What are the Desirable Characteristics of a Competitiveness and Convergence Instrument?
Nando Gevers 5756731
MSc Economics, University of Amsterdam
Master’s Thesis, Submitted 20 October 2013
Supervisor: Dr. D. Veestraeten
Abstract
To mitigate the divergence of real exchange rates within the European Monetary Union (EMU), the European Commission proposed the creation of an instrument to help governments depreciate their real exchange rate; the Convergence and Competitiveness Instrument (CCI). The primary purpose of this thesis is to investigate what the desirable characteristics of the CCI are.
Structural reforms in the labor and product markets and budgetary reforms help to depreciate the RER. These reforms however, are accompanied by adjustment costs. Governments of countries with problematic real exchange rates tend to postpone the reforms due to the associated adjustment costs. The CCI can help overcome the adjustment costs by providing support. While properly implemented structural reforms can help depreciate the RER of countries, there are limitations to the effectiveness of the CCI. Even if the structural reforms are implemented, these limitations could preclude the current account in the EMU from balancing.
The thesis will begin with an introduction to the problem of diverging real exchange rates in the EMU. In the second section, structural reforms will be identified that can help mitigate this problem. The thesis will further discuss how the CCI can support the implementation of these structural reforms and how the support can be provided most effectively. The thesis will conclude with a discussion of the limits to the effectiveness of the CCI.
Key words: Convergence and Competitiveness Instrument, real exchange rate divergence, real exchange rate depreciation, structural reforms, adjustment costs
Table of Contents
1. Introduction 1
2. The Problem of Diverging Real Exchange Rates within the EMU 3
2.1 Description of the real exchange rates 3
2.2 The developments of real exchange rates in the EMU 4
2.3 What problems are encountered when real exchange rates diverge? 5
2.4 Necessary realignment of real exchanges rate in the EMU 6
2.5 Concluding remarks 7
3. Reforms to Facilitate Adjustment of the Real Exchange Rate 8
3.1 Labor market reforms 8
3.1.1 The effect of labor market reforms on the real exchange rate appreciation 8 3.1.2 Empirical results on the effect of labor market reforms 8 3.1.3 Labor market reforms that depreciate the real exchange rate 9
3.1.3.1 Reform 1: Elimination of temporary contracts 10
3.1.3.2 Reform 2: Collaborate with unions to increase acceptance of reforms 11
3.1.3.3 Reform 3: Lower the minimum wage 12
3.1.3.4 Reform 4: De-emphasize the importance of employment protection laws 12 3.1.3.5 Reform 5: Increase unemployment benefits with attached conditionality 13
3.2 Product market reforms 15
3.2.1 The effect of product market reforms on real exchange rate appreciation 15 3.2.2 Empirical results on the effect of product market reforms 15 3.2.3 Product market reforms that depreciate the real exchange rate 16 3.2.3.1 Reform 1: Lowering the barriers to entry for firms 16
3.2.3.2 Reform 2: Lowering the exit barriers for firms 17
3.3 Budgetary reforms 18
3.3.1 The effect of budgetary reforms on real exchange rate appreciation 18
3.3.2 Reform 1: Move towards a more VAT-based tax system 18
3.3.3 Reform 2: Reduction of government expenditures 19
3.4 Concluding remarks 20
4. Design of the Convergence and Competitiveness Instrument 21
4.1 How can the CCI help governments implement reforms? 21
4.1.1 Role of the CCI in labor market reforms 22
4.1.1.2 Supporting active labor market policies 23
4.1.1.2.1 Training programs 24
4.1.1.2.2 Wage subsidies 24
4.1.1.2.3 Job search assistance 24
4.1.1.2.4 The government as “Employer of last resort” 24
4.1.2 Role of the CCI in product market reforms 25
4.1.2.1 Subsidy for startups 25
4.1.2.2 Simplifying procedures for setting up firms 26
4.1.2.3 Lower the required paid-in capital 27
4.1.3 Role of the CCI in implementing budgetary reforms 27
4.1.3.1 More generous unemployment benefits 27
4.2 Design of reforms 28
4.2.1 Disbursement of support in installments 28
4.2.2 Performance criteria on policy outcomes versus policy implementation 28
4.2.3 Limiting the amount of performance criteria 29
4.2.4 Loans versus grants 29
4.2.5 Built-in safeguards to prevent moral hazard 29
4.3 Concluding remarks 30
5. Limits to the Convergence and Competitiveness Instrument 32
5.1 The “problem” of well-performing countries within the EMU 32 5.2 The effect of global business cycles on the current account 33 5.3 Risking deflation after the implementation of structural reforms 33
5.4 Self-correcting unit labor costs in a crisis 34
5.5 Income versus substitution effect on imports in a crisis 34
5.6 Concluding remarks 35
6. Conclusion 36
1 1. Introduction
Since the time that the plans for the EMU were drafted, the divergences in real exchange rates within the EMU have attracted much attention. The prevailing conclusion of the empirical literature is that the divergence of real exchange rates could possibly endanger the future stability of the EMU. The divergence of real exchange rates leads to widening gaps in competitiveness between EMU member states. These differences in competitiveness cause underperforming countries to run persistent current account deficits. The current account deficits cause a buildup of foreign liabilities, which eventually need to be repaid. The repayment of these liabilities becomes increasingly difficult over time. In order to repay the liabilities, these EMU member states must regain competitiveness and run current account surpluses in the future. EMU members cannot accomplish this by a nominal devaluation of their currency since they are in a currency union. The deficit countries need to become more competitive by depreciating their real exchange rate via the implementation of structural reforms.
In December 2012, this problem was acknowledged by the president of the European Commission José Manuel Barroso, when he presented recommendations for the implementation of a “convergence and competitiveness instrument” (CCI) to the European Council. The instrument is intended to provide support to European governments that are dealing with appreciated real exchange rates (RERs) and are willing to implement structural reforms. Since the announcement of the Convergence and Competitiveness Instrument, the European Commission communicated that the CCI will work with a two-step approach.
1. The Member states that want the support of the CCI commit to structural reforms with associated timetables. These structural reforms (and timetables) are stipulated in so called “reform contracts”.
2. To help the government in implementing the reforms, the CCI will provide financial support. Should the country fail to comply with the reforms in the reform contract, than the financial support could ultimately be terminated
Apart from the two pillars above, little is known about the specifics of this instrument. The European Commission still needs to decide what structural reforms are eligible for financial support, how the financial support of the CCI could help in the implementation of these reforms and how the reform contract should be designed. All these questions need to be addressed, and that is the topic of this thesis:
2 Although it is obvious that politics will play an important role in the ultimate design and implementation of a CCI, this thesis will solely take economic arguments into account. The effect of politics should however not be underestimated (especially in the case of the European cooperation). However, if these factors were to be incorporated into this analysis, the thesis would become too comprehensive.
This thesis will begin with an introduction to the RER divergence problem and the expected developments of the real exchange rates in the future. To mitigate the divergence of real exchange rates, structural reforms should be implemented. Chapter 3 will discuss what reforms could help in depreciating the real exchange rate. Attention will then be given to the design of the CCI and the desired characteristics of the instrument will be identified.
This discussion will first detail the role of the CCI and how it can help governments to implement the reforms that will be discussed in chapter 3. Countries that seek the support of the CCI will be required to sign a “reform contract” that stipulates timetables and proposed reforms. The design of the reform contracts is important for the success of the support of the CCI. Paragraph 4.2 will discuss these issues and also how the support of the CCI could be optimized.
This thesis will conclude with an overview of the limitations to the effectiveness of the CCI. Even though the CCI can support reforms that depreciate the real exchange rate, this does not necessarily mean that current account imbalances can be prevented.
3 2. The Problem of Diverging Real Exchange Rates Within the EMU
This section will introduce and elaborate on the most important terminology. Real exchange rates play an important role in this thesis, and it will therefore be essential to properly define this term. However, to properly understand this concept, the nominal exchange rate (NER) must first be discussed.
2.1 Description of the real exchange rates
A country´s nominal exchange rate (NER) is the rate at which its currency can be exchanged for foreign currencies. More specifically, the NER is the price of foreign currency denominated in domestic currency. If the NER increases, this is associated with a decrease in the value of a domestic currency, meaning that the exports become less expensive. The increase in the NER is therefore defined as a depreciation of the nominal exchange rate, while a decrease is an appreciation of the NER. For the calculation of international competitiveness however, knowing the NER is not sufficient.
Cost- and price differences between countries determine competitiveness as well. The real exchange rate (RER) is commonly used to measure the relative international competitiveness of a country. The RERs are calculated by adjusting the nominal exchange rates by a price deflator, or:
ܴ = ܧ ∗ܲ ி ܲ
With E being the nominal exchange rate, P being a measure of domestic price level and PF is a measure of the foreign price level. Which price index is used is of great importance to the real exchange rate. The most commonly used index for the calculation of RERs is the unit labor cost (ULC) deflator. The ULC deflator indicates the average labor costs per unit produced and is often seen as the most appropriate measure of price and cost competitiveness. By increasing productivity or lowering cost and wages, the ULC can be decreased. Some databases use different deflators such as the WPI (wholesale price index), the CPI (consumer price index), the GDP deflator (Gross domestic product index), the export goods price deflator (PXI) and the PPI (Producers price index). All of these deflators have specific merits and drawbacks, but discussing these is beyond the scope of this thesis. Unless otherwise specified, this thesis will use the RERs that are based on the ULC deflator.
4 -15,0 -10,0 -5,0 0,0 5,0 10,0 C u rr e n t a cc o u n t b a la n ce i n % o f G D P 80 90 100 110 120 130 140 1994 1996 1998 2000 2002 2004 2006 2008 2010 Germany Ireland Greece Spain Italy Portugal D e p re ci a ti o n A p p re ci a ti o n Time 2.2 The developments of real exchange rates in the EMU
Data from the European Commission shows the recent developments among the EMU member states. Graph 1 depicts the divergence of real exchange rates since 1994 (the base year).
The previous section mentioned that an appreciation (decrease) of the RER is associated by a loss in
competitiveness. Portugal, Italy, Greece and Spain (the (PIGS countries) suffered the strongest appreciation. Differences in the development of RERs translated into a divergence of current account balances in the EMU. Graph 2 illustrates this problem with the current account balances of different
member states in 2011. Countries that were dealing with low RERs also suffered from sizeable current account deficits. Since the countries became less competitive, exports decreased while
Graph 2: Current account vs. rest of EMU in 2011 (Eurostat) Graph 1: RERs (ULC deflated) in the EMU. Source Eurostat
5 imports continued to remain stable or increased. Having clarified the specifics of the current account balances and the real exchange rate movements in the EMU, the following section will go into further detail on the nature and consequences of current account deficits and appreciation of real exchange rates.
2.3 What problems are encountered when real exchange rates diverge?
When a decrease of the RER is interpreted as a deterioration of the international competitiveness, it is implicitly assumed that inflation is harmful. This is true for EMU members, since the nominal exchange rate is fixed. Inflation cannot be offset with adjustment of the nominal exchange rate, so that inflation differentials between EMU members lead to changes in competitiveness.
One of the most prominent theories used to explain inflation differences is the Balassa-Samuelson hypothesis. This model divides the economy into a tradables sector and a non-tradables sector, with the production factor labor being mobile between the two. A productivity increase in the tradables sector will lead to an increase in wages in this sector, which will ultimately attract workers to this sector. Labor market forces will reach new equilibrium with equalized wages between the two sectors. Since there is no productivity gain in the non-tradables sector, the higher wages are financed via an increase in prices. The Balassa-Samuelson hypothesis thus links productivity gains in the tradables sector (an increase in international competitiveness) to aggregated inflation. The Balassa-Samuelson hypothesis identifies “catching-up” inflation. This is an incidence in which countries with initially low levels of productivity can realize higher levels of productivity growth. It is therefore likely that these low income countries will have higher inflation rates when compared with higher income nations.
The magnitude of the Balassa Samuelson effect has been questioned by much of the empirical literature regarding the EMU. Égert (2011) used various econometric techniques to identify the determinants of inflation differentials in the EMU. His study found that the Balassa Samuelson effect was not useful to explain the inflation differentials in the EMU. He explained the absence of the Balassa Samuelson effect by introducing the quality effect. This is when the income of countries starts catching up and the inhabitants of these countries switch their consumption patterns and buy more high quality products (the quality effect) and services. Also, Sinn (2013) found little evidence that the Balassa Samuelson effect played a significant role in the current EMU crisis.
Since the Balassa-Samuelson effect is the transition between equilibrium states, there is usually no need for policy intervention. High inflation could however also reflect harmful developments that could lead to persistent appreciation of RERs. This appears to be the case for most of the EMU-members that are experiencing large current account deficits. Well-performing countries (Germany,
6 Finland, Austria and the Netherlands) are able to produce cheaper and higher quality exports which translate into a current account surplus. Rapid growth of wages and costs that are not accompanied with productivity gains, have induced a deficit in the current account for the Southern countries. A current account deficit is financed via depletion of foreign assets or by the buildup of foreign liabilities. If the diverging RERs are not addressed, the current account deficits of the Southern countries will persist. When an EMU member state runs a current account deficit over a longer period of time, it becomes more unlikely that it will be able to repay its foreign liabilities. Investors could become worried about the return on their investments and will reconsider financing the deficit. The capital flows will dry up, which will exclude the deficit countries from international capital markets.
There is no easy way to fix the RER problem in the EMU. Since the creation of the EMU, country specific monetary and exchange rate policy have disappeared. Countries with depreciated RERs have large current account surpluses while in contrast, EMU members with appreciated RERs have large current account deficits. The only tool at the disposal of EMU members to address this problem is to improve the RER via structural reforms, since the nominal exchange rate cannot be altered. Structural reforms take time, and often come at great political costs. It is therefore important that such reforms are implemented in an adequate and timely manner. This is precisely the goal of the European Commission when they introduced the CCI.
2.4 Necessary realignment of real exchange rates in the EMU
In the previous paragraph, it was explained that there is a fundamental problem with diverging RERs in the EMU. To understand the exact scope of these problems, it is helpful to estimate the necessary adjustment of the real exchange rates. Since the RER is difficult to correctly measure, these estimates vary among the different studies. However, to gain insight it is still useful to review the most important literature on this subject to obtain an idea of the extent that RERs need to be adjusted.
Smídková, Babecky & Bulíř (2010) estimate that the PIGS countries deal with persistent overvaluations of their real exchange rates. Portugal and Spain had overvalued exchange rates of respectively 14.7 and 13.7 percent. The problem for Greece is more severe, and they estimate that a devaluation of 38.6 percent is needed to regain current account balance. In a 2009 IMF country report, time series simulations found that Greece needed a 20-35% devaluation of the RER. The latest study that calculated the required adjustments for some of the Euro countries was conducted by Goldman Sachs Economics Research (2013). Coudert, Couharde & Mignon (2012) estimated the misalignments of the RERs in the EMU by using panel data. They found that the RERs of Spain,
7 Portugal and Greece had the most overvalued RERs of the EMU. The results of the literature have been summarized in table 1.
Table 1: Necessary realignments of RERs
IMF Staff Report (2009)
Smídková, Babecky & Bulíř (2010)
Coudert, Couharde & Mignon (2012) Goldmann Sachs (2013) Portugal - 13.7 % 13.8 % 25-35 % Italy - - 10 % 5-15 % Greece 20-35 % 38.6 % 20 % 25-35 % Spain - 14.7 % 6.6 % 25-25 % Germany (appreciation) - - 0.5 % 15-25%
As discussed in the previous section, the only tool for correcting current account deficits is via depreciation the RERs. If the RERs do not depreciate, the current account divergence will persist and will become unsustainable in the future. The data in table 1 estimates that the required adjustments will be severe. To facilitate these adjustments, structural reforms will have to be supported by the CCI. Chapter three will go into further detail about the desirable reforms and how the CCI can support the required policies.
2.5 Concluding remarks
In conclusion, there is a large problem with diverging RERs in the EMU. When real exchange rates diverge, they can translate into problematic current account deficits. The design of the EMU only allow for one policy tool at the country-level to correct the imbalances. Deficit countries must depreciate their RER by decreasing the unit labor costs via the implementation of structural reforms. Various studies estimate that the required adjustments will be severe and that these adjustments are difficult to realize by the deficit countries. To help accomplish these difficult tasks, the European commission will introduce the Competitiveness and Convergence Instrument. The following chapters will discuss what policies should be supported by the instrument and how it can facilitate governments in implementing structural reforms.
8 3. Reforms to Facilitate Adjustment of the Real Exchange Rate
As discussed in the previous chapter, divergence of RERs in the EMU can lead to a crisis due to a widening of current account deficits. Now that country-specific monetary policy and devaluations of the nominal exchange rate are no longer an option to narrow current account deficits, structural reforms are thus needed to depreciate RERs. These structural reforms aim to increase productivity and decrease prices. This chapter will identify reforms that should help to overcome the problem of appreciating RERs. The reforms will be categorized into the following three fields; labor market reforms, product market reforms and budgetary reforms. The next chapter will go into further detail about the way in which the CCI can support the structural reforms that are proposed in this chapter. Chapter 5 will discuss the limitations of the CCI in mitigating the divergence of current accounts in the EMU.
3.1 Labor market reforms
Reforms in the labor market are crucial to depreciate the real exchange rate of a country that is suffering from a competitiveness problem. Due to “rigidities” in the labor market, the nominal wage rate does not adapt swiftly enough to changing economic conditions. Such rigidities arise for various reasons and are mainly meant to protect employees. Labor market rigidities might arise due to factors such as; high minimum wage and wage indexation etc. These rigidities should be weakened via structural reforms so they do not create divergence of RERs. This section will discuss what reforms can be implemented by governments that aim to depreciate their real exchange rate.
3.1.1 The effect of labor market reforms on the real exchange rate appreciation
Real exchange rates are predominantly determined by the labor costs incurred by an employer per unit of output; the unit labor costs. The unit labor costs are determined by the productivity of the workers combined with the nominal wage. Rigidities in the labor market may prevent a downward adjustment of nominal wages or an increase in productivity could occur. These rigidities therefore prevent a smooth adjustment of the real exchange rate in an economic downturn and must be weakened by the implementation of structural reforms.
3.1.2 Empirical results on the effect of labor market reforms
In the empirical literature, there is a consensus on the effect that structural reforms in the labor market have on RERs. This section will provide an overview of the main findings on the effects of structural reforms in the labor market on competitiveness.
9 An article by Ju and Wei (2007) found that labor market rigidities (measured by the Investment Climate Assessment, or ICA, of the World Bank) were negatively related to performance of the current account. They also found that when external imbalance occurs, the speed of adjustment toward the long-term equilibrium of the current account decreases when the labor market is less flexible. Similar results were found in a study by Berger and Nitsh (2010) that used a sample with a long time-span (from 1948 to 2008) and included 18 European countries. They found that less flexible labor and product markets negatively affected the current account. Berger and Nitsch (2010) also found evidence that labor market institutions that increased rigidity, measured by OECD indexes of market rigidities, decreased the speed of adjustment of the current account following an imbalance. Zemanek, Belke and Schnabl (2010) found significant results for structural reforms on competitiveness. They used a panel data set for Europe and using the “Fraser Index of Economic Freedom of the World”, estimated the effect that reforms had on competitiveness. In all regressions, the structural reforms of the labor market had a great impact on the level of competitiveness. They concluded that such reforms are crucial for the future stability of the Euro-system. Ivanova (2012) concurs with the literature and found that measures taken to reduce labor market rigidities such as lower minimum wage and looser employment protection were associated with an improvement in the current account balances. She found that the strongest results occurred after a decrease in the minimum wage had been implemented. Finally, Morsy & Jaumotte (2012) found robust results from a panel dataset that ranged from 1983 to 2007 which included 10 EMU countries that had increased high employment protection, increased union influence and intermediate coordination of collective bargaining and that had also increased the persistence of inflation. They concluded that a reform of labor market institutions was needed to decrease persistent inflation.
Although the literature broadly agrees that labor market rigidities negatively affect the adjustment of an economy to a current account deficit, there is little mention of how these reforms should actually be designed. In the next paragraph, certain reforms will be discussed that can reduce labor market rigidity and therefore increase the adjustability of real exchange rates.
3.1.3 Labor market reforms that depreciate the real exchange rate
The following paragraphs will examine five labor market reforms that could help weaken rigidities in the labor market. The specific role of the CCI and how it can help accomplish these reforms will be discussed in chapter four.
10 3.1.3.1 Reform 1: Elimination of temporary contracts
In most EMU countries, the labor market is divided into two tiers: temporary and permanent contracts. Temporary contracts are often seen as a type of contract that will make the labor market more flexible since they enable employers to hire additional workers that can be fired more easily. This lowers the costs of firing new employees that underperform. Temporary contracts could also be beneficial for workers because employers would be less hesitant to hire additional employees, and it would increase the overall employment rate. Workers that are hired on a temporary basis will develop skills that enable them to ultimately find permanent work. However, these benefits of temporary contracts are only present when it is otherwise difficult and costly to fire staff. Should the labor market become more flexible (via reforms that will be discussed in the upcoming paragraphs), the benefit of having a system with temporary contracts diminishes.
Apart from additional flexibility in an otherwise overly rigid labor market, temporary contracts also bring disadvantages that might harm RER adjustment. A two-tier labor market leads to discrimination between the two types of workers in an economic downturn. Since it is easier to dismiss temporary workers, the firing decision of the employer is influenced. It would however be optimal if such distortion was not present and if the employers could base their decision solely on the performance of the employee in question. Although permanent workers are often more productive because of the training they have received, even those who underperform have more employment protection than skilled temporary workers. If underperforming, permanent workers remain employed at the expense of more skilled temporary workers the overall productivity (an important determinant of the RER) will be decreased.
Additionally, Booth, Francesconi and Frank (2002) found that temporary workers experience lower wages, less job satisfaction and above all: less training by the firms. This could also harm the productivity of those who remain stuck in temporary work. Booth, Francesconi and Frank noted that temporary work provides employers with some needed flexibility in the hiring decision, but again this benefit is only present when alternative contracts provide too little flexibility. Kahn (2010) found robust evidence to show that when governments institute policies that decrease the costs of creating temporary work, the probability that workers will end up in temporary jobs will increase. Kahn used data ranging from 1996 to 2001 from the “European Community Household Panel” and concluded that, although temporary work is often perceived as a jumpstart to work, it predominantly serves as a substitute for permanent contracts.
The increase in flexibility however, still plays an important role in the adjustability of the real exchange rate. Temporary contracts are needed in an otherwise rigid labor market since it provides employers with much needed flexibility. Temporary work however can hurt the productivity of workers and therefore the real exchange rate through distorted hiring decisions and insufficient
11 training of temporary workers. Eliminating temporary contracts in favor of more flexible permanent contracts has two positive effects on the real exchange rate via an increase in productivity. It would therefore be optimal to eliminate the two-tier labor market system and dramatically increase flexibility in the labor market for all workers.
3.1.3.2 Reform 2: Collaborate with unions to increase acceptance of reforms
When a sector suffers from a competitiveness problem and requires wage cuts, unions may collectively resist the proposed reforms. Unions often fear that cuts in one sector will result in wage cuts in other sectors and weakening of labor conditions in general. It is therefore important that the wage cuts and weakening of labor conditions are coordinated and remain coordinated with the unions from various sectors of the economy. Intense collaboration between social partners is important to lower the resistance to structural reforms. This system was already successfully implemented in the Netherlands through the Wassenaar treaty in 1982. The treaty of Wassenaar was a successful collaboration between social partners which allowed both parties to collectively work on depreciating the real exchange rate. The agreement focused on reductions of working hours, ending ‘automatic’ wage increases and the promotion of part-time jobs. Although the details of the treaty fall outside the scope of this thesis, it is important to realize that a close collaboration between social partners will achieve the best result in fighting a high real exchange rate. The collaboration between the social partners to regain competitiveness reduced the resistance against the reforms. These policies directly increase the flexibility of nominal wages and the flexibility of the labor market. The Wassenaar treaty has been credited with successfully depreciating the real exchange rate and restoring the Dutch competitiveness. This also had an important effect on the unemployment rate which dropped from 10.2% in 1983 to 3.5% in 2001. Although the reduction in the unemployment rate was partly due to the promotion of part-time work and job sharing; evidence shows that the increase in employment was due to more than just the increase in part-time employment. Wage moderation was the main reason that the Netherlands was successful in restoring competitiveness and lowering unemployment. In a paper by Blanchard and Philippon (2004), it was discovered that the unemployment rate in the Netherlands was negatively correlated with the wage in efficiency units1. They found that the wage in efficiency units decreased by over 83% from 1970 to 2001. This moderation in wage was far greater than the average of the European Union.
1 Efficiency wage lies above the market-clearing wage and is offered by employers to raise workers moral. Efficiency wages are also used to keep well-performing workers and to prevent high turnover of staff. This is especially important when the replacement costs of staff are high.
12 3.1.3.3 Reform 3: Lower the minimum wage
One of the most common reforms proposed for increasing flexibility in the labor market is to decrease the minimum wage. The minimum wage was implemented to protect workers from being exploited and ensure a decent standard of living for those that fall into the lowest income categories. The effect of the minimum wage on competitiveness and wages is complex. Most importantly, a decrease in the minimum wage directly lowers the unit labor costs to employers that contract minimum wage workers. Indirectly, the minimum wage also serves as a guideline for other wages. In general, many wages move in accordance with the minimum wage, especially in countries where the differences in income are not great (which is the case in EMU countries). Decreasing the minimum wage would therefore not only affect the minimum-wage workers, but would provide downward nominal wage flexibility for workers with income that exceeds the minimum wage. Lowering the minimum wage is thus important when the goal is to increase flexibility in the labor market. The decrease in minimum wage has distributional effects since it lowers the welfare of the lowest incomes in society. A more progressive tax system could be introduced to offset the welfare losses to these groups. By decreasing tax rates for lower incomes, the drop in the welfare for this group could be decreased. Should the government require this compensation to be income-neutral, the loss of revenue could be regained by increasing the taxes on higher incomes.
3.1.3.4 Reform 4: De-emphasize the importance of employment protection laws
Firing restrictions make it increasingly difficult for employers to adjust to fluctuating business cycles. These restrictions were instituted to prevent workers from being fired and would directly contribute to a decrease in unemployment. The prevailing opinion however, is that overly rigid firing restrictions make businesses more hesitant to hire additional workers. Most economists agree that these firing regulations have an overall negative effect on employment. Employment protection however, continues to play an important role for various reasons. The first is that the increased costs of firing staff creates an extra incentive for companies to invest in their human resources. Second, high levels of unemployment have an effect on the welfare of society as a whole. People that are unemployed receive unemployment benefits, which are a large cost to society. These effects are generally not taken into account by companies and it is therefore justified that the government requires sufficient payment for the dismissal of staff (in the form of severance, tax or otherwise). The most important argument against the use of excessive firing restriction is that the allocation of resources of an economy will be distorted. Skilled and capable workers could remain employed due to firing restrictions, while these workers may have higher marginal benefits to another sector/firm. This
13 directly affects the unit labor costs to employers and the productivity of the workforce; which are both important determinants of the real exchange rate.
The effectiveness of reforms of employment protection laws was confirmed in a recent study by the European Commission (2012). The European Commission analyzed the effect of newly introduced reforms of employment protection laws on the job finding rate. The results are impressive; with the reforms, the “steady state” job finding rate increased from 12 percent in Spain to a staggering 46 percent in Italy. Another paper published by the European Commission in 2006 found that employment protection laws increase the bargaining strength of workers in Europe. In an economic boom, this leads to accelerated growth of nominal wages (European Commission 2006). Bernal-Verdugo, Fureri & Guillaume (2012) found further empirical results using panel data that covered 97 countries from 1985 to 2008. They found that with a variety of labor market reforms, hiring and firing regulations and hiring costs had the strongest effects on the real exchange rate. Similar results were found in a paper by Tella and MacCulloch (2005). In this study, panel data from OECD countries was used to conclude that an increase in labor market flexibility decreases unemployment and increases the participation ratio2. These effects are more important for females than males although both groups are projected to benefit in the long run. Moreover, they found that decreased labor market flexibility increased the duration of unemployment.
3.1.3.5 Reform 5: Increase unemployment benefits with attached conditionality
Unemployment benefits are meant to decrease negative financial consequences that workers suffer when they become unemployed. There are several ways in which unemployment benefits affect the labor market. Higher unemployment benefits could strengthen the bargaining position of the workers when negotiating nominal wages. Workers exiting unemployment may also demand a higher wage or they may prefer to remain unemployed. Second, high unemployment benefits do not provide an incentive for unemployed workers to actively search for a job. And finally, when offered high unemployment benefits, employees are more willing to accept dismissal since their financial situation would not decrease drastically with unemployment. The final point clearly makes firing staff easier, but the first two effects initially contribute to rigidities in the labor market.
Empirical evidence does suggest that high unemployment benefits are not necessarily negative. It is very important however that active labor market policy (ALMP) is combined with these unemployment benefits. This concept of benefits with attached conditionality is known as the “Flexicurity model”. Sufficiently large unemployment benefits and flexibility in the labor market are
2
The participation rate: total of people that are either currently employed or actively searching for occupation.
14 seen as complements to each other. Unemployment benefits allow workers to find more appropriate jobs and their job search is simultaneously facilitated by the help of active labor market policies. The fact that individuals take longer to find a job increases the probability that workers find employment that better suits their talent. This increases their productivity, therefore contributing to a depreciation of the real exchange rate. The allocation of (human) resources over the economy is therefore also improved. When no compulsory AMPL is combined with unemployment benefits, the resulting increased unemployment duration tends to lead to demotivation and, if the unemployment period is too extensive, difficult employability due to the depreciation of human capital. Excessive employment protection laws should be reduced to allow the real exchange rate to adjust correctly. The eventual loss to workers will be offset by more generous unemployment benefits.
One of the most successful programs that implemented unemployment benefits with conditionality was the so-called Hartz reforms. This reform package was introduced by German chancellor Gerard Shröder in 2003 and aimed to reduce the unemployment rate in Germany. A commission, chaired by the former CEO of Volkswagen Peter Hartz, recommended that unemployment benefits should be conditional on the participation in active labor market programs. If the unemployed refused to participate, they suffered severe reductions in the benefits they received. These reforms drove down unemployment and depreciated the real exchange rate of Germany. The Hartz reforms were however accompanied with large cuts in welfare that provoked outrage among many of the German population. In an IMF report, Krebs & Scheffel (2010) calculated that the long-term unemployment rate was decreased by 1.2%. The welfare of the employed increased while the welfare of the unemployed decreased.
With this information, some important lessons for the CCI can be learned. Unemployment benefits with attached conditionality and active labor market policies do work in reducing unemployment and depreciating the real exchange rate. The resistance to the reforms that followed after the implementation of the Hartz reforms was mainly due to the cuts in benefits and not the conditions attached to the benefits. Increasing the acceptance of reforms is an important goal of the CCI and it is therefore not recommended that large cuts in benefits accompany the reforms of unemployment benefits.
15 3.2 Product market reforms
Rigidities in the product market also cause RER inflexibility. An overly rigid product market prevents prices from adjusting to changing economic conditions. This price rigidity directly influences the adjustability of the real exchange rate, but also makes it increasingly difficult to achieve wage flexibility. Since product market reforms directly affect the prices of goods, they directly affect real wages and employment. Another way that product market reforms affect the RER is via their effect on innovation. Both effects will be discussed in the following paragraphs.
3.2.1 The effect of product market reforms on real exchange rate appreciation
The key to a smooth adjustment of prices is to create a high level of competition in the home market. Generally the tradables sector already faces sufficient international competition, which ensures a seamless adjustment of prices. Increased competition in the domestic market could still play an important role in increasing the adjustability of prices. Increased competition puts downward pressure on prices and therefore has a positive effect on the real wages of workers. This positive effect on real wages also means that workers are less likely to demand nominal wage increases. Downward pressure on nominal wages also has a positive effect on the unit labor costs for companies in the tradables sector. A decrease in unit labor costs directly depreciates the real exchange rate. The second effect that product market reforms have on the real exchange rate is via prices in the non-tradables sectors. A large part of the output from the non-tradables sector is used to facilitate export, such as transportation and the market for inputs. If these costs fall due to increased competition, this will translate into lower costs for the tradables sector and depreciate the real exchange rate.
3.2.2 Empirical results on the effect of product market reforms
Fortunately, there is rich empirical data on the effect of competition on competitiveness and innovation. Griffith, Harrison and Simpson (2006) examined the effect that the EU Single Market Program had on competition. Their research showed that the average markup decreased after the reforms i.e. SMP were implemented. According to the authors, this pointed to increased competitive pressures. Furthermore, they concluded that this positively impacted the level of innovation, which led to increased productivity. These results were robust for different estimation methods. Griffith, Harrison and Simpson (2006) concluded that product market reforms are important for innovation. These results were confirmed by Nicoletti and Scarpetta (2003), who found evidence that productivity growth improved when public ownership and barriers to entry were decreased.
16 Economic theory predicts that imperfect competition is harmful to the adjustment of prices and empirical evidence confirms the predictions made by that theory. Griffith, Harrison & Macartney (2007) found that adequate product market reforms increased the relative competitiveness of firms in OECD countries in the late 1990s. They also found that competition reduces unemployment and that this effect is intensified when workers have strong bargaining power. This empirical evidence is in accordance with economic theory. If competition is deficient in a market, firms will have the ability to restrict output and collect monopoly profits. As competition increases, the output increases while profits decrease. This increased production is likely to be realized with additional workers, which will increase employment. Hoekman and Javorcik (2004) found similar results and concluded that governments should help firms enter and exit the market in order to facilitate competition.
3.2.3 Product market reforms that depreciate the real exchange rate
Data from the SMP in the EMU showed that structural reforms in the product market can increase competitive pressures. Existing literature also shows that this increase in competition led to a smoother adjustment of prices and therefore a fluid adjustment of the real exchange rate. Finally, innovation appears to increase when competition increases. In the following paragraphs, reforms to the product market will be discussed.
3.2.3.1 Reform 1: Lowering the barriers to entry for firms
The entry of new firms into the market is essential as it ensures the presence of sufficient competition and the decrease in overall market power. In turn, the increased competition enables an efficient allocation of available resources. One measure that has previously had a positive effect on the entry of firms is to subsidize the startup of promising firms. This subsidy generally takes place (it has already been implemented in the Netherlands) via the exemption of VAT in the first years of the start-up. The VAT that was initially paid to the start-up did not need to be remitted to the government. It could however also take place in the form of other tax-exemptions or via direct subsidies. Another way to decrease the financial burden of starting businesses is the elimination of required paid-in capital for firms with limited liability.
In addition to the financial concern, the legislative burden on startups should also be as minimal as possible. So called “one-stop-shops” where companies can take care of all administrative tasks at once could greatly diminish the time and effort it takes to start a company. The requirements for registration should also be minimized and preferably online procedures should be initiated or improved.
Although these measures may seem straightforward, there are still substantial differences within the EMU regarding the ease of doing business.
17 The World Bank Group published eleven indicators that measure business regulation in 133 countries. In table 2, several EMU countries are ranked according to the WBG indicators.
Germany is highly ranked on the WBG indicators, while Greece ranks 78th. This means that according to the WBG, Greece performs poorly in providing smart business regulation compared to countries such as the Kyrgyz Republic and Ghana. The CCI could help by providing policy advice and resources to improve business regulation.
3.2.3.2 Reform 2: Lowering exit barriers for firms
The survival of inefficient firms has an important effect on the real exchange rate. When a sub-optimal bankruptcy mechanism is in place, the exit of inefficient firms consumes more time and resources. Increasing the quality of bankruptcy mechanisms is therefore essential for many countries. The CCI could help governments to improve their existing bankruptcy mechanisms. Criscuolo, Haskel and Martin (2004) found that the exit of firms is very important for increasing the overall productivity of firms and that the correct institutional framework will ensure the efficient exit of firms from the market. In addition to a swift exit of inefficient firms, a proper bankruptcy mechanism will decrease the costs to creditors in the case of a bankruptcy and will increase confidence in trade.
The most important merit of a proper bankruptcy system is that it will facilitate debt restructuring and the re-start of insolvent firms. The majority of bankruptcies are non-fraudulent and these entrepreneurs should be able to continue their operations. However, a bankruptcy mechanism that facilitates debt restructuring is needed to achieve this. These entrepreneurs are an important pool of talent that could provide an increase in competition. If governments enable entrepreneurs to continue their businesses following a bankruptcy, many potential entrepreneurs who are hesitant to
Table 2: Ease of doing business. Source: World Bank (2013)
World Rank Country
20 Germany 30 Portugal 31 The Netherlands 44 Spain 73 Italy 78 Greece
18 start their own business due to the high costs of bankruptcy may be more motivated to form a new enterprise.
3.3 Budgetary reforms
In addition to the reforms suggested in the labor and product markets, governments could also adapt their fiscal and budgetary policies to depreciate the RER. This section will provide an overview of the budgetary reforms that should be supported by the CCI.
3.3.1 The effect of budgetary reforms on real exchange rate appreciation
Governments directly impact the real exchange rate via the level of expenditures and taxes. The way that taxes are levied influences the behavior of agents in the economy. Micro-economic theory suggests that all taxes are distortionary and that this distortion increases when taxes increase. To help depreciate the real exchange rate, a move towards indirect taxes is needed. A cut in expenditure, and subsequently a cut in taxes, would also help to depreciate the real exchange rate.
3.3.2 Reform 1: Move towards a more VAT-based tax system
Governments could help their export sector by changing the way taxes are levied. In Europe, the gap between the costs of hiring a worker and the net pay, also called the “tax wedge”, is particularly high. The tax wedge has a significant influence on the unit labor costs. A shift away from direct labor taxation and toward a more VAT-based system (called a “fiscal devaluation”) is therefore required. This would directly decrease the unit labor costs, thereby depreciating the real exchange rate.
In graph 3 (next page), the government revenues of different EMU members are depicted. Value-added taxes are already a large part of government revenues in the EMU, although a substantial part is still levied in the form of direct taxes.
It is important to note that an increase in VAT will not make export products more expensive. Companies are not required to pay VAT, while consumers must pay the VAT-rate of their home country. The adoption of a more VAT-based tax system would therefore help to decrease the ULC via a decrease in taxation on labor and depreciate the real exchange rate.
19 3.3.3 Reform 2: Reduction of government expenditures
The previous paragraph briefly mentioned that taxes are distorting which occurs when the level of tax rises. There are two ways in which high taxes could discourage production. The first is that high taxes create the incentive to produce less since the fruits of production are diminished. More importantly however, cutting expenditures is especially important. Ivanova (2012), Jaumotte and Sodsriwiboon (2010), Lane and Milessi-Ferretti (2011) and many other researchers all found significant positive effects of a cut in government expenditure on the current account and the real exchange rate. This is predominantly explained by the fact that government expenditure is generally on domestic markets. Governments favor domestic suppliers because this is politically less sensitive. Fiscal policy is therefore an important tool to correct current account imbalances now that many other channels no longer are an option for EMU members. Fiscal consolidation will help to decrease pressure on domestic demand and therefore decrease the domestic prices.
0,0 10,0 20,0 30,0 EU 27 BE DE IE EL ES FR IT NL PO
Taxes and duties on imports excluding VAT
Value added type taxes (VAT)
Taxes on income including holding gains
Taxes on the income or profits of corporations including holding gains
percentage of GDP Graph 3: EMU government revenue
20 3.4 Concluding remarks
This chapter identified several reforms that could be undertaken to ensure a smooth adjustability of RERs. The CCI should attempt to overcome adjustment costs and distributional effects associated with executing the reforms. Reforms need to be undertaken in the labor and product markets and budgetary reforms also need to be implemented. These reforms aim to reduce price and wage rigidities and increase productivity and competition. Although the reforms must be made in different fields, they are complementary to each other and should be implemented together. These reforms are accompanied by large distributional effects, adjustment costs and implementation costs. The CCI should attempt to alleviate these adjustment costs, thereby facilitating governments to implement the reforms. Now that the focus and purpose of the CCI is known, the following chapter can be used to discuss the design of the instrument. This thesis will conclude with an overview of the shortcomings of a CCI and the challenges that need to be overcome in the divergences of RERs.
21 4. Design of the Convergence and Competitiveness Instrument
The previous chapter identified several reforms that could help to depreciate the real exchange rate. As mentioned in the introduction of this thesis, there is little known about the specifics of the CCI. Although the European Commission communicated that the CCI would provide financial support to governments that are implementing structural reforms, the specific role that the CCI could play in these reforms has not yet been discussed. This chapter will make recommendations for the appropriate role of the CCI and under what conditions the funds should be made available. The chapter will start with recommendations about how the CCI funds should be used. The following paragraphs will discuss suggestions how to design appropriate reforms contracts.
4.1 How can the CCI help governments implement reforms?
The implementation of reforms is associated with costs to society. The goal of the CCI is to stimulate timely and targeted structural reforms so that the divergence of real exchange rates in the EMU is mitigated. Since these costs to society prevent governments of deficit countries to implement the reforms, the CCI aims to decrease these costs. It is therefore important to understand through which channels adjustment costs may arise. Adjustment costs can be categorized into three different sources.
Transition costs. These costs may arise from negative effects in the short term (benefits will occur in the longer term) such as a temporary increase in unemployment. It is important not to dismiss the importance of transition costs and focus on benefits in the long run. Short term costs are important since they limit the willingness of governments to reform. The purpose of the CCI is to decrease adjustment costs and to ensure the transition to a new, more flexible steady state.
Implementation costs are the costs associated with the time and resources that the government must expend to develop and implement the reforms.
Distributional costs are the final source of adjustment costs. Reforms almost always create winners and losers and in order to build consensus for reforms, it is important that the losers are compensated. Losers are likely to oppose the reforms and could resist reforms that would ultimately increase welfare. Well-designed compensation schemes could decrease the resistance towards the reforms. Distributional costs differ from transition costs in that only the distributional effects of reforms are taken into account. Transition costs are incurred when the aggregate welfare decreases in the short run, while reforms increase the aggregate welfare in the long run.
All three sources of adjustment costs are important and must be targeted by the CCI. In the upcoming paragraphs, adjustment costs from reforms in the labor market, product market and budgetary reforms will be discussed.
22 4.1.1 Role of the CCI in labor market reforms
The goal of the CCI is to help governments implement reforms and to help design reforms that are effective. Labor market reforms are often strongly opposed because these reforms have major consequences for the distribution of income.
The proposed reforms in this paper will likely decrease the unemployment in the middle and long terms. Increased flexibility comes at a cost: the volatility of unemployment will increase. To reduce the distributional and transition costs, it has already been argued that unemployment benefits must become more generous of flexicurity. The increased social safety net could make it easier for workers to accept the proposed change. Many of the reforms weaken the position of the employed and aim to decrease unemployment. Higher unemployment benefits are often believed to increase labor market rigidity since they offer negative incentives to the unemployed. This is however not the case when these higher unemployment benefits are conditional on mandatory training, reported job search and decreased duration of unemployment benefits. This conditionality must be accompanied by well-designed active labor market policies such as schooling projects and training programs. It should also be compulsory that the unemployed search for jobs. These active labor market policies are discussed in further detail in the following paragraph.
4.1.1.1 Assisting to reform unemployment benefits
Chapter 3 mentioned the Hartz IV reforms in Germany at the beginning of the 21st century. Social welfare was cut and the new welfare system had incentives built in to stimulate the unemployed to find work as soon as possible. Although there is evidence that the reforms succeeded in lowering unemployment and depreciated the real exchange rate of Germany, the resistance towards the reforms package was severe. However, the expected increase in inequality after the Hartz reforms did not occur. Biewen and Juhasz (2010) found evidence that the Hartz reforms slightly reduced inequality in Germany. Nevertheless, there was fear that the introduction of the reforms would lead to an increase in inequality. It is this public resistance toward the reforms that the CCI is attempting to overcome. Distributional costs can be decreased by designing compensation schemes for those who suffer welfare loss as a result of the reforms.
The proposed reforms will increase labor market flexibility but will also weaken the position of the unemployed. A more progressive tax system will certainly not compensate the unemployed for the loss in welfare. Labor market reforms will make it easier for employers to fire staff and it is likely that this will lead to unemployment in the short term. An increase in unemployment benefits will therefore in the short term lead to large costs for governments struggling with appreciated real exchange rates. The increase in government expenditure to finance unemployment benefits will only be incurred in the short run. As mentioned previously, there is proof that structural reforms will
23 lower unemployment, decreasing the total future costs of unemployment benefits. It is therefore recommended that the CCI provides financial support to governments to increase the unemployment benefits. When the economy has reached its new equilibrium, the CCI can stop its support since lower levels of unemployment will pay for the increase in unemployment benefits.
4.1.1.2 Supporting active labor market policies
Another lesson to be learned from the Hartz IV reforms is that unemployment benefits must be given on the condition of participation in active labor market programs. Active labor market programs are crucial for the successful reintegration of the unemployed into the labor market. When unemployment duration increases, deterioration of skills and knowledge makes it increasingly difficult to employ these workers. This could lead to hysteresis of unemployment after the economy has reached its new equilibrium (with a depreciated real exchange rate). Active labor market programs ensure smoother operation of the labor markets. The European commission recently published the article “Labor Market Developments in Europe 2012”, which provided evidence of the effectiveness of active labor market programs (European Commission, 2012). The European commission found that if the program is properly designed and implemented, it is effective in helping workers increase their skills in order to secure more suitable work. These programs decreased unemployment. This result is supported by Blundell, Dias, Meghir and Reenen (2004). They found that, if training programs are appropriately designed, the employment rate will increase by about 5 percentage points annually compared with the control group. However, if training programs are improperly designed, the effect on employment will be insignificant, small or even negative. Workers participating in the program could have even more trouble finding work than participants who did not participate since there is a stigma placed on this group. The empirical evidence regarding the impact of the programs differs greatly. Blanchard, Jaumotte and Loungani (2013) found evidence that poorly designed active labor market programs could decrease the job finding rate of the workers who participated in the program.
There are several ways in which active labor market programs could be designed. The next few paragraphs will discuss appropriate active labor market programs (according to the European Commission).
24 4.1.1.2.1 Training programs
Among active labor market policies, training programs are the most popular in the OECD. Evidence shows that the re-employment rate for participants of (adequate) training programs compared to non-participants is higher. When training programs are accompanied by a combination of wage subsidies, the effect increases (Martin and Grubb, 2001). Training is however only effective when the specific background of the worker is taken into account. Expanding existing work experience or finding apprentices is very effective for young and inexperienced workers, but do not help workers who are already highly educated or who already have a great deal of working experience. When unemployment benefits are conditional on participation in ALMP, these more experienced/educated workers should be offered different incentives. Wage subsidies or job search assistance is more likely to have a greater effect on the group of more experienced and educated workers.
4.1.1.2.2 Wage subsidies
The CCI could temporary provide resources to firms to hire additional labor in the short term. Growing literature supports the formerly unpopular use of such subsidies (if they are well designed). Jaenichen and Stephan (2011) estimated the effect on employment when the wages of participants are subsidized. They found that the employment rate is 25 to 42 percent higher relative to the control group that did not participate in an ALMP, even when the subsidy was terminated three years earlier. They concluded that employment subsidies have a positive effect on employment and further note that these results are in line with existing literature. The subsidies are very effective in promoting employment for workers that have been unemployed for a longer period. Since motivation and skill deteriorate over time, it is especially important for this group to find work soon.
4.1.1.2.3 Job search assistance
In order to decrease frictional unemployment, government agencies must help to find appropriate work. Although difficult to structure, it remains one of the most inexpensive ways to battle unemployment. These programs significantly impact the employment rate (Blundell, 2004) and decrease the duration of unemployment (Centeno, 2009). Although governments in the EMU already try to help workers find appropriate work, their efforts should be increased.
4.1.1.2.4 The government as “Employer of last resort”
Data from Eurostat (2012) shows that the expenditures on direct job creation are still an important part of active labor market programs in the EMU. Direct job creation by the government is one of the most expensive ways to battle unemployment. This is also one of the least successful ALMPs with regard to ensuring longer term employment. A variety of literature criticizes the effect of direct job
25 creation. Among others, Kluve (2010) found that direct employment programs in the public sector do not help to reduce long term unemployment. The use of such policies is therefore not recommended.
4.1.2 Role of the CCI in product market reforms
The reforms in competition and product market are politically less sensitive than reforms in the labor market since there are no major distributional costs. An increase in competition forces existing companies to work more efficiently. This leads to a temporary increase in unemployment since companies dismiss staff and try to keep ULC low. The costs of this increase can be mitigated by the set-up of a proper unemployment benefits system as discussed in the previous chapter. However, the main costs for product market reforms are the direct implementation costs. The CCI should therefore focus on compensation of direct implementation costs, and to a lesser extent focus on the distributional effects.
4.1.2.1 Subsidy for startups
Start-up incentives are only a small part of the total expenditure relative to the total amount of active labor market programs (Eurostat 2012). Germany however had success in offering start-up subsidies to the unemployed. In his paper, Caliendo (2009) found that Germany had succeeded in finding an effective way to support startups. Caliendo found that in 1994 over 37 thousand unemployed started their own company. This number increased steadily until in 2004 the number of startups was over 350 thousand individuals. The program responsible for this success was called the start-up-subsidy (SUS), or “Existenzgründungszuschuss” and was part of the aforementioned Hartz IV reforms. This SUS supported individuals who started a company with a fixed payment of 600 Euros per month in the first year, 360 Euros in the second year and 240 in the third. Another German start-up subsidy introduced in 1987 was the so-called "Überbrückungsgeld" (bridging allowance). Participants in this program were required to go to the German chamber of commerce to have a business plan approved. Should the participant succeed, then the German authority would pay social benefits to the participant regardless of the performance of the start-up.
The results of both programs have been celebrated, although little empirical research has been done on this subject to date. Caliendo (2009) presented one of the few empirical studies in this field. Caliendo found that at the end of the program, the unemployment rate of the participants of the Überbrückungsgeld was 25 percent lower than that of the control group. The Existenzgründungszuschuss program was even more successful. Caliendo found that this number was 34 percent lower for men and even 44 percent lower for women.
26 4.1.2.2 Simplifying procedures for setting up firms
In the EMU, the procedures for setting up a firm are not the same. This leads to a difference in time and cost to start businesses. High start-up time and costs are barriers for potential entrepreneurs that want to start a business of their own. In the Doing Business 2013 report of the World Bank (2012), the effect of simplification of entry requirements was discussed in multiple case studies. The World Bank found that in Colombia, a 5 percent increase in startups was realized after the implementation of a one-stop-shop in which new entrepreneurs could take care of all requirements at once. Another example was Portugal that implemented a one-stop-shop for under-educated
entrepreneurs. The World Bank found a 17 percent increase in the startup of new firms (World Bank Group 2012). Table 3 presents a list with the world rank of countries on starting a business.
Surprisingly, Germany is not a good place to start a business while Portugal scores very well. Either way, there are still great differences between EMU countries that could be overcome with the help of the CCI.
Reducing the number of procedures and cutting start-up time is associated with implementation costs. The CCI could assist by providing funds to realize simplification of procedures. For example, switching to online procedures and the training of public servants to manage this online application system requires IT professionals and training of public servants.
Country World Rank Number of procedures Minimum days before start-up is realized Cost (% of income)
Ireland 10 4 10 0.3 France 27 5 7 0.9 Portugal 31 5 5 2.3 Belgium 44 3 4 5.2 Netherlands 67 5 5 5.1 Italy 84 6 6 16.5 Luxembourg 93 6 19 1.9 Germany 106 9 15 4.9 Spain 136 10 28 4.7 Greece 146 11 11 20.5
