Meeting Global Economic Challenge (Part-III)

"A combination of market-based and public policy initiatives is needed to both to encourage capital market development and to overcome this fragmentation."

Article by Dr. Zia-Ur-Rehman zia177@yahoo.com

Let me turn now to structural reform. Structural reforms can improve both national prospects and people's lives. Indeed, we estimate that the structural reforms that make up the Lisbon package could raise potential growth by ½ to ¾ percentage points each year over the medium term. I will mention today two areas that the Fund believes are particularly important.

First, deregulation. There is very strong evidence that countries that adopt a package of labour market and product market liberalization can achieve good outcomes in both employment and economic growth. There are many approaches that can be taken to labour market reform. Recently the Fund published a study of four successful reformers: Denmark, Ireland, the Netherlands, and the United Kingdom. Each did different things, and each made important progress. Moreover, all kinds of labour market reform are likely to be most effective if they are accompanied by product market reform, and especially liberalization of regulations in services sectors. This enables more flexibility in labour markets to be translated into increases in incomes, rather than increases in rents accruing to businesses in protected sectors. The second important set of measures is in the area of financial sector reform. Banks, and financial markets more generally, play a vital role in directing capital towards the most productive investments, and increasing productivity is itself vital for Europe's growth prospects. In the area of banking, I see three priorities: improving competition in the banking sector, integrating clearing and settlement systems, and addressing issues relating to supervision and regulatory regimes and approaches to crisis management that differ between countries. Capital market development is also important. Relative to the size of their economies, EU capital markets are much smaller than those in the United States, and this may have costs for the EU in terms of productivity and growth. There is some evidence that financial systems dominated by arm's-length transactions (markets with less bank density and greater disinter mediation) do better in reallocating resources from declining to expanding sectors than systems dominated by relationship-based transactions. Arm's-length transactions tend to be more characteristic of capital markets than of banks, so that economies with more developed capital markets tend to be more flexible and dynamic, and therefore more likely to experience higher productivity and growth, than those with bank-based financial systems. Integration of equity markets in Europe also remains incomplete, and research by the Fund indicates that the partial integration that has taken place between some countries often results in diversion of investment rather than its allocation in the most efficient way possible. A combination of market-based and public policy initiatives is needed to both to encourage capital market development and to overcome this fragmentation.