Unblocking growth


With some of the world’s G7 economies finally shaking off the sluggish economic growth of recent years, what are the priorities for reform? “Beware of reform complacency” is a common warning issued by economists during times of economic buoyancy.

In such times, budgets perform well and tough reform decisions are put off. That is, until the next downturn, when finances tighten and painful changes become inevitable and more difficult to absorb.For the OECD’s chief economist, Jean-Philippe Cotis, the rule is simple: writing in the annual study, Going for Growth, he warns that all governments should resist the temptation to ease up on reforms aimed at boosting productivity and creating more jobs.Consider the rebalancing that is now under way in OECD growth patterns. To be sure, a slowing in the US has contributed to this, but so has a pick-up in Germany and Japan, which is in part thanks to the progress already made in reforming labour and product markets. Still, more needs to be done to boost long-term growth in all countries. Going for Growth 2007 advises removing further obstacles to job creation and helping more people back into the labour force as this would increase incomes per head and raise overall material living standards. Opening up product and financial markets to greater competition would raise productivity, and would help shift the balance of national income from profits and capital income back towards higher salaries and more jobs, the report argues.Economists tend to take two broad complementary approaches in looking at growth. On the one hand, they analyse short-term trends and prospects, which are affected by the likes of higher commodity prices, volatility in equity markets and changing conditions in foreign exchange markets. This approach is captured in the twice-yearly OECD Economic Outlook, for instance. But economists must also examine what influences underlying growth trends in the long run, by looking at structural factors such as regulation, mobility, skills, productivity, technology and competition.This is where the Going for Growth series comes in. Now in its third year, it also responds to questions OECD member governments have asked since about 2000. The world economy was buoyant in the late 1990s, but not all countries had managed to take advantage. Some advanced economies moved ahead while others lagged behind. Why? What might explain the gap in incomes that was widening, notably between the US on the one hand and France, Germany, Italy and Japan on the other? Why did economies such as the UK and Australia do better, or Sweden and Ireland for that matter? And why did countries like Germany and Japan find it hard to grow at all? Was the underlying economic structure in need of reform and if so, what and where? What lessons might the lower income and transition economies draw?Going for Growth attempts to answer such questions in practical terms. It mixes diagnoses of the main weaknesses holding back OECD economic potential with constructive policy advice. It presents recommendations tailored to each country, though some principles emerge that are common to different groups of countries.Chief among these is a need to improve labour market performance to reduce unemployment, and lift labour force participation, particularly in parts of Europe. All countries have to invest in innovation and skills, and in English-speaking economies there is a particular need to raise skill levels through improvements in secondary education. Raising productivity is a challenge for all countries too, though especially in lower-income ones where a key goal remains that of catching up with the OECD average. Going for Growth sets out five priority areas for action in each of the OECD’s 30 members and the EU as a whole; for country notes see references.Though the US economy has served as a benchmark in terms of GDP per capita, it too comes under scrutiny. For instance, the report highlights the need to improve educational achievements in primary and secondary schools, where poor outcomes belie relatively high spending per pupil. US school performance has been found wanting in several OECD studies, and inaction could affect costs, social chances, employment and human capital. The efforts under the aegis of the 2002 “No Child Left Behind” act should be pursued, in particular with greater accountability, the report suggests. Click here for bigger graphThe US and the EU are urged to reduce their farm support, while the EU is also asked to raise competition in energy, telecommunications and other network industries.Both Germany and France are urged to reduce barriers to competition, and also to reduce wage costs to help fight unemployment. For France, for instance, the report recommends that the minimum cost of labour be allowed to grow less quickly than productivity and suggests introducing a single job contract, with job security rising with length of service.Competition, liberalisation and reducing support for agriculture are also recommendations for Japan and Korea, where productivity remains relatively low. Japan should also fully open its mergers and acquisitions market to foreign-owned firms. Snapshots of other recommendations include phasing out early retirement for Finland, and reforming sickness and disability schemes in Norway and Sweden. This recommendation also applies to the UK where, the report notes, the number of disability benefit recipients has grown rapidly. Transport congestion also affects UK productivity, and the report recommends investing in infrastructure and pushing ahead with road pricing schemes. As for Mexico and other lower income countries, the level of productivity must be lifted, which means improving education and competition, as well as easing restrictions on foreign investment to help boost growth.Beyond recommendations on individual countries, Going for Growth also examines some of the factors that drive growth and which might further explain the gaps in GDP per capita between OECD countries. A year ago, the authors focused on financial market liberalisation and innovation, and this year the spotlight turns to labour, technology and policy design.Labour utilisation is a key determinant of growth, and it is no surprise that laggard countries tend to display lower employment rates. The report reiterates some of the findings in the 2006 reassessment of the OECD Jobs Strategy, arguing that the differences appear to reflect policy and institutional settings, such as labour regulation, training, job mobility, and so on, all of which affect labour performance.Technological progress also helps explain productivity differences. Innovation has offered the opportunity for all countries to increase their prosperity, but those countries with higher trend growth also harnessed these innovations better and faster than others. And again, those with lightly regulated markets have tended to gain most. One reason is that competition-restraining regulations have a habit of slowing innovation and preventing ideas and technology from filtering through to the production process. Moreover, countries that embrace foreign investment tend to benefit also from innovations that those investments bring.Strengthening competition in product markets is another area of policy considered in the report. Indeed, a review of the remaining obstacles to competition shows that enforcement of laws differs across OECD countries; regulations still limit competition in a number of sectors, notably in services; and the design of regulations in network-based industries does not always ensure access to those networks nor provide incentives to expand capacity.Some will say they have heard much of this advice in Going for Growth before, from the OECD and others. However, some messages are worth repeating, for although facts might not change, the circumstances do: decision makers come and go, and new support builds to push reforms that were once seen as unpalatable or impractical.Also, whereas some governments may have implemented reforms successfully, others may simply have had less luck. One reason, the report concludes, may be poor policy design, which led to a bumpier ride than expected. Together with a knowledge of how to “grease the wheels”, whatever the market, better design would help reform-minded governments achieve growth by bringing about changes in both policies and institutions.No reform is not an option. As Mr Cotis points out, lack of reform has often worsened perceived insecurity, depressing confidence. Yet, while reform sluggishness is understandable, it is also paradoxical, he writes, since the effects of good reforms are there for all to see.So, why does best practice in policy not spread? The report suggests that reform is often wrongly perceived as a threat to social cohesion and deeply held values. Aside from any philosophical objections to market-oriented reforms, gains from reform take time to materialise, but progress may be slowed down by those who fear they may lose from change. The risk then is for a crisis to occur as the main driver of institutional change. That is a situation which timely, well-designed reform to unblock growth would help avoid. RJCReference ©OECD Observer No. 260, March 2007 

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