Blog Post

Distressed Europe should not be bribed to reform

European leaders have started a discussion on German-inspired “contracts for competitiveness and growth”. To implement structural reforms in eurozone member states, the European Commission has proposed to negotiate with selected countries contracts underpinned by financial support.

By: Date: February 6, 2013 Topic: Macroeconomic policy

European leaders have started a discussion on German-inspired “contracts for competitiveness and growth”. To implement structural reforms in eurozone member states, the European Commission has proposed to negotiate with selected countries contracts underpinned by financial support.

The idea, to put it bluntly, is to bribe reluctant governments into economic change. Instead of exhorting governments in vain (the Lisbon agenda was a depressing example of such behaviour) and before a country reaches the point where there is no choice but to dispatch the troika of international lenders – the European Central Bank, European Commission and International Monetary Fund – the EU would support its reforms with temporary conditional transfers. It would agree with the government on a policy agenda and give grants in exchange for its implementation.

There is a case for such an approach. Reforms, even the most beneficial ones for society as a whole, are often opposed because they erode rents. Those enjoying rents, for example because the market for their product is kept closed, have all reasons to fight against change. Those who would benefit from reform are not organised, and they are also uncertain that they will in the end see the positive effects of it, so they do not fight for it. To overcome resistance, buying off the rents may be an advisable option (as advocated some years ago by the economists Jacques Delpla and Charles Wyplosz). However, countries in need of reform generally also suffer from too weak public finances to consider the option. Hence, the idea of relying on other countries’ money.

From the partners’ point of view it may also be better to pay a bit now rather than a lot later. Lack of reform hinders growth and competitiveness and is likely to end up creating troubles. Investing in the partners’ reform may be a valuable investment, if it helps avoid resurgence of financial tensions down the road.

Yet there are objections. Buying off rents may be very costly. Furthermore, and importantly, the politics of the proposal are awful. To negotiate domestic policy with foreign partners or international bodies is a humbling experience no government is likely to be keen on, unless forced to do so by markets. At any rate the partisans of the status quo would no doubt be quick to picture the reforms as foreign-inspired rather than homegrown, and the government as Brussels’ lackey. The whole endeavour could backfire terribly.

There is a better option. Instead of telling governments what they should do, the EU should decide what it wants to do and it should spend for it wherever needed, via new contributions from member countries if necessary. But it should also state clearly that it cannot spend money for certain goals if the national government’s policies make its spending ineffective. So it should make spending for a given goal in a given country conditional on national policies not hindering the achievement of the goal.

Here is an example. Assume the EU wants to foster employment of senior workers by supporting retraining and re-employment schemes. It could for instance introduce special grants to national employment agencies to help them enrol unemployed people in their 50s in dedicated training and placement programmes. These would primarily benefit countries where the employment rate of senior workers is low. But it would be absurd to support employment of older workers if national legislation discourages it (through, for example, early retirement programmes or overly generous disability benefits). So it would be fully justified for the EU to make access to its scheme conditional on the country reforming the provisions that discourage senior employment.

The same approach could be applied to other EU schemes, for example to foster labour mobility across regions and countries, unskilled employment or the improvement of university curricula. In each case the EU scheme should be accessible to all member states, conditional on the policy environment not being adverse to the fulfilment of the scheme’s goals.

The difference with the competitiveness contract would be threefold. First, the EU would not be telling governments what is good for them. It would set its own goals and pursue them. Second, a scheme would not single out a priori particular countries. De facto, the choice of priorities would imply a focus on some of them (as a scheme intended to remedy long-term unemployment would necessarily target countries where long-term unemployment is high), but de facto only. Third, conditionality would not consist in a comprehensive laundry list, rather it would in each case be targeted at significant roadblocks to the achievement of specific EU goals.

Such an approach would have defined goals and its effectiveness could therefore be assessed. And it would be more palatable politically than patronising contracts.

This column was originally published on the Financial Times’ A-List.


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