A. Adapt Advice to Different Jobs and Growth Challenges

14. This section provides pointers to the most relevant jobs and growth challenges across countries. Further information, including relevant literature, is available through the Surveillance Toolkit for Jobs and Inclusive Growth (see Box 1). Key questions to consider in the context of different jobs and growth challenges are listed in Table 3.⁴

Table 3.

Key Questions on Specific Jobs and Growth Challenges

Table 3.

Key Questions on Specific Jobs and Growth Challenges

Take Account of the Business Cycle
Identify the country’s position in the business cycle. In case of recession/recovery, focus on boosting aggregate demand with due regard to fiscal and other space.		Should aggregate demand management be accompanied by structural reforms, and which reforms would be most useful? How long would the benefits of the structural reforms take to materialize? Are there short-term adverse effects and how can they be mitigated?
Address Country Specific Challenges
Advanced Economies Challenges
What are the key bottlenecks to growth, jobs, and equity? What are the key barriers to increased productivity growth? Is population aging an issue?		Identify structural reforms that address, or get around, the key bottlenecks. Identify any adverse impacts of needed structural reforms and propose measures to mitigate them. If aging is an issue, consider how the growth of health and pension expenditure can be limited while maintaining adequate health and pension insurance. Also identify other needed adjustments, such as policies to raise productivity and labor supply.
Developing Economies Challenges
What is the share of work in the formal market and how many people are poor though working? Is there discrimination in the access to productive resources? What are the problems and opportunities posed by the demographic transition? What are the main external shocks and who is most affected by them? In which sectors are growth and employment concentrated? How can diversification be achieved? How can a shift from unproductive to productive activities be achieved? Is the given income distribution helpful in fostering growth?		Focus on job creation strategies: Find strategies to increase private sector and human capital investment. Advise on policies to provide equal access to productive resources for all parts of the population: Propose tackling infrastructure and transportation bottle necks, deepening financial inclusion, and providing access to education and health care. Advise on measures (such as targeted transfers) to limit the exposure of the most vulnerable to external shocks.
Middle-Income Challenges		Low-Income Challenges
Identify the major risks to remaining in the “middle-income trap” and develop a strategy for avoiding it. What are the policy lessons from other MICs and would similar policies work given the specific country characteristics? Can a more equal income distribution help prolong the highgrowth episode and which are appropriate policies to generate redistribution? Do high public sector wages negatively affect job creation in the private sector?		Are current growth policies consistent with the aim of poverty reduction? Do privileges held by a minority undermine growth? In cooperation with other institutions: What is the role of institutions, stability, education, and trade and financial openness in boosting growth?
Low Labor Force Participation in Certain Groups	Fragile States and Small States	Resource-Rich Developing Countries
What are the growth and stability implications of a part of the population (for example women) limiting their participating in the labor market? What are the disincentives for these groups to join the labor market and how can they be removed? Would a different tax regime help (see section III.C)? What other measures could help (e.g., better access to childcare)? See IMF (2013b).	Identify institutional weaknesses: How do they affect proposed macroeconomic and structural policies? What is the political context? Are there opportunities for “quick wins” and what are key structural reforms? Do high public wage bills, government intervention, and reliance on trade tax revenues undermine growth or limit fiscal space for growth promoting policies? Collaborate closely with donors. See IMF (2011) and IMF (2013a).	Advise on: Transforming depleting resources wealth into a portfolio of other assets (e.g. human and physical capital) Policies to avoid boom-bust cycles Improving institutional quality and governance See IMF (2012d).

View Table

Table 3.

Key Questions on Specific Jobs and Growth Challenges

Take Account of the Business Cycle
Identify the country’s position in the business cycle. In case of recession/recovery, focus on boosting aggregate demand with due regard to fiscal and other space.		Should aggregate demand management be accompanied by structural reforms, and which reforms would be most useful? How long would the benefits of the structural reforms take to materialize? Are there short-term adverse effects and how can they be mitigated?
Address Country Specific Challenges
Advanced Economies Challenges
What are the key bottlenecks to growth, jobs, and equity? What are the key barriers to increased productivity growth? Is population aging an issue?		Identify structural reforms that address, or get around, the key bottlenecks. Identify any adverse impacts of needed structural reforms and propose measures to mitigate them. If aging is an issue, consider how the growth of health and pension expenditure can be limited while maintaining adequate health and pension insurance. Also identify other needed adjustments, such as policies to raise productivity and labor supply.
Developing Economies Challenges
What is the share of work in the formal market and how many people are poor though working? Is there discrimination in the access to productive resources? What are the problems and opportunities posed by the demographic transition? What are the main external shocks and who is most affected by them? In which sectors are growth and employment concentrated? How can diversification be achieved? How can a shift from unproductive to productive activities be achieved? Is the given income distribution helpful in fostering growth?		Focus on job creation strategies: Find strategies to increase private sector and human capital investment. Advise on policies to provide equal access to productive resources for all parts of the population: Propose tackling infrastructure and transportation bottle necks, deepening financial inclusion, and providing access to education and health care. Advise on measures (such as targeted transfers) to limit the exposure of the most vulnerable to external shocks.
Middle-Income Challenges		Low-Income Challenges
Identify the major risks to remaining in the “middle-income trap” and develop a strategy for avoiding it. What are the policy lessons from other MICs and would similar policies work given the specific country characteristics? Can a more equal income distribution help prolong the highgrowth episode and which are appropriate policies to generate redistribution? Do high public sector wages negatively affect job creation in the private sector?		Are current growth policies consistent with the aim of poverty reduction? Do privileges held by a minority undermine growth? In cooperation with other institutions: What is the role of institutions, stability, education, and trade and financial openness in boosting growth?
Low Labor Force Participation in Certain Groups	Fragile States and Small States	Resource-Rich Developing Countries
What are the growth and stability implications of a part of the population (for example women) limiting their participating in the labor market? What are the disincentives for these groups to join the labor market and how can they be removed? Would a different tax regime help (see section III.C)? What other measures could help (e.g., better access to childcare)? See IMF (2013b).	Identify institutional weaknesses: How do they affect proposed macroeconomic and structural policies? What is the political context? Are there opportunities for “quick wins” and what are key structural reforms? Do high public wage bills, government intervention, and reliance on trade tax revenues undermine growth or limit fiscal space for growth promoting policies? Collaborate closely with donors. See IMF (2011) and IMF (2013a).	Advise on: Transforming depleting resources wealth into a portfolio of other assets (e.g. human and physical capital) Policies to avoid boom-bust cycles Improving institutional quality and governance See IMF (2012d).

Jobs and Growth Challenges in Advanced Economies

15. Beyond addressing any near-term cyclical challenges, such as boosting aggregate demand in the aftermath of the Great Recession, advanced countries need to tackle longer-term issues. Many advanced countries are now at a stage in their structural transformation where labor is increasingly reallocated from high-productivity manufacturing to lower-productivity services (OECD, 2012; ILO, IMF, OECD and World Bank, 2012). Hence overcoming barriers to increased productivity growth in services is one of the key structural challenges facing advanced economies. New sources of growth may also be needed in some countries, for example where earlier models based on financial services and construction have proved unsustainable.

16. Many advanced countries also face challenges to long-term growth stemming from population aging. This challenge needs to be addressed through structural reforms that gradually increase labor supply, including of women where relevant, and ensure adequate buffers to counter future increases in health and pension related expenditures.

17. Further, many advanced countries face growing inequality. Fund research has found that technological change has been a main driver of inequality and that financial globalization has contributed as well, particularly where it led to balance of payments or banking crises, while trade globalization has tended to lower inequality (Jaumotte et al., 2013). Overall, however, the debate about the drivers of inequality is not yet settled.

Jobs and Growth Challenges in Developing Economies

18. Jobs and growth issues in developing countries are complicated by a list of factors: a much smaller proportion of workers are employed in formal jobs than in advanced countries; there tends to be significant underemployment, and thus a prevalence of working poor; labor markets tend to be fragmented; and mobility is more limited. Many developing countries are also facing a demographic bulge with large increases in the working age population, creating both challenges and opportunities. Thus, in these countries, job creation strategies need to be focused on creating the conditions for higher investment by the private sector (quality infrastructure including in agriculture, well functioning financial intermediation, and strong institutions of governance), equipping workers with basic education and job relevant skills, and protecting the working poor who are most exposed to shocks (including from weather cycles and other natural disasters).

19. Many developing countries still face the challenge of strengthening growth through structural transformation and diversification (World Bank, 2012). For many developing countries and even some emerging markets, structural transformation needs to occur through more rapid reallocation of labor from agriculture to industry and services, where TFP growth is higher. Reallocation across sectors needs to be complemented by the movement of labor out of lower-productivity firms in manufacturing and services into higher-productivity firms within those sectors. Reallocation both across and within sectors will require significant physical capital accumulation, investment in human capital, and equal access to education and health services. However, these processes take time, limiting the extent to which structural transformation can absorb labor from agriculture in countries with large shares of agricultural employment in the medium term. In such cases, raising the productivity in agriculture is an important medium-term goal for poverty reduction and growth. Another driver of rapid growth in developing countries is diversification. Imbs and Wacziarg (2003) document that higher incomes per capita are associated first with diversification, and then with reconcentration, in production and employment.

20. In addition, many developing countries face high and growing inequality. In rapidly growing countries, this may reflect rapid structural change, in line with Kuznets’ theory of rising inequality in earlier stages of development. In others, high inequality may instead reflect a lack of economic and political inclusion and market imperfections that allow an elite to capture large rents. Some extent of income redistribution, including by removing privileges that lead to capture by a few, is therefore likely an important prerequisite for accelerating growth in these countries.

Jobs and Growth Challenges in Other Country Groups

21. Several country groups face particular challenges:

• Middle-income countries: IMF (2012a) acknowledges that the latest slowdown in Asia could possibly reflect the middle-income trap some countries in the region are starting to face. IMF (2012b) Chapter 4 investigates growth episodes in low-and middle-income countries in recent years and documents increased growth resilience due to improved policy and lower incidence of shocks. Berg and Ostry (2011) find that a more equal income distribution can contribute to prolonging a growth spell, hence underscoring the need for policymakers to pay attention to income inequality not just for its own sake but to also in their quest to ensure sustainable growth. Aiyar et al. (2013) document a higher risk for a growth slowdown for middle-income countries than for other countries and identifies the macroeconomic determinants of this slowdown that are amenable to policy interventions.

• Low-income countries, particularly in Africa: Studies (e.g., IMF, 2012c) have focused on the factors behind growth differentials between African countries and other developing and low- income economies, as well as the drivers of growth take-offs and growth-spells. While there is evidence that episodes of growth take-off have occurred under different sets of initial economic conditions, several factors have been typically identified as potential constraints on sustained growth, including factors related to: (i) institutions; (ii) macroeconomic, social, and political stability; (iii) trade and financial openness; (iv) education; (v) saving and private investment; and (vi) inequality.

• Resource-rich developing countries: Fund staff reports, case studies (e.g., Sala-i-Martin and Subramanian, 2003; Limi, 2006; and Aydin, 2011) and cross country analysis (Arezki et al., 2011; Arezki et al., 2012; and IMF, 2012d and references therein, and Lundgren et al., 2013) identify the following main interconnected areas of interventions to support sustained development in resource-rich developing countries:⁵

  • Transforming depleting resources wealth into a portfolio of other assets, including human capital, domestic public and private capital, and foreign financial assets. While avoiding an unsustainable consumption path is key, some frontloading of public spending can improve welfare as future generations can be expected to be wealthier. The savings rate out of resource flows should be, other things equal, higher when resource inflows are short-lived and increase when time to depletion is closer.

  • Avoiding boom-bust cycles that stem from volatility in natural resource prices. In countries with a long resource horizon, the core focus should be on managing the impact of resource price volatility, and fiscal rules based on the “structural primary balance” can help de-link spending from the volatile revenue swing. In countries with a short resource horizon, more focus should be on the exhaustibility of revenue, and fiscal targets based on the non-resource primary balance are particularly helpful.

  • Improving institutional quality and governance. Given capacity and absorption constraints in resource rich developing countries, it is critical to strengthen institutions, especially public financial management systems, and to enhance transparency of both resource revenue and fiscal spending. The more limited the country’s capacity, the more of the windfall should be saved in an asset development fund while investment capacity is built domestically. Governance should also be strengthened to ensure investment into most profitable projects.

• Fragile states face particular challenges such as pervasive institutional weakness and often elevated levels of violence. IMF (2011a) provides suggestions for how the Fund can best assist these countries. It calls for (i) an explicit consideration of the political context to improve the prospects of reform, (ii) a well-tailored pace of macroeconomic adjustment, (iii) close collaboration with donors, and (iv), given the typically low capacity of these countries, for a strictly prioritized and gradual agenda of key structural reforms.

• Small states often exhibit high government wage bills, high levels of state intervention, not fully developed financial sectors, heavy reliance on trade tax revenues, and the use of fixed exchange rates. Many of them also face slow growth, high levels of public debt, and the risk of natural disasters. While pointing to the heterogeneity across small states, IMF (2013a) gives the following policy guidance:

  • High public debt levels require fiscal consolidation accompanied by structural reforms and, in some cases, more exchange rate flexibility.

  • In many countries, stability risks arising from large and concentrated financial sectors call for an enhancement of the legal and supervisory infrastructure and, in many cases, the reduction of domestic public debt.

  • Macroeconomic vulnerability to natural disasters can be reduced by: (i) identifying and integrating natural disasters into the macro frameworks, (ii) ensuring sufficient fiscal and external space and flexibility to redeploy spending rapidly and mitigate BOP shortfalls, (iii) exploring how to promote insurance coverage, (iv) strengthening cooperation among multilateral institutions, (v) improving transparency to ensure effective use of disaster assistance, (vi) using reconstruction to pursue growth-enhancing structural reforms, and (vii) preventing a weakening of external competitiveness.

• Countries with low labor force participation among women or other demographic groups: In countries where the gender gap is of particular importance, the Fund can analyze the impact of low female labor force participation on economic growth to better inform the dialogue with the authorities about policies aimed at enhancing opportunities for women (see IMF (2013b) for an analysis of the gender aspects of jobs and growth).⁶ For instance, the Fund can assist its members in reviewing tax codes to identify and remove provisions that discourage second earners, and could provide other policy options to boost the labor supply of women, such as child care. In developing countries, female labor force participation can be enhanced through equal access to health and education services, legislation allowing women to participate in the labor market on an equal basis, and the removal of bottlenecks in infrastructure and transportation. Similarly, in countries with limited opportunities for older workers, analysis could focus on removing disincentives for labor force participation by the elderly, including though pension reforms. More generally, Fund analysis and advice with regard to fiscal policies should where relevant take into account the potential impact of measures on under-represented groups, including women, older workers, and the young. Specifically, the Fund can assess whether tax regimes and the allocation of public resources contribute to better opportunities for these groups.

B. Focus Structural Reforms on Key Constraints and Address Any Adverse Short-Term Effects

22. Staff is encouraged to try to identify some of the key constraints to growth, possibly in cooperation with other institutions, and focus on reforms that will remove or get around those constraints. Identification of key constraints is a recommendation of the growth diagnostics framework proposed by Hausmann, Rodrik, and Velasco (2006). The framework is presented in Annex 1. A number of Fund country reports and papers have applied the framework and could serve as a reference for staff. For example, Moore and Vamvakidis (2007) use the framework to examine the constraints that affect potential growth in Croatia and policies that can influence them. Lledo (2008) carries out a growth diagnostics exercise to identify governance, finance, and regulatory issues as key constraints to a thriving private sector in Mozambique, consistent with a benchmarking exercise against better-performing comparator countries. Rungcharoenkitkul (2012) combines the growth diagnostics approach with a quantitative model to identify the infrastructure gap as one of the biggest impediments to higher growth and calculate the growth dividend of its mitigation in Cambodia.

23. Staff should be mindful of uncertainties regarding the timing and size of the effects of structural reforms on growth, and aim to counter any potential adverse short-term effects (Box 2). The experience of countries with high and sustained growth suggests that there are a variety of ways in which reforms can be combined to deliver growth. In addition, it is advisable to exercise caution in linking projected increases in growth to specific structural reforms and to allow for the fact that effects may accrue only after substantial and hard-to-predict delays. Also, staff should assess the potential adverse short-term effects and consider how these could be countered.

Box 2.

Impact of Structural Reforms on Productivity and Growth

Evidence on the growth impact of structural reforms is mixed. Results are not always precise, and small specification or measurement changes can result in starkly different conclusions (Levine & Renelt, 1992). Moreover, to the extent they often focus only on successful episodes, many studies have been potentially muddied by selection bias—there have been over 80 cases of sustained growth accelerations since 1950, but cross-country regressions reveal little about their underlying cause and they are not always correlated with reform episodes (Hausmann et al., 2005). Indeed, detailed case studies accounting for political and implementation constraints suggest that reforms made in response to immediate pressures, and with a lack of electoral support, are often less successful (Tompson & Dang, 2010).

Reform benefits only accrue over time, with sometimes adverse or uncertain near-term prospects. Although cumulative returns over the long horizon are typically positive, the near- to medium-term payoff for some reforms, such as labor and product market reforms, can be negative, particularly when economic activity is already depressed (IMF, 2004, IMF, 2006, Barkbu et al.,2012, Bernal-Verdugo et al, 2012, Bouis et al., 2012). Tax-system reforms by contrast, offer substantial benefits even in the short run.

Product market reforms tend to have the largest impact on growth. Product market reforms (PMR), such as reforms of rules affecting market access, seek to promote competition and can increase productivity. Estimates suggest that, for OECD countries, the average change in PMR over 1998-2003 likely led to a 9 percentage point increase in GDP per capita after 10 years. This contrasts with much smaller impacts from labor market reforms (see table). Human capital reforms also contribute sizeable contributions to output, although these effects tend to have a much longer lag. For example, reforms to the quality and quantity of education in OECD countries between 1995 and 2004 increased GDP per capita by 3.7 percentage points but would take 50 years or longer to have their full effects (Barnes et al, 2013).

Response of Real Percapita GDP to a 1 s.d.

Increase in Reform indicator

Citation: Policy Papers 2013, 078; 10.5089/9781498341301.007.A001

Source:WEO (Apr 2004)

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Response of Real Percapita GDP to a 1 s.d.

Increase in Reform indicator

Citation: Policy Papers 2013, 078; 10.5089/9781498341301.007.A001

Source:WEO (Apr 2004)

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Response of Real Percapita GDP to a 1 s.d.

Increase in Reform indicator

Citation: Policy Papers 2013, 078; 10.5089/9781498341301.007.A001

Source:WEO (Apr 2004)

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The impact of structural reforms on growth can be assessed using the country’s distance to an estimated global best-practice frontier. The first step is to gauge each country’s output relative to an estimated global best-practice frontier, taking into account the country’s factors of production (physical and human capital, labor, etc). This approach not only provides a transparent assessment of each country’s catch-up potential, but is also motivated by the recent growth literature, which notes that the effectiveness of different types of reform will depend on a country’s proximity to the frontier (Aghion & Durlauf, 2007; Prati et al, 2013). The frontier can be estimated using statistical techniques,¹ or can be approximated instead by identifying an ex ante global leader, which then serves as a benchmark.² Having identified the best-practice frontier, the gap between this benchmark and a country’s actual performance serves as an indicator of country-level “efficiency”—a country lying on the frontier can be deemed to have an efficiency level of 100 percent. The second step is to examine the link between the efficiency measure and various indicators of structural reform. In one staff study (Tiffin, 2013), the reform effort is proxied by movements in the Fraser Institute’s regulatory liberalization index, which captures the extent of regulation in the labor, product, and credit markets. The results suggest that less-burdensome regulations (represented by a higher index score) are typically associated with greater efficiency (see chart). This effect is particularly pronounced for low- and middle-income countries, where catch-up gains are more readily available, but it is still significant even for the subset of high-income countries. In a middle-income country, for example, a one standard-deviation improvement in the reform index is associated with a 9½ percentage point increase in efficiency. For a high-income country, the impact is around 5 percentage points. It should be noted here that some regulations may reflect a conscious tradeoff between efficiency and equality, but the details of this tradeoff – and the availability of Pareto improvements – are likely to be country specific. Depending on the country in question, a rough estimate of the impact of reform on TFP can then be added to factor-of-production projections to arrive at a forecast for potential growth. Staff studies have also investigated “headwind” factors that may delay the payoff from reform. Looking mainly at high-income countries, high debt levels, exchange-rate rigidity, or low levels of human capital seem to slow the pace at which countries converge to the frontier. Other staff studies have stressed that growth payoffs may depend critically on the sequencing of reforms, particularly for developing economies (IMF, 2008).

As an alternative, staff simulations have also drawn on structural macroeconomic models to estimate the impact of reform. In this approach, economic inefficiency is viewed as the result of limited competition and economic rents. So, an improvement in efficiency is modeled formally as a reduction in the markup between marginal costs and prices. In this regard, GIMF is well suited for the analysis of structural reforms, owing to the explicit presence of monopolistic competition in both product and labor markets (see Lusinyan & Muir, 2012, and IMF 2013c). Analogous to the frontier approach above, modeling structural reform in this manner often entails calibrating the gap between a country’s markup parameters and those of a world leader (or regional average), and then assuming that (part of) this gap is closed over a pre-specified time period. The pace of improvement is based either on the experience of others, or is simply assumed ex ante. The frontier and modeling approaches both have benefits. The former is less technically demanding and provides an intuitive framework that can be applied across a broad range of income classes. The latter approach, on the other hand, provides a more complete set of projections (output, prices, exchange rates, etc) and may allow for a richer discussion of policies—including a more finely crafted representation of the reform package under consideration, as well as the potential impact of offsetting monetary or fiscal measures.

Impact of Regulatory Burden, 2000-07

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Impact of Regulatory Burden, 2000-07

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Impact of Regulatory Burden, 2000-07

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Study	Country Sample	Estimated Impact on Growth
Product market reforms
Barnes et al. (2013)	OECD	9 ppt increase in GDP per capita after 10 years due to the change in product market regulation implemented by OECD countries on average between 1998-2003
Bayoumi et al. (2004)	Euro area and US.	8.6 ppt level increase in GDP in the long run by reducing the price mark-up in the euro area to US levels.
Cincera and Galgau (2005)	9 EU countries	0.6 ppt increase in labor productivity and 2.7 ppt increase in employment growth from reforms to increase the firm entry rate.
Salgado (2002)	20 OECD	0.2-0.3 ppt increase in TFP growth in the long run, weak results in the short run from product market reforms implemented over 1985-1995.
Tang and Verveij (2004)	EU	1 ppt level increase in GDP from a 25% reduction in administrative burdens.
Labor market reforms
Barnes et al (2013)	OECD	0.9 ppt increase in GDP per capita after 10 years due to the change in labor market policies implemented by OECD countries on average between 1996 and 2006.
European Commission (2010)	EU	0.3 ppt increase in potential output in the long-run from a 1% tax shift from labor to VAT.

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Study	Country Sample	Estimated Impact on Growth
Product market reforms
Barnes et al. (2013)	OECD	9 ppt increase in GDP per capita after 10 years due to the change in product market regulation implemented by OECD countries on average between 1998-2003
Bayoumi et al. (2004)	Euro area and US.	8.6 ppt level increase in GDP in the long run by reducing the price mark-up in the euro area to US levels.
Cincera and Galgau (2005)	9 EU countries	0.6 ppt increase in labor productivity and 2.7 ppt increase in employment growth from reforms to increase the firm entry rate.
Salgado (2002)	20 OECD	0.2-0.3 ppt increase in TFP growth in the long run, weak results in the short run from product market reforms implemented over 1985-1995.
Tang and Verveij (2004)	EU	1 ppt level increase in GDP from a 25% reduction in administrative burdens.
Labor market reforms
Barnes et al (2013)	OECD	0.9 ppt increase in GDP per capita after 10 years due to the change in labor market policies implemented by OECD countries on average between 1996 and 2006.
European Commission (2010)	EU	0.3 ppt increase in potential output in the long-run from a 1% tax shift from labor to VAT.

¹ A pre-specified best-practice production function can be estimated parametrically, using techniques such as stochastic frontier analysis (see Tiffin, 2006, or IMF, 2013d), or the frontier can be instead identified non-parametrically, using techniques such as data envelope analysis (see Mattina & Gunnarson, 2007, or Ramanathan, 2005).² See IMF, 2013e.

C. Advise on Fiscal Policies for Higher Growth and Employment and a More Equal Income Distribution

24. Fiscal revenue and spending policies have important effects on growth, employment, and income distribution. In some cases, a certain fiscal policy may support growth, employment, and equality. In others, however, there may be trade-offs. It is therefore important that staff assess the impact of fiscal policies on all three target variables (growth, employment, and, where relevant, income distribution), and recommend policies that promote the overall best outcome, taking into account sustainability requirements and country preferences. In many cases, it will be possible to offset undesired outcomes by designing appropriate structures of taxation and spending. For example, the impact of a high uniform value added tax on the purchasing power of lower-income groups can be offset through targeted transfers (provided there is sufficient administrative capacity for targeted transfers). This said, there may be limits to what can be achieved in some circumstances. In particular, there may be limits to the extent of income redistribution that can be achieved while also maintaining growth. Research on these limits is ongoing at the Fund. Its results will be reflected in future versions of this guidance note.

Fiscal Policy to Support Growth

25. Fiscal policy can help boost growth by contributing to macroeconomic stability over the short- and long-term and improving the supply side capacity of the economy. The role of fiscal policy as a tool for macroeconomic demand management is not examined here.⁷ In some cases, policy reforms that boost growth can potentially have unintended adverse effects on equity. However, appropriate policy design (for example, better targeting of spending to the poor) can allow countries to strengthen growth while preserving equity.

26. Expenditure reforms in advanced countries:

• Reforming public sector wages and social welfare benefits. Countries where public sector wages are above those prevailing in the private sector should focus on containing these outlays. Reducing public sector employment and the wage bill can boost growth by putting downward pressure on the equilibrium wage in the private sector (Ardagna, 2004). Reforms of social welfare benefits that link the receipt of social benefits to work (in work-benefits) or participation in effective active labor market policies (ALMPs) can also increase incentives for labor force participation. Greater use of means-testing (which affects less than 10 percent of social benefit spending in the OECD) can create fiscal space while preserving benefits for those most in need (Adema and Ladaique, 2009).

• Containing increases in age-related spending. This is necessary to avoid placing an even heavier burden on more productive spending. Health and pension spending consumes close to half of government non-interest spending. Over the 2013-30 period, pension spending is expected to rise by 1½ percentage point of GDP (unweighted; weighted average, 1½ percent of GDP), while health spending will rise by 1½ percentage points (unweighted; weighted average, 2¾ percent of GDP, see Clements et al., 2012a; Clements, et al., 2012b; IMF, 2013g). Reform of age-related spending will thus need to be a necessary ingredient in advanced countries’ fiscal structural reforms in coming years.⁸ Pension reforms that help increase the number of years worked, such as raising the retirement age, will also have a salutary effect on growth (Karam et al., 2010) while helping contain projected spending increases. Reforms of age-related spending will need to be designed in a manner that maintains adequate levels of protection against poverty. For example, pension reforms that reduce benefit levels should be carefully assessed in terms of their impact on poverty; in some cases, benefits for low-income pensioners may need to be maintained in light of equity objectives. On health care, reforms to slow the growth of public expenditure should be designed to maintain the access to basic health care services for low-income groups. For example, the poor may need to be exempted from reforms that attempt to rationalize the use of health services by raising copayments (Clements et al., 2012b).

• Preserving spending on public investment that addresses infrastructure bottlenecks. The empirical literature suggests that fiscal adjustments focused on cuts in wages, subsidies, and transfers, rather than public investment are the least damaging for long-term growth (Hauptmeier et al., 2006; Kumar, et al., 2007; and Gemmell, et al., 2009).⁹

27. Tax reforms in advanced countries: Changes in the composition of tax revenues can help foster stronger economic growth. Income taxes and social contributions have the most adverse effects on growth, followed by consumption taxes, while property taxes have the lowest output impact (Arnold 2008).^{10 11} At the same time, the design of a tax also matters for its impact on growth (IMF, 2013g). For example, improving the design of corporate tax systems can reduce vulnerability to crises (and, in turn, their impact on growth) by reducing the bias toward debt financing (Keen, Klemm, and Perry, 2010; IMF, 2013g). In addition, targeted tax relief can boost labor supply including for low-income workers and secondary earners (typically women) (IMF, 2012f). Eliminating distortive tax expenditures and reducing tax evasion should also be considered, as these help raise revenues in a more “growth-friendly” way than rate increases. Furthermore, there is scope for a greater use of corrective taxes. Energy taxation can correct prices that are below the levels that would fully capture externalities such as the effects of energy consumption on greenhouse gas emissions (Clements et al., 2013). Increasing these taxes can increase welfare and help avoid the need to raise other taxes that could impinge on economic efficiency. Finally, appropriately-designed financial sector taxes may either offset distortions from the value-added tax (VAT) exemption of financial services (Financial Activities Tax) or internalize externalities from excessive risk taking (Financial Stability Contribution; see IMF, 2010).

28. Expenditure reforms in developing countries: Reforms should focus on improving both the composition and efficiency of public spending. ¹²

• Reallocating spending toward productive activities: Spending should be reallocated away from unproductive activities toward those that can support the development of human and physical capital. Spending that should be examined for rationalization includes energy subsidies, which disproportionately benefit upper-income groups and retard growth (Arze del Granado et al., 2012); the government wage bill, especially where public sector wages are high relative to the private sector and public sector employment is high; ¹³ and social benefits where these disproportionately benefit upper-income groups. The empirical literature suggests that reallocating this spending toward education, health, and public investment could have positive effects on growth (Baldacci et al., 2008; and Arslanalp et al., 2010).¹⁴

• Replacing generalized subsidies with more targeted income assistance. This helps allocate resources to their most productive use while maintaining protection for the poor. A challenge for many countries in this respect is energy subsidy reform. Clements et al (2003), drawing on country experiences, identifies six key elements of successful energy subsidy reform: (i) a comprehensive reform plan entailing clear long-term objectives, an impact analysis, and consultation with stakeholders; (ii) an extensive communications strategy, supported by improvements in transparency; (iii) appropriately phased price increases; (iv) the improvement of state-owned enterprise efficiency; (v) institutional reforms that depoliticize energy pricing; and (vi) targeted measures to protect the poor from the price increases.

• Improving efficiency: Many countries could improve their delivery of essential public services to support growth by improving the efficiency of spending. In health, for example, at least 20-40 percent of spending is typically wasted (World Health Organization, 2010), and there is scope for substantial gains in health indicators at current levels of spending (Grigoli and Kapsoli, 2013). The link between public investment and growth can also be strengthened in many countries by improving project selection and implementation (Gupta et al., 2011). Other reforms in public financial management (PFM) that improve the quality of budget formulation, execution, and reporting can also be helpful in improving the efficiency of spending by ensuring that public funds are spent as intended.

29. Tax reform in developing countries: Tax reform, including with a view to raising a higher volume of taxes, is essential to finance higher levels of productive and pro-poor spending while maintaining a sustainable fiscal position.¹⁵ As in advanced economies, tax reform can also boost growth by making the tax system more efficient.¹⁶ The efficiency objective can be met in principle with low and relatively uniform tax rates imposed on broad tax bases. For example, the VAT should have a single rate with exemptions limited to the extent possible. The base for corporate income tax should also be broadened by rationalizing tax incentives. Furthermore, greater emphasis could be placed on raising revenues from property taxes. Improving tax and customs administration could also help raise revenue without raising tax rates and improve the efficiency of the tax system.

Table 4.

Potential Fiscal Policy Measures to Support Growth

Table 4.

Potential Fiscal Policy Measures to Support Growth

	Advanced Economies	Developing Economies
Tax Policy	Improve the composition of tax revenues in light of the effects of different taxes on growth (from low to high impact on growth: property tax, consumption taxes, and income taxes and social contributions). Reform corporate taxes to reduce bias toward debt financing. Adopt targeted tax relief to boost labor supply. Eliminate distortive tax expenditures and reduce tax evasion. Enhance use of corrective taxes (such as energy taxes). Reform financial sector taxes to offset distortions (from VAT exemptions) or internalize externalities from excessive risk-taking.	Limit VAT exeptions to the extent possible. Rationalize tax incentives in corporate tax system. Raise tax revenues from property taxes. Improve tax and customs administration. Enhance use of corrective taxes (such as energy taxes)
Expenditure Policy	Reduce the wage bill where public sector wages exceed prevailing wages in the private sector. Link the receipt of social benefits to work or participation in effective ALMPs. Enhance use of means-testing. Contain increases in age-related spending. Preserve spending on public investment that addresses infrastructure bottlenecks.	Reduce untargeted energy subsidies. Contain government wage bill and employment where they are high relative to the private sector. Reallocate spending toward education and health, and toward public investment where this addresses infrastructure bottlenecks. Improve the efficiency of public spending—examine opportunities to deliver services with lower level of inputs (including employment). Improve project selection and implementation in public investment. Implement other PFM reforms.

View Table

Table 4.

Potential Fiscal Policy Measures to Support Growth

	Advanced Economies	Developing Economies
Tax Policy	Improve the composition of tax revenues in light of the effects of different taxes on growth (from low to high impact on growth: property tax, consumption taxes, and income taxes and social contributions). Reform corporate taxes to reduce bias toward debt financing. Adopt targeted tax relief to boost labor supply. Eliminate distortive tax expenditures and reduce tax evasion. Enhance use of corrective taxes (such as energy taxes). Reform financial sector taxes to offset distortions (from VAT exemptions) or internalize externalities from excessive risk-taking.	Limit VAT exeptions to the extent possible. Rationalize tax incentives in corporate tax system. Raise tax revenues from property taxes. Improve tax and customs administration. Enhance use of corrective taxes (such as energy taxes)
Expenditure Policy	Reduce the wage bill where public sector wages exceed prevailing wages in the private sector. Link the receipt of social benefits to work or participation in effective ALMPs. Enhance use of means-testing. Contain increases in age-related spending. Preserve spending on public investment that addresses infrastructure bottlenecks.	Reduce untargeted energy subsidies. Contain government wage bill and employment where they are high relative to the private sector. Reallocate spending toward education and health, and toward public investment where this addresses infrastructure bottlenecks. Improve the efficiency of public spending—examine opportunities to deliver services with lower level of inputs (including employment). Improve project selection and implementation in public investment. Implement other PFM reforms.

Fiscal Policies to Support Employment¹⁷

30. A key element of a jobs strategy is to put in place tax and social benefits structures that support employment. Taxation and spending affect employment by influencing labor demand by firms and labor supply decisions by individuals. Empirical estimates suggest considerable responsiveness of workers and firms to these incentives in advanced countries (Bassanini and Duval, 2006; and Chetty et al., 2011). Elasticities of labor supply are especially high for low-skilled workers, women, and older workers. Given the wide divergence in labor market challenges, job strategies should take into account both short- and medium-term objectives. Where unemployment has risen sharply in the wake of the crisis, an immediate priority is to support employment growth. Options include lowering labor taxes and enhancing active labor market policies (Table 5). Fiscal policy measures to foster higher labor force participation will affect employment only in the medium to long run, but should not be delayed. Examples of these policies include child-care subsidies and tax policies that do not discourage second earners. Countries with tight fiscal constraints should prioritize reform options that are budget-neutral or can provide budgetary savings, such as reforms that link the receipt of social benefits to job search requirements.

Table 5.

Potential Fiscal Policy Measures to Increase Employment

Source: IMF (2012b), IMF (2012f).

Table 5.

Potential Fiscal Policy Measures to Increase Employment

	Expenditure Policy	Tax Policy
Policies to increase labor demand	Implement hiring and wage subsidies. Introduce employment support schemes. Implement public work programs.	Reduce labor taxes (fiscal devaluation: shifting from labor to consumption taxes). Lower business taxes.
Policies to increase labor supply or facilitate matching	Expand effective ALMPs. Tighten eligibility criteria and job search requirements for social benefits. Reduce the duration and level of social benefits when too high. Increase child-care subsidies. Increase effective retirement age. Strengthen rules for disability pensions when too high.	Reduce labor tax wedge, targeted to: Older workers (earnings tax credits). Low-skilled workers (tax relief to and in-work tax credits).
Policies to increase female labor force participation	Strengthen financed parental leave schemes. Provide greater parity in maternity and paternity leave. Improve access to child-care. Increase expenditures on female education and infrastructure. Link child benefits to labor force participation to give incentive to rejoin the labor market.	Reduce labor tax wedge, targeted to secondary earners (mostly women) by replacing family with individual taxation. Give tax credits to low-wage earners.

Source: IMF (2012b), IMF (2012f).

View Table

Table 5.

Potential Fiscal Policy Measures to Increase Employment

	Expenditure Policy	Tax Policy
Policies to increase labor demand	Implement hiring and wage subsidies. Introduce employment support schemes. Implement public work programs.	Reduce labor taxes (fiscal devaluation: shifting from labor to consumption taxes). Lower business taxes.
Policies to increase labor supply or facilitate matching	Expand effective ALMPs. Tighten eligibility criteria and job search requirements for social benefits. Reduce the duration and level of social benefits when too high. Increase child-care subsidies. Increase effective retirement age. Strengthen rules for disability pensions when too high.	Reduce labor tax wedge, targeted to: Older workers (earnings tax credits). Low-skilled workers (tax relief to and in-work tax credits).
Policies to increase female labor force participation	Strengthen financed parental leave schemes. Provide greater parity in maternity and paternity leave. Improve access to child-care. Increase expenditures on female education and infrastructure. Link child benefits to labor force participation to give incentive to rejoin the labor market.	Reduce labor tax wedge, targeted to secondary earners (mostly women) by replacing family with individual taxation. Give tax credits to low-wage earners.

Source: IMF (2012b), IMF (2012f).

31. Reforms should favor approaches that mitigate trade-offs between employment and equity. This can include the use of in-work tax credits and benefits that increase incentives to work and active labor market policies (ALMPs). Some reforms that seek to increase incentives to work (such as cuts in social benefits) can increase wage dispersion because of their relatively stronger effects on unskilled labor. If these reforms are successful, however, they can increase employment, offsetting the effect of greater wage dispersion on inequality at the household level.

Fiscal Policies to Reduce Income Inequality¹⁸

32. Fiscal policy has played a key role in reducing income inequality in advanced economies, but has become less redistributive since the mid-1990s. Over the past two decades, fiscal policy has ensured that inequality of disposable income in OECD countries is about one-third lower than inequality of market income (defined as income before taxes and government transfers), primarily as a result of transfers (such as child benefits and public pensions) and income taxation. The redistributive impact is higher when in-kind transfers for education and healthcare are included. However, since the mid-1990s, disposable income inequality has increased more than market-income inequality due to reduced generosity of redistributive benefits and the diminished progressivity of income taxes.

33. Advanced economies could reinforce the redistributive role of fiscal policy in several ways. These include greater reliance on wealth and property taxes, more progressive income taxation, removing opportunities for tax avoidance and evasion, better targeting of social benefits, and the reallocation of public spending to programs that strengthen the human capital of the poor, such as education and job training programs.

34. In developing economies, fiscal policy has had much less impact on income inequality. This, in turn, reflects their lower levels of taxation and public spending and the use of less progressive tax and spending instruments.

35. Developing economies could implement fiscal policies that enhance redistribution, while also promoting growth and fiscal sustainability. On the tax side, the focus should be to broaden tax bases through reduced tax exemptions, closing loopholes, and improving tax compliance, rather than raising tax rates. Revenue constraints are likely to remain tight, however, and fiscal resources will continue to be needed to finance spending that enhances growth, such as public investment that addresses infrastructure bottlenecks. This implies that greater emphasis will need to be placed on improving the progressivity of public spending through, for example, eliminating general price subsidies for energy (IMF, 2012g); ensuring that education and health expenditures are targeted to meeting the needs of the poor, rather than providing subsidized services to upper-income households; and putting public pension systems (which highly favor upper-income groups in developing economies) on sound financial footing, while adjusting fiscal spending in line with national poverty reduction and development strategies.

Table 6.

Potential Fiscal Policy Measures to Reduce Income Inequality

Source: Bastagli et al. (2012).

Table 6.

Potential Fiscal Policy Measures to Reduce Income Inequality

	Advanced Economies	Developing Economies
Tax Policy	Remove opportunities for tax avoidance and evasion. Increase reliance on targeted social expenditures to meet the needs of the poor.	Broaden tax base by reducing tax exemptions, closing loopholes, and improving tax compliance.
Expenditure Policy	Improve targeting of social benefits. Reallocate public spending to programs that strengthen the human capital of the poor, such as education and job training programs.	Increase reliance on targeted social expenditures to meet the needs of the poor. Eliminate universal price subsidies for energy.

Source: Bastagli et al. (2012).

View Table

Table 6.

Potential Fiscal Policy Measures to Reduce Income Inequality

	Advanced Economies	Developing Economies
Tax Policy	Remove opportunities for tax avoidance and evasion. Increase reliance on targeted social expenditures to meet the needs of the poor.	Broaden tax base by reducing tax exemptions, closing loopholes, and improving tax compliance.
Expenditure Policy	Improve targeting of social benefits. Reallocate public spending to programs that strengthen the human capital of the poor, such as education and job training programs.	Increase reliance on targeted social expenditures to meet the needs of the poor. Eliminate universal price subsidies for energy.

Source: Bastagli et al. (2012).

D. Strengthen Advice on Labor Market Policies

36. Staff should ensure that advice on labor market policies reflects the state of knowledge and is evidence based about which combinations of labor market institutions work well. This means advice should aim for labor market policies that enable both “micro-flexibility” (allowing for the continuous reallocation of workers to jobs needed to sustain growth) and “macro-flexibility” (allowing the economy to adjust to macroeconomic shocks) while providing adequate protection for workers (see Box 3). Staff should thus discuss with country authorities whether employment protection and mandated benefits provide sufficient micro-flexibility; whether minimum wage arrangements, the tax wedge, and the collective bargaining structure provide sufficient macro-flexibility; and whether workers benefit from adequate protection. In developing countries, at a minimum staff should discuss whether labor market regulations “stay on the plateau,” i.e. avoid extremes of excessive worker protection with the result of hindering labor reallocation across sectors or of near-complete disregard for worker protection (World Bank, 2012, and Betcherman, 2013).

37. Staff should also ensure that advice on labor market policies takes account of the issues discussed in the preceding section on structural reforms, namely time spans needed for reforms to become effective and potential adverse short-term effects. In this context, it will be important that advice on labor market issues be mindful of the macroeconomic context. For example, reforms aimed at limiting labor market duality by, among other things, paring back employment protection for those benefitting from excessive protection, may result in large increases in unemployment if aggregate demand is depressed.

38. Further, as previously stressed, in analyzing labor market conditions and developing policy options, staff should always determine the extent to which unemployment is driven by cyclical factors and to which it is driven by structural factors. This is to better integrate analysis of the business cycle and labor market outcomes and to avoid potentially costly mistakes that can result from misdiagnosing the cause of high unemployment. Box 4 provides guidance on this and points to a recently developed resource staff should use. Staff may also wish to consult the Surveillance Toolkit for further resources on labor market issues.

Box 4.

Understanding the Growth-Employment Links and Differentiating Between Cyclical and Structural Unemployment

The growth-employment links may be tighter than it appears. There is a tendency to assert that there is a ‘disconnect’ between (output) growth and labor market developments, e.g. by showing that real GDP growth for a group of countries over some time period is only weakly correlated with employment growth or unemployment rates. This apparent disconnect is then used to argue that countries need a ‘jobs strategy’ in addition to a ‘growth strategy’. Ball et al. (2013a) show that, for 20 OECD countries, the relationship between output growth and unemployment is quite strong, though the responsiveness of unemployment to output growth does vary across countries. A follow-up study for a large group of emerging and developing economies finds that the relationship is also strong in many of these economies (Ball et al, 2013b). The policy implication of these findings is that it is worth first investigating whether weakness in labor markets is simply due to poor short-run output growth, before advocating more intrusive structural remedies. Bakker and Zeng (2013) use this approach by first showing the primary role of output growth in driving employment growth in EU countries and then looking for structural factors that can explain the residuals from the output-employment relationship.

Fund staff (Abdih et al, 2012) have developed a labor market template that allows desks to analyze and project labor market indicators, including cyclical and structural unemployment, for any country with sufficient data coverage. The template uses Excel to generate inputs in the form of user-customized employment and output data for Fund member countries (see the case study for Algeria). Specifically, the template produces the following:

• Estimates of employment-growth elasticities: these estimates are produced using a variety of econometric methods including individual country time-series regressions and panel data estimation methods. Estimation is performed by means of an easily executed program written using the Stata econometrics package. (Crivelli, Furceri and Toujas-Bernate, 2012 provide evidence on the determinants of employment-growth elasticities.)

• Medium-term labor market outcomes table: after the appropriate elasticity has been selected, a table of possible labor market outcomes is provided in Excel, with four different scenarios that the user may adjust as needed.

• Projection charts: using the elasticity estimate, projected future growth, and other parameters previously customized by the user, two charts are provided in Excel: employment growth projections for the period of interest under a range of elasticities, and unemployment rate projections under baseline and reform assumptions.

Ideally, short- and medium-term desks’ projections of unemployment and other labor market indicators could be regularly included in staff reports and possibly program documents and complement the set of tables and indicators typically reported. The table below presents a possible example on how to report key labor market projections.

Source: Country X authorities and Fund staff estimates.

^1/Projections based on employment-growth elasticity estimates (period x-2011).Source: Fund staff estimates (or Ball et al. 2013a, 2013b).

^2/Country X authorities; and Fund staff (ILO-Laborsta, ILO-KLIM) projections.

Projections 1/
	2011	2012	2013	2014	2015	2016	2017
Real GDP Growth (%)	…	…	…	…	…	…	…
Labor force (millions) 2/	…	…	…	…	…	…	…
Employment (millions)	…	…	…	…	…	…	…
Unemployment rate (%)	…	…	…	…	…	…	…

Source: Country X authorities and Fund staff estimates.

^1/Projections based on employment-growth elasticity estimates (period x-2011).Source: Fund staff estimates (or Ball et al. 2013a, 2013b).

^2/Country X authorities; and Fund staff (ILO-Laborsta, ILO-KLIM) projections.

View Table

Projections 1/
	2011	2012	2013	2014	2015	2016	2017
Real GDP Growth (%)	…	…	…	…	…	…	…
Labor force (millions) 2/	…	…	…	…	…	…	…
Employment (millions)	…	…	…	…	…	…	…
Unemployment rate (%)	…	…	…	…	…	…	…

Source: Country X authorities and Fund staff estimates.

^1/Projections based on employment-growth elasticity estimates (period x-2011).Source: Fund staff estimates (or Ball et al. 2013a, 2013b).

^2/Country X authorities; and Fund staff (ILO-Laborsta, ILO-KLIM) projections.

39. A Fund-wide effort is underway to improve the availability and quality of labor market data for the most populous countries, and to maintain an inventory of data sets assembled by Fund staff. The initial data sets compiled under this Fund-wide project will be made available by end-2013. Staff are also encouraged to probe international and national data sources and to try to iron out inconsistencies in the data to the extent possible.

Table 7.

Advice on Labor Market Policies

Table 7.

Advice on Labor Market Policies

Enable Both Macro-flexibility and Micro-flexibility
	Advanced Economies	Developing Economics
Macro flexibility	Minimum wage: combine a low minimum wage with well targeted social transfers. Tax wedge: strengthen the connection between taxes and corresponding benefits; shift to other taxes when the tax wedge increases labor cost in demand shocks. Collective bargaining structure: combine national and firm level bargaining.	Minimum wage: minimum wage compresses wage distributions and reduces earnings inequality; pay attention to negative employment effects of minimum wage on specific groups (youth, women, and workers in small firms). Labor unions and collective bargaining have limited role given the large informal labor markets.
Micro flexibility	Protect workers through unemployment insurance rather than high employment protection. Generous unemployment insurance should have ALMPs in place and effective. Employment protection should be limited, linked to employment length, and without threshold effects.	Protect workers, not jobs; enhance education and job related skills. Pay attention to negative employment effects of employment protection legislation (EPL) on disadvantaged groups. Avoid stringent EPL as it would slow down structural transformation and the speed of adjustment to shocks. Given informality and incomplete enforcement, mandated benefits would have small employment effects.
Take Account of the Macroeconomic Context
Be aware of uncertainties of the timing and size of the effects of reforms. Address the potential adverse short-term effects of reforms. Take account of overall economic conditions in assessing the effects of reforms. Take account of institutional settings in assessing the effects of reforms. Take account of macroeconomic policies in assessing the effects of reforms.
Take Account of the Business Cycle
Differentiate between cyclical and structural labor market developments (see the IMF template for labor market analysis in the Surveillance Toolkit). Develop policy advice while considering the cyclical and structural factors in the labor market.

View Table

Table 7.

Advice on Labor Market Policies

Enable Both Macro-flexibility and Micro-flexibility
	Advanced Economies	Developing Economics
Macro flexibility	Minimum wage: combine a low minimum wage with well targeted social transfers. Tax wedge: strengthen the connection between taxes and corresponding benefits; shift to other taxes when the tax wedge increases labor cost in demand shocks. Collective bargaining structure: combine national and firm level bargaining.	Minimum wage: minimum wage compresses wage distributions and reduces earnings inequality; pay attention to negative employment effects of minimum wage on specific groups (youth, women, and workers in small firms). Labor unions and collective bargaining have limited role given the large informal labor markets.
Micro flexibility	Protect workers through unemployment insurance rather than high employment protection. Generous unemployment insurance should have ALMPs in place and effective. Employment protection should be limited, linked to employment length, and without threshold effects.	Protect workers, not jobs; enhance education and job related skills. Pay attention to negative employment effects of employment protection legislation (EPL) on disadvantaged groups. Avoid stringent EPL as it would slow down structural transformation and the speed of adjustment to shocks. Given informality and incomplete enforcement, mandated benefits would have small employment effects.
Take Account of the Macroeconomic Context
Be aware of uncertainties of the timing and size of the effects of reforms. Address the potential adverse short-term effects of reforms. Take account of overall economic conditions in assessing the effects of reforms. Take account of institutional settings in assessing the effects of reforms. Take account of macroeconomic policies in assessing the effects of reforms.
Take Account of the Business Cycle
Differentiate between cyclical and structural labor market developments (see the IMF template for labor market analysis in the Surveillance Toolkit). Develop policy advice while considering the cyclical and structural factors in the labor market.

E. Advise on Financial Sector Inclusiveness to Decrease Poverty and Improve Distributional Outcomes

40. More varied and accessible financial services not only boost overall growth, but also reduce poverty and inequality. Financial systems serve a vital purpose, offering savings, credit, payment, and risk management products to people with a wide range of needs. Without inclusive financial systems, individuals must rely on their limited savings to invest in their education or become entrepreneurs, and small enterprises must rely on their limited earnings to pursue growth opportunities. This can contribute to persistent income inequality and slower economic growth. A well-developed financial system can allow a society to invest in more productive projects, promoting diversification and dampening cyclical fluctuations (Acemoglu and Zilibotti, 1997). Better and cheaper services for saving money and making payments and access to insurance products also allow poor households to avoid the cost of barter or cash transactions, cut the costs of remitting funds, and provide the opportunity to accumulate assets and smooth income against shocks.¹⁹

41. Staff should ensure that advice on financial inclusion takes account of heterogeneity across developing country financial systems. Lessons from cross-country experiences on broadening financial access and enhancing financial inclusiveness suggest the following directions:

• Develop information and market infrastructure to lower the costs and risks of expanding access to financial services. The literature shows a positive correction between credit information sharing and credit availability, especially to small and medium enterprises (SMEs).

• Limit excessively intrusive public sector interventions to avoid distortions (IMF 2012h).

• Prioritize enhancing access to funding and financial services for SMEs. Lack of SME access to finance reflects market failures and is a key constraint to job creation, particularly in developing countries.

• Enhance property rights and contract enforceability. Beck and Demirguc-Kunt (2006) find SMEs in particular benefit from a stronger legal environment.

• Encourage competition in a strong regulatory environment. Removing barriers to entry in the financial service sector and enhancing transparency would expand the sector and increase credit availability. Strong regulation and supervision including an appropriate bank resolution mechanism need to be in place when the financial sector is opened up to greater competition.

• Support the introduction of new financial tools and products (including credit cards, pensions, mortgages, and micro-loans) to promote a wider range of services.

• Investigate the issue of financial repression to safeguard the store-of-value function of money and therefore private sector savings and deepening.

42. The creation of a development bank (DB) with funding clearly established in the state budget is a significant step to transparent development funding. A comprehensive legal framework and an operational framework for DBs are essential. In assessing proposals, staff should ensure that the principles for internal and external oversight are codified in the DB’s legislation and internal regulations.²⁰ At a minimum, the authorizing law and respective procedural legislation should:

• Define the permissible activities, including the mission, method of funding;

• Define the government’s responsibilities in providing initial and additional capital;

• Identify the agency responsible and the criteria for evaluating the institution’s performance in meeting its goals;

• Grant authority to the supervisor to set and enforce binding prudential standards;

• Address fit-and-proper criteria for the management bodies, clarify their fiduciary duties, and the division of responsibilities between the oversight function (board of directors or supervisory board) and the operational management function;

• Define policies governing the accounting and auditing, including the valuation and disclosure of off-balance sheet positions and guarantees;

• Define public accountability and regular reporting obligations.

43. Deposit taking and non-deposit taking micro-finance institutions (MFI) have also proven to be effective in financial deepening in many countries. In the case of deposit-taking MFIs, it is essential to have appropriately strong supervision to ensure public confidence in the financial sector. Staff should ensure that advice on MFIs takes into account that most of the above cited legal framework, supervisory responsibilities and prudential requirements would also apply to the MFIs. Some control over non-deposit taking MFIs should also exist. The level of control would largely depend on the number of MFIs and their scope of operations. It is important to recognize that if private funding is the source of funds for lending operations, those sources have a vested interest in good governance. Oversight may be limited to registration/licensing and consumer protection.

44. Deposit insurance is an important component of any financial system safety net. Other components include a lender of last resort and prudential regulation and supervision. Deposit insurance needs to be well constructed, properly designed and well implemented, as risks - especially of moral hazard - are high. Core Principles for Effective Deposit Insurance Systems offer additional information on desirable features of deposit insurance framework.²¹ Whether establishing or reforming a deposit insurance system, staff should ascertain that pre-conditions exist on which to base the deposit insurance system. These preconditions include (i) ongoing assessment of the economy and banking system; (ii) sound governance of agencies comprising the financial system; (iii) strong prudential regulation and supervision; and (iv) well-developed legal framework and accounting and disclosure regime.

F. Collaborate, Reach Out, and Take Advantage of Training Opportunities

Collaborate Closely with Other Institutions in Line with Respective Mandate and Expertise

45. Staff should collaborate with other institutions as appropriate, in line with respective mandates and areas of expertise. The Fund with its traditional focus in macroeconomic (fiscal, monetary, and exchange rate) and financial policies has a key role to play in advising on macroeconomic demand management. The Fund can also advise on fiscal policies to help boost growth and employment. Further, it can advise on fiscal policies to reduce income inequality. Labor market policies are another area where Fund staff often have some expertise. To improve policy advice and avoid duplication, staff should seek to collaborate with other institutions such as the World Bank, the OECD, and the ILO.

• The World Bank has expertise in a wide range of areas relevant for developing countries, including labor market policies, financial sector issues, social safety nets, health, education, and utilities. Expectations for collaboration between the staffs of the two sister institutions are laid out in the Joint Management Action Plan on Bank-Fund Collaboration in Middle- and Low-Income Countries. Under the plan, Bank and Fund country teams working on middle-income and low-income countries where both institutions are active should consult each other regularly to develop a joint understanding of a country's macroeconomic challenges and the macroeconomic policies and structural reforms needed to address them, and to agree the division of labor in helping the country design and implement these policies and reforms.²²

• The OECD has particular expertise in labor market policies and other areas of structural policies and their effects of growth.

• The ILO has expertise in several areas such as labor market institutions, tripartite labor relations, and social protection.

• Other bodies such as research institutions may also be able to share expertise of value to the Fund’s work, and staff are encouraged to seek collaboration with them. For example, the Center for International Development at Harvard University conducts research on growth that may be of help.

Conduct Outreach on Jobs and Growth Issues

46. Sustained efforts are needed to raise awareness of the Fund’s efforts to help countries reach their jobs and growth goals, as well as to enable the Fund to keep learning from the perspectives of external partners. It is therefore important in surveillance and program contexts to ensure an ongoing dialogue with social partners, including labor unions, the business community, civil society organizations, academia, and the public at large. A key goal of outreach is to explain how the Fund’s policy advice and, where applicable, financial support, will help countries reach their jobs and growth goals and benefit all parts of society. For this, staff should lay out a longer-term vision and strategy, explain why any policy measures that may impose costs on some are needed as a part of the strategy, and present the measures will be taken to shield the most vulnerable from these costs.

47. Outreach to labor unions can be particularly important, especially where adjustment of wages or of labor market policies is needed. Successful outreach with labor unions has included early consultations with labor unions on possible Fund-supported programs before reaching agreement with country authorities and during program reviews; and regular interactions with labor unions as part of Article IV consultations in various countries. Strong relationships with unions may also help tripartite agreements between governments, employers and employees to support job-focused growth.

Stay Abreast of Fund Research and Take Advantage of Training Opportunities

48. Staff is advised to stay abreast of Fund research, positions, and guidance on these issues, which are not discussed further in this note. The literature on the determinants of growth, employment is still evolving, and there is no “silver bullet” answer as to the best policies to promote them. The economic developments since the start of the global financial crisis which prompted a rethinking of many aspects of macroeconomic policies are only one example demonstrating the necessity of keeping up with the current state of the art.

49. Fund staff should take advantage of training provided on jobs and growth issues. The ongoing RES/SPR Jobs and Growth Seminars are open to all staff and feature external and internal speakers. ICD is expanding its internal training offer of seminars and courses on jobs and growth issues, taught by academics at the forefront of the field. The Surveillance Toolkit provides material for self-directed learning on jobs and growth issues.