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The economic and sovereign debt crisis revealed significant gaps in the economic resilience of several euro area countries, pointing to a strong need for structural reforms. Despite the long-term benefits of structural reforms, their implementation prior to the crisis was suboptimal. Typically, the main resistance to the adoption and implementation of structural reforms stems from the vested interests of affected groups in society. Besides this, the possible short-term economic and fiscal costs of structural reforms are also sometimes mentioned as a reason for postponing their adoption, suggesting a short-term trade-off between fiscal consolidation and reforms.
The European Commission’s Communication on making the best use of the flexibility within the existing rules of the Stability and Growth Pact (SGP) follows this logic and foresees an allowance for the direct short-term fiscal costs of reforms, enabling European Union (EU) Member States implementing structural reforms to delay fiscal adjustment compared with the SGP benchmark requirement. This article reviews the evidence of the short-term effects of structural reforms, given the prominence that the latter may gain in the application of the SGP. Their quantification is surrounded by uncertainty and is conditional on a large number of assumptions.
That said, only a small set of structural reforms appear to have direct short-term fiscal costs, with “systemic” pension reforms being the most prominent example. This suggests that the structural reform clause should be carefully applied. In particular, it is important that the assumptions underlying the decision to apply such a clause are spelled out in a clear and transparent way, which will also ensure a consistent application over time and across countries.
Conclusions
The short-term fiscal effects of structural reforms have recently gained prominence in the implementation of the SGP. The structural reform clause introduced by the 2005 reform of the SGP allowed for a delay in fiscal adjustment if a Member State implemented a major structural reform with direct long-term positive budgetary effects, including by raising potential sustainable growth. However, the clause did little to spur reform momentum. The recent Communication of the European Commission on making best use of existing flexibility within the existing rules of the SGP attempts to revive the structural reforms clause, partly by relaxing the requirements for its application.
However, the structural reform clause of the SGP should be carefully applied. Structural reforms can affect the economy, and public finances in particular, via multiple channels. As shown in this article, the reforms with direct short-term costs are systemic pension reforms. In other cases, the net effect is difficult to pin down (for example, labour and product market reforms), as it also depends on how reforms are bundled in practice. Moreover, there are many examples where the short-term effects of structural reforms are actually positive. Therefore, it is important that the assumptions underlying the decision to apply such a clause are spelled out in a clear and transparent way.
While a quantification of the costs of reforms is necessary for their incorporation in the SGP, this generally has to rely on judgemental assumptions. Model simulations of the effects of reforms are typically surrounded by a large degree of uncertainty. The lack of a shared methodology at the EU level to assess the effects of structural reforms speaks in favour of a cautious application of the SGP provisions on structural reforms.
Alternative ways to support the adoption and implementation of structural reforms in the euro area should be sought. The Five Presidents’ Report42 published in June 2015 is a useful reference point in this respect. The Report identifies steps towards a genuine Economic Union and emphasises, among other things, the need to achieve sustainable convergence in the euro area, which requires a renewed impetus to foster structural reforms in Member States. The report encourages further steps towards better coordination and surveillance of policies that are relevant for competitiveness. It recommends the creation by each euro area member country of an independent national body – or “competitiveness authority” – which would be in charge of tracking performance and policies that influence a country’s competitiveness. The report foresees scope for strengthening the Macroeconomic Imbalance Procedure not only as a tool to detect imbalances, but also to encourage structural reform implementation via the European Semester.The importance of an institution-based approach for the governance of structural reforms in the euro area has also been reiterated by the ECB’s President in his call for “a move from rules towards institutions”. A European institution could help in two respects: first, by making it easier to agree on the aims of structural reforms by aligning to best practice; and, second, by making it easier to implement them, using European law to bypass vested interests.