Arguments in Favor of Structural Reform Kaitlyn Lannan, Camille Darko, Jess Zawadzki, Ariane Dalarun -

Defining structural reform: -

Structural reform can be defined as supply-side policies that help empower demand by increasing the potential for future growth and raised income, which encourages spending today.

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Main arguments in favor of structural reform: -

“Policies that support demand empower policies that support supply, and vice versa.” -

The key to sustainable economic growth concerns both demand and supply, not one or the other.

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For example, policies on the demand side have been shown again and again to support supply. A period of weak demand creates lower growth (along with a shortfall of investment and risk that workers are unemployed for long periods of time), but the quicker demand policies return the economy to normal, the less at risk jobs and living standards are.

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Though macroeconomics do not typically show demand being affected by the outcome of supply, the situation that occurred in the euro area as a result of the economic crisis indicates otherwise.

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Some examples of applicable situations are the pre-crisis credit boominduced debt overhang, a labor market plagued with high unemployment (some of which stemming from structural adjustments of overpopulated fields), and weak productivity trends due to misallocation of resources during the pre-crisis period, such as to construction and other lowproducing sectors.

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Structural reform increases the potential for growth in the economy, therefore increasing the space for more government, firm, and household spending immediately. -

Additionally, by having a hand in the restructuring of the economy, the government guarantees that this higher demand is being utilized properly

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Structural reform reactivates and re-skills the workforce, allowing employment to respond faster to the higher demand. -

This is similar to what we discussed above regarding supply-side policies supporting demand.

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In times of weak demand, investment decreases and there is a chance that workers become structurally unemployed, also known as hysteresisleading to lower overall growth.

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Fast policies bring the economy back to performing closer to its potential, lessening the risk that unemployment will permanently increase.

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They also help the economy to restructure, ensuring that the previously mentioned higher demand is directed towards the right sectors. -

Conditions in the European Union include weak productivity trends left over from the pre-crisis period and reflects a poor allocation of resources into low-productivity sectors, along with a large debt overhang across all sectors and high unemployment, as we mentioned before.

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In this type of environment, increases in demand and stabilisation policies are less effective in stimulating economic activity.

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Without other policies, stimulating demand might only cause the restructuring of the economy towards higher productivity sector to slow due to the structural nature of unemployment and capital market fragmentation (the inability to channel savings where investment is needed to create jobs).

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Why structural reforms matter especially in times of crisis ? -

In times of crisis, it is more difficult to stimulate demand, because of high debts ratios, high unemployment, weak productivity. Therefore, also seeking for supply stimulation is not only a good idea, but actually necessary

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Making structural reforms in times of crisis is also a way to align with the vested interests, to restore confidence in the economy. With a structural reform in sight, people will have much more faith in the economy, as the expectations of permanent income will raise. Though, it is required to reform all the sectors at

once, and quickly, in order to have real effect, and not to create uncertainty about the future, that could lead to a disinflationary process -

In the case of the European crisis : Latvia has shown good results in terms of reforming its economy fast enough. Yet, it is true that the reforms might not have been fast enough in other countries. Stopping reforming right now would probably be worse though, because it would make that much efforts worthless. However, it is a good lesson on the importance of implementing structural reforms fast enough -

Fast policies have led more quickly to higher growth prospects and higher current/expected inflation (conditions where the positive income effects of reforms can outweigh the negative real interest rate effects.)

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Counterarguments: -

Those opposed to structural reforms may cite Greece as an example of their imminent failure. -

Structural reforms in Greece failed not because structural reforms are inherently a weak means to reignite an economy, but rather because the Greek situation was unique in that implementation and political difficulties also existed.

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Critics of structural reform may contend that when aggregate demand is depressed, high productivity products neither expand or hire more labor and instead lead to an increase in unemployment. -

We suggest that structural reforms can raise expectations of higher income, create more space for spending, and ensure that high demand is channeled towards the right sectors

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The impact of structural reforms is entirely dependent on their pace and composition, and it is possible for structural reforms to be successful in the short term.

References: http://www.ecb.europa.eu/press/key/date/2014/html/sp141017.en.html https://www.project-syndicate.org/commentary/saving-the-long-run-in-the-eurozone-by-danirodrik