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

to a significant loss, to feel the pain up-front and to be well organised (e.g. Olson, 1965). By
contrast, the gains from reform accrue to no clearly identifiable group, are usually widely
dispersed with limited benefit for each individual and often occur with a considerable delay. As a
general observation, opportunity cost is not a concept that plays well in politics.

As a result of those features, structural reform is usually an uphill battle. This paper will
not address in detail the overall incentives and disincentives to undertake structural reform.
Rather, and more modestly, it deals with the possible impact of fiscal positions and fiscal
adjustment on the political economy of structural reform in product and, in particular, labour
markets. In this regard, two caveats are in order.

First, putting the main focus on labour markets is justified by some of the main obstacles
to euro-area growth and employment being related to labour-market policies.⁶⁸ At a more
mundane level, and relevant for the empirical part of the paper, more information is available for a
wider range of policies over a longer period as concerns labour markets than is the case for most
policies directly affecting product and financial markets. However, the focus on labour markets
should not be taken to imply that reforms in other markets are unimportant. Second, despite the
emphasis on the role of fiscal policy, other general arguments concerning the political economy of
structural reform are likely to retain a major role in terms of either facilitating or hindering
structural reform.

The paper proceeds by reviewing in Section 2 some of the arguments that have been put
forward as to how the state of public finances may affect the political economy of structural
reform. Section 3 then provides some descriptive evidence based on recent OECD work on labour
and product market reforms. Section 4 proceeds to an econometric investigation of the impact that
fiscal positions and/or fiscal adjustment may have on the propensity to undertake structural
reform. Finally, Section 5 sums up the evidence and concludes.

2. Arguments linking structural reform intensity to fiscal positions

2.1 Fiscal position and structural reforms

A sound fiscal situation should facilitate the implementation of structural reforms, for at
least three reasons:

• A budgetary cushion provides room for compensation of losers who would otherwise
block reforms.

• A poor state of public finances is likely to force governments to spend their political
capital on unpopular fiscal adjustment measures, leaving them with less ability and/or

67. This is the case whether hard indicators, such as poverty rates, or soft indicators, such as surveys of happiness, are considered (OECD,
2005a).

⁶⁸.OECD (2005b) uses a consistent procedure to derive policy priorities to enhance economic growth across OECD countries and identifies labour
market reforms as being particularly important in euro-area countries.

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