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

1. Presentation to ETUC conference ‘Labour market reforms and macro-economic policies in the Lisbon agenda’ Brussels, 20-21 March 2005 Structural reforms and macroeconomic policies: some thoughts on a complex relationship Andrew Watt European Trade Union Institute for Research, Education and Health and Safety http://www.etui-rehs.org

2. 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

3. 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

7. Labour productivity growth, annual rates in % Data source: IMF (2004): 11

8. EU-US labour productivity, 1995-2001 * includes real estate Data source: O’Mahony and van Ark (eds.),(2003): 29

9. Unemployment rates EU 25 & EU 15(% of labour force 15/64) Data source: Eurostat (2005), New Cronos, Labour Force Survey

10. Productivity down instead of up Data source: OECD Economic Outlook Data source: OECD Economic Outlook

11. Sharp decline in potential output, rise in NAIRU merely arrested Data source: OECD Economic Outlook Data source: OECD Economic Outlook

12. Mainstream view: MOSR => growth

13. 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

14. 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

15. 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)

16. 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)

17. 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

18. 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

19. Real effective exchange rates (1998 = 100) Source: AMECO

20. 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

21. 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

22. 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)

23. 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

24. 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

25. 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