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Quantification of reforms Balázs Égert OECD, Economics Department Structural Surveillance Division Quantification Unit What we do at the Structural Surveillance Division • Going for Growth publication • Quantification unit – Producing indicators • Product Market Regulation (PMR) indicator • Electricity, Transport and Communication Regulation (ETCR) indicator • Regulatory Impact (regimpact) indicator – Work on the framework of quantifying the impact of structural policies on economies outcomes (growth) Renewed interest in quantifying the impact of reforms on growth • low economic growth in the aftermath of the crisis – help mitigate the negative impact of fiscal consolidation – help restore fiscal sustainability (public debt crisis => more growth lower debt) – mitigate the impact of slowing potential growth (population ageing) Quantifying the effects of reforms Key drivers in a production function approach GDP per capita Labour productivity (GDP per employee) Investment in physical capital Multi factor productivity Employment rate (No. of employees / Pop) Labour force participation Unemployment rate Purpose: • Links to policies assessed through well-established channels • Supported by empirical evidence from aggregate, industry and firm-level data Framework allows for multiple policy channels to be explored and quantified GDP per capita Top level performance Capital deepening (capital per hour) Intermediate drivers Policies and institutions Labour utilisation (Hours worked per capita) Labour productivity (Output per hour worked) Knowledgebased capital / innovation Openness to foreign trade and FDIs Product and financial market policies Hours worked per worker Multi-factor productivity Human capital / skills development Innovation policies Framework conditions and institutions Employment rate Structural unemployment rate Education policies Labour force participation Labour market policies Policy variables can be classified according to their systemic importance Channel-specific policies • Knowledge-based capital (R&D tax credit or grants, industry-university links) • Openness to foreign trade and investment (barriers, trade support measures) • Human capital and skills development (education and employment policies) Framework conditions => Market competition, resource allocation • Product and labour market regulation (barriers to entry and labour mobility) • Competition Law and Policy • Efficiency of bankruptcy legislation Legal infrastructure and basic institutions • Rule of law, contract enforcement and efficiency of judicial systems • Intellectual property rights • Public sector efficiency 6 Main steps of quantification exercise Policies Supply-side impact Macro outcome • Mapping of specific reform into corresponding policy indicator • Assessing effect on productivity, investment and employment • Aggregating the effects coming through different channels to provide profile of impact on GDP 7 Step 1 - Mapping reforms into indicators Policy area Indicators Restrictiveness of regulatory barriers Product Market Regulations (PMR), to competition including trade openness and FDI Employment protection legislation Strictness of employment regulation (EPL) Share of indirect taxes in total Tax structure revenues Research and Development Share of R&D spending in GDP Childcare / maternity leave Childcare spending (CHILDC) Active labour market policies (ALMP) Active labour market policies (ALMP) – spending Incentives of unemployment benefits Average gross unemployment benefit replacement rate (ARR) Labour tax wedge Labour income taxes and SSC Coverage of exercise defined by existence of indicators 8 Step 2 – Unit effect on productivity Step 2 – Unit effect on productivity Policy Indicator Policy shock PMR (overall index) 20% reduction Tax structure R&D spending Employment protection of open-ended contract Structural impact after 5 years 2.4% level gain (AMEs) 3.4% level gain (EMEs) 3 p.p. rise in the share of 0.75% level increase indirect taxes 20% increase in 0.2% level increase R&D/GDP ratio 20% reduction 0.4-0.5 p.p. level increase Benchmark elasticity but allows for country-specific impact in some cases Step 3: Aggregation of reforms Example of quantification: Reform programme in Italy Impact after 5 years, % GDP Product market reform1 Labour market reform (Jobs Act)2 Tax reform Public administration and judicial system reform Total Additional average annual growth Via employment growth 1.5 Impact after 10 years, % Via productivity growth GDP 1.5 2.6 Via Via employment productivity growth growth 2.6 0.6 0.5 0.1 1.2 1.1 0.1 0.7 0.5 0.2 1.6 1.6 0.0 0.6 0.9 0.6 0.9 3.4 1.0 2.4 6.3 2.7 3.6 0.7 0.2 0.5 0.6 0.3 0.4 1. OECD estimates for the impact of product market reform include the results of reforms from 2012 onwards. Approximately two thirds of the quoted impact are due to measures taken in 2012-13. 2. The impact of the labour market reform is based on a judgement, based on the Jobs Act Legge Delega (enabling law), although not all details are defined yet. 11 The estimated longer term impact on the profile of GDP Per capita GDP, index 2000=100 130 120 Growth with reform 110 100 Growth without reform 90 80 70 1990 1995 2000 2005 2010 2015 2020 2025 2030 Expected medium-term benefits for reforms introduced in “normal” times, i.e. in broadly favourable economic conditions 12 The pace of reforms has been faster in countries facing hardest macro conditions Average pace of reform 2011-14 0.9 GRC 0.8 0.7 PRT IRL 0.6 MEX NZL POL GBR ISR HUN FIN CHN AUTAUS CAN ITA BRA DNK FRA KOR JPN USA RUS NLD DEU TUR NOR CHL LUX SVN CHE SWE BEL 0.5 EST ESP SVK CZE 0.4 0.3 0.2 0.1 ZAF ISL 0.0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 Unemployment rate in 2010 Countries reforming most were also those engaged into strongest fiscal consolidation efforts 13 Contrast between medium-term expected gains and persistently weak growth performance raises questions Are we asking too much from structural reforms? • Structural reforms a substitute for demand? • What type of reforms would best support (weak) demand in the near term? How best to mitigate contractionary effect? • Is going for broader reform package better? • Does the usual argument in favour of boldness hold in weak demand? 14 Reforms to be promoted in a context of weak demand Shift in the composition of public spending towards investment • Public infrastructure investment with high growth impact (broadband network) • Regulatory harmonisation Product market reforms in specific service sectors • Removing restrictions on the entry of new suppliers in services characterised by low entry costs – and in some cases – latent demand (professions, taxis, etc). Reforms of benefit entitlements in the areas of pensions and/or health • Improve sustainability of public finances and create space for fiscal stimulus • Effective/credible back-loaded consolidation Reforms easing frictions in the reallocation of resources • Reducing barriers to geographical or jobs mobility • Housing market policies and job-search assistance 15 Product market reforms that can ease supply constraint can bring benefits even in a difficult context Regulatory barriers to competition in regulated professions (legal services, engineering, architecture and accounting) Reducing entry barriers in service sectors with large pent-up demand and low entry costs can unleash the entry of new firms 16 Reforms least likely to succeed in a context of weak demand Reforms that initially put downward pressures on wages or mark-ups • Employment protection legislation, minimum wages or product market regulation (network industries) Factors mitigating the impacts of such reforms • Packaging: Simultaneous reforms of labour and product markets reduce risks or extent of contractionary effects. • Synchronisation: In euro area, help to reduce transition costs by giving greater scope to monetary policy • Boldness: Once and for all price level adjustment vs lower inflation expectations Measures to shift the relative strength of channels • Addressing financial sector dysfunctions to improve credit flow • Reducing policy uncertainty to boost the positive confidence channel 17 Improving on the current quantification frameworks Improving on the current quantification frameworks 1. Updating outdated estimates – Existing estimations mostly run only till mid-2000s 2. Extending to more policies and channels – Including complementarities – Taking into account more country-specificities 3. Better mapping policy changes into indicators 4. Incorporating emerging markets (EMEs) – Current frameworks cover mostly OECD Increasing consistency For the different channels (MFP, investment, labour market outcomes) • • • • Similar time period and Similar country coverage Same data sources and variable definitions Harmonised estimation approach Extending policy channels • Policies specific to production factors (widely used in earlier studies) • Innovation, trade (MFP) • Corporate tax (physical capital) • Active labour market policies (employment) • Framework conditions (used to varying extent in earlier studies) • Product and labour market regulations (widely used) • Competition law and policy (not used) • Efficiency of bankruptcy legislation (used to some extent) • Basic institutions, legal infrastructure (rarely used in earlier studies – infrequent observations) • Rule of law, efficiency of judicial systems • Intellectual property rights Better mapping policies into existing indicators • Starting point of quantification: the identification of actual policy changes in existing indicators – The more policies we manage to bring into the new framework, the impact of more actual policy changes we will be able to evaluate – A better mapping of actual policy changes into existing indicators (PMR) also increases the preciseness of quantification. 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