Reforming Europe-but how?

• Pages: 208-209

Page 208

With weak growth and high unemployment continuing in much of Europe, and with key reforms stalled for lack of popular support-including the much maligned directive that would have liberalized the European Union's (EU's) trade in services-obstacles to a revitalization of economic activity seem formidable. In a recent IMF Working Paper, Professor Tito Boeri from Bocconi University researched the political economy of labor and product market reform in Europe over the past two decades. His findings suggest that there may be effective strategies for those increasingly discouraged policymakers who still wish to fight eurosclerosis but don't know how to.

Institutional "rigidities"-a catch-all phrase used by economists for barriers that keep markets from operating effectively- exist because, somewhere, there is a group benefiting from them and lobbying for their preservation, Boeri writes.What's more, such barriers rarely operate in isolation; a regulation in one area calls for regulations in another area. That's why countries with the most restrictive labor markets usually also have the most tightly regulated product markets.

Removing these rigidities is proving extremely difficult, not because governments do not wish to carry out reforms, but because reforms usually encounter strong political opposition. So what can politicians do? While there are similarities between labor and product markets, there are also important differences, which matter tremendously when it comes to adopting a viable reform strategy.

Piecemeal does just nicely

Boeri and his colleagues looked at labor market reforms in EU countries during 1985-2003 and categorized them as either marginal or radical. This analysis revealed that- contrary to popular belief-many reforms have, in fact, been carried out over the past two decades. Boeri and his colleagues counted 414 reforms, amounting to more than 1.6 reforms per year per country. But almost all of the reforms-roughly 95 percent-were marginal.What's more, they were almost evenly split between initiatives aimed at increasing labor market participation (for instance, tightening unemployment benefits and making employment contracts more flexible) and policies that moved in the opposite direction.

But as the research also showed, even marginal reforms can help build strong momentum for change. "Reforms 'at the margin' or the...