‘Structural Reforms’ Only Help in the Long Run? Apparently Not.

Economists often argue for the need for ‘structural reforms’. Especially in Sri Lanka right now, this phrase is often used, to indicate that the Sri Lankan economy cannot hope to attain a fast growth trajectory and sustain it without undertaking tricky but essential ‘structural reforms’ in education, trade, industry, labour markets, taxation, agriculture, transport, etc. But one of the key issues that often makes such structural reforms unattractive for politicians to undertake is that the pain of the reforms vs the gains from them are simply out of sync with a politician’s electoral horizon. The widely held view is that structural reforms only reap rewards in the long term. In the ongoing crisis in Europe, the debate on the need for vs pitfalls of structural reforms is raging. A recent article by an economist in the Brussels-based think tank Breugel aimed to debunk this, in so far as Europe is concerned.

This article presents new evidence to show that the widely held view might not be entirely accurate. Yes, much of the gains do occur in the long term and there are likely to be dampeners in the short term, but there are some clear positive impacts in the short-term as well. The article observes,

“The crucial takeaway is that reforms – either directly through business restructuring and temporary layoffs, or indirectly through the real interest rate – are indeed expected to dampen consumption. However, a counter effect is expected to stem from a boost in short-term investment based on prospects for higher productivity, real wages, and incomes in the future. […] the pick-up in investment and, to a smaller degree, an expanding current account will more than off-set the adverse dynamics of consumption, refuting the “short-term pain before long-term gain” principle at aggregate level. This however does not imply that individual categories will not be severely affected by policy changes, and hence the complexity of the politics of reform adoption”

The author also puts forward three key observations on factors that need to be considered when implementing structural reforms – 1) sequencing of reforms, 2) access to credit, and 3) role of fiscal policy. I agree with all three.

The sequencing of reforms is crucial to get right to ensure there isn’t too much shock to the system too quickly, potentially controversial reforms may need to be done after those that demonstrate ‘quick wins’. Meanwhile, access to credit is important not only to aid with financing adjustment costs but also help unlock funding for new investments looking to take advantage of the prospect of a more productive and competitive economy in the future. It is particularly crucial to ensure access to credit is there for SMEs, as I argue here. As for fiscal policy, the tax revenue that the government has (essentially fiscal space) to provide a welfare cushion for the biggest losers of reforms, can really help prevent backlash against the reform agenda owing to difficult adjustment costs.

But amidst all of this I think it’s imperative that economists remain keenly aware that structural reforms are inherently tricky, politically. The gains are not always easily understood by the wider public in general, and affected sectors in particular. The gains may not be immediately visible, while the immediate losses may be more conspicuous. There will always be a strong ‘political economy of reform’ dynamic at play. Governments need to demonstrate early success of reform in order to garner public support to sustain broader reform programmes over several years. As the article rightly concludes,

“Understanding the dynamics and time profile of structural reforms may ultimately increase the political feasibility of reform packages”

Read more at: ‘The Pub Economics of Structural Reforms: Can Reforms Only Be Expected to Pay Off in the Long Run?’ http://www.bruegel.org/nc/blog/detail/article/1600-the-pub-economics-of-structural-reforms/

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