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2008/SRMM/012
The Benefits of Structural Reform
Purpose: Information
Submitted by: SRMM Deputies
Ministerial Meeting on Structural Reform
Melbourne, Australia
3-5 August 2008
The Benefits of Structural Reform
Background Paper
CONTENTS
EXECUTIVE SUMMARY .............................................................................................................. 1
INTRODUCTION ........................................................................................................................ 2
WHAT IS STRUCTURAL REFORM? .............................................................................................. 2
Impediments to well-functioning markets ............................................................................................2
Why are well-functioning markets important? .....................................................................................3
What is the role of government? .........................................................................................................3
BENEFITS OF STRUCTURAL REFORM: STRONGER ECONOMIC PERFORMANCE ............................... 4
Efficiency (microeconomic) impacts ....................................................................................................4
Economy-wide (macroeconomic) impacts ..........................................................................................7
Benefits for trade and foreign direct investment ................................................................................12
OVERCOMING SHORT-TERM ADJUSTMENT COSTS ..................................................................... 13
SUMMARY ............................................................................................................................. 13
iii
Executive Summary
Removing structural barriers to the operation of efficient markets and doing business in
the APEC economies can bring with it significant benefits to citizen welfare. Structural
reform can enhance allocative, productive and dynamic efficiency by helping to allocate
scarce resources to best use, maximise the production of goods and services for a given
quantum of inputs and spur innovation. These efficiencies lead to lower prices, better
quality products and more choice for citizens.
From an economy-wide perspective, structural reform can enhance overall productivity in
an economy, contributing to economic growth, employment and higher incomes. In
addition, promotion of well-functioning and efficient markets encourage trade and
investment, which in turn contributes to economic growth, employment and higher
incomes over time.
Structural reform can also help prepare an economy for unexpected shocks, such as
large capital flows, changes in investor confidence or changes in the price of important
commodities such as oil. Efficient markets accurately transmit price signals in a timely
manner, and a flexible economy unhampered by structural barriers is well placed to
adapt to changed economic conditions.
1
Introduction
1.
The Asia-Pacific region is one of the most dynamic regions in the world. It is
home to rapidly developing economies, burgeoning global production networks and
massive investment flows. It is also a major force of global economic growth. In its first
decade, APEC member economies generated nearly 70 per cent of global economic
growth and the APEC region consistently outperformed the rest of the world, even during
the 1997-98 Asian financial crisis.1 The promotion of sustainable economic growth and
improved living standards in the Asia-Pacific region through enhanced trade and
economic integration lies at the heart of APEC’s mission.
2.
As APEC’s trade agenda has advanced, there has been an increasing recognition
that the removal of non-trade barriers has also played a significant role in achieving
economic growth. The APEC agenda has, therefore, evolved to place an equal emphasis
on the reform of structural or behind-the-border barriers in the region. Experience
suggests that economies that pursue structural reforms to address domestic or
behind-the-border impediments to business are more resilient to economic shocks,
achieve greater macroeconomic stability, and experience increased productivity and
higher living standards over time. This paper focuses on structural reform: what it
means generally and in an APEC context, and its potential benefits for individual
economies.
What is structural reform?
3.
Structural reform consists of improvements made to institutional frameworks,
regulations and government policy so that ‘behind-the-border barriers’ to regional
economic integration and improved economic performance are minimised. Structural
reform helps foster an economic environment that supports the efficient functioning of
markets; contributes to macroeconomic stability, productivity and economic growth; and
ultimately enhances living standards in a sustainable way.
4.
Structural reform is an evolutionary process that can provide on-going benefits for
all APEC economies. While sweeping reforms may at times be necessary, even
economies with highly efficient markets can benefit from ongoing and incremental
reforms. Structural reform assists market forces to function properly — this includes
facilitating investment in productive activities, regulating natural monopolies, building
stronger businesses and letting new businesses enter and inefficient businesses exit a
market through the removal of structural barriers.
Impediments to well-functioning markets
5.
Structural barriers impede the full and efficient use of an economy’s resources.
Structural reform is intended to remove these barriers. There are two broad types of
barriers. Cross-border structural barriers are direct restrictions on international trade
and investment at the border. These external impediments impact on foreign investors.
Examples of these barriers are tariffs, such as, duties, licences, quotas and subsidies.
They can also include non-tariff barriers, such as, anti-dumping measures and
countervailing duties or manufacturing or production requirements where imports are
restricted for failure to comply.
1 APEC (2005) APEC at a glance.
2
6.
Behind-the border structural barriers refer to domestic policies and institutions
which impede the efficient operation of markets and the capacity of business to operate
efficiently. Behind-the-border barriers may include regulatory systems, competition
frameworks and governance structures, including domestic policies, rules, procedures
and laws that unnecessarily hinder businesses from operating effectively, such as,
excessive regulation, poor property rights and/or poor legal systems.
7.
The existence of behind-the-border barriers has a detrimental impact on both
domestic and foreign business. These barriers increase direct financial cost, which
reduces business profitability and diverts resources away from productive use. For
example, cost can be increased through licence fees or the compliance costs associated
with understanding and complying with unnecessary regulatory requirements. These
barriers can also limit business competition, which stifles innovation and removes
incentives to increase efficiency within individual businesses and ultimately, increases
costs to citizens. Measures that restrict entry to a market or impose price controls can
also restrict competition. These barriers also increase risk, which reduces the incentive
to invest and imposes cost to business in managing the risk. Inconsistent policy or
uncertain property rights or unenforceable contracts can further increase risk.
Why are well-functioning markets important?
8.
Efficient and well-functioning markets can produce numerous benefits.
Well-functioning markets allocate resources to their most valued use and facilitate
competition. Scarce resources can act as a constraint on a domestic economy’s growth
potential. By ensuring that resources such as land, labour and capital are efficiently
utilised, an economy ensures that both output and the welfare of citizens can be
maximised. Efficient markets facilitate the optimal allocation of resources by providing
firms and citizens with timely and reliable information about the demand of a good
relative to supply through price signals. Timely and accurate transfer of price
information enables an appropriate response from citizens and firms, increasing
competition. This leads to better quality products and services at lowest possible prices
and better choice for citizens. Increased competition also encourages innovation and
productivity gains and, ultimately, sustainable economic growth, improving the
well-being of citizens. The economy as a whole benefits from the more efficient
allocation of resources to industries in which it has a comparative advantage.
What is the role of government?
9.
Markets do not always produce the most efficient outcomes. There is a role for
governments to manage the economy where markets do not produce efficient outcomes
(market failures). Government intervention may be necessary to address market failures
through information, the use of laws, regulation, taxation and payments.
10.
In the case of public goods, markets do not optimally produce these goods
because no one can be effectively excluded from using that good (non exclusive).
Another characteristic of a public good is that consumption of the good by one individual
does not reduce the amount of the good available for consumption by others (non-rival).
The classic example is national defence — once an economy has provided for its national
defence, all citizens enjoy its benefits. This means governments may need to provide
these goods, financed through taxation.
3
11.
Externalities are another source of market failure, which sometimes require
government intervention. Externalities are costs or benefits to third party stakeholders,
which are not properly reflected in market transactions. For example, pollution affects
everyone but is not often priced in the market, requiring governments to introduce
carbon taxes or emissions trading schemes to ensure markets reflect proper costs and
behaviours shift appropriately.
12.
Markets also fail where there is inadequate information (information failure), and
there is a role for governments to remedy information failures. For example,
governments can address information failures by providing adequate information or
regulating to make businesses disclose such information. These interventions will lead to
better functioning markets.
Benefits of structural reform: stronger economic
performance
Efficiency (microeconomic) impacts
13.
The immediate goal of structural reform is to create stronger and more efficient
markets. Removing structural barriers in a market enhances competition, which is
important for the efficient operation of markets. Competition stimulates allocative and
productive efficiency, in which the most appropriate range of goods and services is
produced using the least cost combination of inputs; and dynamic efficiency by spurring
innovation in resource use, product design, production processes and management
practices. Efficiently operating markets boost productivity, underpins stronger and more
sustainable economic growth and enhances living standards.
14.
Allocative efficiency is where resources (such as labour, capital and natural
resources) are allocated to producing goods and services demanded by citizens, thus
maximising citizen welfare. The efficient allocation of resources in this way will only
occur where price signals, which reflect citizen demand and the scarcity of supply, are
transmitted accurately and in a timely fashion. This allows producers to gauge the
optimal mix of goods to produce. Strengthening the legal system as an example of
structural reform, can increase allocative efficiency of an economy, as producers can
invest in capital with certainty regarding the enforceability of contracts, the risk of the
investment is reduced, which means producers no longer have to dedicate resources to
managing that risk.
15.
Structural reforms that enhance competition or restore market price signals also
spur producers to remain competitive and seek productive or technical or supply-side
efficiency. Technical efficiency occurs where goods and services are produced at the
lowest cost possible, given the production of other goods. In other words, producers are
able to maximise the production of goods and services for a given amount of inputs. For
example, removing unnecessarily restrictive product manufacturing standards on goods
can increase productive efficiency. Removal reduces cost for producers in complying with
standards, which enables production of the same number of goods at a lower cost and
therefore lower prices for citizens.
16.
Finally, efficient markets encourage innovation. This is known as dynamic
efficiency. Dynamic efficiency refers to spurring innovation in resource use, product
design, production processes and management practices. Competitive markets create
stronger incentives for producers to improve their productivity and quality and to
4
innovate in order to achieve a competitive advantage. Removing barriers to entry can
lead to significant improvements in dynamic efficiency. Many APEC economies have
removed entry restrictions in their telecommunication markets, which has resulted in
increases in the number of providers in the market. This competition encouraged
providers to innovate, which has increased the range of products available to citizens.
17.
Well-functioning markets that encourage competition and produce appropriate
price signals can simultaneously reinforce allocative, productive and dynamic efficiency
gains. For example, Box 1 shows the success of Viet Nam’s enterprise law reforms in
stimulating investment growth. The increased investment stimulated by the reforms also
led to an increase in the number of new businesses. This in turn led to an increase in
competition and allocative, productive and dynamic efficiency gains.
Box 1:
Viet Nam’s enterprise law reforms2
Relaxation of controls on the private sector in Viet Nam has been taking place since
1986, with the decision to embark on reforms known as the ‘doi moi’. In December
1989 the first legal guarantee for the private sector was established with the
introduction of the Law on Company and Law on Private Enterprise. Support for
private enterprise in Viet Nam was further achieved in 1992 with the explicit
recognition of the role of the private sector in Viet Nam’s Constitution.
The reforms created a role for private enterprises and also reduced administrative
barriers to the formation of new companies and addressed corporate governance
issues. This led to an increase in the number of new companies. The reform is also
estimated to have contributed to the creation of 2 million new jobs.
Most importantly, these reforms allowed the domestic private sector to invest in a
broader range of private enterprises and stimulated additional investment from the
domestic private sector. Following various reforms, the share of investment in GDP
had increased from around 15 per cent in the late 1980s to almost 30 per cent by the
mid-1990s. However, the investment share of GDP levelled out in the late 1990s.
Following the implementation of the Enterprise Law in 2000, the investment share of
GDP increased to more than 35 per cent (Figure 1).
Figure 1: Investment as a share of GDP and milestones in reform process
2 Investment Experts Group (2007), Enhancing investment liberalisation and facilitation in the
Asia Pacific region (stage 2), APEC.
5
18.
The case study of electricity generation in Chile (Box 2) illustrates the benefits to
be gained from competition. In this case, competition stimulates allocative and
productive efficiency which become mutually reinforcing. The restoration of market price
signals in a state-owned enterprise enhanced efficiency by allowing investment to flow
according to market generated price signals, rather than determined administratively, in
isolation from market prices. The introduction of competition into electricity generation
also had dramatic effects on the efficiency of electricity generation and provision, leading
to falling prices and higher citizen welfare.
Box 2:
Electricity generation in Chile3
In the 1980’s Chile began a program of restructuring and privatisating its electricity
sector. Chile’s restructuring sought to achieve competition in generation and freedom
of users to purchase power from any generator or distributor. The state owned
enterprises were vertically and horizontally split into generation and distribution
companies.
Privatisation and regulation of the market has lead to dramatic efficiency
improvements in Chile’s electricity industry. Labour productivity increased
substantially, particularly in electricity generation, where gigawatt-hours generated per
employee increased from 6.3 in 1991 to 34.2 in 2002.
The quality of supply has also dramatically improved. The average time for emergency
repair service declined from five hours in 1988 to two hours in 1994. In addition,
power outages due to transmission failures have fallen steadily since privatisation.
Energy losses have also decreased, falling from 21 per cent in 1986 to 9 per cent
in 1996.
Prices have been kept low due to increases in supply capacity. Wholesale prices fell
37 per cent and final prices fell 17 per cent between 1986 and 1996. Network
expansion has also benefited the poorer citizens, with the share of the poorest citizens
without a connection falling from 29 percent to 7 per cent in 1998.
19.
Dynamic efficiency can be seen in the case of airline deregulation in the United
States, as shown in Box 3. Removal of structural barriers to enhance competition led to
dynamic efficiency gains, as firms started to innovate to create different services for
citizens and new systems to deliver the services. This dynamic efficiency also enhanced
airline companies’ productive efficiency, as these services were provided at the lowest
cost possible via the creation of new management and route systems.
3 Fisher R and Serra P (2003), ‘Efectos de la privatización de los servicios públicos en Chile: casos
sanitario, electricidad y telecomunicaciones’, Universidad de Chile, and Kessides (2004),
Reforming Infrastructure: Privatisation, Regulation and Competition, World Bank Policy
Research Report.
6
Box 3:
Airline deregulation in the United States4
In 1978 the Airline Deregulation Act abolished the Civil Aeronautics Board (CAB). Prior
to 1978, the CAB exerted substantial control over the pricing practices and route
structures of US airlines. Fare changes required CAB approval, and entry and exit on
individual routes were subject to similar scrutiny.
The result of deregulation was the entrant of new airlines into the market, and also a
substantial increase in competition over routes. The result of such competition was an
increase in consumer welfare as fares decreased. Increased competition arising from
airline deregulation is estimated to have resulted in savings for travellers of at least
USD 6 billion annually in reduced fares.
However, the dynamic efficiency benefits that were achieved from deregulation are
also significant, as airlines began to create new services in order to compete.
Deregulation led to airlines offering customers different prices for seats on the same
route, depending on the customer’s preferences. In addition, airlines developed
management systems for selling unsold seats on flights in the most efficient fashion.
Deregulation also spurred airlines to find innovative, efficient methods of organising
and managing flight routes in order to remain competitive. The ‘hub and spoke’ model
of organising flight routes was developed. This model of organising routes became the
most competitive and efficient method of scheduling flights for a large number of
passengers at the lowest cost.5
Economy-wide (macroeconomic) impacts
Improved productivity and employment growth
20.
As well as increasing productivity in a specific industry or sector, comprehensive
structural reform can lead to economy-wide improvements in productivity6, which is a
major determinant of long term economic growth. The efficiency improvements arising
from structural reform mean that a greater amount of goods and services can be
produced for a given amount of inputs. The World Bank Development Report 2005
illustrates that productivity gains account for over 40 per cent of growth measured
among 84 countries from 1960 to 2000 (figure 2).
4 Chung, C and Szenberg, M (1996) ‘The Effects of Deregulation on the U.S. Airline Industry’ Journal of
Applied Business Research, Vol. 12, Issue 3.
5 Brueckner, J K, Goebel, A and Niskanen, E (1997) ‘Airline deregulation: the American
experience and prospects for Europe’, Government Institute for Economic Research Helsinki.
6 Productivity describes the efficiency with which labour, capital and natural resources are
organised to produce outputs, and increasing productivity means that a greater amount of
goods and services can be produced for the same amount of input (such as labour, capital or
natural resources).
7
Figure 2: The contribution of productivity to growth
Note: Sources of growth for 84 Countries from 1960-2000. ‘TFP’ is total factor productivity.
Source: World Bank Development Report 2005.
21.
Box 4 outlines Australia’s structural reform experience over the past three
decades and illustrates that a package of comprehensive structural reforms can have
significant beneficial effects on overall productivity in an economy.
Box 4:
Australia’s microeconomic reforms7
In the last 30 years Australia has transformed its economy by removing barriers to
competition. Prior to that, poor productivity performance, together with the declining
terms of trade, led to a decline in livings standards. From being ranked 4 th out of OECD
economies in 1950, Australia’s position fell to 9th in the early 1970s and 16th by the late
1980s. This situation forced a rethink of institutional and policy frameworks and led to a
substantial program of microeconomic reforms.
Table 1: Change in Australia’s policy frameworks
1970s
2000s
Fixed exchange rates
Floating exchange rate
Capital controls
Capital account and interest rate controls liberalised
High trade barriers
Low trade barriers
Weak competition policy
Stronger competition policy
Centralised labour market
Decentralised labour market
Macroeconomic policy not anchored
Macroeconomic polices credibly anchored to medium term
targets.
As a result, Australia’s multifactor productivity growth more than doubled during the
1990s, averaging 2.3 per cent. Accompanied by an increase in labour utilisation, this led
to annual growth in per capita incomes of around 2.5 per cent in the decade. It has been
estimated that Australia’s household incomes are AUD 7,000 higher as a result of these
reforms.
22.
Box 5 shows that introduction of greater competition even in one industry, such
as telecommunications, can have positive effects by lowering prices and stimulating
economic and employment growth.
7 Wonder, B (2006) Policy determinants of Productivity Growth in Australia, East Asian Bureau of
Economic Research Working Paper Series.
8
Box 5:
Papua New Guinea (PNG) mobile telecommunications reform
Papua New Guinea undertook a major reform in 2007 with the introduction of
competition to the mobile telecommunications market. Following an open tender
process, two additional mobile licenses where issued to Digicel and Greencom. This
reform introduced competitors to the State owned subsidiary company of Telikom,
B-Mobile, ending the monopoly in PNG’s mobile telecommunications market.
This reform has also brought significant benefits to businesses and private citizens
through reduced prices, for both calls and handsets, and increased output, as access
and availability of services has greatly improved.
This reform is a significant milestone in PNG’s telecommunication sector, having
considerably improved the service reliability and produced a rapid increase in
telecommunications coverage. Rural and urban areas that have never had access to
telephone services in the past are now enjoying the success of competition. In 2007,
the economy has been estimated to have grown by 0.9 percent as a result of
introduction of the mobile competition.
The reform has also seen a large increase in local employment. These employees are
learning new skills which can potentially be transferred to the wider population
increasing the capacity of PNG’s labour market. These benefits have translated into
tangible improvements in people’s daily lives, as communication flows are improved
and employment opportunities increase.
23.
The ability to produce more goods and services for the same amount of input
when productivity increases means that the economy has created more wealth for
distribution amongst citizens in the form of lower prices. Citizens are able to purchase
more goods and services from the same amount of income and accordingly, their real
incomes rise.
24.
Initially, higher incomes may increase private consumption, business investment,
government taxation to fund government spending and savings. This may lead to
additional increases in capital and labour supplies and a further increase in economic
activity. Rising incomes are likely to entice more workers to join the labour force. Rising
capital returns is likely to encourage more investment, which is financed through
domestic and overseas savings. By increasing the supply potential of the economy,
structural reform allows the economy to grow further before inflationary pressures arise.
Ultimately, this allows stronger sustainable growth in incomes and employment.
25.
Recent OECD analysis found that, for developing economies, pro-competitive
reforms, including competition, investment and trade reforms, had the potential to
increase, on average, income per capita by 7.7 per cent.8
8 Miroudot, S, Pinali, E and Sauter, N (2007), ‘The Impact of pro-competitive reforms on trade in
developing countries, OECD Trade Policy Working Paper No. 54, OECD.
9
Table 2: Potential GDP per capita gains from pro-competitive reforms in developing
economies
Economy
% increase in GDP per capita
Economy
% increase in GDP per capita
Algeria
7.7
Malaysia
6.6
Argentina
7.6
Mauritius
7.7
Bangladesh
8.6
Mexico
4.9
Belarus
8.7
Morocco
7.7
Bolivia
7.4
Pakistan
7.7
Brazil
8.3
Panama
4.0
Cameroon
8.8
Paraguay
9.0
Chile
3.5
Peru
6.6
China
7.9
Philippines
6.8
Colombia
7.4
Senegal
8.5
Costa Rica
6.6
South Africa
5.5
Croatia
9.0
Sri Lanka
6.8
Egypt
9.2
Tanzania
10.2
Georgia
9.8
Tunisia
8.2
India
7.7
Turkey
6.8
Indonesia
8.4
Uganda
9.7
Jordan
8.3
Uruguay
4.6
Kenya
9.3
10.5
Korea
4.7
Venezuela
Zambia
Macedonia
8.2
Zimbabwe
10.4
Madagascar
8.6
Average
9.0
7.7
Source: Miroudot, S, Pinali, E and Sauter, N (2007), ‘The Impact of pro-competitive reforms on trade in developing countries,
OECD Trade Policy Working Paper No. 54, OECD.
Economic stability
26.
The removal of structural barriers can help an economy maintain macroeconomic
stability when exposed to large, often international, shocks. These shocks might involve
large capital flows, changes in the price of important commodities such as oil; and
political crises that affect market confidence. This is because improvements to market
efficiency provide an economy with more flexibility and the ability to more smoothly
transition in response to shocks.
27.
Efficient markets rapidly transfer economic shocks into prices, allowing the players
in an economy to react and adjust quickly to the altered economic environment. Efficient
markets also provide a second round effect. When the investment community assesses
that an economy has well-functioning markets then business expectations are framed
accordingly and minor shocks are somewhat mitigated by business confidence in the
market to adjust accordingly. Box 6 below outlines Singapore’s resilience to economic
shocks largely due to its advanced state of structural reform efforts.
10
Box 6:
Singapore’s resilience to economic shocks9
Singapore’s total trade in goods and services was 338 per cent of gross domestic
product in 1997, while foreign investment penetration was extensive at 80 per cent of
gross national product in 1996.10 When the Asian financial crisis swept through East
Asia in July 1997, Singapore’s high level of openness to trade and financial flows meant
that it could not remain unaffected by crisis in the region, despite Singapore’s strong
macroeconomic and financial fundamentals.
However, strong public institutions and good business norms which encouraged good
public and private sector governance sheltered Singapore from the worst of the crisis.
Three decades of financial market liberalisation coupled with appropriate prudential
regulation had resulted in a strong financial sector able to intermediate large capital
inflows. Well-managed banks were able to prudently assess risks and contain the
incidence of non-performing loans.
The relative stability maintained by the economic system in the face of the catastrophic
external shock meant that Singapore had time to plan incremental, surgical measures
to prepare the Singapore economy for the next upturn rather than having to undertake
sweeping emergency reforms to deal with immediate crises.
The experience highlighted the importance of ensuring the structural integrity of the
economic system at all levels on an ongoing basis, from business corporate governance
to government regulation. Apart from the government platforms facilitating regulatory
reform documented in the 2007 APEC Economic Policy Report, other examples include
the institutionalisation of the Accounting & Corporate Regulatory Authority and the
Competition Commission of Singapore which provide greater assurance of corporate
governance and a level playing field within Singapore.
Ultimately, the best reflection of the structural integrity of the Singapore economy is
the continued confidence that businesses have in Singapore and the ease with which
they are able to do business in Singapore.
28.
The impact of shocks can be further dampened by optimal policy and institutional
settings. Structural reforms that introduce automatic stabilisers, such as, floating
exchange rates or fiscal polices, can moderate income loss by making exports relatively
cheaper and reducing taxes.
29.
However, some policy and institutional frameworks that dampen shocks may
actually work against the market adjustment to increase the persistence of the shock.
For example, labour market policies aimed at supporting employment and private
consumption, such as, strict employee protection legislation may deter firms from laying
off workers in the short-run. However, this delays the return of output and employment
to their initial levels by impeding the reallocation of labour to more productive jobs.
9 Adopted from APEC Economic Committee (2006), Economic Policy Report, APEC.
10 Department of Statistics, Singapore.
11
Benefits for trade and foreign direct investment
30.
Domestic structural reforms that improve market efficiency have spill-over effects
that increase trade and foreign direct investment. Trade is sensitive to the business
environment in an economy and structural barriers that increase risk, cost or reduce
competition in an economy. Structural reforms to remove these barriers reduce
transaction and production costs in that economy. As the economy becomes more
attractive, trade and foreign direct investment opportunities expand. For example,
reforms to assist domestic business such as reducing regulatory compliance costs will not
only create more efficient markets but improve an economy’s competitiveness by
reducing the cost of trading. The relationship between structural reform and foreign
direct investment is demonstrated by the International Monetary Fund (IMF) (Box 7).
31.
Structural reforms to increase competition in markets can also be crucial to
realising the gains from trade liberalisation. APEC has been very successful in increasing
trade in the region. The benefits from lower trade barriers will be further realised in the
region as economies continue to pursue well functioning markets. Some economies have
found it difficult to fully exploit the benefits from lower trade barriers. This is because
gains from trade are realised through well-functioning markets. Even if trade is possible
with an economy, foreign businesses are unlikely to invest unless they can access a
competitive market. Thus, domestic reforms complement APEC’s trade and liberalisation
facilitation agenda and contribute to APEC pursuits of economic integration in the region.
Box 7:
FDI and structural reform: Evidence from Latin America and Eastern
Europe11
Both Latin America and transition economies of Eastern Europe undertook extensive
structural reforms, starting in the 1990s. Financial markets were liberalised, trade
barriers reduced and state-owned enterprises were privatised to a large extent.
The successful implementation of structural reforms by the host governments
increased the confidence of investors because it implied a reduction in risks associated
with investment in that economy. In addition, these structural reforms generated real
benefits by encouraging foreign direct investment through the creation of, and support
for, robust and efficient financial and other markets. Foreign investors are also
attracted to countries with stable macroeconomic environments and higher levels of
economic development and infrastructure, all of which are facilitated by appropriate
structural reform.
A strong empirical relationship has been found by the IMF between structural reforms
and foreign direct investment. For Latin America, both privatisation and trade
liberalisation were found to have a strong relationship with foreign direct investment
flows. In addition, financial sector development was found to have a strong
relationship to foreign direct investment flows.
Moreover, it was found that countries’ efforts to develop well-functioning financial
sector also encouraged greater foreign direct investment, even after controlling for the
level of financial development.
11 Campos, N F and Kinoshita, Y (2008), ‘Foreign Direct Investment and Structural Reforms:
Evidence from Eastern Europe and Latin America’, International Monetary Fund Working
Paper 08/26.
12
Overcoming short-term adjustment costs
32.
Structural reform can create short term adjustment costs, however in the longer
term these costs should be more than offset by the benefits generated by well targeted
reforms. IMF studies have shown that while structural reforms may have short-run
costs, in the long run, structural reforms have been found to have significant positive
effects on productivity growth, potentially increasing productivity growth by
0.3 percentage points on average.12
33.
Those disadvantaged by structural reform in the short term may include industries
and occupations confronted with large reductions in specific industry assistance or large
increases in the cost of key inputs. The adjustment costs and risk borne by these
disadvantaged industries and occupations can also be managed and minimised by
government through transfer mechanisms. Automatic stabilisers, such as the welfare
payments system and the tax system can support those who lose employment or income
as a result of structural adjustment. For example, through payment of unemployment
benefits to individuals that cannot find employment and job retraining programs, or
through a progressive tax system that provides an incentive for individuals to engage in
the workforce. With appropriate use of the tax and welfare systems, it is possible to
distribute efficiency gains from structural reform in a way that equity objectives are
achieved.
34.
Governments may also introduce initiatives to improve the capacity of employees.
Initiatives such as skill development programs can assist employees to transfer to more
productive industries and occupations.
35.
The design of reforms may be able to mitigate some of the short term costs of
reforms. Further, an economy in a strong fiscal position will be well placed to smooth the
transition and ease the adjustment process for citizens. The challenges to government in
managing and minimising these adjustment costs and the distribution of benefits are
outlined in the discussion paper, ‘The Political Challenges of Structural Reform’.
Summary
36.
All economies face significant challenges in undertaking structural reform. The
reform of structural policies is an ongoing process and that presents problems and
challenges for all economies. While structural reform is not an easy path, the benefits
that can be realised are too significant to overlook. A well-implemented structural reform
agenda can stimulate business profitability, encourage economic growth and boost
productivity. By building strong and efficient markets that are capable of stable and
sustainable economic growth, member economies will be well placed to utilise resources
for maximum gain. There is growing consensus that structural reform that facilitates well
functioning markets is crucial in responding to emerging economic challenges, such as
ageing, new technologies and globalisation. Further, structural reform has the potential
to build on the growth and prosperity that trade liberalisation has already brought to the
citizens of APEC economies. The path of ongoing structural reform provides the
mechanism by which economies can continue to improve the living standards of citizens
in a sustainable manner.
12 Salgado R (2002), ‘Impact of Structural Reforms on Productivity Growth in Industrialised
Countries’, International Monetary Fund Working Paper 02/10.
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