Europe’s next job: Getting us out of the employment crisis
Product Markets: The Evidence
Our statistical analysis suggests that the adoption of the euro has had a significant effect in promoting the adoption of product market reforms, at least in some sectors.
There are three possible interpretations of the results. One is that it is simply a coincidence: some countries decided to reform right at the end of the 1990s, and this time period happened to coincide with the adoption of the euro. The second interpretation is that the euro did indeed have an effect in promoting liberalization by eliminating the palliative of competitive devaluations.
Firms found themselves losing competitiveness and became more vocal in demanding liberalization in sectors that were providing intermediate goods and services (including non tradable ones) in order to keep their costs low. A third story, related to the second, is that the euro did not matter that much economically per se but that it was used as a political tool by reformers to argue that countries belonging to the euro area needed structural reform; in other words, the euro was used as a justification to promote a product market reform agenda.
One should be worried about the possibility of spurious correlations because of the relatively small number of countries involved in the tests; however, the results do appear quite robust to a battery of econometric tests. It is hard to entirely disentangle the role of actual economic pressures introduced by the euro and the political rhetoric associated with it, but certainly, the results of our econometric exercise have moved us from our prior assumptions toward believing that the euro might indeed have had an effect, if not in promoting, at least in weakening the opposition to product market reforms.
Future work should take some further steps toward trying to disentangle these three alternatives. One step in this direction would be to focus on where the political and economic pressure to liberalize certain sectors came from.
The adoption of the euro does not seem to have had much of an effect in promoting labor market reforms, at least in the primary labor market sector: in general, labor markets have proceeded more slowly and tentatively than product markets. However, a secondary labor market with temporary labor contracts has grown in a few countries that did not reform the primary labor market. In addition, the run- up to euro adoption has led to some wage moderation.
This timing has led us to consider the question of whether product market reform should indeed precede labor market liberalization.
We find that regulation decreases when value added and labor costs of the sector fall (i.e., when a sector’s rents decrease) and that product markets are deregulated in country- sectors-years with lower employment. Hence, in less labor- intensive sectors, governments can meet less resistance and can more easily implement deregulation measures.
However, we also find that product market deregulation is easier to implement when unemployment subsidies are more generous and is more difficult to implement when there are higher firing costs, which interfere with market reallocations. Therefore, the type of labor market policies more prone to facilitating product market reforms are those in which the workers are protected with unemployment subsidies but specific jobs are not, making the (re)matching between firms and workers easier.
Labor market reforms are multidimensional in nature and are often quite complex and difficult to capture with one macro indicator. Also, several countries in the euro area have two separate markets: the traditional and highly regulated market and a second, much more flexible one based on temporary contracts. Further investigation into the role of the euro in promoting labor market reform is an excellent topic for future research.
