WHY DO SOME COUNTRIES UNDERTAKE STRUCTURAL REFORMS WHEN OTHERS DO NOT?

Abstract

It is widely accepted that structural, institutional and labour market reforms are essential for the development of the OECD and emerging market economies; and that argument has been incorporated into official policy in the EU as part of the Lisbon agenda. Yet there is little analysis in the economics literature of how these reforms should work, or of which reforms would be most effective. Similarly, there is no explanation of why policy makers extol the virtues of reform, but often fail to carry them out. Or why some countries embrace reform, but others in similar circumstances do not. To explain these differences we develop a general equilibrium model with imperfect competition, extended to include labour market imperfections and tax distortions. We find that fiscal constraints to be the principal reason that reforms do not get undertaken, though labour market regulation can be a serious complicating factor in certain cases. As a result, the reduction of tax distortions, rather than market or institutional reform, is usually the most effective type of reform. The implication is that we need models that combine different reform instruments and different distortions to analyse this kind of problem.