The Short-Term Impact of Product Market Reforms
A cross-country firm-level analysis*
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
  • | 2 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Contributor Notes

Author’s E-Mail Address: alexander.hijzen@oecd.org and peter.gal@oecd.org

This paper analyzes the effects of product market reforms in the short and medium term across 10 regulated industries and 18 advanced economies for the period 1998-2013 using internationally comparable firm-level data based on Orbis. It provides four key insights. First, product market reforms have positive effects on capital, output and employment and their effects increase over time. After two years, they raise capital by 4%, output by 3% and employment by 1.5%. Second, differences in production technology and the nature of product market regulations across sectors generate important differences in the mechanisms through which reforms operate. In network industries, reforms tend to benefit small firms, while the opposite is observed in retail trade. Product market reforms also promote firm entry, particularly those that reduce entry barriers. Third, credit constraints can play an important role in weakening the positive impact of product market reform on investment. Fourth, product market reforms also tend to have positive effects on firms in downstream sectors—both at home and abroad—that make intensive use of intermediate inputs from deregulated sectors.

Abstract

This paper analyzes the effects of product market reforms in the short and medium term across 10 regulated industries and 18 advanced economies for the period 1998-2013 using internationally comparable firm-level data based on Orbis. It provides four key insights. First, product market reforms have positive effects on capital, output and employment and their effects increase over time. After two years, they raise capital by 4%, output by 3% and employment by 1.5%. Second, differences in production technology and the nature of product market regulations across sectors generate important differences in the mechanisms through which reforms operate. In network industries, reforms tend to benefit small firms, while the opposite is observed in retail trade. Product market reforms also promote firm entry, particularly those that reduce entry barriers. Third, credit constraints can play an important role in weakening the positive impact of product market reform on investment. Fourth, product market reforms also tend to have positive effects on firms in downstream sectors—both at home and abroad—that make intensive use of intermediate inputs from deregulated sectors.

I. Introduction

Given the secular decline in productivity growth and the weakness of the economic recovery in many advanced economies, increased attention is being paid to the potential role of structural reforms for restoring economic growth. While the weak economic recovery reflects in part a problem of aggregate demand, the global financial crisis also had a tendency to undermine aggregate supply, notably through its impact on investment. Moreover, the current economic situation should be seen in the context of the secular slowdown in productivity growth that started well before the beginning of the global financial crisis which suggests that deeper structural forces are also at play (Dabla-Norris et al., 2015; IMF, 2015; OECD, 2015a).1 The hope is that structural reforms can promote potential output, while at the same time giving a boost to aggregate demand by raising consumer and business confidence.

While structural reforms can take many forms (e.g. banking supervision, property right laws and employment-protection rules), product market reforms feature particularly prominently on the agenda of many advanced economies (OECD, 2015b). There are at least two reasons for this. First, the long-term benefits of product market reforms are well established and considered relatively high (see Boeri et al., 2015, and Nicoletti and Scarpetta, 2005, for surveys). Second, there is substantial scope for further product market reform. During the past 15 years, most reform activity has tended to be concentrated in network industries (energy, transport and communication) which used to be heavily regulated in most advanced economies. However, there remains room for further action in specific network industries and countries. Moreover, attention is increasingly shifting to other regulated sectors, most notably, retail trade and professional services.

Although the long-term benefits of product market reforms are well established, much less is known about their effects in the short-term and how they are distributed across workers and firms. Theoretical analyzes by Blanchard and Giavazzi (2003), Cacciatore and Fiori (2016) and Cacciatore et al. (2016a, 2016b) suggest that the positive effects of product market reforms only materialize gradually and may even involve some short-term costs. Recent empirical studies provide some evidence for these predictions by showing that the benefits of such reforms tend to materialize only over time, but yield somewhat conflicting insights with respect to the possible presence of short-term costs (e.g. Bassanini, 2015; Bordon et al., 2016; Bouis, Duval and Eugster, 2016; IMF, 2016; OECD, 2016).2 Moreover, since these studies are conducted at the macro or sector level they do not provide evidence on the allocation of costs and benefits between different firms and workers. Consequently, important questions remain both with respect to the dynamic and distributive effects of product market reforms. Understanding how the effects of product market reforms come about, however, is crucial not only for understanding what role they can play in the current context, but also for shedding light on the political economy of these reforms and the potential need for complementary policies to mitigate their costs or enhance their effectiveness.

This paper contributes to the emerging literature on the short-term effects of product market reforms by providing a comprehensive analysis using internationally comparable firm-level data based on Orbis. It focuses on 10 regulated industries in three broad sectors (network industries, retail trade and professional services) across 18 advanced economies during the period 1998-2013. These sectors feature prominently on the deregulation agenda and exhibit significant differences in their product technology and the nature of regulations. Together they account for about a quarter of non-farm private sector employment. Their economic significance is likely to be even larger as their outputs tend to be widely used as inputs elsewhere in the economy. The main value of firm-level data in the present context is that they allow analyzing the effects of reforms in more detail than has been the case so far by comparing their effects across different firms and sectors, thereby providing insights into the mechanisms through which reforms operate.3 While a number of previous studies have employed firm-level data to analyze the effects of product market reforms, they tend to focus on a single sector and do not explicitly examine short-term effects (e.g. Bertrand and Kramarz, 2002, for retail in France; Schivardi and Viviano, 2011, for retail in France, Italy, and the United States; Lanau and Topolova, 2016, for network industries, retail and professional services in Italy; Fabrizio et al., 2010, and Goolsbee and Syverson, 2008, for respectively electricity and airlines in the United States).

In order to document the short-term effects of product market reforms, we estimate impulse-response functions of employment, capital and output to major reforms using the local projection method (Jordà, 2005; Teulings and Zubanov, 2014). Since the main value of using firm-level analysis in the present context is to shed light on the way firms behave in response to product market reforms, the analysis in this paper focuses on the typical firm by employing unweighted regressions. This means that one should be careful making inferences about the macro-economic implications of the results featured in the present analysis.4 Furthermore, the core analysis is restricted to incumbent firms that remain in business in the years following a reform. Since product market reforms have potentially important implications for firm entry and exit, an effort is also made to estimate their effects for firm entry.5

The key findings from the paper are:

  • The short-tem effects of product market reforms are positive and strengthen over time. The effects are immediate for both output and investment, and increase to 4% and 3% respectively after two years. The effects for employment are considerably smaller and only materialize after two years.6 These results control for key firm characteristics, reforms in the two preceding or subsequent years, and many unobserved factors through a rich dummy structure that controls for country-industry specific trends, sector-specific technological developments and country-specific macro-economic conditions. The latter is particularly important since product market reforms often take place when economic conditions are weak. Moreover, the results are robust to the measurement of major reforms and a number of other sensitivity checks.

  • There are systematic and plausible differences in the effects of reforms across firms of different size across the different industries. More specifically, in network industries, small firms tend to benefit most from pro-competitive product market reforms, while larger ones downsize to reduce costs and maintain market share. By contrast, in retail trade, large and potentially more efficient businesses tend to be benefit more from such reforms. These qualitative differences in the impact of deregulation between network industries and retail trade highlight important differences in the underlying mechanisms that bring about the positive effects of product market reforms due to differences in production technology, such as for example the degree of capital intensity, and the nature of product market regulations. Moreover, there is also evidence that reforms are associated with increased firm entry in the two sectors.

  • Credit constraints weaken the short-term impact of product market reforms on investment. The main challenge of identifying the role of credit constraints is to control for the confounding role of credit demand, i.e. the possibility that firms demand less credit because they face worse investment opportunities. In order to disentangle the role of credit supply from that of credit demand, this paper builds on Rajan and Zingales (1998) by analyzing how the impact of product market reforms depends on the need of external funds to finance investment in periods when credit supply is severely constrained versus in periods when it is not. We find that credit constraints can indeed reduce the impact of product market reforms on investment.7 This highlights the importance of addressing the problem of weak bank balance sheets when considering product market reforms, and points to the complementary role of financial sector reform more generally.

  • Deregulation yields positive spillovers on firms in downstream industries—both domestically and abroad—through input-output linkages. This is consistent with sector-level results by Barrone and Cingano (2011), Bourles et al. (2013) and OECD (2016), but extends the literature in two directions. First, it employs a stronger identification strategy based on the use of intermediate inputs by individual firms in combination with sectoral information on input-output linkages and, in addition, features a much richer set of fixed effects.8 Second, it focuses not only on backward linkages between domestic firms but also between firms in different countries. The findings confirm the positive effect of product market reforms on downstream firms through backward linkages within the same country, but also provide some indication that these effects also extend to firms abroad.

This paper also makes a few contributions on the data side. The first is to construct annual indicators of product market regulations in retail and professional services. While indicators on de jure product market regulations for network industries are available at an annual frequency from the OECD, similar indicators for retail trade and professional services are available only every five years and, hence, do not allow identifying the timing of reforms and analyzing their short-term effects. Annual indicators for retail trade and professional services are constructed by complementing the OECD indicators with external information on the timing of reforms. The second contribution is to construct a historical firm-level dataset by combining three different vintages of Orbis (2005, 2010, 2015).9 The construction of a historical dataset is an important part of our analysis since the standard Orbis data as provided by Bureau van Dijk only contains a limited time horizon (typically 5 to 10 years) and, hence, greatly limits the number of reform episodes that can be considered as well as the ability to follow firms through extended periods of time. The resulting historical dataset provides high and relatively stable coverage for the period 1998-2013. It therefore captures at least part of the wave of product market deregulation that took place from the early 1990s to the early 2000s.

The remainder of this paper is structured as follows. Section 2 discusses how product market reforms are measured and documents their distribution over time and across industries. Section 3 provides details on the construction of the firm-level dataset based on Orbis. Section 4 discusses the baseline methodology, the baseline results and their sensitivity to different specifications. Section 5 analyzes the mechanisms through which product market reforms operate by comparing the effects on different types of firms (size and age), as well as the response of firm entry to reforms in each of three broad sectors considered in this paper. Section 6 analyzes the role of credit constraints for the short-term impact of product market reforms on investment. Section 7 analyzes the indirect effects of product market reforms through backward linkages in the same country as well as abroad. Finally, Section 8 concludes.

II. Product market reforms across advanced economies

Sectoral indicators on the restrictiveness of product market regulations are provided by the OECD (Koske et al., 2015). The OECD’s database on product market regulations is based on a detailed questionnaire sent out to governments every five years. To give an indication of the degree of detail, the 2013 questionnaire includes around 1400 questions on economy-wide and sector-specific provisions. The indicators are based on rules and regulations and hence capture de jure policy settings. The objective nature of the indicators allows making meaningful comparisons across countries. A drawback of focusing on de jure policy settings is that the indicators do not take account of differences in implementation and enforcement across countries. This means that not all reforms considered in this paper are fully implemented and strictly enforced in practice. The indicators range from 0 to 6 with higher values reflecting more restrictive product market regulations.

In principle, sectoral indicators are available for 7 network industries (which can be classified into three broad groups: energy, transport and communication), the retail sector and 4 professional services sectors (accounting, legal, engineering and architecture) (see Figure 1). Together these sectors account for about a quarter of non-farm private sector employment for the average country in our sample in 2010. However, their economic significance is broader since most of their output is heavily used as inputs in production elsewhere in the economy (Table A6, Annex A3). Regulation in network industries is mainly about the organization of network access to potential service providers. Regulation in retail trade typically takes the form of entry barriers, specific restrictions for large firms and the flexibility of shops in terms of opening hours and prices. Regulation in professional services relates to barriers to entry and the way services are delivered and includes, amongst others, rules governing the recognition of qualifications and the determination of fees and prices.

Figure 1.
Figure 1.

The OECD indicators on the restrictiveness of product market regulations

% of total non-farm private sector employment

Citation: IMF Working Papers 2016, 116; 10.5089/9781475516852.001.A001

Source: OECD Structural Demographics and Business Statistics for 2010. Unweighted average across 18 OECD countries (see Table 1).

An important limitation of the OECD indicators in the present context is that they are available on an annual basis only for network industries and only every five years for retail and professional services.10 This means that the timing of product market reforms in retail and professional services cannot be precisely identified. Consequently, previous studies that have made use of the OECD indicators to analyze the short-term effects of product market reforms have restricted the analysis to a relatively small segment of the economy for which annual indicators are available by concentrating on network industries (Bassanini, 2015; Bouis et al, 2016) or have focused on economy-wide indicators of product market regulations (Bouis et al. 2012; Bordon et al., 2016).

In order to allow analyzing the short-term effects of product market reforms not only in network industries, but also in retail trade and professional services, this paper constructs annual series indicators on the restrictiveness of product market regulation in those sectors. This is done by combining the OECD indicator values for retail trade and professional services, available at five-year intervals, with detailed information on reforms collected by the IMF on structural reforms, drawing on comprehensive raw information from all historical OECD Economic Surveys for 26 advanced economies (Duval et al., 2016a). Using this information on the timing of reforms, the OECD sub-indicators for retail and professional services are filled up for the intermediate years by an automated procedure based on a string-search algorithm for each major component of product market regulation within these sectors.11 If there was only one reform within the five-year interval the indicator was held constant at its latest value until the year of the reform and changed to its next value from the year of the reform onwards. If there were several reforms within the five-year window it was assumed that the quantitative impact of each reform on the PMR indicator for that sector was the same. For a detailed description, see Annex A1.

Apart from extending the focus from network industries to retail and professional services, the use of firm-level data in the present paper allows analyzing the role of product market reforms in each of the seven network industries by exploiting the detailed industrial-activity information available in Orbis. In contrast, previous studies that rely on sectoral data could not utilize the full detail in the OECD indicators and were only be able to use the policy variation across three or four broad network industries. Since the nature of rules and regulations with respect to the different categories of professional services tends to be relatively similar, the four professional services sectors were regrouped into two categories: i) business services, consisting of respectively accounting and legal services, and ii) technical services, consisting of respectively engineering and architecture services. As a result, the policy variation for each country will rely on 10 separate industries (7 in network industries, 1 in retail, and 2 in professional services).

Figure 2 documents how the restrictiveness of product market regulation evolved from 1998 to 2013. More specifically, it shows the evolution of the extended indicator on the restrictiveness of product market regulations by broad sector in terms of the median country, as well as its dispersion as measured by 25th and the 75th percentiles and the minimum and the maximum. The figure provides a number of insights. First, the median restrictiveness of product market regulations has declined significantly in network industries, fallen modestly in retail and remained largely stable in professional services. Second, the dispersion in the restrictiveness of product market regulations across countries was relatively low in network industries and has declined further, while it is much higher in retail and professional services and has declined only modestly. This indicates that in some countries there remains significant scope for further reforms in retail trade and professional services.

Figure 2.
Figure 2.

The restrictiveness of product market regulations over time, 1998-2013

Panel A. Network industries

Citation: IMF Working Papers 2016, 116; 10.5089/9781475516852.001.A001

The horizontal line in the boxes represents the median, the upper and lower edges of each boxes reflect the 25th and 75th percentiles and the markers on the extremes denote the maximum and the minimum across countries.Source: Authors’ calculations based on OECD indicators on product market regulation.

The econometric analysis focuses mainly on major product market reforms with respect to the overall restrictiveness of product market regulation as well as that with respect to entry barriers only.12 There are two main arguments for this. First, previous evidence suggests that reforms need to be sufficiently large to have a detectable impact (Alesina et al., 2005). Second, it is likely to yield more robust results because it reduces their sensitivity to measurement error.

A major pro-competitive reform is defined as a large reduction in the indicator of product market regulation while an anti-competitive reform is defined as an increase in the regulatory stance of at least the same size. We consider three alternative criteria to identify major reforms. The first defines major reforms as a change in the PMR indicator of at least 0.5. This corresponds to almost the 5% largest annual changes in the PMR indicator regulation across all 10 sectors (R1). While this rule ensures that only major reforms are taken into account it also implies that the number of reforms can vary widely across sectors. In order to ensure that the number of reforms is similar across sectors one may also concentrate on the top 5% in each sector. However, since the number of major reforms in professional services is relatively limited this means that also relatively small changes in the PMR indicator are classified as major reform changes. To address this issue, we use the highest of either the top 5% or a 0.5 change in the indicator of product market regulation (R2). Finally, we make use of indicators of major product market reforms developed by Duval et al. (2016a) for network industries in combination with R1 for retail and professional services (R3). The former are based on a narrative approach that makes use of qualitative information about the significance of the reform as well as changes in the OECD indicator.13

Figure 3 shows the number of major reforms, in either direction, with respect to the overall restrictiveness of product market regulation for each sector during the period 1998-2013. In order to ensure a meaningful comparison across sectors, the definition of major reforms in terms of the absolute threshold is used (R1). This shows that major reforms were most common in the network industries, and particularly in telecoms and electricity, while they were least common in road transport, retail trade and professional services.14 The relatively low number of major reforms in retail and professional services in part reflects the relatively low reform activity in those sectors, consistent with Figure 2, but also the possibility that not all major reforms were identified. Table A3 in Annex A1 reports the number of reforms in each sector for each reform measure.

Figure 3.
Figure 3.

Number of major product market reforms, 1998 – 2013

Based on absolute changes in the PMR indicator larger than 0.5

Citation: IMF Working Papers 2016, 116; 10.5089/9781475516852.001.A001

In order to analyze the effects of product market deregulation on downstream firms in other industries, indirect reform measures are constructed. They measure the exposure of firms in downstream sectors to product market reforms in upstream network industries. This is done, for each downstream industry, by weighting major reforms in upstream industries by the share of intermediate inputs from the network industry in question by total intermediate input use in the spirit of Conway and Nicoletti (2006). See Section 7 for details.

III. Creating a “historical” firm-level database using Orbis

In order to analyze the short-term effects of product market reforms we combine the indicators on product market reforms with firm-level data on economic outcomes from Orbis. Orbis is a firm-level dataset of companies worldwide provided by Bureau van Dijk, a private company. It contains information on the productive activities and financial conditions of firms based on balance sheets and income statements. While Orbis in principle has global coverage, country coverage is restricted here to advanced economies, for which we have historical information on the restrictiveness of product market regulations and a reasonable coverage in Orbis.

A. General data preparation

In order to prepare Orbis for analysis the following steps were taken:15 (i) constructing a “historical” dataset by combining different vintages of Orbis; (ii) ensuring comparability of monetary variables across countries and over time (PPP conversion and deflation); (iii) constructing a number of key variables which are widely used in empirical work; and (iv) keeping company accounts with valid information. The next sub-section then presents further steps that are aimed at filtering out observations that are not suitable for the present analysis.

A historical dataset is created in order to extend the time horizon in the standard version of Orbis, which is a maximum of 5-10 years depending on the country, but considerably shorter for the majority of firms.16 This is done by combining three different vintages of Orbis (2005, 2010 and 2015). To implement the merge across vintages, correspondence tables provided by Bureau van Dijk between the old and new company identifiers (BvD ID-s) are used. As will be shown below, this results in good and relatively stable coverage for the period 1998 to 2013.17

To ensure the comparability of monetary variables (revenues, assets, etc.) across countries, the currencies have to be harmonized.18 Industry-level deflators are obtained from the OECD STAN database (version ISIC4) and applied - with based year 2005 - after converting the data in national currency. Country-industry level purchasing power parities (PPPs) are applied, for the same reference year, to arrive at internationally comparable values, using the database of Inklaar and Timmer (2014). This ensures that firms in less advanced economies do not appear to be less productive in international comparisons simply because the price level is lower. For details on the procedure, see Annex A2.

The following additional variables are constructed for use in the empirical analysis.19 A measure of real capital stock constructed by, first, deriving the real value of gross investment flows by deflating the difference in the book value of net capital stocks (fixed tangible assets) and depreciation between two years and, subsequently, applying the perpetual inventory method (PIM) to gross investment flows using the book value of fixed tangible assets as the starting value to generate real net capital stocks. Labor productivity is calculated as value added divided by the number of employees. The age of firms is derived as the difference between the current year and the year of incorporation.

Only company accounts are kept that satisfy each of the following criteria: i) refer to the entire calendar year, thereby excluding reports that pertain to only part of the year; ii) are either unconsolidated, consolidated but without unconsolidated counterpart or whose consolidation status is unknown;20 iii) contain non-missing and strictly positive values for employment and gross output (measured in terms of operating revenues). The resulting sample corresponds to about 30 million observations for 18 countries for the years 1998-2013 (Table A4 of the annex).

In order to get an indication of the actual coverage of the database, we compare the sample with the universe of companies using official statistical sources from the Structural Demographics and Business Statistics of the OECD (SDBS) on the number of employees. The Structural Demographics and Business Statistics of the OECD (SDBS) contains information on the number of enterprises, establishments, employees by country * industry * employment size class cells, for each year. The underlying sources of the information are national administrative databases which cover the universe of firms – typically business registers. As such, the SDBS can be used to assess the degree of coverage in Orbis by comparing the number of firms in the data with the population of companies.21 Table A5 in the annex shows that coverage in terms of employment is close to complete among large firms and in network industries (80-100%), while other sectors, populated by smaller firms, tend to have lower coverage (20-40%).

B. Additional cleaning steps for the present analysis

In addition to the preparatory steps described above which may be deemed useful for any analysis based on Orbis, we apply a number of cleaning rules which are more directly relevant for the present analysis. First, in order to reduce noise from micro and self-employed units, the sample keeps only those company accounts that report at least three employees. Second, since our methodology focuses on growth rates, implausibly high changes in employment, capital stock and output are filtered out. In particular, they are set to missing when their growth rates are related to large level shifts (larger than 100-fold increase or smaller than 1/100-fold decrease). In addition, the same variables are also set to missing if they are related to more than 50-fold changes that are reversed the next year (“spikes”). Finally, only firms with at least four consecutive observations with valid information are retained.

After implementing these cleaning rules, the sample used for the analysis of the direct effects of product market reforms consists of about 1 million observations across the 10 PMR industries, 18 OECD countries and the period 1998-2013 (Table 1). The sample for the analysis of the indirect effects of product market reforms that covers entire market economy – defined for the present purposes as the non-farm, non-financial business sector22 – consists of over 5 million observations sector (Table A4 in the annex).23

Note that the unbalanced nature of the data along the sector and the country dimension does not necessarily mean that the identified impact of the reforms will largely be driven by the largest sectors in our analysis. As Angrist and Pischke (2009, Chapter 3.3) explain, if there are heterogeneities in the effects across groups (in our case, sectors and countries), then the estimated overall effect is a weighted average. But the weights are not the sizes of these groups but to the variations in the treatment variable (in our case, reform intensity) across these groups.

Table 1.

Number of observations used in the direct effect analysis

By PMR sector, country and year

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C. Descriptive statistics

The three main sectors considered in this paper (network, retail and professional services) differ importantly in terms of their average firm characteristics (Table 2). Firm in network industries tend to be relatively large and capital-intensive, in line with the presence of strong technological entry barriers that increase optimal firm size. In contrast, firms in retail – with the exception of large retail store chains – and in particular professional services tend to be relatively small and labor-intensive, with professional services firms also being somewhat younger. Finally, firms in professional services are also less indebted, consistent with their lower capital intensity, whereas retail companies may need higher debt levels to purchase and maintain relatively high inventory levels.

Table 2.

Descriptive statistics on selected firm-level variables by industry

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Note: monetary variables are expressed in millions of 2005 PPP dollars.

IV. The short-term effects of product market reforms in network industries, retail and professional services

A. Baseline methodology

The methodology for assessing the short to medium-term impact of product market reforms is based on the local projection estimator due to Jorda (2005) and Teulings and Zubanov (2014).24 This estimator allows for the robust estimation of impulse response functions by estimating its coefficients directly for each time horizon as opposed to deriving them indirectly from the estimates of a specific dynamic model, which are typically more sensitive to misspecification. Moreover, focusing directly on differences in the outcome variable of interest naturally allows controlling for country and industry-specific linear trends through the inclusion of country-industry dummies. This effectively relaxes the common trends assumption of the standard difference-in-difference estimator by transforming it into a triple-difference estimator. The main outcome variables considered are employment, capital stock, and gross output.

In the baseline regressions, the log difference in the outcome variable of interest y between t-1 and t+S in firm i is modeled as follows:

(1)yit+syit1=α+Σs=2SβsRjct+s+γXit1+ηcj+θjt+vct+ɛits=0,1,2

where Rjct refers to an indicator variable that equals one in the event of a major pro-competitive reform and minus one in the event of a major reform in the opposite direction in industry j, country c and year t. In order to control for past reforms the first two lags of the reform indicator are also included. To control for reforms during the post-reform period the first lead is included when considering the impact of product market reforms at horizon t+1 and the first two leads when considering its impact at horizon t+2. The impulse response function is obtained by combining the coefficients β0 for each time period S.

The empirical model further controls for wide variety of observable and unobservable factors. All observable factors are expressed in terms of categorical variables and lagged by one period.25 These include firm size measured in terms of the number of employees (3-9; 10-19; 20+), age measured in years (0-9; 10-24; 25+), debt leverage defined in terms of the debt to asset ratio (no debt; some debt, <0.25; high debt, 0.25+), and labor productivity in terms of value added (bottom, middle, top tercile). It further includes industry*country fixed effects (ηcj) to allow for differences in linear trends in the outcome variable of interest across country and industry pairs, country-time dummies (vct) to control for differences in macro-economic developments across countries and industry-time dummies θjt to control for sector-specific technological developments that are common across countries.26 Standard errors are robust and clustered by industry and country.

For the estimation, we impose the condition that our panel is “locally” balanced, such that over the four-year horizon, from s=-1 to s=2, there are no changes in the composition of the sample. This means that the results exclusively capture within-firm effects. From this perspective, it does not change the interpretation when firm fixed effects are included instead of country*industry fixed effects. However, since the panel is not fully or “globally” balanced the results are not identical. Firm-fixed effects will therefore be used in the sensitivity analysis.

B. Baseline results

The baseline results for employment, capital and output are reported in Table 3 and Figure 4. These focus on major reforms defined in terms of the absolute threshold (R1) with respect to either the overall restrictiveness of product market regulation (Table 3a and Panel A of Figure 4) or only that of barriers to entry (Table 3b and Panel B of Figure 4).

The results indicate that the short-term effects of product market reforms on incumbent firms are positive and strengthen over time. The positive effects on output, and capital are immediate and increase to around 3% for output and 4% for capital after two years. The impact on employment is smaller and only emerges after two years, reaching between 1.5 and 2%. Given the relatively weak impact of product market reforms on employment compared with output, reforms also tend to increase labor productivity. The results are similar when focusing on the overall restrictiveness of product market regulation or entry barriers. This may indicate the results for reductions in the overall restrictiveness of product market regulations are to an important extent driven by reductions in entry barriers.

The firm-level controls suggest that larger and older firms tend to grow less fast than their smaller and younger counterparts who remain active.27 The impact of indebtedness on firm growth is a priori ambiguous since it may reflect the importance of profitable investment opportunities or impede investment by limiting further access to external finance. The results suggest that indebtedness is associated with less investment, but with more output growth. This could reflect the possibility that indebtedness captures the importance of past investment opportunities (increasing both indebtedness and output capacity), but may also become an obstacle to further investment in the future as access to credit is reduced. Excluding these firm-level controls does not have a significant impact on the results.

Figure 4.
Figure 4.

The short-term effects of product market reforms on incumbent firms

Percentage change in the outcome variable of interest in years after the reform

Citation: IMF Working Papers 2016, 116; 10.5089/9781475516852.001.A001

Solid lines represent impulse response functions based on the estimated coefficients; dashed lines represent 90% confidence intervals. See Table 3a and Table3b for full details.

Table 3a.

The effects of a reduction in the overall restrictiveness of product market regulation

Percentage change in the outcome variable of interest in years after the reform

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Standard errors are robust and clustered by country and industry. *, **, *** refer to statistical significance levels of 10%, 5% and 1% respectively.
Table 3b.

The effects of a reduction in entry barriers

Percentage change in the outcome variable of interest in years after the reform

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Standard errors are robust and clustered by country and industry. *, **, *** refer to statistical significance levels of 10%, 5% and 1% respectively.

Table 4 summarises the results using different reforms measures by focusing on the coefficients that define the impulse response function only. It reports results for the three measures of major reforms as well as the change in the extended OECD indicator. Panel A focuses on the overall restrictiveness of product market regulation, whereas Panel B focuses on barriers to entry. The results are qualitatively similar across each of the four measures of product market reforms in terms of the relative size of the effects across outcomes variables as well as the shape of the impulse response function.28 This is reassuring since this suggests that the results are not driven by the specific way reforms are defined. Moreover, the results are rather similar when focusing on the overall restrictiveness of product market regulations and when focusing on barriers to entry. As mentioned above, this may reflect the possibility that much of the reform activity with respect to product market regulations relates to the barriers to entry.29

The results based on the measure of major reforms that uses the narrative approach are most closely comparable to results by Bouis et al (2016) at the sector and country-level since they use the same measure of major reforms.30 The medium term results for employment and output at t=2 are qualitatively and quantitatively similar. This may either suggest that the effects of product market reforms on the entry and exit of firms are not that important or that the effects on entry and exit approximately cancel each other out. However, the positive effects appear to materialise somewhat more quickly in the present paper. This may reflect our emphasis on the typical firm, which is relatively small and affected more positively by product market reforms, at least in network industries. It may also be that sector-level studies capture the fact that the effect on entry takes some time to materialize whereas the impact on exit is more immediate.

Table 4.

Results by reform measure

Percentage change in the outcome variable of interest in years after the reform, selected coefficients

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Regressions control for reforms in the previous and subsequent two years, include firm-level controls, as well as country-industry dummies, country-year dummies and industry-year dummies. Standard errors are robust and clustered by country and industry. *, **, *** refer to statistical significance levels of 10%, 5% and 1% respectively.

Both the size of the reform and the initial restrictiveness of product market regulations appear to matters. Panel A of Table 5 documents the effects of respectively small reforms defined in terms of reductions (increases) in the overall restrictive of product market regulation of between 0 and 0.25, modest reforms defined in terms of reductions (increases) between 0.25 and 0.5 and major reforms defined as reductions (increases) of one half or more. The results indicate that the minor or modest reforms have effectively no effects, with the possible exception with modest reforms in the case of investment. This suggests that concentrating on major reforms does not substantially reduce the policy variation in the data. Panel B of Table 5 documents how the results differ depending on the initial restrictiveness of product market regulations. For the present purposes, initial restrictiveness is defined in terms of the terciles of the distribution of the extended PMR indicator across countries and years within each industry. The results indicate that the short-term effects of pro-competitive reforms are more positive the lower the initial restrictiveness of product market regulations. One possible explanation for this is that major reforms in the context of strict initial regulations have both larger short-term costs (smaller short-term benefits) but also longer short-term benefits.

Table 5.

Results by absolute reform size and initial regulatory stance

Percentage change in the outcome variable of interest in years after a reduction in the overall restrictiveness of product market regulation, selected coefficients

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Regressions control for reforms in the previous and subsequent two years, include firm-level controls, as well as country-industry dummies, country-year dummies and industry-year dummies. Standard errors are robust and clustered by country and industry. *, **, *** refer to statistical significance levels of 10%, 5% and 1% respectively.

C. Sensitivity analysis

Product market reforms tend to be conducted when economic conditions are weak (Duval et al., 2016b; IMF, 2016). This creates a potential endogeneity problem which is likely to downward bias the estimates. The rich dummy structure, and particularly the country-time dummies, already controls for the role of economy-wide business conditions. Nevertheless, it cannot be excluded that product market reforms respond to sector-specific business conditions as well.31

In order to address the possibility that product market reforms respond to sector-specific business conditions, we pursue an instrumental variable strategy that attempts to purge the variation in reforms driven by sector-specific business conditions from our reform indicator. We use two alternative instruments (Table 6, rows 1 to 2): i) the overall restrictiveness of product market regulation in the previous year, as measured by the lagged level of the extended OECD indicator, which represents an absolute measure of reform pressure; ii) the relative restrictiveness of product market regulation, measured by the difference between the OECD indicator and its average level in other industries in the same country compared that in other countries.32 Each of these measures has a positive and statistically significant impact on the probability of observing a pro-competitive reform (see Table A8 in the Annex A4). These instruments can be considered exogenous as long as they are uncorrelated with future changes in the growth rate in the outcome variable of interest. While reforms are likely to be correlated to the growth rate in levels they are less likely to be correlated to changes relative to the country*industry trend. There is some indication that the instrumental variable estimates strengthen the estimated impact of product market reforms, at least in the case of capital and employment. This is consistent with the idea that reforms are taken in response to weak sectoral performance.

As an alternative approach, we also attempt to control for sector-specific conditions directly through the inclusion of an indicator that captures the demand for an industry’s output by downstream industries in the spirit of Baily et al. (2001), Bems et al. (2011) and Eaton et al. (2011) (Table 6, row 3). This allows focusing on the impact of product market reforms conditional on sector-level business conditions. We measure such linkages at the sector level by output growth in downstream industries weighted by their intermediate input use from upstream producers using the World Input-Output Database (WIOD). The results are qualitatively very similar to those reported for the baseline specification. This suggests that the correlation between product market reforms and output demand from firms in downstream industries is weak.

The baseline results control for country*industry fixed effects because this corresponds to the variation in our reform indicators. An alternative possibility is to include of firm-fixed effects instead (Table 6, row 4). This does not change the interpretation of the results since the data are locally balanced - over each four-year horizon from t-1 to t+2, there are no changes in the composition of the sample – and hence the results already reflect within-firm effects. However, controlling for firm-fixed effects could affect the efficiency of the estimates by controlling more effectively for any unobserved time-invariant factors. The results are similar to those in our baseline specification.

The baseline results focus on the typical response of firms in the dataset to competition-enhancing product market reforms. In order to get an indication of the aggregate effects of product market reforms, we also present results based on weighted least squares that use the average level of employment as weights (Table 6, row 5). This yields an estimate for the aggregate effect of product market reforms which reflects the importance of firms in terms of employment. To the extent that the data cover the large majority of large firms in all countries and industries and the weight of small firms is relatively small in aggregate employment, this is similar to the aggregate effect of product market reforms in the population of firms.33 The results suggest that the effects of competition-enhancing product market reforms are also likely to be statistically significant and positive in the aggregate, but may be significantly larger than the effect for the typical firm. Firm size differences in the impacts are explored in more depth in Section 5.

Finally, we conducted a falsification test by assessing how the results change when we focus on a reform that takes place after our observation window at s=3 and hence should not affect the results in the absence of anticipation effects. The results indicate that this is the case, except when considering major reductions in the overall restrictiveness of product market regulation for output (Table 6, row 6). The role of anticipation effects in the case of output may explain why the results for output are not statistically significant in all specifications, despite there being significant effects for employment and capital.

Table 6.

Sensitivity analysis

% change in the outcome variable of interest in years after major reform, selected coefficients

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Regressions control for reforms in the previous and subsequent two years, include firm-level controls, as well as country-industry dummies, country-year dummies and industry-year dummies. Standard errors are robust and clustered by country and industry. *, **, *** refer to statistical significance levels of 10%, 5% and 1% respectively.

V. The heterogeneous effects of product market reforms across firms and sectors

While the analysis so far focused on the response of the typical firm to product market reforms, the main value of using firm-level data is to analyse how the response differs across different types of firms and, by doing so, advantage describe the mechanisms through which product market reforms operate. In particular, depending on the production technology, and the nature of regulations, and the resulting market structure, the effects of deregulation are likely to differ across different types of firms. This section explores this issue by focusing on the role of industry and firm size.

A. Results by sector

As a first step to understanding the role of production technology and the nature of regulations for the impact of product market reforms, the analysis is conducted separately for each broad sector: network industries, retail trade and professional services. The results are reported in Table 7.

First, the impact of product market reforms is typically positive and increasing in each of the broad sectors and for each of the outcome variables outcomes. Second, while most reform activity during the sample period was concentrated in network industries, the returns to reforms in terms of output appear to be similar or even larger in retail trade and professional services. This implies that there may not only be considerable scope but also substantial benefits to making further pro-competitive reforms in those sectors. Third, the impact of product market reforms on investment is concentrated in network industries and retail.34 Fourth, the role of reductions in the overall restrictiveness of product market regulation and that in barriers to entry tend to be rather similar in each of the three sectors (Panel B).

Table 7.

The short-term effects of product market reforms by industry

% change in the outcome variable of interest in years after a major reform, selected coefficients

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Regressions control for reforms in the previous and subsequent two years, include firm-level controls, as well as country-industry dummies, country-year dummies and industry-year dummies. Standard errors are robust and clustered by country and industry. *, **, *** refer to statistical significance levels of 10%, 5% and 1% respectively.

B. Results by firm size

In order to shed light on the mechanisms through which the effects of product market reforms operate in each sector, this sub-section analyzes their effects across firms of different sizes. The results, summarized in Table 8, reveal important differences within each sector. Figure 5 visualises the results for employment by focusing on firms with less than 20 employees and those with 20 or more employees. 35

Figure 5.
Figure 5.

The short-term effects of product market reforms on incumbent firms

Percentage change in employment in years after the reform

Citation: IMF Working Papers 2016, 116; 10.5089/9781475516852.001.A001

Notes: Dashed lines represent 90% confidence intervals

In network industries, the impact of product market deregulation on employment is positive for small firms, but negative, if anything, for large firms. For investment, a similar pattern is observed, with a positive impact on small firms and no significant impact on large firms. Interestingly, reforms have a positive impact on output, but there are no significant differences across size groups. This suggests that large firms are able to maintain their market share by restructuring employment and downscaling investment plans. A very different picture is observed for the retail sector. Product market deregulation in retail has a positive impact on employment and investment among large firms, but no significant effect on small firms. At the same time, deregulation has no significant effect on output for any size group. The absence of a more positive effect on output among large firms, despite positive effects on employment and investment, may indicate that increases in production scale are associated with market-share preserving output price declines.36 Size differences do not play much of a role in professional services.

The heterogeneous response of different firms to deregulation between network industries, on the one hand, and the retail sector on the other, highlights important differences in the underlying mechanisms that drive the effects of product market reforms. Network industries tend to be dominated by a small number of large firms with considerable market power. In order to maintain their market share in the threat of entry, incumbents have a tendency to reduce their production costs by cutting back employment and investment plans. Consistent with this narrative, the results in Table A9 in Annex A4 show that the heterogeneous response by firm size to reductions in entry barriers is even more pronounced than in the case of reductions in the overall restrictiveness of product market regulation. By contrast, in retail small traditionally-managed firms do not benefit from deregulation or even leave the market while large and typically more modern firms expand their activities further.37 The heterogeneous response to reductions in the overall restrictiveness in product market regulation is similar or more pronounced than that to reductions in entry barriers, which suggests that the threat of entry plays a less important role for the heterogeneous response of firms to deregulation in retail than in network industries. The finding that employment in large network firms responds negatively to liberalization in the short run is consistent with the recent industry-level results in Bassanini (2015) and OECD (2016).

Table 8.

The short-term effects of product market reforms by industry and firm size

% change in the outcome variable of interest in years after a major reduction in the overall restrictiveness of product market regulation, selected coefficients

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Regressions control for reforms in the previous and subsequent two years, include firm-level controls, as well as country-industry dummies, country-year dummies and industry-year dummies. Standard errors are robust and clustered by country and industry. *, **, *** refer to statistical significance levels of 10%, 5% and 1% respectively. Small, medium and large firms are defined as having 3-9 10-19 and 20+ employees, respectively, in year t-1.