Going For Growth Despite Crisis – Analysis

By J. C. Suresh

In the midst of unusual global economic uncertainty, caused by the unpredictable course economic policies could take in major economies over the next few years, the 34-nation OECD has come out with a flagship report passionately pleading for structural reforms as a way out of the crisis.

The report titled ‘Going for Growth’ identifies and reviews progress on five key priorities to boost long-term growth in each OECD (Organisation for Economic Cooperation and Development) country, but also in Brazil, China, India, Indonesia, Russia and South Africa (BRIICS), that is, almost all of the non-OECD members of the Group of 20 (G20) comprising world’s major economies.

Presenting Going for Growth on February 24 in Mexico, OECD Secretary-General Angel Gurría said: “Worst-case outcomes can be avoided if monetary policy remains very supportive, sovereign debt and banking sector problems in the euro area are contained, and excessive fiscal tightening is avoided where it could proceed gradually, such as in the United States.”

Emerging economies will continue to enjoy sustained growth rates, he added, thus contributing to global recovery, provided they deal effectively with macroeconomic pressures, including inflation, and make progress in rebalancing demand, including through structural reforms.

“But even under this rather benign scenario, without profound change, unemployment would stay high through 2013, there would be no prospect of recovering the output foregone with the crisis, and public budgets would remain on unsustainable paths in a number of G20 countries,” Gurría said.

The crisis has had a dire social cost. More than 200 million people are unemployed worldwide, and 45 million of them are in OECD countries – 14 million more that before the crisis. The situation is especially dramatic in terms of youth unemployment, which now stands at about 20% on average and reaches almost 50 % in Spain.

“We must use every possible means to avoid the risk of a ‘lost generation’. Another vital step to deal with the unemployment surge is to reverse the steep rise in the number of people who have been unemployed for a year or more. Today, this concerns a third of unemployed workers in the US, meaning wasted resources and, worse: exclusion and poverty,” the OECD Secretary-General said.

Priority should therefore be given to policies that boost jobs. Going for Growth reform priorities would not only boost growth but also jobs, assured Gurría. He is convinced that structural policies recommended in Going for Growth can help alleviate the possibility that higher unemployment becomes entrenched in many countries.

“We must ensure that ongoing fiscal consolidation efforts do not affect the active labour market policies, which would help job seekers find work more quickly,” said Gurría. For instance, the decision by Spain to permanently increase resources in the public employment services and to facilitate placement of job-seekers by private agencies was welcome.

Growth-friendly tax reforms could also help strengthen a job-rich recovery, while also helping fiscal consolidation insofar as they are implemented in a way that raises tax revenue. These include removing tax expenditures and shifting the tax burden towards tax bases that are more conducive to higher employment and growth, such as real estate, consumption and environmental taxes.

Gurría – a Mexican national – presented the report in Mexico City with Mexico’s finance minister Jose-Antonio Meade, ahead of February 25-26 meeting of G20 finance ministers. He said the OECD’s country-specific structural reform recommendations are applicable to all G20 countries as they steer their economies out of the crisis.

Since Going for Growth was launched in 2005, the annual report has identified key reform priorities to boost economic activity and raise living standards in each OECD country. Since 2011, the report also addresses reform potential in Brazil, China, India, Indonesia, Russia and South Africa, and has been a key part of the OECD’s wider contribution to the G20 Framework for Strong, Sustainable and Balanced Growth.

The OECD report assesses and compares progress that countries have made on structural reforms since the start of the crisis, covering the 2007-2011 period. It shows that the pace of reform has accelerated where it is needed most – in the European countries hardest hit by the sovereign debt crisis, including Greece, Ireland, Portugal and most recently, Spain and Italy.

The new European reform agenda has been spurred by the need to consolidate public finances and better manage pressures from the sovereign debt crisis. This has led governments to announce and begin implementing politically difficult yet ambitious reforms in areas including pension schemes, labour market policies and product market liberalisation. “Structural reforms now underway in Europe will eventually help reduce the economic imbalances that contributed to the debt crisis,” Gurría said.

The long-term gains from reforms are sizeable: recent OECD work shows that a broad and ambitious reform agenda could lift GDP growth by as much as one percent annually on average across the OECD area over the next decade, while delivering sizeable gains for emerging-market economies as well.

Drawing on three decades of reform experiences, the report finds that concerns about adverse short-term effects of such reforms are overblown. Indeed a number of structural reforms appear to boost growth fairly quickly, while usually very few if any have short-term costs.

“The design and timing of reforms matters. A broad package of reforms delivers more quickly and strongly than a piecemeal strategy,” Gurría said.

OECD Deputy Secretray-General Pier Carlo Padoan, who is also the organisation’s chief economist, points to the often voiced and legitimate concern that structural reforms could initially deepen the slump. “The truth is that economic theory is thin and empirical evidence virtually non-existent on the short-term effects of reforms,” he assures.

“Our new research . . . fills some of this gap and delivers an optimistic message: fears that reforms may depress economic activity in the short run are overblown. Indeed among the wide range of reforms we looked at, none was found to have had systematic adverse short-term effects in the past, while many quickly stimulated output and employment,” says Padoan.

At the same time, he adds, OECD analysis suggests that some labour market reforms can indeed be temporarily detrimental if implemented in bad times. Where possible, these should wait until the labour market improves decisively, and be preceded by product and financial market reforms.

Another important implication of OECD analysis is that a comprehensive reform package is necessary to alleviate the adverse short-term effects of some reforms while contributing to kick-start the economy, especially through investment induced by stronger product market competition. In any event, effective communication and consensus building are of the essence to foster the confidence households need to take advantage of reform-driven income gains.

Another legitimate concern, says the OECD chief economist, is that reforms may harm the least well-off. Income inequality was already on the rise in most OECD countries before the crisis, and it has likely risen further in its aftermath. It is also a major issue in the BRIICS.

Padoan points out that two special chapters in the report yield encouraging lessons regarding what reforms do to inequality both in the long term and in the wake of macroeconomic shocks like financial crises. He adds:

“We find that several reforms, notably enhancing the quality and equity of secondary education, liberalising product markets and making employment protection legislation more uniform across workers, appear to have favourable growth and distributive impacts. Some tax reforms can also be beneficial on both grounds.

“Starting with a drastic cut in tax expenditures would seem especially warranted at the current juncture, not least since it would also help fiscal consolidation. Now not all growth-friendly reforms would yield such double or triple dividends, of course.

“In particular, it remains challenging to design tax and transfer systems in ways that are conducive to both higher growth and lower inequality. For one, the experience of some Nordic countries shows that it can be done. And again, broad reform packages including win-win policies could deliver on both goals.”