Proceedings from the ECFIN Workshop "The budgetary implications of structural reforms" - Brussels, 2 December 2005

positively linked to the extent of reforms and that a (almost significant) effect of increasing social
benefit spending is partly behind this budgetary deterioration - lending some credibility to the
compensation hypothesis.

Clearly, labour market effects do not foster business and consumer optimism in a direct and short-
run way. This result is consistently found both in the reform cycle analysis (sentiment indicators
and private consumption decline with reforms) and the test on direct expectation effects: In the
latter labour market reforms do not result in a direct positive expectation effect contrary to the
cases of tax and product market reforms. Obviously, economic agents do not typically perceive
labour market deregulation as an institutional adjustment improving the economic perspective.
This is consistent with the finding that the situation prior to labour market reforms is often
characterized by favourable growth and expectation data. A good starting point allows coping
with short-run negative consequences of reforms.

Generally, the results stress the fact that expectation effects should be included in any thorough
exercise on reform economics. The perception of reforms can be a crucial driver of any short-term
consequences for employment, growth and the budget. The finding of negative expectation effects
associated with labour market reforms is likely to be one of the explanations that these reforms are
particularly slow to materialize.

Finally the results as a whole point to a sometimes neglected aspect in the discussion of structural
reforms and the Stability and Growth Pact: Even if certain types of reforms lead to a short-run
increase in deficits, an unfavourable deficit situation makes it very unlikely that certain reforms
are initiated in the first place. This underlines the necessity of effective deficit rules in the Pact in
order to safeguard EU countries’ future structural flexibility.

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