Structural Reforms and European Integration: Theory, Measurement and Econometric Evidence

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Since the 2007 financial crisis, most EU countries have been unable to return to their pre-crisis growth path. From many European capitals, we hear incessantly that structural reforms are the key to economic growth. Although this view has led many countries in Europe into implementing reform programs, we still lack a clear understanding of structural reforms. The almost exclusive focus on product and labor market regulations (in detriment to other important reforms such as trade liberalization) has contributed to this dearth of analysis. This project aims to fill this gap. The issue of whether structural reforms lead to growth remains controversial. One critique of current policies departs from a New Keynesian interpretation of the low growth experienced in many European countries. Policies that improve the supply side through structural reforms may not automatically lead to more demand and output. Structural reforms may even lead to reduced demand and thus to a more repressed level of economic activity. In this context, one key issue is the timing of the implementation of these reforms. Some reforms, if implemented during a recession, can exacerbate it and, as an unintended side effect, can weaken the political resolve to undertake reforms. Another critique of structural reforms stresses the importance of identifying a range of structural reforms that can boost a country's economic capacity to grow. Structural reforms usually include opening up of the economy to international trade, to international competition and to foreign direct investment, the transfer of state assets to the private sector, product market deregulation and measures aimed at making labour markets more flexible. The current focus on labour market and product market flexibilities is limited and incomplete. Some key lessons from the experience of the "new EU members" (economies that transited from communism to a market-based system) is that there is a comprehensive range of structural reforms (beyond labour and product markets) that needs to be implemented and that the sequencing of reforms matters. Thus the ultimate impact of reforms on economic outcomes is complex. Our research has three objectives: (1) To construct a panel data set reflecting the extensive reform experience of the 28 EU members between 1990 and 2015. (2) To use this data set to provide a study of the determinants of structural reforms. We will analyse the role of initial conditions, institutions and political development, and of economic growth on the dynamics of structural reforms. (3) To investigate how structural reforms may affect economic growth and income inequality. This will allow us to shed light on the policy questions formulated earlier, i.e. should policymaking focus on structural reforms to boost growth, and if so, which individual reforms are most beneficial? This project will build on three strands of literature. The first one focuses on the determinants of structural reforms. Especially, we will exploit insights from the reform experience of Central and Eastern European countries during their transition in the 1990s. The second one studies the issue of how structural reforms can be used to boost economic growth. It has led to an intense debate on the relative merits of supply side policies against policies aimed at boosting aggregate demand. The third one focuses on the theory and empirics of the relationship between structural reforms and income inequality. We will use a new and unique data set and advanced econometric methodologies to tackle various challenges. One key challenging issue is that there may be a two-way causality between structural reforms, on the one hand, and economic growth and income inequality on the other. One key objective of the research project here proposed is to disentangle this complex causal relationship.