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IMF Survey: Crisis Could Help Spur European Reform, IMF Says

March 17, 2008

  • current financial crisis may help mobilize support for reforms in Europe
  • priority in Europe is to deal with containing damage from crisis
  • inflation and recession are both potential problems

Despite the current financial market crisis, Europe should still continue to pursue structural reform because it will help shape what Europe is like when it emerges from the current period of financial and market turmoil, IMF Managing Director Dominique Strauss-Kahn said.

Crisis Could Help Spur European Reform, IMF Says

IMF Managing Director says reforms can be tailored to each country's needs in Europe, no need for uniform approach. (IMF file photo)

Structural reform conference

While acknowledging that structural reform in Europe was politically difficult, Strauss-Kahn said in a speech in Paris on March 17 that the current crisis may help mobilize support for reforms.

"In an economic environment such as this, governments and citizens should also be interested in reforms that can promote growth without inflationary risks—that is in the kind of labor and product market reforms that we are talking about at this conference. So this is not a bad time to be thinking about structural reforms," he said at a conference sponsored by the Organization for Economic Cooperation and Development (OECD) and the IMF on structural reform in Europe.

Containing economic damage

Strauss-Kahn, a former French Finance Minister who took over as head of the IMF last November, said that right now, the priority for European governments should be containing the economic damage from the financial market crisis. "This is difficult because we are in an economic environment where inflation and recession are both potential problems."

But he said it was still a good time to talk about structural reform, because it has an important bearing on what Europe will be like when it emerges from the financial crisis, and because mobilizing public support for reform is vital to the success of the European model.

The IMF recently held a conference organized by the Research Department to discuss progress with structural reform around the world. In general, structural reforms aim to reduce economic bottlenecks, liberalize financial and product markets, and reduce barriers to trade (see related story "Structural Reforms Play Important Role in Fostering Growth ").

Three broad areas

Strauss-Kahn said that Europe should focus on reform in three broad areas:

Labor markets. Europe should focus on creating the conditions for new jobs, rather than on protecting old ones. Social safety nets need to move away from a focus on specific jobs and toward a focus on job opportunities and career development.

Competition in services. Competitive and contestable markets for goods and services (including financial services) are crucial for economic growth. Europe needs to open up service industries to competition in the same way that industries that make tradable manufacturing goods are already open. Productivity in non-tradable goods continues to lag behind. Market reforms aimed at promoting equality of opportunity and increasing contestability can lead to large benefits to consumers—air travel and cell phones, for instance. They can also benefit workers in those industries and raise growth in the economy by increasing productivity.

Fiscal reforms. Europe is aging and budgets need to adapt to deal with this. The trick will be to reform in a way that increases incentives to work in the private sector —for example exercising restraint in public sector wages while at the same time reducing labor taxes, which will promote employment.

Tailored to diversity

Because structural reforms are politically sensitive, policymakers must win support for changes, Strauss-Kahn said. There was no need for a uniform approach; change could be handled differently in different countries. "We need approaches tailored to the diversity of Europe," he stated.

But within countries it can help if different reforms are pursued together. This can help to create a broad consensus for reform, as different actors see the benefits to them of the totality of reforms, and may be less inclined to focus on the costs to them of specific reforms.

Strauss-Kahn said that the countries that have done best in implementing structural reforms—for example Denmark and the Netherlands—adopted comprehensive approaches: a mix of labor market, fiscal, and product market reforms that complemented and reinforced each other.

Cutting government spending and reducing labor taxes increased the labor supply in these countries and supported prudent wage setting. Relatively free product and labor markets allowed labor supply reforms to translate into more jobs rather than higher rents. In turn, job growth generated further revenue, which paved the way for further tax cuts and continued wage moderation—a virtuous cycle.

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