At the moment when a new EU leadership is taking office and new policy priorities are being discussed, talks about the need to encourage structural reforms in euro area economies are reviving with force. There is however much confusion on why it is so important right now to promote reforms in the euro area and what would be the best mechanism to do so.
This Policy Paper distinguishes between three different rationales to promote reforms in the euro area:
• improving the competitiveness of euro area as a whole,
• enhancing the euro area’s capacity to adjust to shocks
• and reducing current intra-euro competitiveness gaps.
The main argument of the Policy Paper is that each of these rationales, all relevant in today’s EMU, point at different obstacles to reform and thus require a different policy response. After presenting this argument, the Policy Paper analyses in more detail which type of policy response would be more appropriate to address each rationale. Three main conclusions derive from this analysis.
• First, the costs of reforms are not fully recognised in the implementation of the Stability and Growth Pact, particularly for countries under the corrective arm of the Pact. To favour pro-competitive reforms in the euro area, a more direct link should be made between efforts of reform and the extension of deadlines for deficit correction.
• Second, non-cost competitiveness factors – and particularly, the quality of public institutions – account for an important part of the intra-euro competitiveness divide. To close this divide, there is a case to accompany current efforts of “internal devaluation” with a EU action aimed at supporting public governance reforms in peripheral euro area countries.
• Finally, while there is a clear case to induce euro area countries having excessive market rigidities to reform, monetary incentives do not seem the most appropriate tool to do so. A more effective incentive to reform would be establishing minimum requirements of market flexibility and openness to competition as a pre-condition to member states’ participation into a future euro area fiscal stabilisation mechanism.