Australians are asking ‘where will economic growth come from?’ A common response is ‘structural reform’, about which we are likely to hear more and more in coming weeks as the election campaign proceeds.
What is that and does it matter? Structural reform has many dimensions but really it’s about making market works better as they allocate resources. The European Commission (http://ec.europa.eu/economy_finance/publications/economic_briefs/2014/pdf/eb34_en.pdf) said:
“Growth is not so much about working harder, it is about working smarter. In other words it is about using productive factors as
efficiently as possible…Reallocating resources efficiently can bring significant gains and this is the aim of structural reforms”.
This is a big agenda, but it matters a lot.
To illustrate both the scope and impact of structural reform, here are some results from an earlier study organised by the APEC Policy Support Unit and managed by the author. We looked at a package of the following reforms in infrastructure, transport and energy across the APEC membership.
- Air transport: reforms to entry conditions to air transport markets for domestic and foreign carriers, and to rules that limited foreign ownership;
- Maritime transport: dismantling of entry restrictions, quotas or cargo sharing arrangements and the granting of domestic-vessel treatment to foreign-owned carriers located domestically;
- Rail transport: free entry in freight operations in those economies that do not have them;
- Electricity and gas: providing third party access, unbundling, wholesale prices set through market arrangements and/or retail competition in economies that have not implemented them; and
- Telecommunications: removal of remaining foreign equity limits.
The study found that across the whole APEC region, USD175 billion a year in additional real income (in 2004 dollars) could be generated relative to what would have accrued had these reforms not occurred. This is a snapshot of the gains projected after a 10-year adjustment period – a point often made is that the gains from structural reform take some time to materialise.
The study covered the whole region but we also found that the reforms don’t have to be coordinated to generate these sorts of benefits: there are in other words gains from economies taking their own initiatives.
The big point was that APEC-wide, the projected gains from these structural reforms are almost twice as big as the gains from further liberalisation of merchandise trade.
If structural reform is a good deal, why does it seem so hard to make progress?
There is a perception that structural reform means losing job. That is, the perception is that reforms which are good for productivity are bad for jobs, and that these costs of adjustment come quickly while the gains from the reforms will take a long time to come, as already noted, so the short term costs look too high. Hence there is resistance to the reform agenda. This is a dilemma since without structural reform, we risk being locked into a low growth (and wasteful) world.
The challenge is to bring forward the impacts of structural reform, since they help manage the adjustment. That is, structural reforms in some areas, like those listed above, reduce costs for other parts of economy, improve their international competitiveness, encourage their growth and add to their employment.
So in this context, what more can we say about designing a structural reform program?
- First, sequencing helps. It helps to think about a sequence in which to undertake reforms, in order to manage the adjustment in a better way. A good ‘step one’ is usually tax reform.
- Second, it has been noted that good access to credit is critical to unlocking the benefits of structural reform (see, for example, here). We actually found in another study (available here) that structural reform has this effect itself! It lowers the cost of debt, that is, the financial markets lower the risk premium on lending to countries which undertake reform This effect brings forward the benefits of structural reform.
There are other things that governments can do to build confidence in and support for a program of structural reform. I have elsewhere presented a 10 point plan to promote structural reform (more details are available here). The plans include the value of:
- Focussing first on generating competition in markets where possible (and otherwise generating competition for a market) – this matters more than tackling issues of public ownership and privatising public organisations;
- The analysis and public reporting on the cost of current policy, and the benefits of reform – this is the sort of role that the Productivity Commission plays in Australia, which helps people understand the agenda and helps leaders to commit to it;
- Using experiments to demonstrate the scope for reforms to have an impact, eg try something out in a local area and learn from that; and
- Taking seriously community service obligations (eg access to services) and figuring out a better way of funding them.
One last point. Who should manage structural reform? Given the nature of the policies relevant to the structural reform agenda, the scope for action is often just as much in the hands of state governments as the federal government. The 10 point plan then applies just as much at that level, including the idea of having state-level productivity commission types of structures and processes. ‘Think global and start local’ applies here too!
Note: Material here is taken from the paper by the author available here.