## sdnea2019005 ## Source details **Canonical URL:** [sdnea2019005](https://www.imf.org/-/media/files/publications/sdn/2019/sdnea2019005.pdf) ## Other formats - [Markdown version](/-/media/files/publications/sdn/2019/sdnea2019005.pdf.md) - [Structured JSON version](/-/media/files/publications/sdn/2019/sdnea2019005.pdf.json) --- ### Executive summary and purpose - Investigates whether and how national structural reforms of labor and product market regulations, and corporate insolvency regimes, can enhance euro area member states’ resilience to shocks and help safeguard people’s income and living standards. - Analyses include model simulations and country, sector, and firm-level data across the euro area and other advanced economies. - Key high-level findings: - Recessions in euro area economies have been both more severe and more frequent relative to other advanced economies over the last two decades. - Policies that reduce real and nominal rigidities and encourage reallocation of labor and capital after shocks are associated with greater resilience. - Labor and product market reforms deliver disproportionate benefits for resilience in a monetary union versus a flexible exchange rate regime. - Structural and cyclical policies interact: greater rigidities raise sensitivity to shocks and tend to make fiscal policy more powerful, but without fiscal space adverse debt and confidence channels can undo stimulus effects. - There is no one-size-fits-all strategy; diverse packages (for example, “Anglo-Saxon” and “Nordic”) and designs (for example, “flexicurity”) can combine flexibility with income protection. - National and euro area reforms can be mutually reinforcing (banking and capital markets unions, improved insolvency regimes). ### Empirical context and measurement - Business cycle identification: - Business cycle phases identified using the Harding and Pagan (2002) algorithm applied to quarterly real GDP in purchasing power parity terms from Q1 1972 through Q1 2018 by country and for the EA-12 aggregate. - Recoveries defined as periods from identified troughs to the time when their previous historical maxima are reached; expansions are periods between identified troughs and peaks. - Statistics for pre-global financial crisis are calculated using completed phases during 1972–2006. Statistics post-global financial crisis are calculated using completed recovery phases during 2007–17. Italy's recovery phases after the global financial crisis are incomplete and hence marked by a hollow bar in the source figures. - Time-in-phase summary: - Since the early 1970s, advanced economies have spent about 80 percent of their time on average in the same business cycle phase. - Some advanced economies have spent about 10 percent of the time in recession (France and United States), while for others it is closer to 20 percent (Germany and Italy). - Post-1990s divergence: - Euro area economies split from other advanced economies since the late 1990s, with more widespread and longer downturns, most notably after the global financial crisis. - After the global financial crisis, euro area economies on average took longer to recover, with many experiencing double-dip recessions and longer and weaker recoveries. - Heterogeneity increased after euro adoption (examples: Germany’s anemic growth and protracted early-2000s downturn versus Spain’s boom and bust). ### Major empirical and model-based findings - Structural reform evidence: - Over the past four decades, output responses after major recessions were dampened in advanced economies that had reformed labor and product markets. - Reforms that improve insolvency regime quality hasten reallocation of resources to more productive sectors and firms, particularly after major downturns. - Monetary union versus flexible exchange rate: - Model-based analysis shows liberalizing labor and product markets improves resilience to shocks less under a flexible exchange rate regime than under a fixed exchange rate regime. - Reforms that increase labor and product market flexibility can offset much of the resilience loss from giving up a national nominal exchange rate. - Interaction with cyclical policies: - Greater rigidities make economies more sensitive to shocks and tend to make fiscal policy more powerful. - Without fiscal space, adverse debt and confidence channels can undo expansionary effects of stimulus, raising the debt burden for no return. - In financial crises with sharply tightened credit, fiscal policy can be more effective in deregulated product markets because stronger competition, by reducing profits, increases firms’ sensitivity to external financing. ### Labor market policies and institutions — key empirical findings - Employment protection legislation: - Less stringent and more equal job protection across contract types can strengthen resilience by reducing labor market dualism. - Many euro area economies still have relatively stringent employment protection for regular workers (longer notice periods, larger severance payments, longer and more complex layoff procedures, additional costs for collective dismissals). - Tighter protection of regular contracts dampens destruction of jobs with regular contracts after a negative shock, but can be more than offset by job losses among temporary workers in segmented labor markets (example: Spain after the crisis). - More stringent employment protection for regular workers is associated with deeper recessions on average; more stringent protections for temporary workers are associated with longer recovery times and shorter expansions. - Over the past five decades, output responses after a major recession have tended to be milder in economies that eased employment protection legislation prior to the recession. - Policy design details matter: reducing uncertainty around layoff procedures may be more important than lowering severance pay; relying on price signals (for example, layoff taxes) rather than cumbersome administrative procedures could improve efficiency and inclusiveness. - Unemployment insurance: - Unemployment insurance provides income security and is generally more efficient for risk sharing than severance payments; it is more robust to changes in the nature of work. - Overly generous benefits (in replacement rate or duration) can discourage search, raise reservation wages, reduce wage responsiveness to the business cycle, lengthen unemployment spells, and slow recoveries. - Historical example: Germany’s Hartz reforms in the early 2000s lowered unemployment benefit duration and generated greater wage flexibility, dampening the rise in unemployment after the global financial crisis. - Countries where unemployment benefits had been lowered show milder output responses after major recessions. - Policy implication: balance income security and improved job matches against the cost of slower recoveries; keep benefits and duration moderate while ensuring broad coverage and design benefits to facilitate wage responsiveness. - Example design: Austria complements pooled regular benefits with individual unemployment insurance savings accounts to reconcile income security with incentives to search and accept jobs. - Active labor market policies (ALMPs): - Job search assistance, training, and on-the-job learning can boost employment resilience, hasten recovery, and help disadvantaged groups. - ALMPs complement unemployment insurance; higher unemployment benefits increase the importance and effectiveness of job search and matching assistance. - ALMP effectiveness depends on context and design and should be closely monitored for value for money. ### Labor tax wedge, minimum wages, and collective bargaining - Labor tax wedge: - A high labor tax wedge can lower wages and employment and possibly dampen turnover. - High labor tax wedges remain in many euro area economies; policy can involve reducing labor tax wedges while raising less harmful taxes and/or cutting inefficient public spending. - Minimum wages: - If set at moderate levels relative to the median wage, minimum wages may support incomes with little adverse impact on aggregate employment or its response to shocks. - Where minimum wages are high, adjustment may be needed to achieve macroeconomic flexibility in the event of major competitiveness losses or recessions. - Policy recommendations: retain discretionary power in minimum wage setting, avoid excessive automatic indexation, use social dialogue or independent expert review, and allow simple differentiation by demographic groups, regions, industries, or occupations where appropriate. - Collective bargaining: - Bargaining coverage averages about 60 percent in the euro area, with wide variation across members. - Coordination tends to support quicker labor cost adjustment and smaller job losses; accommodating firm heterogeneity (for example, via “opening clauses”) can improve resilience. - Administrative extensions of collective agreements can undermine flexibility and should be limited to agreements meeting a public interest and representation test. ### Product market deregulation and open markets - Pro-competitive product market regulations lower barriers to entry and exit, enhancing adaptation. - Effects of greater competition: - Raises firm-level investment and output. - Can make investment more sensitive to financial shocks by reducing firms’ ability to keep investing in noncollateralizable assets, amplifying productivity and output losses. - Facilitates firm exit and speeds capital and labor reallocation away from least profitable uses. - Empirical evidence: - Less stringent product market regulations are associated with less severe recessions. - Counterfactual example: If France loosened product market regulation to the level of the United Kingdom, recessions might be 1.2 quarters shorter on average and 1.25 percentage points shallower. - Product market reforms complement improved corporate insolvency reforms to facilitate firm turnover after adverse shocks. - Status and opportunities: - Significant room remains to liberalize euro area product markets, especially in professional services, retail trade, and network industries. - Enhancing the independent role of local competition authorities and effective implementation of EU-level initiatives can create more competitive services markets. ### Strengthening corporate insolvency regimes — findings and quantitative estimates - Quality of insolvency regimes affects capital and labor misallocation and resilience. - Cross-sectoral misallocation (dispersion of sectoral total factor productivity) tends to be greater in countries with lower-quality insolvency regimes, and misallocation rose in such countries after the global financial crisis. - Reallocation effects: - Efficient and predictable insolvency regimes hasten reallocation of resources, particularly after major downturns. - Capital reallocation efficiency proxied by the strength of the relationship between capital growth and the marginal product of capital; this relationship is weaker in countries with lower-quality insolvency regimes. - Quantitative estimates: - A one standard deviation improvement in insolvency regime quality (roughly equivalent to Italy achieving Spain’s insolvency regime quality) leads to sectoral investment being about 20 percent more tightly related to the marginal product of capital. - At the firm level, such a change could boost capital growth at firms with higher marginal products of capital by almost a quarter of a percentage point. - Recession versus expansion: - Effects on firm-level capital reallocation are typically larger in recessions. - Which aspects matter: - At the sector level, restructuring flexibility is most important. - At the firm level, efficiency of insolvency procedures (speed, predictability, uniformity) is most beneficial. - Policy implication: upgrade insolvency regime efficiency and restructuring flexibility; complement with well-designed unemployment insurance and activation policies to facilitate worker reallocation. - Data note: firm-level regression sample includes about 15 million firms throughout Europe. The OECD insolvency regime quality index used: higher index values indicate less flexible, less efficient, and more costly insolvency regimes. ### Macroeconomic model simulations — exchange rate, fiscal, and monetary implications - Model setup: - New model of an individual euro area economy calibrated to the average euro area economy during 1995:Q1–2013:Q1. - Illustrative reform package: easing of product and labor market regulations to levels seen in the United States. - Risk premium shock calibrated to generate a 5 percent peak-to-trough fall in output. - Illustrative fiscal shock: a 1 percent of GDP increase in public spending in a recession; in the economy with limited fiscal space this 1 percent of GDP fiscal shock is assumed to raise the risk premium by 40 basis points. - Key model findings: - More flexible labor and product markets substantially smooth simulated responses of output and unemployment to an adverse risk premium shock, making responses much closer to those under a flexible exchange rate regime. - A small open economy with a flexible exchange rate benefits less from national structural reforms in terms of enhanced resilience, because nominal exchange rate flexibility already facilitates macroeconomic adjustment. - Greater market rigidity increases output losses after an adverse risk premium shock and raises the burden on stabilization policies; fiscal multipliers are generally larger under a fixed than under a flexible exchange rate regime, and this is reinforced when markets are more rigid. - When a rigid economy has limited fiscal space, positive effects of stimulus can be dampened or reversed due to a rise in the risk premium, hurting investment and consumption through higher financing costs and uncertainty. - Product market deregulation can increase the size of the fiscal multiplier after a financial crisis by helping stabilize intangible investment. - Firm-level interaction evidence after 2008–09: - Intangible investment accounted for about a third of average labor productivity growth during 2000–13 in the European Union. - High-leverage firms reduced intangible investment after the crisis more than low-leverage firms. - The greater weakening of intangible investment in high-leverage firms was larger where product market competition was stronger. - The difference implies a cumulative output loss of more than 2 percent for high-leverage firms compared with low-leverage counterparts over the 2008–13 period. - Higher leverage was associated with smaller intangible investment cuts where fiscal policy was more expansionary; effect especially pronounced in industries and countries where product market competition was stronger. - Monetary policy implications: - National structural reforms could reduce the likelihood of policy rates in the monetary union hitting the zero lower bound slightly by dampening euro area output declines after adverse shocks. - Greater market flexibility across members lessens the need for central bank policy rate cuts for a given shock and improves the transmission of common monetary policy to corporate investment, particularly intangibles. ### Policy implications and priority recommendations - National structural reforms to labor markets, product markets, and corporate insolvency regimes can strengthen resilience, particularly for economies in a monetary union that cannot use nominal exchange rate adjustment. - Build fiscal space in good times so that fiscal policy is available as a stabilization tool when needed, because many euro area economies will likely remain less flexible compared with international peers over the foreseeable future. - Continue pursuing union-wide architectural reforms—completion of banking union, deepening of the capital markets union, and consideration of a central fiscal capacity—to further buttress euro area economies, while recognizing these measures cannot fully insure against country-specific shocks. - Improve corporate insolvency regimes to speed resource reallocation, enhance firms’ access to financing, and diversify financing sources. - Design labor market institutions to combine flexibility with adequate income protection and active reemployment policies (examples: unemployment insurance savings accounts, active labor market policies, layoff taxes). - Tailor reforms to country-specific circumstances and social preferences; reforms need not be one-size-fits-all and can preserve worker protection while enhancing flexibility. *Source: EXECUTIVE SUMMARY and chapter content, STRENGTHENING THE EURO AREA: THE ROLE OF NATIONAL STRUCTURAL POLICIES IN BUILDING RESILIENCE (sdnea2019005).* ### EXECUTIVE SUMMARY __________________________________________________________________________ 4 ### EXECUTIVE SUMMARY ### Context and purpose - The creation of the euro area two decades ago boosted European integration but cross-country differences in economic resilience persist, partly because member states lack independent nominal exchange rates and national monetary policy. - This Staff Discussion Note investigates whether and how growth-enhancing national structural reforms of labor and product market regulations, as well as corporate insolvency regimes, can enhance euro area member states’ resilience to shocks, helping safeguard people’s income and living standards. - Analyses include model simulations and country, sector, and firm-level data across the euro area and other advanced economies. ### Major empirical and model-based findings - Recessions in euro area economies have been both more severe and more frequent relative to other advanced economies over the last two decades. There has also been an increase in the diversity of experiences of euro area economies. - Policies that reduce real and nominal rigidities and encourage greater reallocation of labor and capital after shocks are associated with greater resilience. - Over the past four decades, output responses after major recessions were dampened in advanced economies that had reformed their labor and product markets. - Reforms that improve the quality of insolvency regimes hasten reallocation of resources to more productive sectors and firms, particularly after major downturns. - Labor and product market reforms deliver disproportionate benefits for resilience in a monetary union. - Model-based analysis shows that liberalizing labor and product markets improves resilience to shocks less under a flexible exchange rate regime than it does under a fixed exchange rate regime. - Structural and cyclical policies interact: - Greater rigidities make economies more sensitive to shocks and tend to make fiscal policy more powerful. - Without fiscal space, adverse debt and confidence channels can undo the expansionary effects of stimulus, raising the debt burden for no return. - In a financial crisis with sharply tightened credit conditions, fiscal policy can be more effective in deregulated product markets because stronger competition, by reducing profits, increases firms’ sensitivity to external financing. - There is no one-size-fits-all strategy for national structural policies: - Different packages can achieve flexibility (for example, “Anglo-Saxon” and “Nordic” approaches). - Greater flexibility need not imply weaker worker protection: the Danish “flexicurity” model combines few obstacles to layoffs with generous unemployment benefits, strong conditionality, and active labor market policies. - Unemployment systems can be designed to provide income insurance without undermining labor market flexibility (for example, unemployment insurance savings accounts combined with active labor market policies). - Job protection legislation that relies on price signals—such as layoff taxes—rather than cumbersome administrative procedures, and that is more uniform across permanent and temporary contracts, can help resilience. - Wage bargaining systems can work so long as they allow wages or hours worked to respond to economic conditions. - National and euro area reforms can be mutually reinforcing: - Banking and capital markets unions can lower the incidence and severity of adverse financial shocks. - Structural reforms make it easier to weather a shock of given size, implying smaller and less frequent shocks that are more efficiently countered when they occur. ### Policy implications and recommendations - National structural reforms to labor markets, product markets, and corporate insolvency regimes can strengthen resilience, particularly for economies in a monetary union that cannot use nominal exchange rate adjustment. - Build fiscal space in good times so that fiscal policy is available as a stabilization tool when needed, because many euro area economies will likely remain less flexible compared with international peers over the foreseeable future. - Continue pursuing union-wide architectural reforms—completion of banking union, deepening of the capital markets union, and consideration of a central fiscal capacity—to further buttress euro area economies, while recognizing these measures cannot fully insure against country-specific shocks. - Improve corporate insolvency regimes to speed resource reallocation, enhance firms’ access to financing, and diversify financing sources. - Design labor market institutions to combine flexibility with adequate income protection and active reemployment policies (examples: unemployment insurance savings accounts, active labor market policies, layoff taxes). ### Key analytical scope and methods - The analysis leverages indicators of economic resilience at macro and micro levels and uses information on structural policies and reforms over the past 40 years. - Labor and product market regulations are linked to business cycle patterns and dynamic responses of output to shocks. - Corporate insolvency regimes are examined through sectoral and firm-level capital growth responses to shocks. - Simulations use a new model of an individual euro area economy incorporating key labor and product market regulations to study effects of structural reforms on resilience in a monetary union versus a flexible exchange rate regime and their interactions with cyclical policies. *Source: EXECUTIVE SUMMARY, STRENGTHENING THE EURO AREA: THE ROLE OF NATIONAL STRUCTURAL POLICIES IN BUILDING RESILIENCE* ### 6. While carefully accounting for other drivers of resilience, the empirical analysis in the ### sdnea2019005 - 6. While carefully accounting for other drivers of resilience, the empirical analysis in the ### Economic fluctuations in the euro area and other advanced economies - Since the early 1970s, advanced economies have spent about 80 percent of their time on average in the same business cycle phase. - Some advanced economies have spent about 10 percent of the time in recession (France and United States), while for others it is closer to 20 percent (Germany and Italy). - Euro area economies appear to have split from other advanced economies since the late 1990s, with more widespread and longer downturns, most notably after the global financial crisis. - After the global financial crisis, euro area economies on average tended to take longer to recover compared with other advanced economies, with many experiencing double-dip recessions and longer and weaker recoveries. - Heterogeneity among euro area members increased after euro adoption: Germany had anemic growth and a protracted downturn in the early 2000s before later stronger growth, while Spain experienced the opposite pattern. - There is a weak positive correlation between recession length and recovery length prior to the global financial crisis; this relationship steepens for all countries after the global financial crisis (reflecting drawn-out recoveries from financial crises) and steepens even more for euro area economies. - Statistics for pre-global financial crisis are calculated using completed phases during 1972–2006. Statistics post-global financial crisis are calculated using completed recovery phases during 2007–17. Italy's recovery phases after the global financial crisis are incomplete and hence marked by a hollow bar in the source figures. ### Empirical patterns and measurement notes - Business cycle phases in output are identified using the Harding and Pagan (2002) algorithm applied to quarterly real GDP in purchasing power parity terms from Q1 1972 through Q1 2018 by country and for the EA-12 aggregate. - Recoveries are defined as periods from identified troughs to the time when their previous historical maxima are reached; expansions are periods between identified troughs and peaks. - If real output per capita series are used instead of real output, business cycle patterns may change depending on differences in working-age population growth. ### Structural policies to enhance economic resilience — overview - The analysis focuses on the impact of national structural policies (labor and product market policies and corporate insolvency regimes) on resilience to large shocks, rather than long-term productivity, output, and employment effects. - Channels emphasized include how structural policies affect recession depth, recession duration, recovery duration, expansion duration, and phase amplitudes (percent of previous peak/trough). ### Labor market policies and institutions — key findings - Properly calibrated labor market policies can provide macroeconomic flexibility (stable overall employment) and microeconomic flexibility (timely and smooth worker reallocation) after large shocks. - Relevant policy instruments discussed: employment protection regulations, unemployment insurance programs, the labor tax wedge, active labor market policies, minimum wage, and collective bargaining systems. Employment protection legislation - Less stringent and more equal job protection across contract types can strengthen resilience by reducing labor market dualism. - Many euro area economies still have relatively stringent employment protection for regular workers (longer notice periods, larger severance payments, longer and more complex layoff procedures, additional costs for collective dismissals). - Tighter protection of regular contracts dampens destruction of jobs with regular contracts after a negative shock, but can be more than offset by job losses among temporary workers in segmented labor markets (example: Spain after the crisis). - More stringent employment protection for regular workers is associated with deeper recessions on average; more stringent protections for temporary workers are associated with longer recovery times and shorter expansions (Figure 6). - Over the past five decades, output responses after a major recession have tended to be milder in economies that eased employment protection legislation prior to the recession (Figure 7). - Policy design details matter: reducing uncertainty around layoff procedures may be more important than lowering severance pay; relying on price signals (e.g., layoff taxes) rather than cumbersome administrative procedures could improve efficiency and inclusiveness. Unemployment insurance - Unemployment insurance provides income security and is generally more efficient for risk sharing than severance payments; it is more robust to changes in the nature of work (e.g., gig economy). - It can buffer the macroeconomy if job losses are concentrated among lower-income households with higher marginal propensity to consume. - Overly generous benefits (in replacement rate or duration) can discourage search, raise reservation wages, reduce wage responsiveness to the business cycle, lengthen unemployment spells, and slow recoveries. - Historical example: Germany’s Hartz reforms in the early 2000s lowered unemployment benefit duration and generated greater wage flexibility, dampening the rise in unemployment after the global financial crisis. - Countries where unemployment benefits had been lowered show milder output responses after major recessions (Figure 7). - Policy implication: balance income security and improved job matches against the cost of slower recoveries; keep benefits and duration moderate while ensuring broad coverage and design benefits to facilitate wage responsiveness. - Example design: Austria complements pooled regular benefits with individual unemployment insurance savings accounts to reconcile income security with incentives to search and accept jobs. Active labor market policies (ALMPs) - Job search assistance, training, and on-the-job learning can boost employment resilience, hasten recovery, and help disadvantaged groups. - ALMPs complement unemployment insurance; higher unemployment benefits increase the importance and effectiveness of job search and matching assistance. - ALMPs can address geographic and sectoral mismatches and facilitate reallocation. - Effectiveness depends on context and design; ALMPs should be closely monitored and adjusted when value for money is low. - Risk: in demand-driven recessions, ALMPs targeted at placement of specific groups may displace other workers; untargeted measures (e.g., general vocational training) can help maintain labor force attachment if ramped up in downturns. - Empirical observation: participation dropped more in the United States after the global financial crisis than in some European countries, possibly reflecting differences in ALMP prevalence. *Source: IMF staff calculations and analysis in the provided chapter content.* ### 15. A high labor tax wedge—the difference between what employers pay per worker and ### 15. A high labor tax wedge—the difference between what employers pay per worker and what workers receive net of all contributions and personal income taxes—can lower wages and employment and possibly also dampen turnover ### Labor tax wedge: effects and policy implications - A high labor tax wedge can lower wages and employment and possibly dampen turnover. - When combined with other binding market features, higher tax wedges can further raise labor costs to firms and make it harder to reduce them when needed, decreasing employment and amplifying job losses from adverse shocks. - Example: If there is a high and binding minimum wage, larger labor taxes cannot be passed on to low-skilled workers as lower wages, leading to high overall labor costs that cannot be adjusted down during a bad macroeconomic shock. - Policy implication: It can be desirable to reduce labor tax wedges, which remain high in many euro area economies, while raising less harmful taxes and/or cutting inefficient public spending instead. ### Minimum wages - If set at moderate levels relative to the median wage, minimum wages may support workers’ incomes and make growth more inclusive, with little adverse impact on aggregate employment or its response to shocks. - There is a wide range of minimum wages across Europe and other advanced economies (Figure 8). - Where minimum wages are high, adjustment may be needed to achieve macroeconomic flexibility in the event of major competitiveness losses or recessions (as occurred in some southern European economies during the global financial and euro area sovereign debt crises). - Policy recommendations and options: - Retain some discretionary power in minimum wage setting and avoid excessive reliance on automatic indexation formulas, which can delay wage adjustment. - Use strong social dialogue between representative social partners or a regular review by an independent expert body (whose powers might range from policy recommendations to legally setting the minimum wage); more than a third of euro area countries use such independent bodies (ILO 2013). - Allow some differentiation by demographic groups (such as youth), regions, industries, or occupations for microeconomic flexibility, provided it is kept simple. More than half of euro area countries have differentiation along at least one of these dimensions. ### Collective bargaining - Collective bargaining systems are ubiquitous in the euro area; bargaining coverage averages about 60 percent, with much higher coverage in some southern and northern members and lower coverage in eastern members. - There is wide variation in the degree of centralization and coordination of bargaining systems (Figure 8). - Elements affecting macroeconomic flexibility: - Coordination: Strong coordination can incorporate economy-wide considerations and pin down aggregate competitiveness. Evidence indicates quicker labor cost adjustment and smaller job losses in countries with more coordinated systems (Germany, Netherlands) after the global financial crisis (IMF 2016a; OECD 2018b; Hijzen, Martins, and Parlevliet 2017). Coordination is typically rooted in longstanding social dialogue and mutual trust. - Sector-level contract design: Moderate contract duration and built-in incentives for (re)negotiation—such as avoiding strict “ultra-activity” that lets agreements remain in effect after expiration—and strict union and employer association representation criteria can help. - Accommodating firm heterogeneity: Firm-level flexibility is needed even in coordinated systems. An “opening clause” allows firms under stress to set less favorable wages and working conditions than those in sector-level agreements; opening clauses can cut unemployment and contributed to the resilience of the German labor market during the global financial crisis (technical appendix). - Administrative extensions of collective agreements can undermine flexibility by imposing conditions across firms without regard for individual circumstances. - Policy implication: Country authorities should extend only agreements that meet a test of public interest and are signed by representative unions and employer associations. ### Product market deregulation and open markets - Pro-competitive product market regulations lower barriers to entry and exit, enhancing adaptation to changing circumstances. - Competition-encouraging measures include: less state involvement, lower administrative burdens and start-up costs, and allowing entry of foreign products and firms. - Effects of greater competition: - Raises firm-level investment and output (IMF 2019). - Can make investment more sensitive to financial shocks by reducing firms’ ability to keep investing in noncollateralizable assets, amplifying productivity and output losses (technical appendix). - By reducing profits, greater competition can dampen sensitivity of new entrants’ expected profits and the sensitivity of firm entry to shocks. - Facilitates firm exit and speeds capital and labor reallocation away from least profitable uses. - Empirical findings: - Less stringent product market regulations are associated with less severe recessions (Figure 6). - Example counterfactual: If France were to loosen product market regulation to the level of the United Kingdom, economic recessions might be 1.2 quarters shorter on average and 1.25 percentage points shallower. - Product market reforms complement improved corporate insolvency reforms to facilitate turnover of firms in response to adverse shocks. - Status and opportunities: - Despite progress over the past 20 years, significant room remains to liberalize euro area product markets; many member countries retain stringent anticompetitive regulations in professional services, retail trade, and network industries (Koske and others 2015). - Some countries reduced state involvement via privatization, allowing more firms—including foreign companies—into regulated sectors, and eliminating price and quantity restrictions (examples: Spain 2000, Portugal 2001, Germany 2005). - In areas such as rail and other transport services, competition remains low because entry barriers remain high (for example, in France, Germany, and Italy). - Enhancing the independent role of local competition authorities could encourage greater competition and ensure efficient provision of local public services (for example in Italy). - EU-level initiatives, such as the 2006 EU Services Directive, aimed to remove barriers to trade in services; uneven implementation and lack of enforcement have weakened effectiveness (IMF 2018). - Opportunities exist to create more competitive services markets through effective implementation of existing laws and new liberalization (examples: France, Germany, Italy; Spain’s domestic Market Unity Law). - Maintaining strong competition policies at EU and local levels is a key complement to product market deregulation. ### Strengthening corporate insolvency regimes - The quality of corporate insolvency regimes—their efficiency and predictability—impacts capital and labor misallocation and inhibits resilience. - Cross-sectoral factor misallocation (captured by the dispersion of sectoral total factor productivity) tends to be greater in countries with lower-quality insolvency regimes (Figure 9). - Misallocation rose in countries with lower-quality insolvency regimes after the global financial crisis, suggesting these countries were less able to reorient and reallocate factors (Figure 10). - Reallocation effects: - Efficient and predictable insolvency regimes hasten reallocation of resources, particularly after major downturns. - Capital reallocation efficiency can be proxied by the strength of the relationship between capital growth and the marginal product of capital. - Sectoral and firm-level analyses indicate capital reallocation tends to be inhibited in countries with lower-quality insolvency regimes (Figures 11 and 12). - Quantitative estimates: - A one standard deviation improvement in insolvency regime quality (roughly equivalent to Italy achieving Spain’s insolvency regime quality) leads to sectoral investment being about 20 percent more tightly related to the marginal product of capital. - At the firm level, such a change could boost capital growth at firms with higher marginal products of capital by almost a quarter of a percentage point. - Recession versus expansion: - Effects on firm-level capital reallocation are typically larger in recessions, reflecting the greater importance of efficient firm exits after a downturn. - Which aspects matter: - At the sector level, flexibility in restructuring is most important (giving administrators greater scope to restructure balance sheets and operations). - At the firm level, the efficiency of insolvency procedures—such as speed and predictability of the judicial process and uniformity of treatment—is most beneficial. - Policy implication: Upgrading insolvency regime efficiency and restructuring flexibility is generally beneficial, improving sectoral and firm-level capital reallocation. - Complementary policies: Well-designed unemployment insurance and activation policies can facilitate worker reallocation across industries and job types generated by insolvency regime reform and ease social implications. - Data and scope notes: - Firm-level regression sample includes about 15 million firms throughout Europe (technical appendix). - The insolvency regime quality index from the OECD combines assessments of flexibility in restructuring and efficiency of insolvency procedures; higher index values indicate less flexible, less efficient, and more costly insolvency regimes. ### Macroeconomic and structural policy interactions - The section explores interactions between structural policies and the exchange rate regime and fiscal and monetary policies, and their impacts on economic resilience. - Analysis is primarily through a model-based analysis of a small open economy calibrated to the average euro area economy during 1995:Q1–2013:Q1. - Model features: - Incorporates structural policy channels to compare alternative structural reform scenarios, including a no-reforms baseline (current stringency of labor and product market regulations maintained) versus a package of reforms for greater flexibility. - Labor market features job search and matching frictions, with endogenous job creation and destruction, affected by design of labor market regulation (including layoff costs and unemployment benefits) and the labor tax wedge size. - Endogenous firm creation is related to the stringency of entry barriers to product markets. - Model outcomes (referenced visuals): - Figure 13 presents output and employment responses to a risk premium shock under rigid versus flexible labor and product market regulations (see technical appendix for details and calibration). *Source: sdnea2019005 (IMF staff analyses and figures as presented in the chapter).* ### 1. GDP ### 1. GDP ### A. The Role of the Exchange Rate Regime - Structural reforms to labor and product markets are particularly important for a member of a monetary union that lacks a national nominal exchange rate shock absorber. - Model setup and calibration: - The illustrative structural reform package consists of an easing of product and labor market regulations to the levels seen in the United States (also corresponding roughly to specific euro area country indicators). - The risk premium shock is calibrated to generate a 5 percent peak-to-trough fall in output. - Main findings from model simulations: - More flexible labor and product markets substantially smooth the simulated responses of output and unemployment to an adverse risk premium shock, making responses much closer to those obtained under a flexible exchange rate regime. - A small open economy with a flexible exchange rate benefits less from national structural reforms in terms of enhanced resilience, because nominal exchange rate flexibility already facilitates macroeconomic adjustment. - The effects of individual reforms on resilience vary depending on how they affect real wage flexibility and job destruction and creation rates. - Policy implication: - Reforms that increase labor and product market flexibility can offset much of the resilience loss from giving up a national nominal exchange rate. ### B. Consequences for Fiscal Policy Stabilization - Relation between market rigidity, output losses, and fiscal policy: - Greater market rigidity tends to increase output losses after an adverse risk premium shock, raising the burden on stabilization policies. - Fiscal multipliers are generally larger under a fixed than under a flexible exchange rate regime; this effect is reinforced when markets are more rigid. - Illustrative fiscal shock: - The illustrative shock is a 1 percent of GDP increase in public spending in a recession. - In the economy with limited fiscal space, the 1 percent of GDP fiscal shock is assumed to raise the risk premium by 40 basis points. - Key diagnostic findings: - Under a fixed exchange rate and current policy, output rises more in response to a 1 percent of GDP temporary government spending increase than if further structural reforms were adopted—provided the country has fiscal space. - When a rigid economy has limited fiscal space, positive effects of stimulus are dampened or reversed due to a rise in the risk premium, hurting investment and consumption through higher financing costs and uncertainty. - Interaction with financial crises and intangible investment: - Recessions accompanied by financial crises are associated with large permanent output losses. - Intangible investment accounted for about a third of average labor productivity growth during 2000–13 in the European Union. - Intangible assets are difficult to collateralize or liquidate, making their financing more sensitive in crises. - Product market deregulation can increase the size of the fiscal multiplier in the wake of a financial crisis by helping stabilize intangible investment. - Firm-level investment dynamics after the 2008–09 crisis: - High-leverage firms reduced their intangible investment after the crisis more than low-leverage firms. - The greater weakening of intangible investment in high-leverage firms was larger where product market competition was stronger. - The difference implies a cumulative output loss of more than 2 percent for high-leverage firms compared with low-leverage counterparts over the 2008–13 period. - Higher leverage was associated with smaller intangible investment cuts where fiscal policy was more expansionary; this effect was especially pronounced in industries and countries where product market competition was stronger. - Policy implications: - Countries should rebuild fiscal space in good times to be used during downturns. - Understanding the distribution of firm leverage and market competitiveness is important when designing fiscal policy responses. ### C. Consequences for Monetary Policy Stabilization - Structural reforms and the common monetary policy: - National structural reforms could reduce the likelihood of policy rates in the monetary union hitting the zero lower bound slightly by dampening euro area output declines after adverse shocks. - Greater market flexibility across member countries lessens the need for central bank policy rate cuts for a given shock, providing somewhat greater conventional monetary policy space. - Reforms toward common best practice reduce divergence across countries, better aligning needs and boosting the effectiveness of the common monetary policy. - Product market deregulation can enhance the transmission of the common monetary policy to corporate investment, particularly investment in intangibles. ### Conclusions and Policy Recommendations - National-level structural reforms are essential to improving euro area economies’ resilience and raise long-term output and employment. - A package of growth-enhancing reforms to labor and product market regulations could significantly help individual euro area economies better weather adverse shocks in addition to raising long-term output. - Reforms need not be one-size-fits-all; there is scope to tailor reforms to country-specific circumstances and social preferences for worker protection. - Structural reforms and countercyclical policies are complementary: - Flexible markets reduce the need for countercyclical stabilization. - When markets are rigid and fiscal space exists, fiscal policy is more powerful; when fiscal space is limited, stimulus can be ineffective or counterproductive due to risk premium feedback. - Priority policy recommendations: - Implement labor and product market reforms that facilitate nominal and real adjustment to shocks. - Consolidate public finances in good times to build fiscal space for downturns. - Combine national structural reforms with euro area architectural improvements (for example, banking and capital markets union and improved insolvency regimes) to amplify resilience gains through enhanced cross-border risk sharing and more efficient capital allocation. _Source: IMF staff calculations._ ### REFERENCES ### sdnea2019005 - REFERENCES ### Macroeconomic policy, growth, and productivity - Aghion, P., G. Angeletos, A. Banerjee, and K. Manova. 2010. “Volatility and Growth: Credit Constraints and the Composition of Investment.” Journal of Monetary Economics 57 (3): 246–65. - Ahn, J., C. Sever, and R. Duval. Forthcoming. “Macroeconomic Policy, Competition and Growth: The Intangible Investment Channel.” IMF Working Paper, International Monetary Fund, Washington, DC. - Cerra, V., and S. Saxena. 2008. “Growth Dynamics: The Myth of Economic Recovery.” American Economic Review 98 (1): 439–57. - Corrado, C., J. Haskel, C. Jona-Lasinio, and M. Iommi. 2016. “Intangible Investment in the EU and US before and since the Great Recession and Its Contribution to Productivity Growth.” EIB Working Paper 2016/08, European Investment Bank, Kirchberg, Luxembourg. - Doraszelski, U., and J. Jaumandreu. 2013. “R&D and Productivity: Estimating Endogenous Productivity.” Review of Economic Studies 80 (4): 1338–83. - Duval, R., and D. Furceri. 2018. “The Effects of Labor and Product Market Reforms: The Role of Macroeconomic Conditions and Policies.” IMF Economic Review 66 (1): 31–69. - Duval, R., G. Hong, and Y. Timmer. Forthcoming. “Financial Frictions and the Great Productivity Slowdown.” Review of Financial Studies. - Gopinath, G., E. Boz, C. Casas, F. Diez, P-O. Gourinchas, and M. Plagborg-Moller. 2019. “Dominant Currency Paradigm.” NBER Working Paper 22943, National Bureau of Economic Research, Cambridge, MA. - Bluedorn, J., and D. Leigh. 2018. “Is the Cycle the Trend? Evidence from the Views of International Forecasters.” IMF Working Paper 18/163, International Monetary Fund, Washington, DC. - Reinhart, C., and K. Rogoff. 2009. “The Aftermath of Financial Crises.” American Economic Review 99 (2): 466–72. - Romer, C., and D. Romer. 2017. “New Evidence on the Aftermath of Financial Crises in Advanced Countries.” American Economic Review 107 (10): 3072–118. ### Labor markets, collective bargaining, and employment protection - Blanchard, O. 2018. “The Missing Third Leg of the Euro Architecture: National Wage Negotiations.” Peterson Institute for International Economics, Washington, DC. - Blanchard, O., E. Cerutti, and L. Summers. 2015. “Inflation and Activity—Two Explorations and Their Monetary Policy Implications.” IMF Working Paper 15/230, International Monetary Fund, Washington, DC. - Blanchard, O., F. Jaumotte, and P. Loungani. 2013. “Labor Market Policies and IMF Advice in Advanced Economies during the Great Recession.” IMF Staff Discussion Note 13/02, International Monetary Fund, Washington, DC. - Blanchard, O., A. Leandro, S. Merler, and J. Zettelmeyer. 2018. “Impact of Italy’s Draft Budget on Growth and Fiscal Solvency.” Policy Brief, Peterson Institute for International Economics, Washington, DC. - Blanchard, O., and J. Tirole. 2004. “Redesigning the Employment Protection System.” De Economist 152 (1): 1–20. - Card, D., J. Kluve, and A. Weber. 2018. “What Works? A Meta Analysis of Recent Active Labor Market Program Evaluations.” Journal of the European Economic Association 16 (3): 894–931. - Diez-Catalan, L., and E. Villanueva. 2015. “Contract Staggering and Unemployment during the Great Recession: Evidence from Spain.” Bank of Spain Working Paper 1431, Madrid. - Duval, R., and P. Loungani. 2019. “Designing Labor Market Institutions in Emerging and Developing Economies: Evidence and Policy Options.” IMF Staff Discussion Note 19/04, International Monetary Fund, Washington, DC. - Hijzen, A., A. Kappeler, M. Pak, and C. Schwellnus. 2017. “Labour Market Resilience: The Role of Structural and Macroeconomic Policies.” OECD Economics Department Working Paper 1406, Organisation for Economic Co-operation and Development, Paris. - Hijzen, A., and P. Martins. 2016. “No Extension without Representation? Evidence from a Natural Experiment in Collective Bargaining.” IMF Working Paper 16/143, International Monetary Fund, Washington, DC. - Hijzen, A., P. Martins, and J. Parlevliet. 2017. “Collective Bargaining through the Magnifying Glass: A Comparison between Portugal and the Netherlands.” IMF Working Paper 17/275, International Monetary Fund, Washington, DC. - Jimeno, J., and C. Thomas. 2013. “Collective Bargaining, Firm Heterogeneity and Unemployment.” European Economic Review 59 (C): 63–79. - Kangur, A. 2018. “Competitiveness and Wage Bargaining Reform in Italy.” IMF Working Paper 18/61, International Monetary Fund, Washington, DC. - Pissarides, C. 2001. “Employment Protection.” Labour Economics 8 (2): 131–59. - Wilthagen, T. 2007. “Flexicurity Pathways.” Tilburg Law Review 14 (1/2): 80–9. - International Labour Organization (ILO). 2013. Working Conditions Laws Report 2012: A Global Review. Geneva. - Causa, O, M. Hermansen, and N. Ruiz. 2016. “The Distributive Effects of Structural; reforms.” OECD Economics Department Working Paper 1342, Organisation for Economic Co-operation and Development, Paris. - Krebs, T., and M. Scheffel. 2017. “Labor Market Institutions and the Cost of Recessions.” IMF Working Paper 17/187, International Monetary Fund, Washington, DC. - Card, D., J. Kluve, and A. Weber. 2018. “What Works? A Meta Analysis of Recent Active Labor Market Program Evaluations.” Journal of the European Economic Association 16 (3): 894–931. ### Banking, financial stability, insolvency, and euro-area institutions - Aiyar, S., W. Bergthaler, J. Garrido, A. Ilyina, A. Jobst, K. Kang, D. Kovtun, Y. Liu, D. Monaghan, and M. Moretti. 2015. “A Strategy for Resolving Europe’s Problem Loans.” IMF Staff Discussion Note, International Monetary Fund, Washington, DC. - Allard, C., P. Koeva-Brooks, J. Bluedorn, F. Bornhorst, K. Christopherson, F. Ohnsorge, T. Poghosyan, and others. 2013. “Toward a Fiscal Union for the Euro Area.” IMF Staff Discussion Note 13/09, International Monetary Fund, Washington, DC. - Arnold, N., B. Barkbu, H. Elif Ture, H. Wang, and J. Yao. 2018. “A Central Fiscal Stabilization Capacity for the Euro Area.” IMF Staff Discussion Note 18/03, International Monetary Fund, Washington, DC. - Belhocine, N., and S. Dell’Erba. 2013. “The Impact of Debt Sustainability and the Level of Debt on Emerging Markets Spreads.” IMF Working Paper 13/93, International Monetary Fund, Washington, DC. - Franks, J., B. Barkbu, R. Blavy, W. Oman, and H. Schoelermann. 2018. “Economic Convergence in the Euro Area: Coming Together or Drifting Apart?” IMF Working Paper 18/10, International Monetary Fund, Washington, DC. - Garrido, J., W. Bergthaler, C. DeLong, J. Johnson, A. Rasekh, A. Rosha, and N. Stetsenko. 2019. “The Use of Data in Assessing and Designing Insolvency Systems.” IMF Working Paper 19/27, International Monetary Fund, Washington, DC. - Goyal, R., P. Koeva Brooks, M. Pradhan, T. Tressel, G. Dell’Ariccia, R. Leckow, C. Pazarbasioglu, and others. 2013. “A Banking Union for the Euro Area.” IMF Staff Discussion Note 13/01, International Monetary Fund, Washington, DC. - European Union (EU). 2013. Council Regulation 1024/2013 establishing the Single Supervisory Mechanism. Official Journal of the European Union, 63–89. - European Union (EU). 2014. Council Regulation 806/2014 establishing the Single Resolution Mechanism. Official Journal of the European Union, 1–90. - European Union (EU). 2018. “Statement of the Euro Summit Meeting.” Brussels, December 14. - European Commission (EC). 2015. “An Action Plan to Build a Capital Markets Union.” Communication from The Commission to the European Parliament, The Council, The European Economic, and Social Committee, and The Committee of The Regions, Brussels. - European Commission Directorate General Economic and Financial Affairs (EC DGECFIN). 2017. “Economic Resilience in EMU: Thematic Discussions on Growth and Jobs.” Note for the Eurogroup, Brussels. - General Secretariat of the Council of the European Union. 2013. “Treaty on Stability, Coordination, and Growth in the Economic and Monetary Union (TSCG).” Brussels. - Masuch, K., R. Anderton, and R. Setzer, eds. 2018. “Structural Policies in the Euro Area.” European Central Bank Occasional Paper 210, Frankfurt. ### Fiscal policy, interest rates, and policy analysis - Aisen, A., and D. Hauner. 2008. “Budget Deficits and Interest Rates: A Fresh Perspective.” IMF Working Paper 08/42, International Monetary Fund, Washington, DC. - Blanchard, O., A. Leandro, S. Merler, and J. Zettelmeyer. 2018. “Impact of Italy’s Draft Budget on Growth and Fiscal Solvency.” Policy Brief, Peterson Institute for International Economics, Washington, DC. - IMF. 2016a. “Time for a Supply-Side Boost? The Macroeconomic Effects of Labor and Product Market Reforms in Advanced Economies.” World Economic Outlook, Chapter 3, Washington, DC, April. - IMF. 2016b. “Assessing Fiscal Space: An Initial Consistent Set of Considerations.” IMF Policy Paper 16/5080, Washington, DC. - IMF. 2017. “Euro Area Policies: 2017 Article IV Consultation. Selected Issues.” IMF Country Report 17/236, Washington, DC, July. - IMF. 2018. “Euro Area Policies: 2018 Article IV Consultation.” IMF Country Report 18/223, Washington, DC, July. - IMF. 2019. “The Rise of Corporate Market Power and its Macroeconomic Effects.” World Economic Outlook, Chapter 2, Washington, DC, April. - Belhocine, N., and S. Dell’Erba. 2013. “The Impact of Debt Sustainability and the Level of Debt on Emerging Markets Spreads.” IMF Working Paper 13/93, International Monetary Fund, Washington, DC. ### Methodology, measurement, and other empirical studies - Harding, D., and A. Pagan. 2002. “Dissecting the Cycle: A Methodological Investigation.” Journal of Monetary Economics 49:365–81. - Hsieh, C., and P. J. Klenow. 2009. “Misallocation and Manufacturing TFP in China and India.” Quarterly Journal of Economics 124 (4): 1403–48. - Owyang, M., D. Rapach, and H. Wall. 2009. “States and the Business Cycle.” Journal of Urban Economics 65:181–94. - Franks, J., B. Barkbu, R. Blavy, W. Oman, and H. Schoelermann. 2018. “Economic Convergence in the Euro Area: Coming Together or Drifting Apart?” IMF Working Paper 18/10, International Monetary Fund, Washington, DC. - Garrido, J., W. Bergthaler, C. DeLong, J. Johnson, A. Rasekh, A. Rosha, and N. Stetsenko. 2019. “The Use of Data in Assessing and Designing Insolvency Systems.” IMF Working Paper 19/27, International Monetary Fund, Washington, DC. *International Monetary Fund — sdnea2019005 - REFERENCES* --- _Source: https://www.imf.org/-/media/files/publications/sdn/2019/sdnea2019005.pdf_