Policy complementarities and Growth
OECD/CESifo/Ifo Workshop “Regulation: Political Economy,
Measurement and Effects on Performance”,
Munich, 29-30 January 2010
Jorge Braga de Macedo (U. Nova of Lisbon, NBER)
Joaquim Oliveira Martins (OECD)
Bruno Rocha (U. of Coimbra)
1
Motivation
•
Structural reforms are mutually interdependent. They
are a system. With fragmented reforms the expected
benefits may not materialize
•
Some examples:
–
–
–
–
–
–
Budget stabilisation requires large enterprise restructuring in transition
countries (eg. Romania 1990s)
Banking sector liberalisation requires bankruptcy laws, supervision and
protection of creditor rights, (e.g. Baltic countries, Brazil)
Fixed exchange rates may generate upward pressures in the relative price
of non-tradables, which calls for competition policy/regulatory framework
(eg. Argentina, Portugal , Spain)
Pension reform through longevity indexation only produces benefits if
labour market generates jobs for old workers
Increasing tuition fees requires individual financing of tertiary education
etc.
2
Blockages to broad reforms
•
There are political economy arguments against very broad
reform programmes (shock-therapy type):
–
–
Sometimes large and uncompressible time is needed to change
institutions
Lack of political capital: political cycles are typical much shorter
than the time needed to materialise the benefits from reforms
In practice, removing all distortions simultaneously is
obviously impossible because of:
ƒ
–
–
–
Imperfect knowledge
Transaction costs
Implementation constraints
Î There are very few examples of countries that succeeded to
implement bold & comprehensive reform programmes (e.g.
Chile, Estonia)
3
Reforms & Growth
•
Despite accumulated evidence on the impact of
structural reforms on growth, there is still some
scepticism about this link, somewhat exacerbated
by the current crisis
•
Hausman, Prichett & Rodrik(2004) show
reforms do not explain growth accelerations:
that
Î Reforms Æ Growth (+/-)? Î Require growth diagnostics
•
Focusing on complementarity may help to clarify the
link between reforms and growth.
In this paper: complementary reformsÆ sustainable growth (+)
4
2nd Best & Policy Complementarities
•
2nd Best theory:
–
Lipsey and Lancaster (1956): need to remove all distortions
simultaneously (e.g. shock therapy)
Foster and Sonnenschein (1970): define a reform metric and
implement radial reform approach
Milgrom and Roberts (1995): Supermodularity property of a system of
complementarity reforms
–
–
•
Policy complementarities:
–
–
Î
Î
Policy coherence is often defined on the basis of non-contradictory
effects of reforms or broad-reform approach
The notion of complementarity goes beyond that. When reforms are
mutually reinforcing, a broader reform generates higher returns
Policy complementarity signals a benefit
But complicates policy evaluation because performance of one
reform area may be closely related to progress in other policies
Recent papers on policy complementarities
Subject Method for capturing Policy Complementarities 1990‐2000 (2000 for level regressions); 98 (108) Complementarity between trade openness and regulation (labour and business entry regulations) Interaction term in (cross‐country) level and growth regressions Chang, Kaltani and Loayza (2005) 1960‐2000; (5‐year periods; 82) Complementarities between trade openness and other policies Interaction coefficients in growth regressions Staehr (2005) 1989‐2001; 25 Growth in transition Principal components in growth regressions Dennis (2006) 2 countries (Morocco and Tunisia) Calderón and Fuentes (2006) 1970‐2000 (5‐year periods); 78 Paper Bolaky and Freund (2004) Sample (years; countries) Complementarity between trade openness and labour market flexibility Complementarities between trade and financial openness and the quality of institutions Braga de Macedo and Oliveira Martins (2008) 1989‐2004; 27 Growth in transition Rocha (2007) 1995‐97‐00‐02‐03; 4 (Korea, Thailand, Malaysia and Indonesia) Recovery after the Asian crisis Conclusions Increased trade does not stimulate growth in economies with high regulation – trade may even hamper growth in those with excessive regulation. More trade openness results in a larger increase in economic growth when the investment in human capital is stronger, financial markets are deeper, public infrastructure is more available, governance is better, labour market flexibility is higher, and firm‐entry is easier. Broad‐based reforms are good for output growth (but so is a policy of liberalisation and small‐scale privatisation without structural reforms. Conversely, large‐scale privatisation without adjoining reforms, market opening without supporting reforms and bank liberalisation without enterprise restructuring affect growth negatively. Simulation using GTAP model The gains of liberalising the trade regime are significantly higher under the flexible market scenario: three times for Morocco, six times for Tunisia. Interaction coefficients in growth regressions The impact of increased financial openness becomes positive for higher levels of institutional quality (nonlinear effect). Trade openness has a larger impact on growth when institutional quality is higher (monotonic relationship). Reform level and the change in reform complementarity are Hirschmann‐Herfindhal positively related to output growth. The former provides a (reciprocal of) used in long‐run target for reforms, while the latter provides guidance growth regressions on the conduct of the transition process. “Orthodox” policies must be complemented with other Hirschmann‐Herfindhal policies (e.g. unemployment benefits and good exit mechanisms). The complementarity indicator and the reform (reciprocal of); policy level indicator adjusted for complementarity are related to groupings better immediate reactions and faster recoveries. 6
Policy Indicators used in this study
variable name* (original database) Description (original database) Sources (in order of priority) Trade‐weighted average tariff rate (weights for each tariff are based on the share of World Bank, WTO imports for each good) and non‐tariff barriers (NTBs). Ability to start, operate, and close a business that represents the overall burden as 2. Business World Bank, U.S. Department of well as the efficiency of government regulations. Regulations Commerce (Heritage) International Monetary Fund,
Economist Intelligence Unit, Office 3. Free flow of capital Policies toward foreign investment, as well as its policies toward capital flows (Heritage) internally, in order to determine its overall investment climate. of the U.S. Trade Representative and U.S. Department of Commerce Economist Intelligence Unit, U.S. 4. Banking and Relative openness of each country’s banking and financial system. Department of Commerce, others. Finance (Heritage) Economist Intelligence Unit; U.S. Degree to which a country’s laws protect private property rights and the degree to 5. Property Rights Department of Commerce, U.S. which its government enforces those laws. (Heritage) Department of State 6. Infrastructure A simple infrastructure index was computed for the purposes of this article, using World Bank, World Development index – authors’ (fixed line and mobile) phone subscribers as a proxy. Indicators. calculations 7. Monetary Stability International Monetary Fund The weighted average inflation rate for the most recent three years (Heritage) 1. Trade (Heritage) 8. Government size (Heritage) Government expenditures as a percentage of GDP. World Bank, Economist Intelligence Unit, OECD; others. • All the variables are in a 0-100 scale
• Dataset contains 130 countries and covers a time span of 13 years (1994-2006)
7
Matrix of Policy Complementarities
linkage from
lines to
columns Business regulations Business regulations ‐ Trade openness Increases the scope of resource allocation; more (trade‐related) business opportunities materialize Free flow of capital (Investment) More business opportunities (e.g. FDI projects) materialize; more competition among domestic‐ and foreign‐
owned/financed firms Trade openness Free flow of capital (Investment) Banking and financial system Property rights Infrastructure (ICT, transport, energy) Improved entry‐exit mechanisms facilitate trade‐induced resource allocation Enhances investment e.g. FDI (increased attractiveness); increases the return of this investment (reduction of costs) Improved entry‐exit mechanisms enhance better intermediation (e.g. better selection of investment projects); easier to create and run financial services firms (more competition and efficiency in the sector) Enhances investment and entrepreneurship; simple and clear regulations gives less space to corruption and favours effective protection of private property Effect of good infrastructure increases when firms can operate in a more flexible environment; easier to open and run infrastructure‐related firms Increases the potential profitability of investment (larger markets); more trade‐related investment projects Increases the scope of (viable) investment projects; easier imports of technological equips. (favours financial innovation and banking efficiency) Protection of property rights favours investment and this is enhanced by easier imports of investment goods (e.g. technology‐intensive goods); eased imports of technologic equips. for the court system; low and clear NTBs reduce the probability of cases in courts and eases courts’ work Stimulates demand for (good) infrastructure and logistics; eases importation of technological equips. and other capital goods Increased supply of funds; increased competition between domestic and foreign banks improves credit conditions and financial intermediation Protection of property rights favours investment and this is enhanced by increased supply of funding Favours investment in the sector (namely infrastructure‐oriented FDI); more competition among domestic and foreign firms (e.g. ICT) ‐ Intra‐industry trade requires complementarity between traded goods and factor inputs; development of trade (e.g. due to easier international payments); favours export‐oriented FDI ‐ These n.(n-1) two-by-two complementarity relations ensure supermodularity of the system
8
Reform stages & Policy Dispersion
11
Reform stages & Policy Dispersion
12
Reform stages & Policy Dispersion
11
Reform stages & Policy Dispersion
12
Policy dispersion vs. Reform level by country
Policy Dispersion (DP)
UK
France
16
12
1994
Policy Dispersion (DP)
P o licy D isp ersion (D P )
10
12
14
P o licy D isp ersion (D P )
6
8
10
2005
1997
1995
1996
1998
1999
2000
2001
2003
2002
2005
1996
1997
19951998 1994
2006
2002
2001
2000
1999
2004
2004
4
2003
8
2006
80
82
84
Reform Level (RL)
86
88
65
Reform level (RL)
RL = simple average across 6 reform areas using Heritage indicators
DP = standard deviation of the six individual policy indicators
66
67
Reform Level (RL)
68
69
Reform level (RL)
Policy dispersion vs. Reform level by country
1994
1995
Policy Dispersion (DP)
Chile
The Philippines
1996
1996
1997
22
25
Policy Dispersion (DP)
1997
Policy Dispersion (DP)
19
20
21
Policy Dispersion (DP)
20
1998
1999
2000
2001
64
66
68
Reform Level (RL)
2005
2006
2003
2002
2000
2005 2004
2006
62
1998
2004
70
1994
18
15
2002 2003
1999
1995
72
2001
40
Reform level (RL)
RL = simple average across 6 reform areas using Heritage indicators
DP = standard deviation of the six individual policy indicators
42
44
46
Reform Level (RL)
48
50
Reform level (RL)
Variables used in the empirical test
LHS: GDP per capita growth
RHS:
•
Average level of reforms (RL and ΔRL)
•
Policy dispersion (DP and ΔDP)
•
Interaction between RL and DP
Other controls (depending on the specification):
•
Monetary stabilization
•
Human K (Education level, Immunization rate)
•
Regional dummies
•
Fixed-effects (country, time)
•
Governance (legal origin, Corruption, Political
stability)
•
Size (log of population)
15
Policy Complementarities & Growth: cross-section
Cross-section estimates
Dependent variable
GDP pc growth 1993-2006
Reform level (RL)
Change reform level (ΔRL)
Policy dispersion (DP)
Change Policy dispersion (ΔDP)
Log GDP pc 1993
(1)
all
-0.00147
(0.0316)
0.0536**
(0.0236)
-0.160**
(0.0665)
-0.0514
(0.0378)
-1.179***
(2)
all
(3)
all
(4)
all
(5)
all
(6)
GDP(93)<$14,000
(7)
DP<18.2
(8)
DP>18.2
0.0504**
(0.0250)
-0.145***
(0.0520)
0.0676***
(0.0250)
-0.134***
(0.0458)
0.0529**
(0.0223)
-0.112**
(0.0501)
0.0517**
(0.0222)
-0.147**
(0.0594)
0.0389*
(0.0219)
-0.170**
(0.0746)
0.1000***
(0.0295)
0.0210
(0.0264)
-1.090***
-1.023***
-0.912***
-0.927***
-0.984***
-0.628*
-0.665**
....
Simultaneous equation estimates (3SLS)
(1)
Dependent variable:
GDP pc
growth
Change reform level (ΔRL)
0.0887*
(0.0534)
-0.275**
(0.127)
-1.069**
(0.422)
Policy dispersion (DP)
Log GDP pc 1993
(2)
Change
Reform
Level (ΔRL)
(3)
Policy
dispersion
(DP)
Reduced sample for lessdeveloped countries
Effect of reforming is larger
with lower policy dispersion
-2.405***
(0.858)
-0.942***
(0.363)
1.464**
(0.611)
-0.238
(0.261)
….
Growth rate of GDP pc
NB: Other control variables and tests not shown (see text). Nb. obs: 94
16
Policy Complementarities & Growth: Panel data
GDP pc growth
Reform level (RL)
Change reform level (ΔRL)
Policy dispersion (DP)
Change Policy dispersion (ΔDP)
Log GDP pc 1993
Monet. stabilisation
Education level
Immunization rate
Constant
Observations
R2
Number of countries
Hausman test:
Chi2(15)
Pr >Chi2(15)
Pooled
OLS all
-0.00448
(0.014)
0.147***
(0.046)
-0.133***
(0.026)
-0.0694
(0.057)
-1.132***
(0.14)
0.0213*
(0.012)
0.372***
(0.059)
0.0315***
(0.0087)
6.925***
(1.40)
1175
0.12
104
Pooled
OLS all
FE all
FE & Time effects
all
RE all
RE & Time effects
all
RE & Time effects
GDP(93)<$14,000
0.132***
(0.046)
-0.138***
(0.025)
0.102***
(0.035)
-0.0488
(0.039)
0.0856**
(0.034)
-0.0437
(0.041)
0.112***
(0.034)
-0.0932***
(0.033)
0.101***
(0.034)
-0.0976***
(0.033)
0.0993***
(0.038)
-0.109***
(0.038)
-1.161***
(0.12)
0.0205*
(0.011)
0.362***
(0.054)
0.0316***
(0.0087)
7.129***
(1.40)
1175
0.12
104
--
--
0.0360***
(0.0094)
--
0.0453***
(0.010)
--
0.0339**
(0.015)
-1.957
(1.54)
1175
0.03
104
0.00678
(0.015)
0.128
(1.58)
1175
0.11
104
-1.154***
(0.19)
0.0265***
(0.0083)
0.403***
(0.095)
0.0334***
(0.010)
5.469***
(1.61)
1175
.
104
-1.187***
(0.18)
0.0303***
(0.0089)
0.447***
(0.086)
0.0229**
(0.0099)
7.145***
(1.52)
1175
.
104
-1.048***
(0.21)
0.0269***
(0.0099)
0.521***
(0.096)
0.0138
(0.011)
7.232***
(1.72)
968
.
86
8.27
0.08
2.39
0.99
1.99
1.00
Preferred specification
Hausman test rejects
correlation between RE and
other regressors
Reduced sample for lessdeveloped countries
17
Policy Complementarities & Growth: Non-linearities
Dependent variable: GDP pc growth 1993-2006
Initial Reform level (RL93)
Change reform level (ßRL)
Policy dispersion (DP)
(1) All
0.0388
(0.0256)
0.0745**
(0.0284)
-0.135**
(0.0640)
(2) All
-0.0701
(0.0561)
0.0959***
(0.0269)
-0.602**
(0.231)
0.00764**
(0.00326)
-1.282***
(0.266)
Interaction Term DP* RL93
Log GDP pc 1993
Dependent variable
GDP pc growth
Reform level (RL)
Change reform level (ßRL)
Policy dispersion (DP)
Interaction Term DP* RL
Log GDP pc 1993
-1.128***
(0.272)
(1)
Pooled
OLS all
(3)
FE all
(4)
RE all
(5)
RE & Time effects
all
-0.0792***
(0.0223)
0.135***
(0.0453)
-0.478***
(0.102)
0.00552***
(0.00155)
-1.195***
(0.147)
-0.104**
(0.0430)
0.131***
(0.0368)
-0.189
(0.153)
0.00273
(0.00251)
-0.0775**
(0.0331)
0.123***
(0.0353)
-0.319**
(0.129)
0.00379*
(0.00209)
-1.010***
(0.221)
-0.0864***
(0.0312)
0.115***
(0.0350)
-0.356***
(0.123)
0.00431**
(0.00199)
-1.032***
(0.202)
18
How the impact of Policy Dispersion depends on the
stage of reforms
0.2
0.1
0
-0.1
dY/ dDP
cross_section
-0.2
dYi/ dDP Panel
-0.3
-0.4
-0.5
-0.6
15
35
55
75
95
Reform Level (RL)
19
Main conclusions
• Reforming (ΔRL) and policy dispersion (DP) are,
respectively, positively and negatively related to GDP
per capita growth.
• Without higher complementarity, the effect of reforms
exhausts and does not have a lasting effect on
growth. Complementarity is a condition for
sustainable growth
• The effect of policy complementarities is higher in
developing countries.
20