Blog Post

The cyclicality of structural reforms

What’s at stake: In line with the crisis-induced reform hypothesis, European countries have since 2010 enacted unpopular reforms in labour market regulation and social welfare systems.

By: and Date: June 13, 2016 Topic: European Macroeconomics & Governance

The crisis-induced reform hypothesis

Romain Ranciere and Aaaron Tornell write that structural reforms, whereby organized groups lose their power to extract rents, tend to occur in bad times rather than during prosperous times. Alessandra Bonfiglioli and Gino Gancia write that although most observers tend to agree that promoting product market competition, providing free access to markets and reducing public debt are often essential to preserve economic growth, the extent to which such measures are adopted varies enormously across countries.

Gilles Saint-Paul writes that even though many reforms are best implemented in booms, political logic makes them more likely to happen in slumps. In a boom the politician in power is all too happy to capitalize on existing good macroeconomic conditions, and will not jeopardize his popularity by engaging in a structural reform whose consequences are uncertain, especially if the associated losses are frontloaded and the gains come later. Furthermore, to the extent that society is constantly learning about the costs and benefits of reforms, it should rationally infer in a boom that rigidities are not that costly, and infer the opposite in bad times. That effect alone would tend to favor reforms in bad times.
Nauro Campos and Jeffrey Nugent write that economists see crises as an opportunity to implement needed economic reforms. While welfare enhancing and often technically sound, structural reforms are repeatedly challenged by special interest groups or politically powerful constituencies making the risk of partial or delayed implementation a potential factor preventing the success of the reform itself.

Reform patterns during the crisis

The OECD writes that the crisis and ensuing recession have acted as a catalyst for structural reforms, especially in OECD countries where reforms were most needed. In particular, the depth of the labour market crisis has provided an impetus for structural reforms aimed at raising labour utilization. The need to consolidate public finances and the financial pressure arising from mushrooming sovereign debt have given another impetus to reform, with a clear acceleration of politically sensitive reforms designed to help lift potential growth, regain price competitiveness and restore fiscal sustainability, especially in some euro area countries.

The OECD writes that overall the crisis seems to have acted as a catalyst for structural reforms. Compared with the pre-crisis period, responsiveness rates have increased on average to Going for Growth recommendations for enhancing both labour productivity and labour utilization. For the latter, this partly reflects recent extensive labour market reforms undertaken in the context of the euro area debt crisis. Reform activity has gone through distinct phases since the start of the crisis. At first the recession markedly slowed action on Going for Growth priorities, probably reflecting much greater policy focus on macroeconomic stabilization. The pace of reform slowed down most in the labour productivity area and less so for labour utilization. The subsequent period saw reform action accelerate strongly, with the bounce-back strongest in reforms to boost labour productivity, such as product market or public sector reforms aimed at increasing efficiency.

The OECD writes that the acute crisis forced countries to enact unpopular reforms in “difficult” areas, such as labour market regulation and social welfare systems (e.g. job protection, pension and welfare reforms). Since 2010, there has been a major acceleration in reform action in countries either i) directly affected by the euro area debt crisis and therefore forced into reform as part of the European Union-International Monetary Fund (EU-IMF) financial aid package; or ii) experiencing tensions with sovereign bond spreads. Indeed Greece, Ireland and Portugal all appear among the countries whose responsiveness to Going for Growth recommendations increased the most between 2008-09 and 2010-11, especially for labour utilization, and so does Spain.

Moral hazard and structural reforms

Tito Boeri and Juan Jimeno write that relaxing the fiscal constraint during a recession was deemed to exacerbate moral hazard problems in a monetary union. A typical (and topical) concern when discussing implementation of labour market reforms is indeed that governments are less willing to do so without being constrained by a strong fiscal restriction. The reform experience during the European crisis shows, however, that no significant improvements were achieved in the reform of inefficient employment protection and in the correction of labour market segmentation, not even when these reforms were mandated under a formal rescue programme.

Gilles Saint-Paul writes that the key justification behind conditionality is that a country that is plagued by structural rigidities is bound to end up in another fiscal crisis, because it will always be tempted to inflate its economy above its (suboptimal) equilibrium rate of activity by using fiscal policy.

Francesco Giavazzi and Guido Tabellini write that it is not at all clear that prolonging the depression is a recipe for more willingness to reform. The contrary is more likely to be true, for two reasons. First, a longer stagnation and higher unemployment can only reinforce the more radical and populist political parties in Europe. Second, political opposition to spending cuts and structural reforms tends to be stronger when the economy is depressed, because voters perceive such measures as likely to further dampen aggregate demand and increase layoffs.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic More by this author
 

External Publication

A Safety Net for the Green Economy

How to protect workers hurt by the fight against climate change.

By: Simone Tagliapietra Topic: Energy & Climate Date: July 20, 2021
Read article More by this author
 

Opinion

Inflation, inequality and immigration: Spelling the digital recovery with three “I”s

The digital transition offers us a new opportunity to reach out across the global economy - hopefully we will find the strength to use it.

By: Rebecca Christie Topic: Global Economics & Governance, Innovation & Competition Policy Date: June 3, 2021
Read about event
 

Past Event

Past Event

The Future of Work – a conversation with Commissioner Schmit

EU Commissioner for Jobs and Social Rights Nicolas Schmit joins Bruegel for a conversation around the future of work.

Speakers: Mario Mariniello and Nicolas Schmit Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: May 25, 2021
Read about event More on this topic
 

Past Event

Past Event

Living standards and financial resilience across Europe

What has the impact of the pandemic on households’ financial resilience been, and how should policy makers respond?

Speakers: Romina Boarini, Zsolt Darvas, Maria Demertzis and Daniel Tomlinson Topic: European Macroeconomics & Governance Date: April 21, 2021
Read article More on this topic
 

Opinion

Can households in the European Union make ends meet?

Half the households surveyed by Eurostat see themselves as unable to find the resources they would need to cope with an unexpected expense within a month, estimated by experts at €375 in the case of Greece.

By: Maria Demertzis, Marta Domínguez-Jiménez, Annamaria Lusardi and Bruegel Topic: Finance & Financial Regulation Date: July 24, 2020
Read article Download PDF More by this author
 

Working Paper

The impact economy: balancing profit and impact

Governments and companies can reinforce each other in their pursuit of sustainable development, which is based on three pillars: economic, social and environmental. An impact economy, in which governments and companies balance profit and impact, is best placed to achieve the United Nations sustainable development goals.

By: Dirk Schoenmaker Topic: Energy & Climate, Global Economics & Governance Date: July 7, 2020
Read article Download PDF More on this topic
 

Policy Contribution

The financial fragility of European households in the time of COVID-19

The concept of household financial fragility emerged in the United States after the 2007-2008 financial crisis. It grew out of the need to understand whether households’ lack of capacity to face shocks could itself become a source of financial instability.

By: Maria Demertzis, Marta Domínguez-Jiménez, Annamaria Lusardi and Bruegel Topic: European Macroeconomics & Governance Date: July 2, 2020
Read article Download PDF
 

Policy Brief

Rebooting Europe: a framework for a post COVID-19 economic recovery

COVID-19 has triggered a severe recession and policymakers in European Union countries are providing generous, largely indiscriminate, support to companies. As the recession gets deeper, a more comprehensive strategy is needed. This should be based on four principles: viability of supported entities, fairness, achieving societal goals, and giving society a share in future profits. The effort should be structured around equity and recovery funds with borrowing at EU level.

By: Julia Anderson, Simone Tagliapietra and Guntram B. Wolff Topic: Energy & Climate, European Macroeconomics & Governance Date: May 13, 2020
Read article More on this topic
 

Opinion

What if the rest of Europe follows Italy's coronavirus fate?

The silence from Brussels could be as damaging as the silence on Italian streets

By: Simone Tagliapietra and Bruegel Topic: Global Economics & Governance Date: March 11, 2020
Read article More on this topic
 

Blog Post

Jobs and robots: Europe’s Debate Over the Destiny of the Welfare State

This blog is part of a series following the 2019 Bruegel annual meetings, which brought together nearly 1,000 participants for two days of policy debate and discussion.

By: J. Scott Marcus, Giuseppe Porcaro and Bruegel Topic: Innovation & Competition Policy Date: September 20, 2019
Read article More on this topic More by this author
 

Podcast

Podcast

Backstage at BAM19: AI, robots and platform workers

Backstage at the Bruegel Annual Meetings, Giuseppe Porcaro talks with J. Scott Marcus on AI, robots and platform workers.

By: The Sound of Economics Topic: Innovation & Competition Policy Date: September 4, 2019
Read article More on this topic
 

Opinion

EU policy recommendations: A stronger legal framework is not enough to foster national compliance

In 2011, the EU introduced stricter rules to monitor the implementation of country-specific policy recommendations. Using a new dataset, this column investigates whether these new laws have increased national compliance. There is no evidence that these stricter processes matter for implementation rates, whereas macroeconomic fundamentals and market pressure are important determinants of implementation progress. These results suggest ways to improve the effectiveness of European policy coordination that go beyond stronger legal processes.

By: Konstantinos Efstathiou, Guntram B. Wolff and Bruegel Topic: European Macroeconomics & Governance Date: July 23, 2019
Load more posts