Wednesday, November 26, 2014

Whose Economic Reform?

PARIS – Together with fiscal consolidation, structural reform is the new European mantra. International organizations and European Union bodies regard such reform as a prerequisite of economic recovery, growth, and alleviation of the unemployment plague.

Indeed, the agreement reached between the Greek government and the “troika” (the International Monetary Fund, the European Central Bank, and the European Commission) includes a 48-page list of detailed reforms. Not all countries are given such a long to-do list, but, since new EU legislation was adopted in 2010, specific recommendations are addressed to all. For example, the brief addressed to Italy includes recommendations on the efficiency of public administration, the fight against corruption, corporate governance in the banking sector, the labor market, schools, taxation, opening up the services sector, and infrastructure.

To be sure, European countries urgently need to implement deep reforms. Poor productivity growth and stubborn unemployment are evidence that their economies require comprehensive transformation. But if this observation provides the rationale for reform, it does not provide a firm enough basis for drawing up effective economic-revival plans.

The design of a reform strategy requires solving two problems. The first is one of purpose. Successful societies are a diverse lot. Some are unequal, and others are egalitarian. Some cherish large welfare states, and others starve them. Some rely on extensive collective agreements, and others exclude them altogether. Some are based on arm’s-length transactions, and others rely on recurring relationships. Scholars refer to “varieties of capitalism” to highlight the absence of a single template for success.

But if there are different models, what should the priorities for reform be? International organizations generally point out – rightly – that in most cases a country can improve economic efficiency without changing its economic model. For example, there is often ample room for achieving the same income redistribution at lower budgetary cost, or for ensuring that collective wage agreements take into account the interests of those without a job. So national models can be reformed while retaining arrangements that meet social preferences.

This answer, however, is somewhat facile. Countries are not only inefficient; often, they are also inconsistent. For example, they pretend to become global hubs but do not welcome foreigners, which is what prevented Japan’s emergence as a world financial center in the 1990’s; or they hope to develop as knowledge-based economies but dislike academic freedom; or they aim to nurture innovation but do not want innovators to become rich.

Such inconsistency is often a major impediment to development. By contrast, the success of the United States as an innovation powerhouse relies on a high degree of consistency across fields ranging from education and immigration to taxation and the labor market.

So pro-growth reform not only requires substituting efficient arrangements for inefficient ones; it also demands confronting hard choices, which is, at bottom, a political endeavor. For this reason, it is not something that any international organization can even suggest in lieu of a country’s voters.

The second problem in designing structural reform is one of strategy. As the economist Dani Rodrik has pointed out, standard analysis generally results in a laundry list of desirable reforms that does not tell governments where to begin. Apprehensive leaders start with the most politically expedient items, while bold leaders start with the most challenging prescriptions; but there is no guarantee that either of these approaches will deliver the expected result. Even a seemingly rational strategy of correcting the largest inefficiencies first is not necessarily the appropriate one.

One reason is that the effectiveness of reform may depend on conditions prevailing in other sectors: good universities, for example, cannot remedy the consequences of poor secondary education. Moreover, eliminating one distortion may be ineffective or even counterproductive: in an economy plagued with rents, partial reform may simply result in shifting them across sectors and agents, rather than reducing them to the benefit of consumers.

As a result, considerable political energy may be consumed in pushing through measures that deliver very little. Instead, reform should start with the most binding constraint to performance (which one that is depends on the whole set of hindrances that confront the economy).

In addition, outcomes may depend on cyclical conditions. Advocates of structural reform generally claim that they aim to increase output and welfare in the medium term, and that the short term does not matter. But, while some reforms – for example, those improving access to credit or eliminating rents that harm consumers – can indeed help to boost growth during a demand shortfall like the one that Europe is now experiencing, others can have the opposite effect. For example, labor-market reforms that make it easier for companies to reduce staff may weaken demand further, underscoring the importance of considering reforms’ short-term effects.

What all of this suggests is that an economic-reform agenda cannot result from a mechanical exercise. At some point, hard choices about priorities and sequencing must be made. This is not to say that international organizations and the EU are of no help. On the contrary, these bodies can be very valuable insofar as they carry out international comparisons and point out deficiencies. But there is a line in the sand beyond which only governments can set priorities and act. That, after all, is what voters elect them to do.

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    1. CommentedJose araujo

      The problem is that the so called reforms imposed by the troika are not only blind but extremelly biased. The reform they are inposing on us aims only at labor flexibility and lower wages, so we can achieve the so called competitive deflation.

      Now lowering wages and increasing labor percarity, in countries were the levels of precarity are already high, doesn't sound like a structral reform, its what a export substitution advocate would recomend.

      What is amazing is what are true structural reforms like communication networks, edducation, health investments are being called by the troika overspending, and the root cause off all peripheric troubles.

      This is aimed at disguising what is obvious, the EURO is a failed experiment, and its pushing countries into misery. So its time to end this aberration and get back to normality, where structural reforms are indeed reforms on the structures of the countries.

    2. Commentedhari naidu

      Of course, only governments can set priorities and act, as you so rightly claim (as a Frenchman). However the real constraint in the periphery is fundamentally the issue of governance and their policy priorities.

      Hollande is a serious case in point of not only bad but very poor governance in France. How would you like to be associated with a Socialist Govt which might rightly become the *sick man* of Europe?

    3. CommentedZsolt Hermann

      The main problem is not with what kind of reforms people want to implement.
      The problem is everybody is acting in a vacuum without any stable reference points.
      Humanity has decided that we have become independent, above the natural system we evolved from and we can build our own human subsystem with its own laws, principles, demands and lifestyle.
      The best expression of this attitude is the constant quantitative growth economic system, based on brainwashing people to keep buying products they do not need, that are harmful, and for which products they have no money for.
      And when this system becomes unsustainable, when we exhausted our human resources we try different artificial solutions, trying to reinvent the wheel all the time.
      But the main reason we have no reference points and we drift in a vacuum is that we have become completely disconnected from each other and we all try to go after our own minds, our own ideas, demands, presumed necessities. We compete with each other most of the time succeeding at the expense of others.
      All these things are unprecedented in nature, and since humanity is still part of the natural system this causes the present crisis as the way we want to progress is unsustainable.
      Most people today agree that we exist in a global, and integral human network, but we still don't want to behave adapted to such a system. The necessary mutual, integral communication is totally broken and the interconnections are still used in the opposite way to normal, only for self benefit, regardless of the state of the whole system.
      In Europe and in fact all over the globe only a full integration, a socio-economic system based on mutual responsibility and mutually complementing cooperation can offer solutions.
      The system around us with unbreakable natural laws is not going to change or yield, only we can change, adapt.