## _sdn1207 ## Source details **Canonical URL:** [_sdn1207](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2012/_sdn1207.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2012/_sdn1207.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2012/_sdn1207.pdf.json) --- ### Executive summary: problem, priorities, and broad strategy - Context and actions taken: - European countries and institutions have taken unprecedented actions: rein in fiscal deficits, recapitalize weak banks, strengthen the firewall, provide comprehensive ECB liquidity support, and adopt a new fiscal compact. - Key risks: - Rising unemployment and recession indicators undermine stability and policy effectiveness. - Revival of growth is essential to restore fiscal revenues, reduce debt ratios, heal the financial sector, and sustain social support for adjustment. - Recommended policy mix: - Supply-side: granular structural reforms (Southern Europe: labor market duality, tradable-sector competitiveness, relative price misalignments; Northern Europe: higher labor participation and stronger services sector). - Demand-side: supportive measures to bolster near-term growth; consolidate rapidly where market pressures are severe and gradually elsewhere to let automatic stabilizers operate. - Monetary policy: remain supportive. - Fiscal framework: - Consider substituting pro-cyclical nominal targets with structural balance objectives under the fiscal compact to be more growth-friendly. - External demand and relative prices: - To channel more external demand to the South, relative prices in Southern Europe need to fall vis-à-vis the North; implies higher inflation in the North than in the South, with nominal wage restraint in the South and wage growth in the North in line with productivity. - Financial sector: - Restore health via bank and corporate restructuring (including FDI); promote bank recapitalization with public back-stops where needed; ensure due control and eventual pan-European oversight when centralized capital injection is used. ### Motivation and context: growth trends and heterogeneity - Long-run trends: - Euro area growth has fallen behind peers since the early 1980s; Southern euro area convergence (Greece, Italy, Portugal, Spain) to richer Northern countries has stagnated. - Main drivers of underperformance: - Slower productivity growth—sharp decline in total factor productivity growth. - Lower labor utilization explains two-thirds of the differential in GDP per capita between the euro area and the United States in 2006 (Mourre, 2009). - Divergent growth models: - Northern euro area growth driven by exports; Southern relied on domestic demand and cyclical, credit-dependent non-tradable sectors. - Relative-price divergence: - Nominal unit labor costs and real effective exchange rates diverged, rendering Southern countries uncompetitive. - Cyclical headwinds since the Great Recession: - Output recovery much slower in the euro area than in the United States. - Persistent and higher unemployment than the United States and the United Kingdom; Southern euro area expected to contract further with modest recovery prospects. - Balance sheet repair, bank deleveraging, higher private savings, and fiscal consolidation are significant headwinds, particularly for the South. - Fiscal adjustment projection: - Euro area countries are projected to improve their cyclically-adjusted fiscal balance by 1½ percent in 2012 (excluding Southern Europe, ¾ percent). - Fiscal multipliers: - Estimated to be higher during downturns, implying a larger negative impact from planned consolidation on output, domestic absorption, and employment. ### Lifting growth––high-level strategy and complementarities - Multipronged objectives: - Boost potential output through structural reforms to increase resource use and productivity. - Use structural reforms to generate confidence and short-run demand effects (notably investment), while recognizing near-term output gains may be modest. - Foster aggregate demand tailored to country needs: promote net exports for Southern countries via competitiveness improvements and resource reallocation to tradable sectors; strengthen domestic demand in Northern countries, ideally private-sector-led. - Repair the financial system to support growth in emerging sectors. - Leverage Europe’s strengths: - Largest common market, strong reserve currency, aggregate fiscal position stronger than many economies; build on euro-area actions (fiscal compact, stronger firewall, ECB liquidity support). - Central-level policies: - Increase common resource pools and address tail-risks to bolster confidence and signal progress toward long-run euro-area architecture. ### What can be realistically expected from structural reforms — evidence and magnitudes - Medium- and long-term effects: - Substantial empirical evidence that structural reforms lift growth in the medium to long term. - Staff simulations: large-scale labor, product market, and pension reforms that cut the distance of euro area countries to growth-maximizing benchmarks in half could boost output by 4½ percent over the next five years. - Cross-country benefits: a quarter of this additional growth is expected to derive from positive cross-country and cross-reform spillovers. - Near-term effects: - Immediate gains from reforms are likely modest; reforms take time to yield full benefits and may need complementary demand support. - Labor market institutions: - Collective bargaining, unemployment benefits, and employment protection explain a large part of cross-country labor market performance differentials. - High employment protection, longer/more generous unemployment benefits, high tax wedges, and wage-favoring collective bargaining systems tend to affect employment and productivity negatively. - Product market reforms: - Excessive product market regulation contributes to higher mark-ups and lower output, investment, and employment. - Product market deregulation effects on productivity growth are larger in more advanced countries and in those with better governance. - Regulatory liberalization and efficiency: - IMF staff (Tiffin, 2012) finds that a one standard-deviation improvement in the reform index is associated with a 9½ percentage point increase in efficiency in a middle-income country and a 5 percentage point increase in a high-income country. - Selected quantitative findings from studies: - Comprehensive and ambitious reforms could boost GDP levels by more than 10 percent over a decade in many euro area countries (OECD, 2012; Goldman Sachs, 2012). - Berger and Danninger, 2007: additional employment growth of 1-1.3 percentage points annually from comprehensive labor and product market reforms. - Allard et al., 2010: filling half the gap with the three best EU performers could yield ½ percentage points of additional annual growth over the next 5 years. - Goldman Sachs, 2012: product market reforms could boost potential growth by up to 1.7 percent annually in euro area periphery countries. - Pérez and Yao, 2012: a policy package could reduce unemployment by ¾ -5½ percentage points, depending on initial conditions. ### Policy implications and priorities (condensed) - Implement granular, country-specific structural reforms promptly: - South: focus on labor market duality and tradable-sector competitiveness. - North: focus on labor participation and services. - Pursue coordinated pan-European reform effort to capture spillovers and limit adverse relative-price dynamics. - Adopt a growth-friendly fiscal strategy: - Consolidate rapidly where market pressures are severe and gradually elsewhere to allow automatic stabilizers to function. - Consider structural balance objectives instead of pro-cyclical nominal targets within the fiscal compact. - Maintain supportive monetary policy and expand pan-European common resource pools to address tail-risks and strengthen shared fiscal architecture. - Restore financial sector health via recapitalization (with public back-stops where needed), restructuring (including encouraging FDI), and move toward pan-European regulation and supervision for banks receiving centralized support. - Reallocate existing funds to improve market functioning (e.g., labor market policies) to yield significant short-term employment gains. - Seek to shift external demand toward the South by facilitating relative price adjustment: nominal wage restraint in the South and wage growth in the North aligned with productivity. ### Internal and fiscal devaluation — key findings - Internal devaluation: painful; revival of competitiveness via reduced labor costs/domestic prices often comes with drawn-out recessions; duration of initial adjustment could range from 5 to 15 quarters. - Conditions aiding successful internal devaluation: - More openness, higher factor mobility, price and wage flexibility, low initial public debt, ability to use fiscal policy/transfers to attenuate real economy impacts. - Tax reform complement: - Shifting from employer social contributions to the VAT can improve competitiveness and promote exports, growth, and employment by lowering labor costs borne by exporters; effect fades if wages adjust to higher VAT. - Quantitative simulation evidence: - Portugal simulation: a shift equal to 1 percent of GDP generates a short-term rise in net exports between 0.2 and 0.6 percent of GDP (IMF, 2011). - De Mooij and Keen, 2012: an average reduction in the social contribution rate of 2.6 percentage points and a standard VAT rate increase of 2.7 percentage points could impact net exports between 0.9 and 4 percent of GDP. - Real improvement in net exports depends on terms of trade, relative price adjustment in non-tradable sector, and tradable sector composition. - Positive short-term effects of tax shifts tend to become insignificant in the long run but can last for some time. - Country-specific considerations: - Targeting lower social contribution rates to low-skilled workers reinforces job impacts. - Ability to increase VAT may be limited where VAT rates are already high; broadening the VAT base is a better alternative but may have adverse equity effects. - Fiscal devaluations should be limited to euro area countries with competitiveness problems; if all countries pursue the same tax shift, none gains competitiveness. ### Box 1 — Tales from Successful Structural Reforms in Europe (examples and lessons) - Examples: - Netherlands (1980s): employment rate rose from 53 percent in the 1980s to close to 67 percent in 2011 after macro and supply-side reforms. - Sweden (1990s): annual labor productivity growth rose from 1 percent in 1977–92 to 2.5 percent in 1992–2007; reforms facilitated a 5½ percentage points increase in efficiency over 10 years relative to the global best-practice frontier (an increase in real output per worker of almost 15 percent). - Germany (Agenda 2010/Hartz reforms): unemployment dropped from above 11 percent in 2005 to below 9 percent by 2007, and currently stands at around 6 percent. - Key lessons: - Reforms must be country-specific and adapt over time as bottlenecks change. - Full impact builds over time; short-term effects can be small or negative due to adjustment costs. - Credibility and communication can counter short-run negative effects. - GIMF simulation findings: - Eliminating 50 percent of euro area countries’ gap with OECD best practice in labor market and pension policies could boost GDP on average by almost 1½ percent after 5 years. - Product market reforms could boost GDP by another 2¼ percent (medium run). - Combined reforms could yield additional output of up to 0.6 percentage point in the first year. - Active labor market policies can have immediate positive impacts larger than long-term effects (they entail fiscal spending). - Reforms produce spillovers accounting for one quarter of total gains. - Positive short-run impact of reforms is modest: equivalent to a temporary fiscal expansion close to 1 percent of GDP. - Letting automatic stabilizers operate after a negative output growth shock of around 2 percent would imply an increase in the budget deficit of about 0.9 percent of GDP; letting automatic stabilizers operate would avoid a GDP contraction in the short run between 0.3 and 1 percent depending on fiscal measures chosen. ### Risks, sequencing, and complementarities - Short-run risks: - Weak demand and excess capacity may limit short-term output response and risk hysteresis in unemployment. - Balance sheet concerns and low confidence can encumber private sector decisions. - Example: reducing unemployment insurance can produce a slight short-run output contraction but output expansion in the long run. - Dependence on activity: - Bringing unemployment down in the short run largely depends on the strength of economic activity (Okun’s law). - Evidence: unemployment could increase temporarily after labor market reforms; after a financial crisis, unemployment tends to increase more in the short term in countries with more flexible labor markets. - Complementary policies needed: - Structural reforms need demand-supporting policies—not necessarily simple fiscal stimulus but measures to alleviate headwinds, including demand rebalancing within Europe and reallocation within countries. - Monetary policy, banking sector repair, and reform play important roles. - Short-run growth needs more robust private domestic demand in the North and firmer external demand in the South. - Avoid overshooting domestic demand adjustment while relative price gaps are being closed. ### Annex II — Country-specific structural reform priorities (high-level synthesis) - Southern euro area (Greece, Italy, Portugal, Spain): - Priorities: improve tradable goods production efficiency and regain competitiveness; reduce labor market duality; decentralize wage bargaining; reduce severance payments; lower labor tax wedge; liberalize restricted professions and network industries; improve insolvency frameworks and judicial efficiency. - Examples of measured progress: - Greece: lower minimum wage by 22 percent (youth by 32 percent); promote firm-level bargaining. - Italy: decentralize wage bargaining; allow firm-level derogation from national contracts. - Portugal: organized decentralization in wage bargaining; reduce severance payments. - Spain: reforms to allow distressed firms to modify wages and working time; promote firm-level agreements; include hiring subsidies and tax incentives. - Northern and other euro area countries: - Priorities: increase labor participation (including female and older workers), reduce tax wedge on labor, boost services competition, improve education and R&D, and simplify regulation. - Specific reforms by country (selection): - Austria: close early exit routes; reduce high effective tax wedge for low-skilled workers. - Belgium: phase out early retirement benefits; reform automatic wage indexation. - Germany: lower tax wedge for secondary and low-skilled earners; improve early childhood education. - Netherlands: increase statutory retirement age; relax strict employment protection for regular contracts. - Ireland: reform sectoral wage-setting; strengthen activation and training; reduce replacement rates. - Pensions and retirement-age reforms: - General recommendation to raise effective retirement ages via penalties for early retirement, align indexation to CPI, and expand private pillars where appropriate. - Product, services, and network competition: - Full implementation of EU Services Directive where incomplete. - Reduce self-regulation of professions; streamline land/zoning regulation. - Target regulated network sectors to reduce costs (electricity, telecommunications). - Education, skills, and R&D: - Upgrade labor force skills, align vocational and tertiary education with labor market needs, promote R&D and ICT adoption, and consider tuition/loan systems to better direct students. - Business environment, state involvement, and judicial/administrative reform: - Simplify and accelerate judicial procedures and insolvency regimes; reduce state involvement in firms and accelerate privatization where feasible; improve one-stop shops and reduce administrative burdens. - Credit markets, bank restructuring, and recapitalization: - Carefully calibrate deleveraging; facilitate credit to new sectors via partial underwriting; encourage bank consolidation and FDI; enhance domestic backstops if needed; consider centralized resource pools for capital support against acquisition of due control and eventual pan-European regulation, joint resolution authority, and single deposit insurance fund. - Rebalancing within countries and within Europe: - Regain competitiveness via increased productivity and lower relative prices and wages. - Options include tolerating inflation differentials (higher in North, lower in South), nominal wage restraint in the South, and deficit-neutral fiscal devaluation (shifting revenue from labor to VAT) with careful coordination. - Central (EU/euro area) level actions: - Increase and better target common resource pools; redirect structural funds toward transnational projects and infrastructure connecting Southern euro area to growth leaders; prioritize labor and financial market policies with large short-run payoffs; consider larger common pools and project bonds and further steps toward fiscal integration. ### Final remarks — expected gains and required policy package - Structural reforms have substantial long-run gains but limited immediate pay-offs; simultaneous push can generate cross-country spillovers. - Supportive macroeconomic policies must accompany reforms: - Continue accommodative monetary policy. - Structure fiscal consolidation to avoid excessive procyclicality. - Encourage bank and corporate restructuring, including FDI. - Promote bank recapitalization, possibly supported by centralized resource pools and transition to pan-European regulation and supervision for propped-up banks. - A consistent euro area-level policy package tailored to country-specific reform priorities would yield large gains and facilitate rebalancing within the euro area. - Many countries' priorities include reducing barriers to competition and improving the business environment; product market reforms can provide substantial lift to growth, and labor market reforms can help achieve the price re-alignment needed to regain competitiveness. - Fiscal devaluation and nominal wage restraint would help accelerate rebalancing; reallocation across sectors could be supported by targeted investment and leveraging common resource pools. *Source: _sdn1207 (Executive Summary; Section 3: Internal and Fiscal Devaluation; Box 1; Annex II; References).* ### Executive Summary ...................................................................................................... ### _sdn1207 - Executive Summary ### I. Motivation and Context - Section present: "I. Motivation and Context" (page 5) - Figure referenced: "1. Growth Divergences" - Figure referenced: "2. Total Factor Productivity and Potential Growth" - Figure referenced: "3. Euro Area Countries: Real Effective Exchange Rate and External Imbalances" ### II. Lifting Growth––A 20,000-Foot View - Section present: "II. Lifting Growth––A 20,000-Foot View" (page 8) - Figure referenced: "4. Real GDP and Unemployment Rates" - Figure referenced: "5. Headwinds from Fiscal Consolidation and Unwinding the Credit Boom" ### III. What Can be Realistically Expected from Structural Reforms? - Section present: "III. What Can be Realistically Expected from Structural Reforms?" (page 9) - Table referenced: "1. Selected Recent Studies on Labor and Product Market Reforms" - Figure referenced: "6. Impact of Regulatory Reform on Efficiency, 2000–07" - Box referenced: "1. Tales from Successful Structural Reforms in Europe" - Box referenced: "2. Short- and Long-Run Effects of Structural Reforms" - Figure referenced: "7. Short- and Long-Run Impact of Reforms in Euro Area Countries on the Level of GDP" - Figure referenced: "8. Impact of Reforms and Fiscal Stimulus on the Level of GDP in Euro Area Countries" ### IV. Why Do Structural Reforms Need Other Supportive Policies? - Section present: "IV. Why Do Structural Reforms Need Other Supportive Policies?" (page 17) - Figure referenced: "9. Change in Unemployment and Labor Market Flexibility" ### V. What Should be Done Concretely? - Section present: "V. What Should be Done Concretely?" (page 20) - Table referenced: "2. Main Progress in Structural Reforms in Southern European Countries since 2010" - Figure referenced: "10. Priorities for Structural Reforms in Country-Specific Recommendations" ### VI. Final Remarks - Section present: "VI. Final Remarks" (page 26) - Figure referenced: "11. Inflation Differentials and Possible Output Gain" - Figure referenced: "12. Links to Global Supply Chain" ### Reference and Supporting Material - Reference section present (page 27) - Inventory of Tables, Figures, and Boxes included in the unit: - Tables: 1, 2 - Figures: 1 through 12 - Boxes: 1, 2 *Source: _sdn1207 - Executive Summary (PDF chapter/section).* ### 3. Internal and Fiscal Devaluation ................................................................................... ### _sdn1207 - 3. Internal and Fiscal Devaluation ................................................................................... ### Executive summary: problem, priorities, and broad strategy - European countries and institutions have taken unprecedented actions to address severe economic and financial stresses, including steps to rein in fiscal deficits and recapitalize weak banks, plus pan-European measures: progressive strengthening of the firewall, comprehensive ECB liquidity support, and a new fiscal compact. - Key risks: rising unemployment and recession indicators have undermined stability and policy effectiveness; revival of growth is essential to restore fiscal revenues, reduce debt ratios, heal the financial sector, and sustain social support for adjustment. - Policy mix recommended: - Supply-side: granular structural reforms (Southern Europe: labor market duality, tradable-sector competitiveness, relative price misalignments; Northern Europe: higher labor participation and stronger services sector). - Demand-side: supportive measures to bolster near-term growth, while allowing fiscal consolidation to proceed rapidly where market pressures are severe and gradually elsewhere to let automatic stabilizers operate. - Monetary policy: remain supportive. - Fiscal framework: consider substituting pro-cyclical nominal targets with structural balance objectives under the fiscal compact to be more growth-friendly. - External demand and relative prices: to channel more external demand to the South, relative prices in Southern Europe need to fall vis-à-vis the North; this implies higher inflation in the North than in the South, with nominal wage restraint in the South and wage growth in the North in line with productivity. - Financial sector: restore health via bank and corporate restructuring (including FDI), promote bank recapitalization with public back-stops where needed, and where centralized capital injection is used ensure due control and eventual pan-European oversight. ### Motivation and context: growth trends and heterogeneity - Long-run decline: euro area growth has fallen behind peers since the early 1980s; Southern euro area convergence (Greece, Italy, Portugal, Spain) to richer Northern countries has stagnated. - Drivers of underperformance: - Slower productivity growth (sharp decline in total factor productivity growth) is the largest contributor to the trend growth decline. - Lower labor utilization explains two-thirds of the differential in GDP per capita between the euro area and the United States in 2006 (Mourre, 2009). - Divergent growth models: - Northern euro area growth driven by exports. - Southern euro area growth relied on domestic demand and cyclical, credit-dependent non-tradable sectors (e.g., real estate); capital inflows to the South often took the form of debt while tradable sectors weakened. - Relative-price divergence: nominal unit labor costs and real effective exchange rates diverged, rendering Southern countries uncompetitive. - Cyclical headwinds since the Great Recession: - Output recovery much slower in the euro area than in the United States. - Euro area experiencing persistent and higher unemployment than the United States and the United Kingdom; Southern euro area expected to contract further with modest recovery prospects, implying weak prospects for reversing sharp increases in unemployment, including youth unemployment. - Balance sheet repair, bank deleveraging, higher private savings, and fiscal consolidation are significant headwinds, particularly for the South. - Fiscal adjustment projection: - Euro area countries are projected to improve their cyclically-adjusted fiscal balance by 1½ percent in 2012 (excluding Southern Europe, ¾ percent). - Fiscal multipliers: estimated to be higher during downturns, implying a larger negative impact from planned consolidation on output, domestic absorption, and employment. ### Lifting growth — high-level strategy and complementarities - Multipronged approach required given low trend growth, relative price misalignments, and cyclical headwinds. - Objectives: - Boost potential output through structural reforms to increase resource use and productivity. - Use structural reforms to generate confidence and short-run demand effects (notably investment), while recognizing near-term output gains from reforms may be modest. - Foster aggregate demand tailored to country needs: promote net exports for Southern countries via competitiveness improvements and resource reallocation to tradable sectors; strengthen domestic demand in Northern countries, ideally led by the private sector. - Repair the financial system to support growth in emerging sectors. - Leverage Europe’s strengths: largest common market, strong reserve currency, aggregate fiscal position stronger than many economies; build on recent euro-area actions (fiscal compact, stronger firewall, ECB liquidity support). - Central-level policies: increase common resource pools and address tail-risks (not restricted to financial sector) to bolster confidence and signal progress toward long-run euro-area architecture. ### What can be realistically expected from structural reforms — evidence and magnitudes - Medium- and long-term effects: - Substantial empirical evidence that structural reforms lift growth in the medium to long term. - Staff simulations: large-scale labor, product market, and pension reforms that cut the distance of euro area countries to growth-maximizing benchmarks in half could boost output by 4½ percent over the next five years. - Cross-country benefits: a quarter of this additional growth is expected to derive from positive cross-country and cross-reform spillovers. - Near-term effects: immediate gains from reforms are likely modest; reforms take time to yield full benefits and may need complementary demand support to avoid protracted stagnation. - Labor market institutions: - Collective bargaining, unemployment benefits, and employment protection explain a large part of cross-country labor market performance differentials. - High employment protection, longer/more generous unemployment benefits, high tax wedges, and wage-favoring collective bargaining systems tend to affect employment and productivity negatively in many studies. - Product market reforms: - Excessive product market regulation contributes to higher mark-ups and lower output, investment, and employment. - Product market deregulation effects on productivity growth are larger in more advanced countries and in those with better governance. - Synergies exist between labor and product market reforms, though empirical findings on complementarity vary across studies. - Regulatory liberalization and efficiency: - IMF staff (Tiffin, 2012) finds that a one standard-deviation improvement in the reform index is associated with a 9½ percentage point increase in efficiency in a middle-income country and a 5 percentage point increase in a high-income country (efficiency measured as the difference between total factor productivity and a time-varying frontier). - Selected quantitative findings from recent studies (Table highlights): - Comprehensive and ambitious reforms could boost GDP levels by more than 10 percent over a decade in many euro area countries (OECD, 2012; Goldman Sachs, 2012). - Berger and Danninger, 2007: comprehensive and large-scale labor and product market reforms can lead to additional employment growth of 1-1.3 percentage points annually. - Allard et al., 2010: labor and service market reforms filling half the gap with the three best EU performers could yield ½ percentage points of additional annual growth over the next 5 years. - Goldman Sachs, 2012: product market reforms could boost potential growth substantially, by up to 1.7 percent annually in euro area periphery countries. - Pérez and Yao, 2012: a policy package of services deregulation, reduction in tax wedges, and replacement rate reforms could reduce unemployment by ¾ -5½ percentage points, depending on initial conditions. ### Policy implications and priorities (bullet recommendations condensed from the chapter) - Implement granular, country-specific structural reforms promptly, focusing in the South on labor market duality and tradable-sector competitiveness and in the North on labor participation and services. - Pursue coordinated pan-European reform effort to capture cross-country spillovers and limit adverse relative-price dynamics from unilateral reforms. - Adopt a growth-friendly fiscal strategy: - Consolidate rapidly where market pressures are severe and do so gradually elsewhere to allow automatic stabilizers to function. - Consider structural balance objectives instead of pro-cyclical nominal targets within the fiscal compact. - Maintain supportive monetary policy and expand pan-European common resource pools to address tail-risks and strengthen the shared fiscal architecture. - Restore financial sector health via recapitalization (with public back-stops where needed), restructuring (including encouraging FDI), and move toward pan-European regulation and supervision for banks receiving centralized support. - Reallocate existing funds to improve market functioning (e.g., labor market policies) to yield significant short-term employment gains. - Seek to shift external demand toward the South by facilitating relative price adjustment: nominal wage restraint in the South and wage growth in the North aligned with productivity and market developments. *Italic: Source: _sdn1207 - 3. Internal and Fiscal Devaluation (extracted content).* ### Box 1: Tales from Successful Structural Reforms in Europe ### Box 1: Tales from Successful Structural Reforms in Europe ### Examples of successful reform episodes - Netherlands (1980s) - Context: prolonged subpar performance and a deep recession (Netherlands, 1980–82). - Policies: extensive macro-economic policy and supply side reforms; public expenditure-to-GDP ratio lowered significantly; reduction of fiscal deficit and tax levels; labor markets made more flexible with increased incentives to work; product market reforms to boost competition. - Outcomes: employment rate increased from 53 percent in the 1980s to close to 67 percent in 2011; from being associated with the “Dutch disease,” became known for its employment miracle. - Sweden (1990s) - Context: prolonged subpar performance and a banking crisis (Sweden, 1990–92). - Policies: macro-economic and supply-side reforms targeted at boosting productivity; currency depreciation produced a large downward adjustment in the real effective exchange rate. - Outcomes: annual labor productivity growth increased from 1 percent in 1977–92 to 2.5 percent in 1992–2007; cross-country research suggests Swedish reforms facilitated a 5½ percentage points increase in efficiency over 10 years relative to the global best-practice frontier (an increase in real output per worker of almost 15 percent); Sweden has experienced two decades of rapid growth. - Germany (Agenda 2010 and Hartz reforms, early 2000s) - Policies: introduce labor market flexibility (temporary employment agencies, legal framework for small jobs); restructure labor market agencies and active labor market policies; raise incentives to work (reduce duration of unemployment benefits, reduce restrictions on re-assignment); decentralize wage bargaining and allow firm-level agreements trading job security for flexibility. - Outcomes: matching efficiency improved; unemployment dropped from above 11 percent in 2005 to below 9 percent by 2007, and currently stands at around 6 percent. ### Key lessons from these experiences - Reforms must be country-specific - Netherlands: focus on increasing very low employment rate caused by too rapid wage increases. - Sweden: focus on boosting dismal productivity growth held back by outdated industries and excessive regulation. - Reforms need to adapt over time as bottlenecks change - Example: Netherlands shifted from reducing wage costs (boost labor demand) to boosting labor supply as employment expanded. - Full impact of reforms builds up over time - Short-term effects can be small or negative due to costly and timely reallocation of resources, temporary rises in unemployment, and social costs. - Credibility and confidence can counter short-run negative effects; full impact likely to materialize over a medium- to long-term horizon. ### Short- and long-run impacts (evidence and mechanisms) - Reasons short-run and long-run effects differ: 1. Gradual implementation of reforms and maturation of effects. 2. (Non-convex) adjustment costs and gradual resource reallocation and capital accumulation. 3. Immediate consumption reduction by losers of reforms; beneficiaries take time to increase consumption. 4. Investment may take time to increase and may initially decline as investors “wait and see.” 5. Productivity increases can imply short-run employment decreases when demand for final product is inelastic. 6. Labor reforms lowering dismissal costs raise aggregate employment in the long run, but firms may shed labor and raise productivity in the short run. 7. With substantial slack, reforms may initially reduce disposable income as unemployment rises. - Role of expectations and communication - Announcement of comprehensive reforms can have larger short-term positive effects through investor and consumer confidence, highlighting the necessity of an effective communication strategy, possibly coordinated at the European level. ### GIMF simulation findings (short- and medium-term quantitative results) - Model and caveats - Analysis based on calibration of the IMF’s Global Monetary and Fiscal (GIMF) model using OECD empirical estimates of dynamic effects of structural reforms on labor participation, unemployment, and productivity. - GIMF is a general equilibrium model with nominal and real rigidities and incomplete asset markets; simulations conducted with monetary policy constrained at the zero lower bound in the short run. - Results are illustrative examples rather than precise pay-offs; model does not allow for involuntary unemployment and is conducted around an initial steady state. - Aggregate euro area impacts (GIMF results) - Eliminating 50 percent of euro area countries’ gap with OECD best practice in labor market and pension policies could boost GDP on average by almost 1½ percent after 5 years. - Product market reforms could boost GDP by another 2¼ percent (medium run). - Combined reforms in labor and product markets could yield additional output of up to 0.6 percentage point in the euro area in the first year. - Active labor market policies could have an immediate positive impact larger than their long-term effect (mainly because they entail fiscal spending). - Benefits from product market reforms are mostly achieved in the long run and are larger than labor market reforms given greater distance from “best practice.” - Spillovers and coordination - Reforms can produce sizeable spillovers, accounting for one quarter of the total gains in growth; trade and technology spillovers raise growth in other countries. - Southern euro area countries would gain more from reforms in Northern countries than vice versa for three reasons: 1. Larger size of Northern countries implies a more important trade impact. 2. Productivity improvements spill over from advanced Northern countries (the productivity frontier). 3. In an environment with the zero interest rate floor binding, higher aggregate demand from activation policies raises inflation, reduces real interest rates, and boosts output. - Within-country payoffs depend on whether other reforms are implemented (e.g., labor market reform pays more if product markets are reformed). - Coordinated efforts are underscored as important. - Short-run magnitude comparisons - Positive impact of reforms on activity in the very short run is modest: equivalent to a temporary fiscal expansion of close to 1 percent of GDP. - Letting automatic stabilizers operate after a negative output growth shock of around 2 percent would imply an increase in the budget deficit of about 0.9 percent of GDP; letting automatic stabilizers operate would avoid a GDP contraction in the short run between 0.3 and 1 percent depending on fiscal measures chosen (additional impact through spillovers). ### Risks, sequencing, and complementarities - Short-run risks - Weak demand and excess capacity risk limiting the short-term output response to reforms and may damage long-run potential via hysteresis in unemployment. - Balance sheet concerns and low confidence can encumber private sector decisions and hinder effectiveness of supply-side reforms. - Example simulation: reducing unemployment insurance (cuts in transfers to liquidity-constrained unemployed take effect immediately while employment increases with a lag) can produce a slight output contraction in the short run but output expansion in the long run. - Dependence on economic activity - Bringing unemployment down in the short run largely depends on the strength of economic activity (Okun’s law stability since the 1980s). - Empirical evidence (Bernal-Verdugo et al., 2012): unemployment could increase temporarily after labor market reforms; after a financial crisis, unemployment tends to increase more in the short term in countries with more flexible labor markets, while the medium-term increase in unemployment tends to be higher for countries with more rigid labor markets. - Complementary policies needed - Structural reforms need to be complemented by policies that boost aggregate demand—this is not a recommendation for simple fiscal stimulus, since fiscal consolidation is inevitable, but a combination of efforts to alleviate headwinds, including demand rebalancing within Europe and reallocation within countries. - Monetary policy and banking sector repair and reform play important roles. - Short-run growth needs more robust (ideally private) domestic demand in the North and firmer external demand in the South. - Domestic absorption would need to outpace output in the North for some time; a more competitive tradable sector in the South should cushion domestic demand adjustment. - Labor markets in the South are central to rebalancing as wage adjustments play a crucial role in undoing relative price misalignment in the absence of exchange rate policy. - Avoid overshooting domestic demand adjustment while relative price gaps are being closed. ### Internal and fiscal devaluation (Box 3 findings) - Internal devaluation is painful and revival of competitiveness via reduced labor costs/domestic prices often comes with drawn-out recessions; duration of initial adjustment could range from 5 to 15 quarters. - Conditions that aid successful internal devaluation include more openness, higher factor mobility, price and wage flexibility, low initial public debt, and the ability to use fiscal policy/transfers to attenuate real economy impacts. - Tax reform as a complement - Shifting from employer social contributions to the VAT can, even if revenue-neutral, improve competitiveness and promote exports, growth, and employment by lowering labor costs borne by exporters while VAT does not dampen exports. - Effect fades if wages adjust to higher VAT. - Quantitative simulation evidence on fiscal devaluation - Simulations of a fiscal devaluation in Portugal: a shift equal to 1 percent of GDP generates a short-term rise in net exports of somewhere between 0.2 and 0.6 percent of GDP (IMF, 2011). - Recent econometric estimates for the euro area (De Mooij and Keen, 2012): an average reduction in the social contribution rate of 2.6 percentage points and a standard VAT rate increase of 2.7 percentage points could have an impact on net exports somewhere between 0.9 and 4 percent of GDP. - In reality, improvement in net exports depends on terms of trade, relative price adjustment in non-tradable sector, and composition of tradable sector. - Positive short-term effects of tax shifts tend to become insignificant in the long run but can last for some time, accelerating adjustment if economies are in disequilibrium. - Country-specific considerations - Targeting lower social contribution rates to low-skilled workers would likely reinforce positive job impacts. - Ability to increase VAT may be limited where VAT rates are already high; broadening the VAT base is a better alternative but may have adverse equity effects—alternative measures or acceptance of higher inflation may be necessary. - Fiscal devaluations should be limited to euro area countries with competitiveness problems; if all countries pursue the same tax shift, none gains competitiveness. ### Policy implications and concrete orientation - Structural reforms need to tackle many pre-crisis or “older” challenges. - No one-size-fits-all strategy; granularity is necessary. - Complement reforms with policies that support demand, financial repair, and credibility-enhancing measures; coordinate reforms and policies across countries where feasible. *Source: Box 1: Tales from Successful Structural Reforms in Europe, _sdn1207.* ### Annex II gives a detailed assessment of country- ### _sdn1207 - Annex II gives a detailed assessment of country- ### Structural reform priorities and older challenges - Structural policies need to: - In the Southern euro area: target the efficiency of tradable goods production and help to regain competitiveness. - Elsewhere: open business opportunities in the services sector to boost potential growth. - Significant gaps persist between actual and potential growth-maximizing benchmarks (Annex I). - Current structural priorities concentrate on labor and product markets; broader inventory includes public sector and fiscal composition reforms. ### Labor markets — findings and recommended reforms - Findings: - Southern euro area countries have major gaps in administrative and regulatory environments, employment legislation, and wage bargaining systems that hinder wage sensitivity to economic conditions. - Northern euro area priorities include reducing barriers to competition in the services sector, increasing labor participation, and scaling back tax wedges. - Recommended reforms (country-specific difficulty varies): - More inclusive labor markets: - Lower duality by reducing excessive protection for insiders and dismissal costs. - Create better incentives for remaining in or re-entering the workforce (e.g., more flexible part-time arrangements). - More responsive wages: - Reduce intermediate-level coordination in collective bargaining in Southern euro area countries. - Encourage bargaining systems more favorable to employment than wage increases and minimize automatic indexation. - Calibrate minimum wages carefully to productivity realities. - Higher labor force participation: - Pension system should provide incentives to increase the working age. - Facilitate the transition between school and labor force. - Higher labor mobility: - Improve portability of social benefits (pensions and unemployment insurance) and harmonize labor market conditions across countries where feasible. ### Table 2 — Main progress in Southern European countries since 2010 (high-level summary) - Greece: - Labor market reforms to reduce entry-exit costs, promote firm-level bargaining, reduce rigidities in collective bargaining, lower minimum wage and legislate a gradual reduction in the labor tax wedge. - Product market reforms to liberalize restricted professions, transportation services and energy, and simplifying processes for business start-ups, licensing and judicial procedures. - Italy: - Labor market reforms to foster decentralization in wage bargaining and allow firm-level contracts to deviate from national contracts. - Product market reforms to liberalize restricted professions and industries, enforce competition, and simplify administration. - Portugal: - Labor market reforms: organized decentralization in wage bargaining, reduce severance payments and unemployment benefits, rationalize automatic extension of collective bargaining agreements. - Product market reforms: improve competition, abolish state special rights in companies, revise Competition Law, liberalize restricted professions, reduce costs in network industries (electricity and telecommunications), and improve corporate insolvency framework. - Spain: - Labor market reforms to allow distressed firms to modify wages, working time, temporarily suspend contracts; provide subsidies and tax incentives to promote hiring; ease dismissal conditions and opt-out clauses from collective bargaining for firms in distress. ### Product markets — reforms recommended - Full implementation of the EU service directives; address slow adoption and overly broad invocation of “necessity, proportionality, and public interest” exceptions. - Address regulation of professions: reduce self-regulation and professional orders that impede competition; consider EU-level coordination. - Modify land/zoning regulation: local authorities often do not internalize economic effects, leading to ineffective land use and real estate cycles. ### Public sector reform — recommendations - Justice system reforms: - Strengthen judicial systems to support labor market reform, FDI, innovation, and property rights enforcement. - EU should exert pressure on countries that do not guarantee a minimum acceptable standard. - Education: - Upgrade labor force skills, particularly in countries relying mostly on unskilled labor. - Regulation: - Simplify regulatory authorities across EU, national, regional, and municipal levels to reduce deterrents to entrepreneurship. - Privatization: - Renounce keeping significant participation in key companies; encourage privatization at local level. - Growth-friendly budgets: - Preserve pro-growth programs (education, R&D, infrastructure) under expenditure cuts. - Tax increases should rely on least growth-distorting instruments. ### Newer challenges — need for complementary actions - Closing structural reform gaps alone may not provide enough immediate growth lift. - Structural reforms often yield gradual gains; accompaniment by other policy interventions is crucial given weak economic outlook and fiscal/financial stability woes. ### Macroeconomic policies — recommendations - Context: - The average euro area output gap is 2½ percent in 2012 and unemployment is elevated, partly due to cyclical reasons. - Supportive monetary policy: - Steadfast monetary policy support remains essential while the inflation forecast points to falling and very low rates of inflation on the policy horizon. - If inflation surprises on the downside, further monetary easing might be necessary. - Easing should also contribute to correcting the modest over-appreciation of the euro's real effective exchange rate. - Smart fiscal consolidation: - Consolidation should proceed rapidly where market pressure remains high. - Where financing allows, adjustment should be conducted at a steady underlying pace balancing deficit reduction and not undermining recovery. - If recovery falters in the North, slow the pace of consolidation if fiscal space permits. - Consider modifying pro-cyclical nominal targets for structural deficit objectives. - Priority should be given to reforming future entitlements. ### Credit markets — recommendations - Well-functioning credit markets are key; legacy of the debt crisis risks impeding funds to new investment opportunities, especially in the South. - Steer bank deleveraging: - Financial supervisors should carefully calibrate deleveraging, following European Banking Authority guidelines. - Consider facilitating access to credit by new emerging sectors, e.g., through partially underwriting credit risk. - Bank restructuring: - Encourage bank consolidation, possibly through an EU-level policy. - Southern countries should be ready for foreign banks to take significant domestic credit share. - Actively encourage FDI through a euro area policy to avoid distortionary competition. - Bank recapitalization: - Enhance domestic backstops if market pressures intensify and the private sector cannot cope with capital needs. - Consider using centralized resource pools to provide direct capital support to banks (against acquisition of due control) to limit adverse bank-sovereign feedback loops. - Over time, pan-European-supported banks could be subjected to centralized regulation and supervision, a joint bank resolution authority with a common backstop, and a single deposit insurance fund — a first step toward a unified financial stability framework in the single financial market. ### Rebalancing within countries and within Europe - Southern euro area countries need to lower current account deficits for sustainability; surplus countries can help adjustments. - Regaining competitiveness should occur through increased productivity and lower relative prices and wages. - Key policy options: - Tolerate inflation differentials: - Relative price adjustment requires higher (lower) than usual inflation in the North (South) while respecting the euro area at-large inflation target. - Ideally results from domestic demand outpacing output in surplus countries and continued adjustment toward higher net exports in deficit economies. - Restrain nominal wage growth in the South: - Nominal wage restraint (e.g., freezes or cuts, public sector wage discipline) would accelerate regaining competitiveness. - Wages in surplus countries should be allowed to keep pace with market developments to safeguard flexibility. - Fiscal devaluation: - Deficit-neutral tax reforms shifting revenue from labor or social security taxation to VAT in the periphery would be helpful, mostly in the short run. - Such policy needs careful coordination across countries to be effective. ### More active policies at the central (EU/euro area) level - Increase and better target common resource pools: - Structural funds have been allocated to projects with limited spillovers and low impact on EU-wide growth; transnational projects are around 2.5 percent of total funds. - A strategy to connect the Southern euro area to countries and regions that lead world growth could yield large returns. - Targeted investment: - Better target structural funds toward infrastructure and human capital to connect to export chains and facilitate private sector FDI from surplus countries, especially where sovereigns face market stress. - Prioritize labor and financial market policies with large positive short-run payoffs. - Leveraging common pools: - A larger common pool—with corresponding reduction in domestic budgets—and project bonds would allow more flexible allocation and facilitate public investments where most productive. - Further steps toward fiscal integration should be considered. ### Final remarks — policy package and expected gains - Structural reforms need immediate implementation and must be complemented by other policies. - Long-run gains from product and labor market reforms are substantial and can increase Europe’s growth potential. - Simultaneous push for reform could generate positive cross-country spillovers, but immediate gains are unlikely to be large. - Supportive macroeconomic policies should accompany structural reforms: - Continue accommodative monetary policy. - Structure fiscal consolidation to avoid excessive procyclicality. - Encourage bank and corporate sector restructuring, including through FDI. - Promote bank recapitalization, possibly supported by centralized resource pools and transition to pan-European regulation and supervision for propped-up banks. - A consistent euro area-level policy package tailored to country-specific reform priorities would yield large gains and facilitate rebalancing within the euro area. - Many countries' priorities include reducing barriers to competition and improving the business environment; product market reforms can provide substantial lift to growth, and labor market reforms can help achieve the price re-alignment needed to regain competitiveness. - Fiscal devaluation and nominal wage restraint would help accelerate rebalancing; reallocation across sectors could be supported by targeted investment and leveraging common resource pools. *Source: _sdn1207 - Annex II gives a detailed assessment of country- (IMF PDF chapter/section).* ### REFERENCES ### _sdn1207 - REFERENCES ### Bibliographic references (selected) - Allard, C., L. Everaert, with A. Annett, A. Chopra, J. Escolano, D. Hardy, M. Mülheisen, and B. Yontcheva, “Lifting Euro Area Growth: Priorities for Structural Reforms and Governance,” IMF Staff Position Note No. 10/19 (Washington: International Monetary Fund). - Annett, A., “Lessons from Successful Labor Market Reformers in Europe,” IMF Policy Discussion Paper No. 07/1 (Washington: International Monetary Fund). - Ball, L., D. Leigh, and P. Loungani, 2012, “Okun’s Law: Fit at 50?” IMF Working Paper forthcoming. - Bassinini, A. and D. Venn, 2008, “The Impact of Labour Market Policies on Productivity in OECD Countries,” International Productivity Monitor, Vol. 17, pp. 3-15. - Berger, H. and S. Danninger, 2007, “The Employment Effects of Labor and Product Market Deregulation and Their Implications for Structural Reform,” IMF Working Paper No. 06/137 (Washington: International Monetary Fund). - Bernal-Verdugo, L. D. Furceri, and D. Guillaume, 2012, “Crises, Labor Market Policy, and Unemployment”, IMF Working Paper No. 12/65 (Washington: International Monetary Fund). - Blanchard, O. and F. Giavazzi, 2003, “Macroeconomic Effects of Regulation and Deregulation in Goods and Product Markets” The Quarterly Journal of Economics, pp. 879-906. - Blanchard, O. and J. Wolfers, 2000, “The Role of Shocks and Institutions in the Rise of European Unemployment: The Aggregate Evidence” The Economic Journal, Vol. 110, pp. 1-33. - Bouis, R. and R. Duval, 2011, “Raising Potential Growth After the Crisis: A Quantitative Assessment of the Potential Gains from Various Structural Reforms in the OECD Area and Beyond,” OECD Economics Department Working Papers, No. 835, OECD Publishing, Paris. - De Mooji, R. and M. Keen, 2012, “Fiscal Devaluation and Fiscal Consolidation: The VAT in Troubled Times,” NBER Working Paper No. 17913. - Everaert, L. and W. Schule, 2006, “Structural Reforms in the Euro Area: Economic Impact and Role of Synchronization across Markets and Countries,” IMF Working Paper No. 06/137 (Washington: International Monetary Fund). - Fitoussi, J., D. Jestaz, D. Phelps, and E. Zoega, 2000, “Roots of the Recent Recoveries: Labor Reforms or Private Sector Forces?” Brookings Papers on Economic Activity, Vol. 1, pp. 237–312. - Fialová, K. and O. Schneider, 2008, “Labor Market Institutions and Their Effect on Labor Market Performance in the New EU Member Countries,” CESifo Working paper Series, No. 2421. - Fiori, G., G. Nicoletti, S. Scarpetta, and F. Schiantarelli, “Employment Effects of Product and Labour Market Reforms: Are There Synergies? The Economic Journal, Vol. 122, pp. 79–104. - Goldman Sachs, 2012, “Our 2011 GES: A Sharper Signal for Growth,” Goldman Sachs Global Economics, Commodities and Strategy Research. - Gomes, S., P. Jacquinot, M. Mohr, and M. Pisani, 2011, “Structural Reforms and Macroeconomic Performance in the Euro Area Countries, A Model-Based Assessment,” ECB Working Paper No. 1323 (Frankfurt, European Central Bank). - IMF, 2012a, “Greece: Request for Extended Arrangement under the Extended Fund Facility,” Country Report No. 12/57 (Washington: International Monetary Fund). - IMF, 2012b, “Fiscal Monitor: Caution Advised Amid Improving Fiscal Outlook,” (Washington: International Monetary Fund). - IMF, 2011, Fiscal Monitor, Appendix 1: "Fiscal Devaluation": What is it-and Does It Work? (Washington: International Monetary Fund). - IMF, 2010, “Cross-Cutting Themes in Employment Experiences during the Crisis," IMF Staff Position Note, SPN/10/18 (Washington: International Monetary Fund). - Jaumotte, F. 2011, “The Spanish Labor Market in a Cross Country Perspective,” IMF Working Paper No. 11/11 (Washington: International Monetary Fund). - Mourre, G., 2006, “Did the pattern of Aggregate Employment Growth Change in the Euro Area in the Late 1990s?” Applied Economics, Vol. 38, pp. 1783-1807. - Mourre, G., 2009, “What Explains the Differences in Income and Labor Utilization and Drives Labor and Economic Growth in Europe? A GDP Accounting Perspective,” European Economy Economic Papers No. 354, (Brussels, European Commission). - Nickell, S., L. Nunziata, and W. Ochel, 2005, “Unemployment in the OECD since the 1960s: What Do We Know,” The Economic Journal, Vol. 115, pp. 1-27. - Organization for Economic Co-operation and Development, 2012, “OECD Economic Surveys Euro Area,” Paris. - Ostry, J., A. Spilimbergo, and A. Prati, 2009, “Structural Reforms and Economic Performance in Advance and Developing Countries,” IMF Occasional Paper (Washington: International Monetary Fund). - Pérez, E., and Y. Yao (2012), “Can Institutional Reform Reduce Job Destruction and Unemployment Duration? Yes It Can,” IMF Working Paper No. 12/54 (Washington: International Monetary Fund). - Santos, I., 2008, “Is Structural Spending on a Solid Foundation?” Bruegel Policy Brief 2008/02, February 2008. - Sutherland, D., P. Hoeller, and R. Merola, 2012, “Fiscal Consolidation: How Much, How Fast and by What Means?” OECD Economic Policy Papers No. 01 (Paris: Organization for Economic Co-operation and Development). - Tiffin, A., forthcoming, “Potential Growth Prospects in Euro-area Program Countries,” IMF Working Paper (Washington: International Monetary Fund). - World Bank, 2012, “Golden Growth—Restoring the Luster of the European Economic Model,” (Washington). ### Annex I — Key Gaps in Structural Policies: Cross-Country Comparisons (summary of findings) - Purpose: - Identifying country-specific gaps helps focus reforms that yield larger gains. - Cross-country comparison useful but has shortcomings: institutional features are complex and difficult to measure; indicators are generally geared toward growth and may not capture equity considerations. - Broad findings: - Europe exhibits higher regulations and administrative burdens relative to its OECD peers (Annex Figure 1). - Europe’s work model features: - stronger security for those with jobs, - more generous benefits for those without work, - easier pension eligibility. - European enterprises face: - more administrative burdens, - less competition, - higher employment tax burden than OECD peers. - These features tend to limit labor participation, incentivize fewer working hours, and favor smaller enterprises. - The Southern euro area is more encumbered with administrative and regulatory burdens than the rest of the euro area. - Northern euro area countries that pursued strong labor market reforms in the 1990s and 2000s benefited from greater integration and participation in the pan-European value chain; the Southern euro area remained more regulated and protected. - Figure and measurement notes: - Annex Figure 1 title: "Labor and Product Market Constraints (Relative to OECD average)"; axis ticks shown include 0, 0.5, 1, 1.5, 2. - Footnote: "Southern Europe consists of Greece, Italy, Portugal and Spain." - Footnote 1/: "Average tax wedge on labor; average of two income situations (67% and 100% of average earnings)." - Source: OECD and Staff calculations. - Country-level gaps and reform priorities: - All euro area countries have structural gaps relative to the OECD benchmark, indicated by orange flags (rating below average) and red flags (rating more than one standard deviation below average) in Annex Table 1. - The South stands out with larger structural reform gaps across the board, including institutions and contract enforcement, education, business regulation, and innovation capacity. - Many Southern countries have implemented comprehensive reforms in recent years that may not be captured by the backward-looking indicators; more reforms remain in the pipeline (Annex II referenced). - IMF recommendations emphasize further measures to: - improve functioning of labor markets, - increase labor force participation, - reduce barriers to competition, - enhance competitiveness and mitigate the negative impact of aging. - Labor market institutions and reform lessons: - Labor market institutions are a key reform priority, but reforms should account for differing work models. - German labor market shows significant gaps compared to OECD benchmarks (Annex Figure 2) yet produced favorable employment outcomes during the crisis. - Successful reform episodes across Europe over the last three decades highlight wage moderation as a key ingredient for shifting labor and output growth. - Achieved via agreements between social partners in exchange for higher job security (examples: Ireland and Netherlands) and cuts in labor tax (examples: Denmark and Ireland). - Collective bargaining systems more favorable to employment than wage increases (requiring strong coordination or strong decentralization rather than intermediate coordination) appeared to work better. - Most reform episodes occurred alongside reductions in government wages and transfers, illustrating complementarity between institutional reform and fiscal policy (Annett, 2007). ### Annex Figure 2 and data notes - Source: Organization for Economic Cooperation and Development. - Footnotes: - 1/ 2008 for EPL and minimum wage; 2009 for unemployment benefit; and 2011 for tax wedge. - 2/ Average tax wedge on labor; average of two income situations (67 percent and 100 percent of average worker earnings). Data for Greece are from 2010. - 3/ Average of net replace rates for six family types and two earning levels (67 percent and 100 percent of average worker earnings). - Figure panels referenced: - Employment protection (axis ticks include 0.0, 0.5, 1.0, 1.5, 2.0, 2.5, 3.0, 3.5) - Tax wedge (axis ticks include 0, 10, 20, 30, 40, 50, 60) - Minimum Wage (in percent of median wage) (axis ticks include 0, 10, 20, 30, 40, 50, 60, 70) - Unemployment Benefit (axis ticks include 0, 10, 20, 30, 40, 50, 60, 70, 80, 90) - Country labels appearing in figures include: PRT, FRA, ESP, GRC, BEL, DEU, NLD, AUT, ITA, IRL, OECD in various orders across panels. ### Annex Table 1 — Structural Reform Gaps: methodology and sources - Sources cited for indicators in Annex Table 1: - OECD Going for Growth 2012; - Fraser Institute Index of Economic Freedom 2011; - WEF Global Competitiveness Report 2011-12; - WB Doing Business 2012. - Methodological note 1/: See IMF (2010) for a description of the methodology. Indicators reflect the most recent data available from the sources and do not always capture the most recent reforms implemented. *Content derived from the document: _sdn1207 - REFERENCES* ### Annex II. Euro area: Country-Specific Structural Reform Recommendations ### Annex II. Euro area: Country-Specific Structural Reform Recommendations ### Labor market participation, activation, and wage flexibility - Austria - Progress: Recent ad-hoc pension containment and selective measures to increase effective retirement age (which is the second lowest in the OECD). - Recommendations: Close all avenues to early labor market exit without actuarially fair benefit reductions (including by fully abolishing the specific early retirement scheme for long-time insured, so-called "Hacklerregelung"); further tighten eligibility for disability pensions (including by broadening the scope of alternative occupations against which disability is assessed); revenue-neutrally reduce the high effective tax wedge (social security contributions) for low-skilled workers. - Belgium - Progress: New government reform program agreed in December 2011. - Recommendations: Adjust early retirement benefits to actuarially neutral levels; stepwise phasing out of unemployment benefits over duration of unemployment spells; reallocate active labor market policies towards intensified job search assistance; allow greater geographic and sectoral wage flexibility; significantly reform automatic wage indexation mechanism. - Cyprus - Progress: Entry salaries for new public servants cut by 10 percent; COLA frozen for 2 years (2012 and 2013); increased public sector pension contributions from 0.8% to 5%; CPI indexation for civil service pensions introduced. - Recommendations: Introduce early retirement penalties; increase gradually the retirement age to the same level in the national and civil service scheme; align benefits closer to contribution and lifetime earnings; eliminate or reform the COLA wage indexation mechanism and link wage increases to productivity developments at the firm level; reduce wage increases in the public sector and abolish automatic increments in public sector wages. - Estonia - Progress: Cut unemployment insurance contributions from 2013; introduced targeted wage subsidies; doubled per capita amount for voucher training program; introduced new IT platform for one-stop job matching. - Recommendations: Harmonize vocational education with labor market needs; increase voucher training programs; improve job-matching through the new one-stop IT platform; lower labor market taxes. - Finland - Progress: Part-time pension age limit increased to 60; social guarantee to offer young people a job, training, studies, or rehabilitation within 3 months (Budget 2012). - Recommendations: Tighten unemployment and disability pipelines to early retirement and strengthen work incentives; strengthen activation requirements for sickness and disability benefits. - France - Progress: Pension reform adopted and being implemented; measures to promote alternating work-study schemes approved in 2012. - Recommendations: Achieve minimum wage moderation and reduce inactivity traps for young and low-skilled workers (easing high employment protection, reducing duration or level of unemployment benefits); strengthen activation policies and unified job placement agency; strictly enforce job-search requirements. - Germany - Progress: Some progress in extending child care provision; recognition of qualifications earned abroad improved; authorities contemplating reduction of tax rates and/or social contributions. - Recommendations: Lower the tax wedge, in particular for secondary, low skilled and low income earners through targeted tax measures; improve quality and availability of early childhood education, including child care facilities. - Greece - Progress: Major labor reforms reducing entry-exit costs; promote firm-level bargaining; lower minimum wage by 22 percent (youth by 32 percent); legislate gradual reduction in labor tax wedge. - Recommendations: Achieve a 5 percentage point reduction in the labor tax wedge (employer's social security contribution rate) in a budget-neutral way; take measures as necessary to achieve a 15 percent reduction in unit labor costs over 3 years; simplify the minimum-wage framework. - Ireland - Progress: Draft law reforming sectoral wage-setting agreements; expanded activation places (Jobs Initiative). - Recommendations: Reform sectoral wage-setting to facilitate labor reallocation; strengthen labor activation and training; reform unemployment benefits to reduce high replacement rates; reduce the relatively high minimum wage. - Italy - Progress: June 2011 agreement to foster wage bargaining decentralization; August 2011 package allowed firm-level contracts to derogate from national contracts; April 2012 labor reform proposal submitted to parliament. - Recommendations: Decentralize wage bargaining; introduce regional differentiation in public sector wages; relax job protection on standard contracts and harmonize/reduce number of labor contracts; reorganize social safety net; increase effectiveness of activation policies; reduce tax wedge on labor income by shifting toward indirect taxes. - Luxembourg - Progress: Agreement reached to delay automatic wage increases and limit to once a year. - Recommendations: Drop food and fuel prices from the reference index to eliminate automatic backward-looking wage indexation in the medium term; review employment and income support schemes to better target and minimize adverse work incentives. - Malta - Progress: Revision of a new productivity-linked indexation mechanism. - Recommendations: Encourage female participation through fiscal incentives for part-time and flexible work, training programs and affordable childcare; maintain cautious firm-level wage negotiations; improve human capital targeted to labor market needs. - Netherlands - Progress: Introduction of the Work Capacity Act; increase statutory retirement age to 66 in 2020 and link to life expectancy; introduction of the vitality scheme. - Recommendations: Selectively reduce labor taxes for hiring unemployed workers over 50; phase in income-based tax credit to attract low-earning partners with children; increase statutory retirement age from 65 to 67 while providing financial incentives to continue working after minimum retirement age; relax strict employment protection for regular contracts. - Portugal - Progress: Implemented "organized decentralization"; suspended automatic extensions; reduced severance payments; draft Labor Code revisions under Parliament. - Recommendations: Promote firm-level wage bargaining; disallow extensions of agreements that do not represent at least 50 percent of workers; reduce severance payments toward EU average (8-12 days); relax employment protection for regular workers; relax working time regulations. - Slovak Republic - Progress: Reformed labor code to reduce firing and hiring costs and enhance wage negotiation flexibility. - Recommendations: Reduce employment disincentives by limiting pace of phasing out income support; consider differentiating minimum wages by skill level and region; better target active labor market policies; expand training for unemployed youth. - Slovenia - Progress: Pension reform planned in 2011 was defeated in a public referendum; draft employment acts were defeated by referendum. - Recommendations: Increase penalty for early retirement to 6-7 percent per year to raise effective retirement age to 65; move gradually to full CPI indexation from wage indexation; adjust retirement age by life expectancy when effective retirement age reaches 65; expand private pillar; reduce employment protection by cutting notice periods, severance payments, and dismissal restrictions; avoid further indexation of minimum wage after a binding 23 percent increase in 2010. - Spain - Progress: Feb. 2012 labor reform reduces severance payments for unfair dismissals of new permanent workers; eases fair dismissals for firms in distress; gives priority to firm-level agreements; includes subsidies and tax incentives to promote hiring of young and long-term unemployed. - Recommendations: Ensure well implementation to reduce dualism and foster permanent hires; further reduce severance pay on permanent contracts to at least EU average levels; introduce a single open-ended contract with gradually increasing severance payments; further decentralize wage setting (move to “opt-in” rather than “opt-out”); eliminate automatic indexation; strengthen retraining of the unemployed. ### Pension systems and retirement-age reforms - Austria - Recommendations: Close early exit routes (see labor section); strengthen human capital formation in education. - Cyprus - Progress: Public sector pension contribution raised from 0.8% to 5% and CPI indexation introduced for civil service pensions. - Recommendations: Introduce early retirement penalties; gradually raise retirement age to align national and civil service schemes; align benefits to contributions and lifetime earnings. - Luxembourg - Progress: Introduced “pension a la carte” that when fully in force in 40 years will reduce benefits for those retiring at the current effective retirement age but maintain benefits for those working three more years. - Recommendations: Gradually increase statutory retirement age in line with life expectancy; modify benefit indexation from wage increases to cost-of-living adjustment; eliminate complementary periods. - Malta - Progress: Implementation of remaining 2007 pension reform measures. - Recommendations: Index retirement age to longevity; introduce mandatory privately funded second pillar and voluntary third pillar; consider introducing a notional defined contribution first pension; accelerate gradual increase in retirement age to 65. - Slovenia - Recommendations: Increase early retirement penalty to 6-7 percent per year to raise effective retirement age to 65; move to CPI indexation; align retirement age with life expectancy once effective age reaches 65; expand private pillar to compensate cuts in public benefits. ### Product, services, and network competition - Belgium - Progress: EU Services Directive fully transposed; Competition Authority studied retail price differentials. - Recommendations: Implement EU Services Directive; increase competition and enhance supervision in energy sector; reduce barriers to entry and strengthen regulatory oversight to bring energy prices closer to neighboring countries. - France - Progress: Steps to increase competition in electricity, telecommunications, and retail; G20 commitment to adopt a law to increase competition in retail, energy, telecommunication and real estate by end-2011. - Recommendations: Foster more competition in growth-critical services, reduce regulatory barriers (notably for professional services); implement EU Services Directive; focus Competition Authority on areas with limited progress. - Germany - Progress: Corporate tax reform of 2008 improved tax competitiveness; additional R&D allocation in 2012/13 budgets. - Recommendations: Abolish trade tax; remove debt bias in corporate financing; raise incentives to invest in higher risk, higher growth sectors; promote ICT use. - Greece - Progress: Legislation adopted liberalizing restricted professions, transportation services and energy. - Recommendations: Finalize implementation of law liberalizing closed professions by end-2012; define action plan to tackle remaining product market rigidities. - Ireland - Progress: Amendments to the Competition Bill; strategy to reform water sector regulator and introduce metering designed. - Recommendations: Implement ambitious state asset disposal program with regulatory reforms in gas and electricity; reform sheltered sectors (legal and medical professions); strengthen competition law enforcement. - Italy - Progress: Product market liberalization and administrative simplification reforms introduced; follow-up regulations pending. - Recommendations: Implement liberalization package (separate ownership of main energy company from gas distribution; streamline authorizations for strategic infrastructure; establish independent transport authority; abolish tariffs for professional services; reform professional orders); enhance role and capacity of competition bodies; encourage privatization and reduce state involvement; improve judiciary efficiency. - Netherlands - Recommendations: Ease restrictions on shop opening hours, large scale outlets and zoning; open transportation sector to more competition; introduce road pricing; relax strict zoning regulations. - Portugal - Progress: Competition Law and Public Procurement Code revised; state "Golden Shares" abolished; renegotiation of excessive rents in electricity in progress; privatizations in energy sector under way. - Recommendations: Reduce costs in regulated network sectors (notably electricity); streamline licensing processes; accelerate SIMPLEX program; reform judicial system and insolvency regime; resume and expand privatization with performance monitoring. - Slovakia - Recommendations: Promote better vocational training aligned with employers to improve regional employment dynamics. - Slovenia - Progress: Creation of one-stop shops for establishing new companies. - Recommendations: Accelerate bankruptcy procedures; introduce a cap on social security contributions compensating potential revenue loss. - Spain - Progress: Service and product market reforms ongoing. - Recommendations: Ambitiously implement EU Services Directive to lower entry barriers in retail trade; eliminate restrictions on professional services by narrowing qualification requirements and reducing regional regulatory differences; relax rental market restrictions; simplify product market regulations and reduce regulatory barriers to competition. ### Education, skills, and R&D - Austria - Recommendations: Strengthen human capital formation; close achievement gap for immigrant and first generation children in primary and secondary education; introduce entrance admission tests to avoid overcrowding and high drop-out rates in tertiary education; attract enrollments in engineering and natural sciences; institute measures to rise private funding for education. - Estonia - Progress: Improving R&D capability and education in technical fields; measures to promote FDI and infrastructure. - Recommendations: Improve R&D capability and education in technical fields; address long-term unemployed and skills mismatches. - Finland - Recommendations: Refocus R&D expenditure on academic research and adjust incentives to reward academic quality; speed transition from secondary to tertiary education by introducing tuition fees with a means-tested loan system to better direct students to areas of labor market demand. - Italy - Recommendations: Increase incentives to invest in higher risk, higher growth sectors and promote ICT use to raise productivity in services. - Malta - Recommendations: Improve quality of human capital through education targeted on labor market needs; continue encouraging female labor participation and adopt productivity-enhancing measures (training and R&D). - Slovak Republic - Recommendations: Enhance funding and quality of tertiary education by introducing tuition fees for full-time tertiary students with means-tested grants and loans; give greater autonomy to tertiary institutions with stronger performance-based management; promote occupationally-oriented curricula with employer involvement. - Spain - Recommendations: Strengthen retraining of the unemployed; ensure labor reform supports internal flexibility and permanent hiring. ### Business environment, state involvement, and judicial/administrative reform - Cyprus - Progress: Abolition of 1,200 redundant positions; limit 1 appointment per 4 retirements. - Recommendations: Reduce size of public sector; simplify and shorten court dispute procedures; identify obstacles for technology adoption. - Greece - Progress: Legislation to simplify startup and licensing procedures; simplify judicial procedures. - Recommendations: Facilitate investments by extending and simplifying fast-track investment framework; simplify export legislation and implement electronic export window and e-customs by end-2012; finalize licensing laws by end-2012; continue judicial reforms to reduce backlog and speed proceedings; set up performance framework for courts. - Ireland - Progress: Designed strategy to reform water sector regulator and introduce water metering. - Recommendations: Implement state asset disposals orderly with regulatory reforms; reform sheltered sectors; strengthen competition law enforcement. - Italy - Progress: Administrative simplification reform underway to lower business costs. - Recommendations: Streamline authorization for strategic infrastructure; establish independent transport authority; encourage privatization and reduce state involvement; enhance judiciary efficiency. - Portugal - Progress: New Corporate Insolvency Law approved March 2012; backlog of court cases being reduced; privatization agenda expanded; SOEs given operational targets to achieve operational balance by end-2012. - Recommendations: Reform the judicial system to improve efficiency and out-of-court dispute resolution; reform corporate insolvency; expedite revision of legislation to align with EU Services Directive; resume privatization and expand SOE performance monitoring. - Slovenia - Progress: One-stop shops for company establishment created. - Recommendations: Accelerate bankruptcy procedures; cap social security contributions to offset revenue losses. - Spain - Recommendations: Simplify product market regulations and reduce regulatory barriers to competition; relax rental market restrictions. *Source: Annex II. Euro area: Country-Specific Structural Reform Recommendations* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2012/_sdn1207.pdf_