And they include weak productivity trends, emanating from the precrisis period and reflecting in part the misallocation of resources into construction and other low productivity sectors.5 In this environment, stabilisation policies become less effective in boosting demand and an increase in demand becomes less effective in stimulating economic activity. Fiscal space is squeezed by high public debt, and the impact of monetary policy on investment and consumption is blunted by high private debt. The positive impact of higher demand on jobs is constrained by the partially structural nature of unemployment, such as the skill mismatch between job seekers and vacancies, low mobility of workers and the priority given to insiders. Moreover, it is also constrained by capital market fragmentation, i.e. the inability to channel savings where investment is needed to create jobs. And absent other policies, stimulating demand may in fact only delay the necessary restructuring of the economy towards higher productivity sectors. This is where supply-side policies – by which I mean structural reforms – can help empower demand. By raising potential growth and hence future income, structural reforms create more space for governments, firms and households to spend today. By reactivating and reskilling the workforce, they allow employment respond faster to that higher demand. And by helping the economy to restructure, they ensure that higher demand is channelled towards the right sectors, and thus accelerates rather than retards the creative destruction process.
This seems to be feeding, with about a two years delay from the start of reforms, into a gradual recovery in employment. But these achievements are not yet showing any signs of feeding into productivity growth. Total factor productivity has actually fallen by 0.8% in the euro area since 2008, whereas in the US it has grown by almost 7% in the same period. Higher competitiveness may well contribute to raising productivity, but we know that cheap labour alone will not produce innovative firms. Thus, I see a need today to rebalance our focus: to focus less on achieving internal devaluation, and more on raising productivity. And this entails a broader set of reforms than countries have adopted thus far. Creating a productivity-enhancing environment For advanced countries in today’s globalised economy, productivity is increasingly linked to investment in knowledge-based capital and moving closer to the technological frontier, especially in high value-added sectors such as the digital economy. While this is ultimately about the effort and ideas of individuals, not governments, public policy plays a crucial role in creating the right environment.