with expansionary/compensatory fiscal policies

Indirect tax hikes and monetary policy

No exchange rate or trade barriers

National (relative) disinflation transformed 1:1 into improved competitiveness within currency area

But risk of cumulative causation and rising intra-EMU tensions

Differential effects in small and large countries

Source: AMECO 19

Real effective exchange rates (1998 = 100)

DE

AT

BE

GRES

FR

IEIT

NL

PT

FI

88

90

92

94

96

98

100

102

104

106

108

110

112

114

1998 1999 2000 2001 2002 2003 2004 2005

Examples of national experiences of MOSRs

DK mid 1990s:

small open economy

macro boost (MP, rise in public spending, especially pn training)

positive external environment

SE early 1990s:

small open economy

massive fiscal boost (8% GDP)

substantial currency depreciation

UK early 1990s:

huge currency depreciation

large fiscal deficit

greater autonomy over national monetary and fiscal policy

Examples of national experiences of MOSRs

NL mid 1980s:

small open economy

use of social partner agreements and agreed wage moderation, rather than national Philips curve)

positive external environment

ES 1990s:

restrictive policies and programme of MOSRs lead to sluggish growth and high (structural) unemployment

EMU brings dramatic loosening of monetary policy, strong growth and sustained fall in unemployment and NAIRU

but more recently loss of competitiveness

Examples of national experiences of MOSRs

DE since mid-1990s:

sustained competitive disinflation, exacerbated by MOSRs

major increase in competitiveness but pessimistic expectations and uncertainty lead to depressed domestic demand, sluggish growth, high unemployment and fiscal pressures

recent recovery at cost of rising competitive pressure in EMU (IT, PT)

Some lessons for theory and policy

Against background of volume of MOSRs, focus on explaining why reforms don't occur ('political economy') seems misplaced

Question is why outcomes have been so mixed

theoretical reasons (more market not always best)

oversimplistic and narrow theoretical basis

experience and more realistic theory shows importance of explicit links between structural reforms and macro

Some lessons for theory and policy

MOSRs without support from macroeconomic policy or a favourable external requirement are

unlikely to work (except possibly in small open economies)

within EMU at best to be a beggar-thy-neighbour policy that works via the real exchange rate

Within EMU, either structural reforms need to be coordinated more closely and close interaction with ECB assured

Plus mechanisms that work via the real exchange rate need to be subject to coordination

Proposal: strengthened Macroeconomic Dialogue for the euro area

Some lessons for theory and policy

And/or countries need greater scope for fiscal policy autonomy not just for ‘political economy’ but primarily for effectiveness reasons

Countries should also increasingly look to 'positive' structural reform agenda, that addresses specific supply-side constraints and avoids negative demand/confidence effects

Some elements in EES and Lisbon Strategy