Abstract
AbstractMost people accept that structural and labour market reforms are needed in Europe. However few have been undertaken. The usual conjecture is that reforms are costly in economic performance and costly to finance. Blanchard and Giavazzi (2003) and Spector (2004) develop a general equilibrium model with imperfect competition to show the impact of labourorproduct market deregulation. We extend that model to combine these two types of reform, and then to include the effects of lowering tax distortions, the costs of financing these reforms and the conflict between long run gains and short run costs. Specifically, we use the model to explain the natural rate of unemployment and non-wage employment costs in order to show the impact of these reforms on the short and long run Phillips curve parameters. We find that structural reforms imply short run costs but long run gains; that the long run gains outweigh the short run costs; and that the financing of such reforms will be the main stumbling block. Likewise, we find an ambiguous effect on flattening the Phillips curve in the short run, but favourable effects on the natural rate in the long run. However the implications for welfare improvements and employment generation are quite distinct. Tax reforms are more effective for welfare gains, but market liberalisation is more valuable for generating employment.
Highlights
Tax reform, market liberalisation and deregulation in the labour markets are widely seen as the key to improved economic performance – in Europe
Starting from a standard model of deregulation, we develop a theoretical model of wage bargaining, with imperfect competition in the product markets and different forms of tax distortions, in order to understand the likely incentives, costs and potential benefits of structural reform
We have taken a standard model of the labour market in an economy with imperfect competition in the product and labour markets, and extended it to allow for the endogenous entry of firms, the implications for unemployment, distortionary taxation, and to show the composition of the price mark-up, and for different parameters that affect labour market separation and hiring rates
Summary
Market liberalisation and deregulation in the labour markets are widely seen as the key to improved economic performance – in Europe. In Europe, arguments for market or institutional reforms have been made, and supported, at the political level under the heading of the Lisbon agenda (Sapir, 2004) Despite these reforms having been advocated widely, governments often fail to carry them out in practice (Dellas and Tavlas, 2005; Hughes Hallett et al, 2005). That is based (loosely) on the analytic and empirical evidence of a negative link between economic performance and wage rigidities in many countries (Bruno, 1986) Such a link has certainly been observed in the labour and product markets of Europe (Koedijk and Kremers, 1996) where performance is measured in terms of growth and employment; and deregulation is measured in competition policy, merger codes and the liberalisation of employment practices. The crucial conflict remains the inter-temporal trade-off faced by workers: lower real wages (welfare) in the short run vs. lower unemployment and higher real wages in the long run
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