The current low interest rate environment and the mildly expansionary fiscal stance on aggregate in the euro area provide a good opportunity for governments to minimise the short-run costs of labour market reforms. Finally, there are reforms in other areas of the economy that can compensate for some of short-term loss in disposable income that households might suffer in bad times[23]. Indeed, having the right sequence is a point often made: if you have to implement product and service market reforms as well as labour market reforms, then hold back with the latter[24]. The underlying reason is partly that the short-term negative macroeconomic effects are much greater when a liberalisation of, say, employment protection leads to a spike in unemployment than when product market reforms decrease excessive rents margins, to the immediate benefit of consumers. Another argument made is that product market reforms should be prioritised since they boost output regardless of the overall economic situation, and because they do not weigh on public finances. Why then have we seen exactly the opposite sequence in the euro area countries that have gone through significant reform in recent years, that is, labour market reforms before product and service market reforms? It’s because, unlike in the labour market, where a few changes can often produce major results, product and service market reforms are in practice made up of a huge array of small reforms.
Thus, we need to solve the “fairness/subsidy” issue, but do so in a way that ensures that the resulting regime is more stable, resilient and robust. The fairness/subsidy issue There is considerable debate about the size of the funding advantage of large banks that is due to too big to fail and how much this funding advantage creates incentives to become larger and more complex. One reason is that it is difficult to measure the size of these effects. For example, consider funding costs. We can document that larger banks’ unsecured debt funding costs tend to be lower than those for smaller banks. But the funding costs for larger firms across a broad range of industries also tend to be lower than for smaller firms in the same industries. This reflects, in part, the fact that the debt issues of larger firms tend to be more sizeable and more liquid. In addition, larger firms may be more diversified on average and thus less prone to failure, everything else equal. The measurement challenge, then, is to identify what portion of the lower funding costs at the largest financial firms, after accounting for these other factors, is due to a perception among investors that such firms are too big to fail. Despite these measurement difficulties, most of the evidence is consistent with a too big to fail funding advantage in banking.