Labour and Product Market Reforms in the Economy with Distortionary Taxation

31 Pages Posted: 11 Apr 2006

See all articles by Andrew J. Hughes

Andrew J. Hughes

Cardiff Business School; Centre for Economic Policy Research (CEPR); Vanderbilt University - College of Arts and Science - Department of Economics

Nikola Bokan

University of St. Andrews - Centre for Dynamic Macroeconomic Analysis (CDMA)

Date Written: January 2006

Abstract

It is widely accepted that in order to improve the economic position of the EU relative to the USA certain structural reforms need to be undertaken, mainly in the labour market. However few EU countries have undertaken such reforms. The reason lies in the fact that those reforms are going to be costly in terms of economic performance, unemployment and hence the cost of financing them - at least in the short term. Blanchard and Giavazzi (2003) develop a model based on imperfect competition in both product and labour markets in order to show the impact of deregulation on the economy. However they do not consider the question of how to finance such reforms or overcome the short run costs, a key consideration if the short run costs are large relative to the long run gains. We extend their model by including the effects of another inevitable source of imperfections: distortionary taxation - not only the most likely candidate for reform, but also the most likely instrument for financing the restructuring process. By extending the model in this way we can establish formally that reforms imply significant short run costs as well as long run gains; that (political opposition apart) the financing of such reforms will be the main stumbling block. We come to a number of conclusions which reverse the Blanchard and Giavazzi results; and find that, in addition, the composition of the reform package matters, as does the distribution of the tax burden. This model therefore supplies new results on the design and sequencing of reforms.

Keywords: Structural reform, wage bargains, short vs. long runs substitutability

JEL Classification: E24, H23, J58

Suggested Citation

Hughes Hallett, Andrew J. and Bokan, Nikola, Labour and Product Market Reforms in the Economy with Distortionary Taxation (January 2006). CEPR Discussion Paper No. 5431, Available at SSRN: https://ssrn.com/abstract=896241

Andrew J. Hughes Hallett (Contact Author)

Cardiff Business School ( email )

Aberconway Building
Cardiff CF10 3EU
United Kingdom
+44 292 087 001 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Vanderbilt University - College of Arts and Science - Department of Economics ( email )

Box 1819 Station B
Nashville, TN 37235
United States
615-322-8539 (Phone)
615-343-8495 (Fax)

Nikola Bokan

University of St. Andrews - Centre for Dynamic Macroeconomic Analysis (CDMA) ( email )

Castlecliffe
St Andrews, Fife KY16 9AL
United Kingdom
+44 1334 462 445 (Phone)

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