Box 2.3 Eurozone institutional “architecture”

half of the panel, while the “reds and oranges” dominate in the right hand of the panel. Recall that this report’s definition of the strength of resilience and the underlying institutions is based on a relative ranking within the EU.

In Western Europe, Belgium and Austria were the most resilient. Even though their banking sectors were hard hit by the global financial crisis, this did not undermine inclusive growth in a major way. However, both Belgium and Austria do below average on social protection spending on the bottom 40 percent. They are both are examples of small, open economies that benefited from European integration, while euro adoption did not materially alter their monetary policy options. Belgium’s case also underscores that institutions need to be seen in context: rigid employment protection and reasonable firing costs, and relatively inefficient product markets—which make its economy less resilient—are compensated by several “green” labor market institutions (good opportunities for part-time work, and high wage flexibility)—which make it more resilient. Similarly, Austria has low hiring and firing costs and high wage flexibility which makes it more resilient.

France, the Netherlands, Germany, the UK and, more recently, Ireland, showed resilience by benefiting from strong institutions. The Netherlands suffered a somewhat longer output and median income recession than would be predicted by its favorable policy mix. France is resilient when it comes to unemployment challenges, but scores relatively less well on household income resilience, while it lacks the trust in institutions characteristic of most Western European countries. Belgium, France, the Netherlands and Germany combine strong employment protection—which reduces resilience—with part-time work options and wage flexibility—which boost resilience. In Germany this is because of its unique firm-level governance that supports a coordinated approach to avoid job losses). The UK faces resilience challenges on unemployment: these are associated with low spending on active labor market policies. And Ireland had a weak resilience track record but reformed its institutions rapidly and is now supported by a “greener” policy mix, suggesting less challenges going forward.

In Northern Europe, Sweden stands out. It has “green” institutions, while not in the eurozone and floating its currency. The Baltics rebounded rather well, but with high volatility in output, unemployment and incomes. This would explain why a country like Latvia was often seen as having successfully dealt with the crises—because it continued to converge—but shows up relatively less resilient in the heatmap.

Central Europe shows mixed results. However, Poland and Romania were relatively resilient, Croatia less so. However, Poland’s employment resilience is not strong and its “real exchange rate institutions” show a mixed picture. Poland seems to compensate for these (at least in the short term) through a flexible exchange rate (Box 2.14). The Czech Republic, Bulgaria and Hungary are also newer members of the EU that exhibited considerable resilience during the crises. Both Romania and the Czech Republic showed relatively strong performance with respect to employment. However, in Romania, household incomes were less resilient than in the Czech Republic, which also protected low-income groups considerably well. Slovenia undertook significant reforms during the period, and recorded a number of institutional “green shoots”.

Overall, Central Europe suffers from low levels of trust in institutions, creating challenges for reform going forward. Romania and Bulgaria’s highly unequal income distribution could further complicate these challenges. And while Romania (with little business cycle synchronicity with the euro area’s core) and the Czech Republic have flexible exchange rates that could function as a short-term compensation, Bulgaria does not.

In Southern Europe, Spain and Greece were among the least resilient in Europe. While progress was made on some key policy variables (e.g. active labor market policies in Spain, better product market regulation in Italy and Portugal) the overall policy mix needs strengthening. The overall policy and