World needs better blueprint for structural reform Opinion by Financial Times

The Financial Times has published an opinion piece arguing that governments should be honest about the fact that liberalisation creates losers as well as winners. Caliber.Az reprints the article.

A perennial challenge for every country is ensuring that living standards rise over time, so that today’s adults deliver better opportunities for their children than they had. The key to rising living standards is improved productivity — more output from a given level of inputs. But there also exists a related challenge, to ensure that productivity gains are broadly shared: that growth is inclusive.

Economists who advise governments have a go-to toolbox of policies — structural reforms to liberalise trade, product and financial markets — that they recommend to deliver improved productivity. These reforms are often designed to give greater sway to market forces and free enterprise in the economy. Remarkably, however, this approach — variously referred to as the Washington consensus or neoliberalism — has been largely absent in the policies of recent US administrations. 

In previous work, my colleagues and I documented a global plateauing of economic liberalisation since the 1990s. We perused national legal statutes and official websites to develop measures of structural reforms in product, labour and financial markets. This plateauing is a marked break from earlier decades, and is worrisome given the link between liberalisation and productivity, and the imperative of strong growth to support the green and demographic transitions.

To restore reform momentum, a dose of transparency is needed about what liberalisation can and cannot deliver. Some have noted that multilateral institutions, such as the IMF, are less inclined to push for reforms in their flagship publications, and infer that this reflects diminished enthusiasm for reform. This is not the case. Rather, it reflects a valid concern that reforms are unpopular among voters. The answer is not to pull one’s punches, however. It is, rather, greater forthrightness about the impact of reform.

First, reforms take time to work. Meaningful gains might only be visible in macroeconomic data over five to 10 years. Such a lag will create problems for governments that need to face voters in a shorter timeframe.

Second, the evidence suggests that the extent of the growth dividend differs across reforms. Lowering tariff and non-tariff barriers to trade, and boosting legal protection of property rights, really does deliver: economists’ faith in free trade and a strong court system is well-placed. The dividend from other reforms, such as labour market deregulation (for example, reducing the scope of collective bargaining) or eliminating regulations on cross-border capital movements, seems less robust.  

Third, reforms work by spurring efficiency-boosting resource reallocations in response to relative price shifts. Inherent in such reallocations is that some will gain, while others will lose. Even a small minority of vocal losers can undermine reform, and lukewarm support from winners might not change the outcome. This makes politicians hesitant.

Fourth, reforms are not hard-wired to produce inclusive growth. In the data, it is evident that some reforms (for example, financial deregulation) engender an equity-efficiency trade-off, increasing growth and inequality. In such cases, inclusive growth is not the outcome.

Fifth, the electoral consequences of reform need to be incorporated into economists’ advice. In recent work, my colleagues and I examined how vote shares are affected by reforms implemented during a government’s term in office, controlling for a range of economic and political factors that influence electoral outcomes. The results underscore the importance of implementing reform early in the term to avoid an electoral backlash. This finding is related to the delayed growth dividend from reforms in the face of immediate distributional losses.

The electoral analysis also points to the importance of implementing reform during good economic times. It is difficult for voters to parse whether a downturn is due to reforms or to something else, and they may wrongly attribute a recession to reform when other factors were responsible. When times are good, moreover, it is much easier for workers made redundant in newly-unprofitable sectors to find a job elsewhere.

The evidence also suggests an electoral backlash for reforms that generate a significant growth-equity trade-off, ie, where inequality rises following reform.

Careful design of liberalisation packages is needed to ensure that losers from reform do not derail the agenda. Attention to timing with respect to the economic and political cycles is essential, as are adequate safety nets and trampoline policies to support bounceback for adversely-affected workers. When it comes to structural reform, politicians are right to ignore facile advice to “just do it”.