Even though economic policies in both developed and developing countries have been dominated for much of the past year by the response to the global financial crisis, going forward, countries will increasingly need to refocus on issues related to strengthening medium-term economic performance, including economic growth and resilience. The IMF has a key role to play, through its surveillance activities, in advising country authorities on these issues, including leveraging the lessons from cross-country experience for policy formulation at the national level, and drawing implications about the kind of policies that lead to more favorable “real-financial” linkages in response to country and global shocks. The IMF's role is tied to its responsibilities under Article IV of the Articles of Agreement to ensure that members' economic policies foster sound medium-term economic growth and stability.
The stability-cum-growth objective, while very broad, is linked to policies geared to strengthening market incentives and raising economic efficiency; boosting the sustainable rate of potential growth; and enhancing the economy's ability to absorb shocks. This, of course, is the traditional purview of structural policies, that is, policies that increase the role of market forces and competition in the economy, including by fostering both domestic and international trade and financial flows, while maintaining appropriate regulatory frameworks in the case of market failures or identified externalities. While progress has been made in understanding the role of such policies, empirical evidence based on a consistent global dataset is lacking, with previous studies focused mainly either on the experience of industrial countries or of the transition economies. The paucity of comparable data on indicators of structural reform across the full gamut of different income groups and regions has undoubtedly been a factor behind the lack of global reach of past empirical studies.
This paper examines the effects of structural reforms on two aspects of economic performance—medium-run growth and macroeconomic stability and resilience— from a global standpoint, and in so doing improves the analytical basis of IMF policy advice by drawing on the lessons from broad cross-country experience. Underpinning the results is a significant data collection effort, involving the compilation of indicators of structural reform for a large sample of 91 developing and developed countries over the past three decades. Not only is the resulting dataset unique in its country and time coverage, it also is much broader in terms of the sectoral coverage of reforms—including indicators of liberalization in domestic product markets, international trade, several indicators of liberalization of the domestic financial sector, and measures of the external capital account liberalization. The dataset's breadth along the sectoral dimension is essential to address issues of reform sequencing, an area that has generated much thought from a theoretical standpoint, but where systematic cross-country evidence—as opposed to smaller-scale case studies—is sorely lacking.
The analysis in the paper yields a number of significant results:
There has been a broad tendency to pursue structural reforms across all segments of the IMF's membership over the past three decades. Low- and middle-income countries have on average reached the degree of liberalization achieved by the industrial countries in the early 1990s in the areas of product market and domestic financial sector liberalization, with larger, but shrinking, reform gaps in trade and external capital account liberalization.
Reforms across the IMF's membership appear to have been driven by a number of factors, including the quality of broad political institutions in advanced economies early in the sample, and a significant catch-up effect spurring reform in developing countries subsequently, as sizable cross-country reform gaps—with respect to either reform “leaders” or reformist “neighbors”—emerged. There is also evidence that IMF-supported programs and, for some sectors, economic crises have helped to catalyze structural reforms.
Real and financial sector reforms have exerted an economically significant impact on per capita income growth in all segments of the IMF's membership, with domestic financial sector liberalization, trade liberalization, and liberalization of the agricultural sector exerting particularly favorable effects. A number of channels are in evidence, including a reduction in credit constraints to, and borrowing costs for, capital accumulation, and larger inflows of FDI that seem to result from external capital account liberalization. There is also evidence that structural reforms help to raise allocative efficiency, as firms across different sectors react to the shifts in comparative advantage brought about by deregulation. Firms that are highly dependent on imported intermediate inputs in production, for example, see large growth benefits from trade liberalization, while firms with a high dependence on external finance for their investments see particular growth benefits from financial sector liberalization. The impact of financial and real sector reform on economic growth also seems to reflect a more favorable assessment of the future profitability and solvency of domestic firms as embodied in their credit ratings.
Growth effects differ significantly across alternative structural reform sequencing strategies. There is strong evidence supporting the view that economies that liberalize trade before liberalizing the external capital account grow more rapidly than those that follow the reverse sequence. There is also evidence that a parallel pursuit of both domestic financial sector reform and external capital account liberalization—provided that the trade regime is relatively open—is a growth-friendly reform strategy. While the data do not speak loudly on the relative growth benefits of pursuing domestic financial sector reform versus external capital account liberalization early in the reform process, the stability benefits—in terms of both macroeconomic volatility and crisis propensity—are found to be more favorable when the domestic financial sector is liberalized ahead of the external capital account.
The stability benefits flowing from domestic financial sector reform are also evident in the way in which economies respond to various real and financial shocks, with resilience—the bounce-back of the economy following a shock— enhanced in economies with relatively liberalized domestic financial sectors. Financial reforms tend to reduce the output costs from adverse terms of trade and foreign interest rate shocks, with a variety of mechanisms—especially improvements in credit availability—playing a key role. The greater resilience to real shocks in economies with more liberalized financial sectors is evidence of how such reforms can strengthen economy-wide real-financial linkages.
The remainder of the paper is organized as follows. Section III presents the main features of the dataset and key trends in structural reform over the past three decades. Section IV examines a range of factors that may serve to spur, or retard, the process of structural reform. The subsequent sections present empirical evidence on the impact of reforms, including their effects on economic growth (Section V), related sequencing issues (Section VI), and macroeconomic volatility and resilience (Section VII). Section VIII concludes.