New IMF research: No evidence that labour market deregulation increases growth

In an analytical chapter prepared by the International Monetary Fund (IMF) for the April 2015 edition of its World Economic Output (WEO) report, to be released in full on 14 April, Fund researchers found no evidence that deregulatory labour market reforms could have a positive impact in increasing economies’ growth potential.

The finding is significant given that labour market deregulation has featured prominently in IMF loan conditions and policy advice for many countries, most notoriously so in several EU crisis countries.

The finding is included in an analysis based on data from sixteen G20 countries that attempts to explain a predicted slowing in potential output growth in advanced and emerging market economies.

The analysis identifies ageing populations, weaker investment and lower total factor productivity growth as the principal factors explaining the growth slowdown in both emerging and advanced economies.

However it expects that in the latter there will be a “gradual increase in capital growth from current rates as output and investment recover from the crisis”.

An annexed analysis in the WEO chapter on “The Effects of Structural Reforms on Total Factor Productivity” finds that “lower product market regulation and more intense use of high-skilled labour and ICT capital inputs, as well as higher spending on R&D activities, contribute positively and with statistical significance to total factor productivity…

In contrast, labour market regulation is not found to have statistically significant effects on total factor productivity, possibly owing to difficulty in measuring the degree of labour market flexibility across countries.”

The WEO chapter’s overall projection is that potential output growth in advanced economies will increase slightly from current rates “as some crisis-related effects wear off” but remain below pre-crisis rates.

However it states that in some advanced economies such as the euro area and Japan, “a protracted period of weak demand” could further erode potential growth.

In emerging market economies it predicts that potential output growth will decline further.

Additionally, it identifies geopolitical risks and continued weak commodity prices as factors that could negatively affect potential growth in some countries, and states that in China “potential growth prospects will depend crucially on the growth-rebalancing process”.

The WEO chapter has different recommendations for increasing potential growth in advanced and emerging market economies:


  • “In advanced economies, there is a need for continued demand support to boost investment and thus capital growth and for adoption of policies and reforms that can permanently boost the level of potential output … These policies would involve product market reforms, greater support for research and development… and more intensive use of high-skilled labour and information and communications technology capital inputs to tackle low productivity growth; infrastructure investment to boost physical capital; and better designed tax and expenditure policies to boost labour force participation.”
  • “In emerging market economies, the important structural reforms to improve productivity include removing infrastructure bottlenecks, improving business conditions and product markets, and hastening education reform. In particular, removing excessively restrictive regulatory barriers in product and labour markets, liberalizing foreign direct investment, and improving education quality and secondary and tertiary attainment can have large productivity payoffs in many emerging market economies.”


The inclusion of the recommendation to “remove regulatory barriers” in emerging economies’ labour markets is difficult to explain in light of the chapter’s conclusion that there is no statistically significant effect of labour market regulation on total factor productivity.

It appears to prove once again that at the IMF pre-conceived assumptions about the negative impact of labour market regulations count more than evidence.