The macroeconomic impact of structural reform: an empirical and model-based approach
Structural reforms include a broad set of policies that can permanently change the direction of the supply of the economy and create an environment where innovation can flourish. These policies increase productivity by increasing incentives to increase production inputs or to ensure that those inputs are used more efficiently, thereby increasing productivity. All measures designed to remove difficult and anti-competitive regulations, increase contract enforcement and protect property rights, and even incentives to increase investment in research and development (R&D) and innovation can help achieve such goals. By increasing productive capacity, reform also increases fixed income, which supports overall demand. While the long-term expansionary effects of reform on both GDP and potential output are not disputed, the use of a model is needed to assess the short-term effects on economic activity, employment, and inflation less clearly and thoroughly.
Existing literature generally provides two distinct approaches to assessing the economic impact of structural reform. The first is based on short-term evidence (such as Baron and Singano 2011, Lanau and Topalova 2016, Chemin 2020), which attempts to identify a causal effect of reforms, but does not allow for the exploration of changes in the new direction of the economy. The second method is based on structurally dynamic general equilibrium models (e.g. Forni et al. 2012, Lusinyan and Muir 2013, Eggertsson et al. 2014, Varga et al. 2014, Cacciatore et al. 2016, Bilbiie et al. 16), which. Allows accurate analysis of the short- and long-term dynamics of the effects of reform. However, the size of the simulated reform is usually based on work assumptions (such as “What if the gap closes the best practices in Vis-a-Vis?”), Without any underlying empirical assumptions. The need to examine the path of macro outcomes from micro behavior to uncover barriers and design effective structural reforms has been emphasized by Bartlesman et al. (2015).
In a recent study (Ciapanna et al. 2020), we try to bridge these two strands of literature and propose to evaluate the macroeconomic effects of structural reform on the basis of a three-step approach. First, we determine the amount of reform through an appropriate indicator. Second, we estimate the reduction-form effect of reform on markup (a measure of a firm’s market potential) and total factor productivity (TFP, a measure of production efficiency). Third, we use such approximate effects as external shocks in a structural model to simulate each reform accounting for transitional dynamics towards new static conditions.
Impact of structural reforms
We consider three reform packages: liberalization of regulated services, incentives for innovation, and civil justice reform. Liberalization system was introduced through decree lawSave Italy‘(L. 22 December 2011, n. 214) and with decree law’Grow Italy ‘ (L.24 January 2012, n. 1), through various interventions that have affected various sectors (such as energy, transportation, retail and professional services), and with the aim of removing barriers to entry into competitive markets and other restrictions. Financial incentives for investment in innovation were included in the ‘Industry 4.0’ plan, launched in 2016 and subsequently renewed, which included multiple measures aimed at encouraging investment in various initiatives (over-approval, the so-called ‘new sabatini’ ‘). And to encourage the adoption of so-called ‘Industry 4.0’ technology (hyper-amortization) and R&D expenditure (tax credit on R&D). Finally, the Civil Justice Reform Package, launched in 2011, aims to address the huge backlog of cases in the Italian justice system and the excessive length of trials. The measures taken, of various natures and importance, were designed to reduce the number of legal disputes and improve court productivity.
Estimates of microeconomics, utilizing sectoral, geographical, and firm-level sources of diversity, indicate that structural reforms can increase TFP by reducing the market strength of firms (Table 1). Liberalization of services has had a positive impact on both the TFP (+ 3.5%) and the level of competition in the services sector, where the markup in the services sector has declined by about 1.1 percentage points. Innovation stimulus led to an increase in productivity of about 1.4%. Finally, the reform of the civil justice system resulted in a 0.5% increase in TFP.
Table 1 Short guess
To assess the macroeconomic impact of the three reforms, we simulate a dynamic general equilibrium model of a multi-country bi-sector calibrated in Italy. The model consists of two sectors – manufacturing and services – which combine capital and labor with an external TFP to generate output. Reforms aimed at increasing the level of competition in a sector are modeled as affecting the relevant markup.
We consider each of the three reforms as a separate outward shock. Following the proposed three-step method, the model is given (i) the approximate effect of the reform on the synthetic index considered (markup, TFP); And (ii) the period of implementation of the reforms (see Table 1, last two columns). Model-based simulations provide the final step of evaluation.
Figure 1 reports the effects of reforms on major macroeconomic variables over a period of 20 years All reforms support GDP and have a mild inflationary impact in the short term, reflecting the supply-side expansion initiated by TFP growth and declining market power in the services sector. The only effect of the considered reforms will be to increase the level of GDP in the first decade by about 3%. At present, the second decade will see a further increase of about 3 percentage points. Considering the uncertainty surrounding our micro-econometric estimates, long-term growth in GDP (which will match potential output) will be between 3.5% and 8%. On the same horizon, total employment (expressed here in terms of working hours) will increase by about 0.5%, while the unemployment rate will decrease by about 0.4 percentage points.
Figure 1 The macroeconomic impact of reform
Note:: Horizontal axis: year. Vertical axis: Percent deviation from baseline; For inflation, the annual percentage point deviation from the baseline; For unemployment, the percentage point deviation from the baseline. GDP is assessed at a fixed price.
Structural reform plays a key role in increasing competition and productivity and therefore stimulating long-term economic growth, with non-trivial short-term effects. Our results are consistent with the results obtained in the study by looking at similar reforms using different methods and approaches (e.g. OECD 2015, MEF 2016). Our analysis considers only a select subset of the structural reforms implemented in Italy over the past decade and it deliberately excludes all other factors (i.e. external shocks) that simultaneously hit the Italian economy at the same time. Indeed, policy timing and sequence, revenue consolidation, and external constraints can affect the outcome of structural reform programs (Manase and Katsikas 2018). Our results also suggest that in the absence of reform, the dynamics of Italian TFP, GDP and potential output would have been further weakened.
Barone, G and F Cingano (2011), “Boosting Growth in High-Debt Times: The Role of Service Deregulation”, VoxEU.org, 6 December.
Bartelsman, E, F di Mauro and E Dorrucci (2015), “Eurozone Rebalancing: Are We on the Right Path to Growth? Insights from CompNet Micro-Based Data “, VoxEU.org, 17 March.
Bilbiie, F, F Ghironi and M Melitz (2016), “Access Skills, Exclusive, and Unrestricted Market”, VoxEU.org, 13 September.
Cacciatore, M and G Fiori (2016), “The macroeconomic impact of commodity and labor market deregulation”, Review of economic dynamics 20: 1-24.
Chemin, M. (2020), “Judicial Skills and Strong Productivity: Evidence from the World Database of Judicial Reform”, Economics and Statistics Review 102: 49-64.
Ciapanna, E, S Mocetti and A Notarpietro (2020), | The Effects of Structural Reforms: Evidence from Italy “, Temi di Discussione (Working Papers) 1303, Bank of Italy.
Eggertsson, G, A Ferrero and A Raffo (2014), “Can Structural Reform Help Europe?”, Journal of Monetary Economics 61: 2-22.
Forni, L, A Gerali and M Pisani (2012), “Competition in the service sector and macroeconomic performance in European countries: in the case of Italy”, VoxEU.org, 3 April.
Lanau, S and P Topalova (2016), “The Impact of Product Market Reform on Strong Productivity in Italy”, IMF Working Papers 119.
Lucinian, L. and De Muir (2013), “Assessing the Macroeconomic Impact of Structural Reform: The Case of Italy”, IMF Working Papers 22.
Manasse, P and D Katsikas (2018), “Economic Crisis and Structural Reform in Southern Europe: Policy Lessons”, VoxEU.org, 1 February.
MEF – Ministry of Economy and Finance (2016), “Assessing the Macroeconomic Impact of Italian Reform with a Focus on Credibility”, Quest Workshop, Italian Ministry of Economy and Finance.
OECD (2015), Structural Reform in Italy: Impact on Growth and Employment.
Varga, J., W. Roger, and J. T. Weld (2014), “The Impact of Increased Structural Reform in Southern Europe: Incidents in Greece, Italy, Spain, and Portugal”, Experimental 41: 323-363.