IMF oversells labour market reform, again
Claiming that large-scale reforms of labour markets and pensions in euro-zone countries will deliver a surge in economic growth, IMF officials have urged that deregulatory reforms “should be implemented without delay”. When combined with product market reforms, the Fund asserts that labour reforms will boost the zone’s GDP by 4½% over five years.
However a careful reading of “Fostering Growth in Europe Now”, the IMF staff research paper used to justify these claims, shows that the positive impact would happen only if several major and parallel economic policy shifts take place throughout the euro-zone, and even so would entail high social costs.
Moreover, the predicted 4.5% GDP gain is a projection that depends on economies operating at full capacity, which currently is clearly not the case. In addition, only one-third of it the gain, that is 1.5%, would result from the proposed labour market reforms.
Despite this, more than half of the specific measures put forward in IMF paper concern labour market and pension reforms. The measures proposed include increasing retirement ages, cutting public-sector jobs, eliminating wage indexation, dismantling sector-level collective bargaining, reducing unemployment benefits, relaxing dismissal procedures and shrinking severance pay.
The IMF paper claims that:
“collective bargaining, unemployment benefits, and employment protection explain a large part of the cross-country differences in labor market performance”.
But it acknowledges that:
“studies do not agree on the role of specific institutions, … the evidence is sometimes contradictory for some indicators [and] the issue of complementarity between labor and product market reforms is still debated”.
However the IMF paper shoves aside all the academic uncertainty about the impact of labour market reforms by asserting that “recent empirical work by IMF staff shows that a high degree of liberalization in product, labor, and credit markets boosts a country’s efficiency”, referencing a not-yet-released IMF staff paper. It may be noted that IMF studies, even when published, are not peer-reviewed by outside specialists.
Just as significant are the qualifiers and conditions that the IMF paper attaches to its rosy view of the positive impact of deregulatory labour reforms:
“Several studies find that reforms have a small, and in some cases even negative, short-term effect on output and employment because of costly and timely reallocation of resources and restructuring, with a temporary rise in unemployment and potentially high social costs.”
“Losers from reforms … will reduce consumption immediately…. Weak demand and excess capacity conditions risk limiting the short-term output response to reforms and, if they persist, may also damage the long-run potential.… Relaxing employment protection may not stimulate hiring in the short term, but increase unemployment.”
“Structural reforms, therefore, need to be complemented by policies that boost aggregate demand…. Short-run growth needs more robust 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 …”
While all of the factors mentioned above are currently part of the reality of the euro-zone countries of the “South” – notably slack economies and weak demand – there is no indication that the countries of the “North” of the euro area are prepared to implement significant change in policies they currently practise, notably through a strong boost of aggregate demand. Yet the IMF study’s projection of a (modest) 1.5% GDP gain over five years from labour reforms is contingent upon such a policy change.
Furthermore, the IMF paper includes an annex which undermines the importance given to labour reforms. It cites indicators from various sources showing that employment protection legislation is a relatively minor constraint on growth in euro-zone countries when compared to major deficiencies in other areas: legal systems, infrastructure, education and training, goods markets, financial markets and technology. The paper also acknowledges that Germany’s far-from-flexible labour market “produced favorable employment outcomes during the crisis”.
But the benefits of labour market regulation are quickly forgotten when the paper defends the importance of prioritizing deregulatory labour reforms through tautological argument: “IMF recommendations on reform priorities for each country indicate that further measures are needed, in particular to improve the functioning of labor markets …” (In other words: “We recommend it so it must be right.”)
In 2011, a report by the Fund’s Independent Evaluation Office stated that IMF research papers were of “variable” quality, due in part to the lack of external review, and included the observation “that IMF research was message-driven … staff indicated that they often felt pressure to align their conclusions with IMF views”.
This IMF staff paper may lack academic rigour and relevance to the real world euro-zone economy, but the conclusions are certainly “on-message “.