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posted on 09 April 2016

Time For A Supply-Side Boost? Macroeconomic Effects Of Labor And Product Market Reforms In Advanced Economies

from the International Monetary Fund

Product and labor market reforms raise output and employment in the medium term, but complementary macroeconomic policies are needed to maximize their short-term payoff given the current economic slack in most advanced economies. Product market reforms deliver gains in the short term, while the impact of labor market reforms varies across types of reforms and depends on overall economic conditions. Reductions in labor tax wedges and increases in public spending on active labor market policies have larger effects during periods of slack, in part because they usually entail some degree of fiscal stimulus.

In contrast, reforms to employment protection arrangements and unemployment benefit systems have positive effects in good times, but can become contractionary in periods of slack. These results suggest the need for carefully prioritizing and sequencing reforms.

Worries have deepened over the persistent sluggishness of growth in advanced economies since the 2008 - 09 global financial crisis. The growth rate of potential output - defined as the level of output consistent with stable inflation - has declined in major advanced economies, and it is likely to remain below precrisis levels through the medium term (see Chapter 3 in the April 2015 World Economic Outlook). Although the global financial crisis was a factor in this slowdown, not least through its effect on investment, the decline in potential growth started in the early 2000s, which suggests that deeper structural factors have been at play.

As a result, the continued weakness of growth and shrinking macroeconomic policy space, especially in several euro area countries and in Japan, have led policymakers to emphasize structural reforms. The hope is that such reforms will lift potential output over the medium term while also strengthening aggregate demand in the near term by raising consumer and business confidence.

High on the agenda are several reforms designed to strengthen the functioning of product and labor markets (IMF 2015; OECD 2015). Although the specifics vary widely for individual countries, these reforms broadly involve the following:

  • Deregulating retail trade, professional services, and certain segments of network industries (air, rail, and road transportation; electricity and gas distribution; telecommunications and postal services), primarily by reducing barriers to entry

  • Increasing the ability of and incentives for the nonemployed to find jobs, by boosting resources for and efficiency of active labor market policies, reducing the level or duration of unemployment benefits where these are particularly high, or both • Lowering the costs of and simplifying the procedures for hiring and dismissing regular (that is, permanent) workers and harmonizing employment protection legislation for both regular and temporary workers

  • Improving collective-bargaining frameworks in instances in which they have struggled to deliver high and stable employment • Cutting the labor tax wedge - that is, the difference between the labor cost to the employer and the worker's net take-home pay

  • Implementing targeted policies to boost participation of underrepresented groups in the labor market, including youth, women, and older workers

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