Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
IMF Survey : Structural Reforms in Advanced Economies: Pressing Ahead and Doing them Right
April 6, 2016
- Product and labor market reforms raise output and employment in the medium term
- Complementary macroeconomic policies required to maximize short-term benefits
- Need for careful prioritization and sequencing of reforms
In the current environment of persistent weak economic activity in many advanced economies, there is a strong case for product and labor market reforms to boost jobs and growth, a new IMF study finds.
Job training program in Germany. Structural reforms, including job training programs and other active labor market policies, can help countries boost economic growth, says the IMF (photo: Werner Bachmeier/imageBroker/Corbis)
WEO ANALYTICAL CHAPTER
The worrying sluggish growth in advanced economies since the 2008–09 global financial crisis have led policymakers in many advanced economies to emphasize structural reforms to complement the use of macroeconomic policies such as fiscal stimulus and unconventional monetary policies.
High on the agenda are several reforms designed to strengthen the functioning of product and labor markets. Product market reforms include lowering barriers to firms’ entry in network, retail trade, and professional services. Labor market reforms include strengthening active labor market policies (policies aimed at getting the unemployed back into work), revising unemployment benefit provisions, cutting labor taxes, and streamlining and harmonizing employment protection legislation for regular and temporary workers. These measures aim to improve economic health by increasing the quantity and improving the use of factors of production—labor and capital.
New research, published in the IMF’s April 2016 World Economic Outlook report, shows that these reforms raise potential output and employment over the medium term.
Product market reforms can also deliver gains in the short term, but the impact of some labor market reforms can depend on economic conditions. Hence, careful prioritization and sequencing of reforms, as well as supportive macroeconomics policies, are needed to maximize their short-term benefits, particularly where economic conditions are weak.
Impact: the short and the long of it
The study finds that such product and labor market reforms can make important contributions to output and employment in the medium term. Their short-term effects are likely to be more modest, however, as it can take time for the benefits to materialize, especially when economic conditions are weak:
• Product market reforms aimed at reducing barriers to firm entry have some expansionary effect in the short term. They boost private investment and hiring as new firms enter into the market, and this effect does not depend markedly on overall economic conditions (Chart 1). For example, the widespread deregulation of air transport and telecommunications that took place in many advanced economies mostly during the 1990s led to large increases in output, productivity, and quality of services.
• Some labor market reforms, such as reduced labor tax wedges and increased public spending on active labor market policies, have larger effects under weak macroeconomic conditions, in part because they usually entail some degree of fiscal stimulus (Chart 2, panels 1-2).
• In contrast, reforms to employment protection arrangements and unemployment benefit systems have positive effects in good times, but can weaken aggregate demand and further lower output in bad times (Chart 2, panels 3-4).
The study also finds that supportive macroeconomic policies can maximize the benefits of labor market reforms both directly, through their effect on aggregate demand, and indirectly, by improving the incentives of firms and workers to respond positively to such reforms—for example, making firms willing to recruit new workers rather than lay off existing ones when employment protection legislation is eased (Chart 3).
Now is the time, but do it right
Now is a good time to make a big push for additional product and labor market reforms in many advanced economies. There is strong need and scope for further reforms, the political environment is conducive, and—as the report shows—reforms pay off over the medium term.
But the results also highlight the need for careful prioritization and sequencing of reforms as well as for complementary macroeconomic policies, especially for labor market reforms. This means:
• Reforms that involve fiscal stimulus will be the most valuable, including reducing labor tax wedges and increasing public spending on active labor market policies. Where budget constraints are binding, budget-neutral implementation of such measures can still support growth.
• Product market reforms should be implemented forcefully, as they boost output even under weak macroeconomic conditions and would not worsen public finances.
• Where possible, narrowing unemployment benefits and easing job protections should be accompanied by other policies to offset their short-term cost. Alternatively, they might be enacted now but come into force only when the recovery is more robust, or be applied only to new beneficiaries—so-called “grandfathering” of reforms. There may of course be other considerations that make this first-best approach infeasible, such as the kind of macroeconomic and political economy constraints faced by some Eurozone countries
Finally, product and labor market reforms are no silver bullet; their growth effects appear to be transitory. Therefore, policymakers should undertake them in combination with other growth-oriented reforms, including in the areas of education and innovation.
The IMF will release further research from the World Economic Outlook Report on April 12.
The authors of this study are Romain Duval and Davide Furceri (lead authors), Alexander Hijzen, Sinem Kılıç Çelik, and João Jalles, with contributions from Jaebin Ahn, Romain Bouis, Matteo Cacciatore, Johannes Eugster, Giuseppe Fiori, Peter Gal, Fabio Ghironi, Prakash Loungani, and Jakob Miethe, and support from Bingjie Hu, Olivia Ma, Huy Nguyen, and Rachel Szymanski.