Selected Issues Paper

Abstract

Selected Issues Paper

Taking Stockof Structural Reforms: Afirm-Level Perspective1

Questions, Answers, and Possible Objections

What are the questions this chapter tries to answer? What did the structural reforms under the 2011–14 adjustment program hope to achieve at the firm level (Section B)? What are key characteristics of exporting and non-exporting firms in Portugal (Section C)? What was the structural reform agenda of the adjustment program (Section D)? What are the views of firms regarding the impact of structural reforms on their competitiveness and the urgency of more reform efforts (Section E)? What explains firms’ perception that while structural reforms in many areas had some positive impact on their competitiveness, they still see an urgent need to revisit or step up most reforms, especially as regards public and financial sector reforms (Section F)?

Why is answering these questions important for this Article IV consultation? Views on the effectiveness of structural reform efforts under the program vary widely, in part reflecting different evaluation approaches. Using a firm-level perspective can complement other evaluation approaches. It is also in line with international trade research stressing the need to study competitiveness and exports at the firm rather than the macroeconomic level. Assessing the effectiveness of reforms from a firm-level perspective may also be important for providing specific advice on where and how to revisit or step up structural reforms.

What are the answers to these questions? Structural reforms were hoped to increase the scale and number of high-performing firms, which also tend to be exporting firms (¶5-6). Firm-level data suggest that Portugal has a limited number of exporting firms (¶8-9). On staff’s count, structural reforms were initiated in 35 different areas, with 494 reform actions taken (¶13). Firms perceive that many reforms had at least some positive effects, but few reforms are seen as having had a significant impact (¶18–20). Firms’ perceived urgency to revisit or step up reforms especially in the public and financial sectors likely reflects that these reforms are critical for reducing high transaction costs, especially for exporting firms (¶31). The limited perceived impact of public sector reforms likely reflects implementation capacity constraints (¶32).

What could be possible objections to these answers? Using a firm survey to evaluate structural reforms may extract misleading opinions not related to the outcomes of reforms (¶23). It is too early to assess the effectiveness of most of the structural reforms under the program (¶24). Firms may not be able to disentangle cyclical effects of the crisis from the impact of reforms (¶25).

A. Background

1. Structural reforms were the main available policy tool to mend Portugal’s accumulated imbalances. Portugal’s macroeconomic toolbox was severely constrained by monetary union membership and spillover considerations. The only traditional macroeconomic tool, fiscal policy, had to focus on restoring its credibility to gradually regain full market access. This left structural reforms as the main tool to achieve multiple macroeconomic objectives, including boosting external competitiveness and potential growth.2

2. The effectiveness of structural reforms can be assessed from many angles. Using the reforms’ impact on international competitiveness rankings is one popular—although hazardous—short cut. Macro-based approaches try to link reform indicators to macroeconomic outcomes (for example, Bouis and Duval (2011)). Indicator-based approaches try to link reforms to key performance indicators (KPIs) (for example, EC (2014)). And there are micro-based approaches trying to link reforms to firm level or household data (for example, OECD (2014)).

3. A firm-level perspective seems particularly apt for assessing structural reforms in the case of Portugal. Since joining the euro, Portugal has struggled to build a more competitive economy, and many perceptive macroeconomic studies have documented this struggle (for example, Banco de Portugal (2009); Bento (2010); and Alexandre et.al. (2014)). At the same time, recent firm level research suggests that macroeconomic aggregates, or even aggregates at the level of sectors, can be misleading in assessing external competitiveness because firms tend to be very heterogeneous. This suggests that evaluating structural reforms from a firm-perspective holds significant promise and insights, as already demonstrated by OECD (2014).

4. This chapter takes stock of structural reforms from a firm-level perspective. It discusses what structural reforms were supposed to achieve at the firm level (Section B), documents a few stylized facts about Portuguese firms (Section C), describes the structural reform agenda (Section D), reports the results of a firm survey on the perceived effectiveness of the structural reforms (Section E), and considers explanations why the survey responses suggest that most structural reforms should be revisited or stepped up (Section F).

B. Structural Reforms From a Firm-Level Perspective

5. From a firm-level perspective, structural reforms are expected to reduce costs. Much of a firm’s success, especially in competitive markets, depends on production and transaction costs, including its ability to achieve cost reductions “stemming from 1001 different sources” (Harberger (1998). Production costs refer to unit costs of labor, capital, and intermediate inputs. Transaction costs may be less tangible, referring to a firm’s cost related to searching for information, bargaining with stakeholders, making decisions, and enforcing contracts. But transaction costs tend not only to shape the organizational and contractual arrangements of production, but also the amount of goods and services that are produced and available on the market.

6. If successful, structural reforms act as a catalyst for the scaling up or the emergence of high-performing firms, which tend to be exporters. The literature has documented that firms are more heterogeneous than would be implied by a normal distribution of firm performance indicators. Exporting firms in particular tend to be higher-performing than the average firm in any given sector (Bernhard and Jensen (2004); Altomonte et al. (2012)). And, in general, only higher-performing firms within any sector—whether by convention classified as tradable or non-tradable sectors—tend to become persistent, successful exporters.

7. What would be key features of a structural reform with high impact on the firm’s competitiveness and growth prospects? A high-impact reform would lead to significant cost reductions: (i) in reform areas relevant from the point of view of the firm; (ii) are underpinned by significant changes of formal or informal rules; and (iii), and the reform is backed up by sufficient implementation capacity to make rule changes stick as intended without adverse side effects. If any of these three features of an effective structural reform has a low loading or is missing, a firm will likely perceive little impact from the reform on its competitiveness and growth prospects.

C. Exporting Firms in Portugal: A Few Stylized Facts

8. Portugal has relatively few exporting firms, including in sectors conventionally associated with tradable activities. The extensive margin of exports, i.e. the percentage of firms that are classified by the Statistical Office (INE) as an exporter in a given sector and a given year, reaches only about 13–14 percent in the manufacturing and mining sectors, and about 10 percent in transportation and communication services (text table). While extensive margins are difficult to compare across countries, these margins appear to be low (see, for example, Navaretti et al. (2011), Table 2.1). Puchal et al. (2010) report that the share of exporting manufacturing firms in the U.S. is 18 percent, notwithstanding a much larger domestic market.

Portugal: Non-Financial Firms – Extensive Margin of Exports 2010–2012 1/

(Percent)

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Extensive margin of exports is defined as the share of exporting firms in the sector. An exporting firm is defined by INE as a firm that exports at least 50 percent of its turnover, or that exports at least 10 percent of its turnover and it amounts to more than 150.000 euros.

Source: IMF staff estimates based on data from the Integrated System of Business Accounts (Sistema de Contas Integradas das Empresas, SCIE)

9. The relatively low number of exporting firms reflects to an important extent a firm size distribution tilted toward smaller firms. As larger firms are more likely to be exporting firms, the firm size distribution is one factor limiting the extensive margins. In most sectors, the size distribution is heavily tilted toward SMEs, and micro firms in particular (text table).

Portugal: Size Distribution of Non-Financial Firms, 2010–2012

(Percent)

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Source: IMF staff estimates based on Integradas das Empresas, SCIE) data from the Integrated System of Business Accounts (Sistema de Contas Integradas das Empresas, SCIE)

10. Consistent with findings for other countries, firms that are exporters are associated with much better performance indicators than other firms. Focusing only on the manufacturing sector and on so-called persistent exporters,3 these firms during 2010–12 tended to be about seven times larger than other firms in terms of employment, had significantly higher productivity per worker, invested more per worker, were much more profitable, and had much lower debt-EBITA ratios (text table). As regards firm leverage, however, other leverage indicators, such as the debt-equity ratio tend to be similar across firms. Persistent exporters also responded differently to the crisis than other firms. For example, during 2010–12, persistent exporters maintained their employment and sales levels, and practically all the increase in manufacturing exports (about 90 percent) during 2010–12 is accounted for by persistent exporters (Box 1).

Portugal: Performance Indicators for Manufacturing Firms, 2010–2012

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Source: IMF staff estimates based on data from the Integrated System of Business Accounts (Sistema de Contas Integradas das Empresas, SCIE)

Portugal—The 2010–2012 Export Surge: Who Did It?

During 2010–12, nominal exports by manufacturing firms rose by about 19 percent (box table). The increase in manufacturing exports largely explains the increase in Portugal’s overall exports during this period (firm level data for 2013 and 2014 are not yet available). One question is whether this surge in exports was due to firms that were persistent exporters during this period, or whether the combination of crisis and structural reforms induced many new firms (either newly set up or switching from non-exporting to exporting activities) to enter the export fray.

As a first pass, about 90 percent of the increase in exports is accounted for by persistent exporters. These firms also broadly maintained employment and nominal domestic sales levels during the crisis period 2010–12, while nominal value added declined by about 4 percent (ROEs of persistent exporters shrunk significantly during 2010–12, but remained positive).

Turning to the other firms, while these firms also saw a double-digit increase in their nominal exports, this took place from a much lower level. At the same time, their activity in terms of employment and nominal valued added shrunk significantly (ROEs of this firm group turned negative during 2010–12).

However, there was considerably dynamics underlying the net export performance of the group of other firms. The firm-level data suggest that firms that were newly established since 2010 and which were exporting in 2012 made a contribution of 0.2 billion to the 5.2 billion export increase during 2010–12. At the same time, already established firms that are not classified as persistent exporters increased their exports during 2010–12 by 2.0 billion, but this was offset by a 1.7 billion decline of exports by firms that exported in 2010 but were no longer classified as exporters in 2012. Thus, while the contribution to the export increase by new firms has been relatively small, there were substantial shifts into and out of export activities by other firms.

Portugal: Exports and Production of Manufacturing Firms, 2010–2012

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Source: IMF staff estimates based on data from the Integrated System of Business Accounts (Sistema de Contas Integradas das Empresas, SCIE)

D. Program’s Structural Reform Agenda

11. Already before the crisis, successive governments initiated many structural reforms. Starting in the early 2000s, growth increasingly disappointed relative to expectations. In response, the need to implement more and deeper structural reforms became a constant theme of Portugal’s economic policy discussions. As documented in successive OECD Economic Surveys before the crisis, policy advice typically called for educational reforms to raise skills, labor market reforms to ease restrictive employment protection rules, product market reforms to increase local competition, and a plethora of other structural reforms to reduce the cost of doing business due to complex and time-consuming administrative and legal procedures. In March 2011, still before the EU-IMF-supported program was agreed, the government proposed to parliament a structural reform agenda in the context of its fourth Stability and Growth Program for 2011–14 (PEC IV, 2011). Many of the PEC IV measures, particularly regarding privatization and fiscal consolidation, were later integrated into the adjustment program design.

12. The architecture of the program’s structural reform agenda was extensive. The agenda was topped by four reform fields: (i) product market reforms; (ii) labor market reforms; (iii) public sector reforms; and (iv), financial sector and insolvency reforms (text chart). Within each of the four reform fields there were multiple reform areas, as exemplified in the text chart by the reform areas under the labor market rubric. Each reform area in turn was associated with one or more reform objectives. Finally, associated with a reform objective were a potentially large number of reform actions. These reform actions are defined as specific commitments in the program documents to take steps to move reforms forward along the following four reform phases: (i) to initiate; or (ii) to legislate; or (iii) to implement; or (iv), to evaluate structural reforms.

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Portugal: Architecture of Structural Reforms – Example of Labor Market Reforms

Citation: IMF Staff Country Reports 2015, 127; 10.5089/9781475555790.002.A001

13. The reform action count was high. On staff’s count using the structural reform nomenclature set out in the text chart, 494 distinct structural reform actions were taken to achieve 73 reform objectives. Breaking down the number of reform actions by fields, about ½ of the measures focused on the public sector, about ⅓ on product markets, and the remaining actions were split between labor market reforms on the one hand and financial sector and insolvency reforms on the other hand (text table). Further breaking down the number of reform actions by phases, about ½ of the reform actions aimed at initiating or legislating actions, while about ⅓ of the actions focused on implementation actions.

Portugal: Structural Reform Actions by Phases

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14. The reform objectives can typically be linked to reducing production or transaction costs at the firm level. In general, reforms in the fields of product and labor markets can be associated with reducing unit costs of production, either by lowering prices of inputs or by raising productivity per unit of input (Table 1). On the other hand, reforms in the fields of public sector and financial sector and insolvency reforms can often be associated with reducing transaction costs. Some of the reforms are framed as having aimed at both reducing production and transaction costs.

Table 1.

Firm Survey: Perceived Impact of Structural Reforms 1/

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Numbers indicate average scores across firms’ responses, with scores standardized in the range -1 to +1. As regards perceived impact of reforms, firms had the choice between “no impact” (score = -1), “some impact” (score = 0), or “significant impact” (score = 1). As regards the perceived urgency of more reforms, firms had the choice between “no need” (score = 1), “some need” (score = 0), or “urgent need” (score = -1). Firms also had the option to use “no answer” in case they felt there was not enough information to assess the structural reform. Colors are assigned based on four uniformly spaced intervals as follows: red refers to a value below -0.5; orange to a value between -0.5 and 0; light green to a value between 0 and 0.5; and dark green to a value above 0.5.

Sources: Survey; and IMF staff estimates.

15. The sheer range and high number of reform objectives and actions raise the question why the reforms in Table 1 were picked and why not others. From a pure social planner point of view, structural reforms should be picked to address all the distortions in the economy at the same time. This ideal, however, never applies. A more pragmatic social planner approach is to try to pick a limited number of reforms that address the most binding bottlenecks to competitiveness or growth (Hausmann et al. (2005)). But even this more pragmatic approach seems to presuppose a well-structured decision setting where there is a circumscribed set of decision makers (participants), well-defined and shared objectives (preferences), and a good and shared understanding of the link between policy changes and ultimate outcomes of the reforms (technology). However, decisions on structural reforms more often than not take place in a much less structured setting. The number of participants can be open and fluid, preferences of participants can be diffuse, the link between reform measures and desired outcomes is often complex if not highly controversial among participants. Moreover, when, how, and what decisions are made can depend sensitively on whether good choice opportunities arise to connect solutions and problems from a large, pre-existing reservoir.4 Such settings are likely to generate reform agendas that aim at a wide range of objectives, an approach that could, however, fall prey to the adverse second-best interactions highlighted by Hausmann et al. (2005).

E. Effectiveness of Structural Reforms: Firm Survey Evidence

16. Survey design. The survey was sent to non-financial firms at the beginning of March 2015, and it targeted a group of about 200 large firms and about 300 SMEs.5 In line with the structural reform architecture discussed in the previous section, the survey covered the four reform fields, and the questions were formulated at the level of the reform areas (the annex lists the 34 areas and questions). For each reform area, respondents were asked to indicate the perceived impact of the reform on the competitiveness and growth prospects of the firm (no impact, some impact, significant impact) and the perceived urgency of more reform actions in a given reform area (no need, some need, and urgent need). Respondents also had the option for “no answer” in case they felt there was not enough information to assess the area reform. In addition, respondents had the option to provide written suggestions on the impact of reforms or the urgency of more reforms.

17. Survey responses. The response rate to the survey was 17.4 percent, which appears to be representative for a fairly comprehensive but voluntary firm survey. About half of the respondents were large firms, and about two thirds were exporting firms. Most of the responding firms had their main activity in the manufacturing sector (one third), followed by the trade and transportation sectors. The results reported in this section’s two text tables average scores across firm’s responses, standardized to the range -1 to +1. Colors indicating reform impact or urgency are assigned to scores based on four uniformly spaced intervals, where red reflects an average score below -0.5 (roughly indicating no impact of reform or urgent need of more reforms), orange a score between -0.5 and zero, light green a score between zero and 0.5, and dark green a score above 0.5 (roughly indicating significant impact of reform or no need of more reforms).

Perceived Impact of Structural Reform

18. Overall, the survey scores suggest that many reforms are perceived has having had some positive impact, with significant variations across reform fields. Perceptions were most positive regarding the impact of labor market reforms, and least positive as regards product market reforms (text table next page). The majority of public and financial sector reforms were assessed as having had a positive impact. These overall perceptions seem to be robust across exporting and non-exporting firms, as well as across large firms and SMEs.

19. While product market reforms generally received low scores, labor market reforms scored well. None of the product market reform is perceived as having had a significant positive impact on firms’ competitiveness. Reforms that aimed at reducing the cost of using railways and the cost of professional and other services received particularly low scores. As regards labor market reforms, exporters and SMEs responded that reforms in the areas of increasing work time flexibility, reducing the cost of hiring and firing, and active labor market policies had strong positive impacts. At the same time, reforms of collective bargaining and increasing the effectiveness of employment agencies received low scores.

20. Most public and financial sector reforms received similar, generally positive, although low scores. The highest scoring public-sector reforms concern the cost of paying taxes and investment incentives. Exporting firms were generally more positive on the impact of public sector reforms than non-exporting firms, while firm size seemed to make much less of a difference. As regards financial sector reforms, exporting firms again have more positive perceptions of the reforms than non-exporting firms. SMEs were particularly positive about the impact of reform measures providing alternative financing options.

Perceived Urgency of More Structural Reforms

21. There was strong consensus across all types of firms that both public and financial sector reforms should be revisited or stepped up. Exporting firms and SMEs in particular saw an urgent need for additional reforms to increase the effectiveness of public administrations, both at the central and local levels, the effectiveness of the various courts of the justice system, to improve payments discipline of public sector entities, and to improve the functioning of the insolvency and corporate debt restructuring frameworks. Only privatization was seen as lower priority across firms.

22. Exporting firms also saw a pressing case for more reforms of product and labor markets. As regards product markets, exporting firms urged additional reform efforts in the areas of energy, road pricing, costs of railways, and enforcement of competition. As regards labor market reforms, exporters also perceived a relatively strong need for further reforms of hiring and firing costs and increasing the effectiveness of employment agencies. Non-exporters generally see less urgency in all these reform areas, while firm size seems to make little difference for perceptions.

F. Interpreting The Firm Survey Results

Three Objections to Using Firm Surveys to Assess the Impact of Structural Reforms

23. First, firm surveys may not always capture the actual outcomes of structural reforms. Respondents may not be aware of the actual reform outcomes but nevertheless have strong opinions. Respondents may also be willing to blame adversities that are due to factors internal to the firm, for example lack of managerial skills, to lack of progress on structural reforms. To mitigate these potential biases, first, the survey provided the option to decline answering a question if the respondent felt she lacked the information to assess the impact of or need for more reforms. At the same time, perceptions, whether they are rooted in actual reform outcomes or not, nevertheless may matter greatly for firms’ decisions regarding job creation or investments. Second, the survey sample focused on large firms and relatively successful SMEs, and these firms are less likely to see reforms from a perspective distorted by their internal difficulties.

24. Second, some reforms may need more time to be perceived as having had an impact. This may in particular be the case for some of the public and financial sector reforms, whose effectiveness depends on changing deep-rooted behaviors on the sides of public administration, the justice system, regulators, or banks. In these cases, if firms perceive an urgent need for more reforms, this could also be consistent with reforms not having paid off so far, but they may still pay off in the future even without further reform actions.

Table 2.

Firm Survey: Perceived Urgency of More Reforms 1/

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Numbers indicate average scores across firms’ responses, with scores standardized in the range -1 to +1. As regards perceived impact of reforms, firms had the choice between “no impact” (score = -1), “some impact” (score = 0), or “significant impact” (score = 1). As regards the perceived urgency of more reforms, firms had the choice between “no need” (score = 1), “some need” (score = 0), or “urgent need” (score = -1). Firms also had the option to use “no answer” in case they felt there was not enough information to assess the structural reform. Colors are assigned based on four uniformly spaced intervals as follows: red refers to a value below -0.5; orange to a value between -0.5 and 0; light green to a value between 0 and 0.5; and dark green to a value above 0.5.

Sources: Survey; and IMF staff estimates.

25. Third, firms may have difficulties disentangling the effects of the economic crisis from the impact of the reforms. Firms may not see the pay-offs of reforms because low demand and other cyclical effects of the recession are masking the pay-offs. While this could have been a more serious concern at the height of the recession during 2011–12, at the time of the survey (March 2015) the recovery in output was already well established. Also, with the majority of the firms surveyed representing exporters, these firms were less affected by the sharp decline in domestic demand during the recession years 2011–12.

Interpreting Firms’ Impact Responses

26. The perception of the impact of a reform on firms’ competitiveness likely depends on three main factors. First, firms will likely judge a structural reform as relevant depending on the impact on its own production cost structure and on its transaction costs. If the cost impact of reforms is potentially large, it will likely be seen as a priority (bottleneck factor) by the firm. Second, structural reforms change formal or informal rules, which can range from changing parameters (for example, severance pay rates) to changing criteria (for example, licensing requirements) to changing organizational structures (for example, judicial maps). The impact of a structural reform will therefore also depend on the significance of the change in rules (deepness factor). And third, even if a given reform is highly relevant and the rule changes are significant, if the impact of the reform depends on implementation capacity and this capacity is low, the reform may still be perceived as having had little impact (capacity factor). Thus, for simplicity, the three factors determining the perceived impact may be thought as being linked multiplicatively:

ReformImpact=BottleneckFactor×DeepnessFactor×CapacityFactor

27. The survey responses, together with other information on the significance of rule changes, permit rough judgments on the role of the three factors in shaping firms’ views. The survey responses on the urgency of more reforms can be informative regarding the relevance of a given reform. Combining this information with information on the significance of rule changes, the survey responses on the impact of structural reforms may allow inferring (using the multiplicative scheme outlined before) whether low implementation capacity is the reason for a perceived low impact of a reform.

Interpreting Firms’ Responses on Product and Labor Market Reforms

28. The relatively low impact of product market reforms is likely to reflect the absence of deep reforms. Firms generally believed that reforms here had low impacts, but they, and particularly the exporting firms, also pointed to many reform areas as being highly relevant for their production costs. This would suggest that reforms were not deep enough, or, if the reforms were in fact deep, there were binding capacity constraints. Capacity constraints may indeed have played a constraining role in some areas, including energy policy, or reducing the cost of using ports (see Box 2). But, in general, the lack of deepness of reforms is likely more of a factor explaining the relatively low scores for product market reforms.

Reducing Port User Cost: An Implementation Game in Progress

The port reform is of major importance for the competitiveness of firms. In 2013, Portugal shipped of all exports via ports 58 percent in tons and 37 percent in value. For some exporters, port user cost can reach 10 percent of production costs.

In 2012, a port reform was launched, with the objective to reduce user cost by 25-30 percent. Several actions were taken: (i) the adoption of a port labor law in February 2013; (ii) elimination of the TUP Cargo fee in January 2014; (iii) the start of the renegotiations of port concessions in April 2014; and (iv), the publication of the transport regulator by-laws in May 2014

According to estimates by the authorities, a reduction of 16 percent in the port invoice costs was achieved during the period 2011–2013. However, this estimate is contested, and a private sector study pointed to a cut in user cost of only 2 percent. Notwithstanding the large gap between the two estimates, both are far from the objective to reduce user costs by 25-30 percent. The firm-survey responses also suggest that firms do not see major pay-offs from the port reform so far.

Why did the port reform not have a larger impact so far? Three reasons seem to stand out:

  • Slow implementation pace: The transport regulator is still not operational; and negotiations with and among the trade unions, port authorities, and concession operators are not closed.

  • Lack of legal mechanisms: For example, due to the lack of a legal mechanism to ensure the pass-through of the gains of efficiency and cost reductions, gains may stay with other players than the intended beneficiaries, especially exporting firms.

  • Lack of incentives: The terms of the port concessions are essential to give the right incentives to both port authorities and concession operators. However, the renegotiations of concessions are still ongoing, with only one closed.

29. The relatively high positive impact of labor market reforms likely reflects the high relevance and parametric nature of these reforms. Many labor market reforms require little implementation capacity, and their impact therefore depends mainly on relevance and deepness of the reforms. Given the parametric nature of these reforms, they can directly and visibly affect unit labor costs, as illustrated by the work time flexibility reform. At the same time, capacity issues are likely to emerge as a constraint with regards to active labor market policies and the functioning of employment offices, and this may be reflected in the higher urgency flagged by firms for these reform areas.

30. The initial design of the program took note of the risk that product and labor market reforms may have only moderate and slowly emerging effects on production costs, especially for exporters. The risk that a large number of product and labor reform actions may not add up to meaningful change in the competitiveness of firms was highlighted at the beginning of the program. In response, the program included a fiscal devaluation measure to mimic the effects of real exchange rate devaluation. However, implementing a fiscal devaluation proved much more difficult than foreseen, and the fiscal devaluation option was abandoned about 1½ years into the program (Box 3).

Fiscal Devaluation: A Structural Reform Too Far?

As part of the initial program design, the authorities committed to a major reduction in employers’ social contributions to be financed by offsetting fiscal measures, including changing the structure and rates of VAT (MEFP, May 2011). This reform measure—a so-called fiscal devaluation—had the objective of boosting external competitiveness to mitigate the adverse effect of cutbacks in domestic demand on output and employment.

After two attempts to design and implement a fiscal devaluation, the measure was abandoned. In fact, the second attempt at designing a fiscal devaluation measure, announced in September 2012, triggered a mass demonstration in Lisbon that was attended by an estimated 500,000 demonstrators.

Conceptually at least, a fiscal devaluation can achieve exactly the effects of a real exchange rate devaluation assuming certain conditions are in place. It could thus be a structural reform tool that is superior to a large bundle of structural reforms that may in principle be able to deliver the same increase in external competitiveness, but where the timing and size of effects are surrounded by large margins of uncertainty.

Why did the fiscal devaluation measure encounter serious difficulties? Portugal’s experience seems to hold four lessons:

  • Size of measure needed: To have a significant impact on external competitiveness, large cuts in employers’ contribution would have been needed. This raised questions about the integrity of financing of social security where contributions are generally linked to benefits, and the political acceptability of the needed offsetting fiscal measures.

  • EU rules as a constraint: Mitigating the financing constraint by restricting the cuts in employers’ contributions to tradable sector firms was clearly at odds with EU competition rules.

  • Sticky non-tradable prices: A key assumption for making a fiscal devaluation work was that the cuts in employers’ contributions would lead to reductions in non-tradable prices that would in turn lead to a reduction in intermediate input costs of the tradable sector. Given that high non-tradable prices were the result of uncompetitive structures in the first place, this was an assumption that was seen as doubtful by many participants in the debate on fiscal devaluation.

  • Political economy blowback: Perhaps most surprising from the point of view of many observers was that a fiscal devaluation would be seen as highly unfair by both trade unions and employers.

Interpreting Firms’ Responses on Public and Financial Sector Reforms

31. Firms seemed to perceive reforms that affect their transaction costs as especially relevant. Many of the public and financial sector reforms affect firms’ transaction costs, for example in terms of predictability of their business environment (for example, effectiveness of public administrations and payment discipline of public sector entities) or in terms of enforcement of contracts (for example, effectiveness of justice system or the insolvency and corporate debt restructuring frameworks).

32. But these are also some of the reforms that are most demanding from the implementation capacity point of view. Some of the written answers to the survey indeed pointed to lack of implementation capacity as a bottleneck for the effectiveness of reforms. In particular, respondents seemed to distinguish between “reforms on paper” and reforms accompanied by changes in behavior of the implementation agencies. As put by one of the respondents:

“Many legislative reforms were done, and perhaps there is no need for more reforms of this type. However, the effective implementation of reforms often fails. … The lack of effective implementation may be the reason why reforms have so little or no impact on firms’ competitiveness.”

At the same time, the relatively positive feedback regarding tax administration reforms suggests that implementation capacity constraints in the public sector can be successfully overcome, although this requires time and persistence, as efforts to modernize and upgrade the functioning of the tax administration started well before the program.

Table 3.

Portugal: Overview of Structural Reforms

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Appendix I. Survey Questions

From the structural reforms listed below, please indicate the impact of each in the competitiveness and growth perspective of your company, as well as the need for implementing more reforms. In case you are not familiar with or have no opinion about some of the reforms, please select the option N/A.

For each reform, please indicate:

  • Impact: no impact, some impact, significant impact.

  • Urgency of new reforms: no need, some need, urgent need.

A. Product Market Reforms

Licensing environment. For example: simplification and changing of the licensing paradigm from ext-ante approach to ex-post control by the public administration (zero licensing; legal regime for commerce and services activities; industrial licensing; touristic licensing; environmental licensing).

Energy costs. For example: liberalization of the electricity and gas markets; reduction of the tariff debt.

Cost of telecommunication and postal services. For example: lowering mobile termination rates; new telecom regulators by-laws (ANACOM); privatization of CTT.

Cost of road use. For example: renegotiation of the existing roads PPPs.

Cost of using railway. For example: reduce operational costs of transport SOEs (e.g. REFER and CP); review and render a more effective yield management on long-distance passenger ticket prices.

Costs of using ports. For example: elimination of the TUP Carga; new labor port work regime.

Cost of professional services. For example: new framework law for professional bodies that shall cover professional bodies such as lawyers, engineers or doctors.

Costs of other services. For example: transposition of the Services Directive that envisages reducing barriers to entry the market of new companies and service providers (e.g. real estate brokerage and travel agencies).

Enforcement of competition. For example: strengthen the role of the Competition Authority; creation of specialized competition court.

B. Labor Market Reforms

Increase in work time. For example: uncompensated increase in working days (public holidays and vacation days).

Increase in work time flexibility. For example: bank of hours; reduction in over-time pay.

Collective bargaining. For example: revised criteria for extending collective agreements.

Hiring and firing costs. For example: new rules for individual dismissals; reduction in severance payments.

Active labor market policies. For example: Impulso Jovem program; Estímulo 2013 program.

Effectiveness of employment agencies. For example: support measures to find new jobs undertaken by the employment agency (IEFP).

C. Public Sector Reforms

Effectiveness of central administration. For example: increase from 35 to 40 weekly working hours; PREMAC (reduction of the management positions and administrative units).

Effectiveness of local administration. For example: reduction of public servants; reduction of the local SOEs.

Cost of paying taxes. For example: plan to combat the tax fraud and evasion; new VAT e-invoicing system.

Effectiveness of VAT refunds. For example: cash accounting VAT regime; VAT refund procedures for exporters.

Investment incentives. For example: extraordinary credit for investment; corporate income tax code.

Payment on time by central administration. For example: commitment control law; settlement of arrears program.

Payment on time by local administration. For example: local settlement of arrears program (PAEL); regional and local financing laws, including the Municipality Support Fund for distressed municipalities.

Payment on time by SOEs. For example: settlement of arrears program for hospitals SOEs.

Quality of services provided by SOEs. For example: new framework law for SOEs; improvement of SOEs operational results.

Privatization program. For example: privatization program with the disposal of shares in BNP, ANA, CTT, EDP, REN, Galp Energia, Caixa Seguros; elimination of the golden shares.

Effectiveness of labor courts. For example: new code of civil procedure.

Effectiveness of tax courts. For example: special team for dealing with tax courts cases for amounts higher than 1 million Euros; tax arbitrage procedures.

Effectiveness of civil and commercial courts. For example: new code of civil procedure; improvement of enforcement procedures and strengthening of enforcement agents by-laws.

Effectiveness of alternatives to litigation. For example: new arbitration law; strengthening the justices of the peace regime.

D. Financial Sector and Insolvency Reforms

Efficiency of insolvency framework. For example: insolvency code; role of the insolvency administrators.

Debt restructuring framework (PER). PER (corporate debt restructuring framework).

Out-of-court debt restructuring framework (SIREVE). SIREVE (out-of-court corporate debt restructuring framework).

Provision of alternative financing options. For example: new guarantee lines PME Crescimento and PME Investe to facilitate access to credit; new commercial paper legal regime.

Efficiency of credit allocation by banks. For example: strengthen supervisory role of Bank of Portugal; bank recapitalization law.

Please indicate below, if there is any other reform not listed above that you consider as a priority for the competitiveness of the firms in Portugal.

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1

Prepared by Albert Jaeger and Elsa Martins. We thank Álvaro Matias (Ministry of Finance), João Valle e Azevedo (Banco de Portugal), and participants at a seminar at the Ministry of Finance for helpful comments on an earlier version of this chapter.

2

See chapter “Creating Jobs for Lower-Skilled Workers,” Section C, for more macroeconomic context.

3

Persistent exporters are defined as firms that were classified as exporting firms in each of the years 2010–12. OECD (2014) lists similar results based on manufacturing firm data for 2006–11.

4

Cohen et.al. (1972) proposed a model to study decision making in organizations characterized by these features.

5

The list of large firms was compiled by staff based on publicly available data on large firms in Portugal. The list of SMEs was provided by the public association representing SMEs; the SMEs surveyed are considered “PME Líder” firms, i.e. SMEs with strong performance characteristics.

Portugal: Selected Issues
Author: International Monetary Fund. European Dept.