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The time is right for structural reforms
The European economy has not been doing this well for a decade. Growth is back, unemployment is gradually falling, and leading indicators suggest that confidence has been building. While this cyclical recovery is good news, developments on the structural side have been less encouraging: productivity has barely improved over the last 15 years. Between 2000 and 2014, total factor productivity rose by 1.5% in the Eurozone, compared to nearly 11% in the US. International institutions estimate that potential growth in the Eurozone has dropped below 1% per year, whereas in the US it is thought to be above 2%.
Further structural reforms will be essential to increase the Eurozone's potential growth, and in turn its ability to absorb future shocks. European Central Bank President Mario Draghi has again insisted on this point recently. The good news is that the potential impact of such reforms is particularly high in Europe: OECD estimates suggest that convergence towards best practices on the markets for labour, goods and services, as well as in tax policy and pensions, could raise average GDP per capita by 11% over a 10-year period in the European Union.
Although experience shows that most structural reforms are undertaken in times of crisis, studies by the International Monetary Fund suggest that they are more effective if implemented when macroeconomic conditions are favourable. This is the case in the Eurozone today, thanks in particular to the exceptional monetary accomodation from the European Central Bank, which has brought interest rates to historical lows. Structural reforms aimed at boosting investment and productivity should be particularly effective in this environment, as low interest rates encourage borrowing for investment purposes. Furthermore, some structural reforms – especially in relation to the labour market – pay off over the long term but may have a negative impact on short-term demand. If macroeconomic conditions are favourable, it is easier to provide the fiscal support needed to offset any such temporary fall in demand.
Thus, the argument that structural reforms risk undermining the Eurozone's recovery and therefore shouldn't be pushed too much in the current circumstances does not really seem convinvicing. What is true for the Eurozone as a whole applies even more so to Luxembourg, which is currently in a particularly strong situation, with annual growth rates exceeding 4%.
BGL BNP Paribas
Published in the Echo des Entreprises on 26 October 2017