Labour market reforms and economic growth – the European experience in the 1990s

The purpose of this paper is to reassess the relative impact of labour market regulation on economic performance. Inflexible labour markets combined with high welfare costs are often thought to be the main cause of low growth in Europe.

This paper compares the impact of labour market regulation to that of macroeconomic policies (such as fiscal policy, monetary policy, macroeconomic cost management) and to that of investment into future growth (such as research, education and the diffusion of technology). We develop for this purpose a highly stylised model explaining economic growth; we suggest a synthetic measure of performance and use data for the US and Europe for the empirical test.

The main result is that regulation impacts on growth, the impact of regulatory change is, however, less easy to demonstrate. The impact of macro economic policy can be demonstrated first by the more growth oriented monetary and fiscal policy in the US and the success of some European countries in bringing private and public costs in line with productivity and tax revenues. However, boosting investment into future growth by encouraging research, education and technology diffusion seems to be the most important determinant of performance.

As to the limits of this paper, we have to acknowledge that our analysis refers to a short time period, a small number of countries and uses a highly stylised model.

If the results can be replicated for larger data sets and by more elaborated technical methods, the findings have an important policy implication: country strategies relying only on deregulation, without complementary macroeconomic policy and without strategy to boost “growth drivers” are suboptimal. This questions the policy advice given by some economists and economic think tanks, which call for deregulation as main policy strategy and then expect market forces to boost growth quickly and without specific policy measures.

The attempt to assess the relative impact of the three policy areas is specific to this paper; most other papers focus on one policy area only.