Content

Erik Canton, V.2 Economic impact of competition-friendly deregulation in Germany's professional services in:

Oliver Holtemöller (Ed.)

How Can We Boost Competition in the Services Sector?, page 241 - 263

1. Edition 2017, ISBN print: 978-3-8487-4676-7, ISBN online: 978-3-8452-8902-1, https://doi.org/10.5771/9783845289021-240

Bibliographic information
Economic impact of competition-friendly deregulation in Germany's professional services94 (Erik Canton) Erik Canton, PhD, European Commission Abstract This study investigates in detail the performance of German professional services and the potential macro-economic impact of competition-friendly deregulation. We analyse macro-economic effects of an improvement of the regulatory framework by means of a "closing-the-policy-gap scenario approach", and impute the results into the DSGE model QUEST to simu‐ late the macro-economic impact. The results suggest GDP gains of about 1% in the long term that materialise gradually. Motivation Professional services, also known as "liberal professions", are generally defined as occupations requiring special training in the arts or sciences, such as lawyers, engineers, architects and accountants. Some of these pro‐ fessions are closely regulated by national governments, often supported by professional bodies, with restrictions on number of entrants into the pro‐ fession, rates charged, form of business, and exclusive rights enjoyed by practitioners, this is why they are frequently referred to as "regulated pro‐ fessions".95 Such regulation can hold back the performance of these sec‐ V.2 1 94 Canton, E.; Thum-Thysen, A.; Vogel, L. (2017): Economic impact of competitionfriendly deregulation in Germany's professional services The authors are affiliated with the European Commission, Directorate-General for Economic and Financial Affairs (DG ECFIN). Views expressed are those of the authors, and not necessarily those of the European Commission. We would like to thank Anne van Bruggen, Emmanuelle Maincent, Tsvetan Tsalinski and workshop participants in Berlin for useful comments. 95 In this study we will use the terms professional services and regulated professions interchangeably. V.2 Economic impact of competition-friendly deregulation 241 tors, with non-trivial costs for consumers and downstream businesses. That is why large-scale reforms in some of these services are taking place in a number of Member States, also in the context of the European Semester. Germany is characterised by relatively strict product market regulation in professional services. The Council of the European Union has therefore issued Germany a so-called country-specific recommendation to improve upon this situation: "Step up measures to stimulate competition in the ser‐ vices sector, in particular in business services and regulated professions." Germany has actively participated in the mutual evaluation on access and practise requirements for regulated professions. However, according to the 2016 Country Report for Germany (cf. European Commission, 2016), the action plan submitted by Germany as a result of the mutual evaluation on access and practise requirements for regulated professions gives no indication of a more general willingness to modernise regulated professions and adapt them to new economic challenges. The action plan concludes that there is little need for reform and announces a limited num‐ ber of actions for certain professions, in particular for business services. However, in Germany the proportion of licensed workers equals 33% of the German workforce (Koumenta and Pagliero 2017), which is the high‐ est share of all the Member States (EU average: 21%).96 Changes to the regulatory framework could have a major impact on the sectors concerned. ECFIN (2015) shows that service sectors have both strong backward (demand) and forward (supply) interlinkages with manufacturing, and that productivity growth in services contributes to the export performance in manufacturing. For example, the forward linkages show the total produc‐ tion generated in downstream industries, directly and indirectly, by one euro worth of supply in an upstream industry. The range of these interlink‐ ages for services in euro area economies is 1.3 (for air transport) to 4.8 (for business services). Indeed, business services and wholesale trade are the service sectors with the strongest forward links with the rest of the economy.97 The knowledge-intensive business services (KIBS), which also contain to a considerable extent regulated professions, are of particu‐ 96 This is based on the European Survey of Occupational Regulation, considering the prevalence of licensing in the workforce, i.e. including medical occupations, teachers, taxi drivers etc. 97 The calculations are based on Input-Output tables from the World Input-Output Database. V How to Assess the Economic Impact of Regulation 242 lar importance, as they help to diffuse new knowledge to other industries which increasingly rely on them as inputs to their production process. As such, the significance of KIBS goes beyond their large and growing share of GDP, and is deeply rooted in their solid forward linkages with the rest of the economy. In fact, KIBS may be used by manufacturing and service sectors to enhance product differentiation, thereby increasing the quality and/or technology content of manufactured products. Through these link‐ ages, KIBS can act as a transmission channel of technology, increase the productivity of many manufacturing processes and services, and foster technological change, thereby enhancing a country's competitive advan‐ tage (Di Cagno and Meliciani 2005). Also, Ciriaci and Palma (2015) show that in Germany KIBS use by manufacturing increased substantially over time. This study investigates in more detail the performance of German pro‐ fessional services and the potential macro-economic impact of competi‐ tion-friendly deregulation. Its main results have also been published in the 2016 Country Report for Germany. The analysis starts with examining Germany's position in terms of two important performance indicators, namely mark-ups and allocative effi‐ ciency. Lower mark-ups have a growth-enhancing effect through a posi‐ tive effect on demand (see for instance Varga and in 't Veld 2013). Alloca‐ tive efficiency is shown to have a positive impact on labour productivity, as labour and capital are channelled to their most efficient use (see for in‐ stance Canton et al. 2014). Many countries actively promote competition-friendly policies in order to reap economic benefits.98 In particular, changes in product market regu‐ lations in EU Member States are likely to have changed mark-ups and al‐ locative efficiency. Therefore, this chapter inspects the regulatory frame‐ work in terms of product market regulation. Finally, this study analyses macro-economic effects of an improvement of the regulatory framework by means of a "closing-the-policy-gap sce‐ nario approach", building on earlier analyses from the Directorate-General for Economic and Financial Affairs (ECFIN) of the European Commis‐ sion. Results of this analysis are imputed into ECFIN's DSGE model QUEST to simulate the macro-economic impact. 98 See for example ECFIN (2016) for an analysis on the economic impact of selected structural reforms in Italy, France, Spain and Portugal. V.2 Economic impact of competition-friendly deregulation 243 Our analysis indicates that professional services in Germany feature rel‐ atively strict product market regulation, relatively high mark-ups and that allocative efficiency in these sectors could be improved. Our results fur‐ ther suggest that product market reforms in the respective sectors could have an important impact on productivity growth, output and investment. Measuring performance of professional services: Mark-ups and allocative efficiency Mark-ups An important indicator of competition is the mark-up that firms charge over marginal costs. Lower mark-ups imply lower prices and hence in‐ crease consumers' purchasing power and are generally seen as growth- and welfare-enhancing (via a direct effect on demand or a supply-side effect stemming from increased efficiency as a result of higher competition). Ac‐ cording to Aghion et al. (2002), mark-ups are even to be preferred as indi‐ cator of product market competition to other indicators such as the Herfindahl index of market concentration. Another argument is put for‐ ward in Causa et al. (2014), providing evidence for an equalising effect of lower mark-ups on the income distribution. Earlier work carried out in DG ECFIN has investigated mark-ups and their relationship with product market regulation (Thum-Thysen and Can‐ ton 2015). Results of this work show that on average mark-ups seem to be high in the professional services compared to the retail and transport sec‐ tors (with the lowest mark-ups in the retail sector). This finding is in line with some of the previous literature (see for instance Molnar and Bottini (2010), who find that mark-ups are higher for professional services and lower for retail). A cross-country examination of mark-ups is presented in Figure 5.2.1. The same sectors/activities are covered for all countries, so the data are comparable across countries. The graph shows that mark-ups in professional services are relatively high in Germany. Mark-ups are low‐ est in Finland and Sweden. The highest mark-ups in the professional ser‐ vice sector are found in Poland and Luxemburg. 2 2.1 V How to Assess the Economic Impact of Regulation 244 Mark-ups (MUP) in professional services in 2013 Source: Thum-Thysen and Canton (2015) Allocation of productive resources Another indicator of competition is allocative efficiency (AE). According to Boone (2008), productive resources such as labour and capital are chan‐ nelled towards their most efficient use in competitive markets. To use this view on competition, the analysis applies the method to measure AE de‐ veloped in ECFIN (2013) to professional services.99 To develop the argu‐ ment, Figure 5.2.2 presents labour productivity and market share per firm size class in Germany's legal services and in one of the top performers in terms of the allocative efficiency measure in this area – the UK. Data are from Eurostat and pertain to 2014. The graph immediately shows a dis‐ tinctly different pattern in the two countries. In the German legal activities sector it is found that the larger firms show higher average labour produc‐ Figure 5.2.1: 2.2 99 We focus on legal activities (NACE Rev. 2 code M69.1), accounting activities (M69.2), architectural activities (M71.1.1) and engineering activities (M71.1.2). V.2 Economic impact of competition-friendly deregulation 245 tivity. However, the combined employment share (measured in terms of the fraction of workers in the sector allocated to firms in a certain size class) of the group of most productive firms is very low (8.2%), whereas the group of firms with the lowest average labour productivity (i.e. in this case the firms employing 2-9 workers) have by far the largest combined employment share (48.3%). For the UK a somewhat peculiar U-shaped re‐ lationship between average labour productivity and firm size is observed, but the most productive group of firms (here the ones with at least 250 employees) also has the largest employment share (33.8%). A similar pat‐ tern is found for accounting activities and architecture & engineering: em‐ ployees are concentrated in the most productive firms in the UK, and in the least productive firms in Germany. Average levels of labour productivity also differ across countries. Using Eurostat average labour productivity per worker in legal services (NACE Rev. 2 code M69.1) we observe that in Germany employees' annual value added is on average about 60,000 euros while it is 88,000 euros in the UK and 107,000 in Sweden (not adjusted for price differences). As mentioned in the 2015 Country Report for Germany (cf. European Commission, 2015), the weak labour productivity growth observed in the German professional services sector may partly be explained by an ineffi‐ cient allocation of resources within the sector. Such inefficient use of re‐ sources reflects a situation of malfunctioning markets because of weak competitive forces. In a competitive environment the most productive firms gain the largest employment shares. Barriers to competition can pre‐ vent reallocation of resources, enabling inefficient firms to survive while hampering growth of the efficient companies. These facets can be sum‐ marised by the indicator on allocative efficiency (AE) presented in Figure 5.2.3. This indicator measures the extent to which the most productive firms have the largest market share.100 Germany is presented together with a number of other EU countries, depending on data availability. 100 A more elaborate description of the allocative efficiency indicator can be found in Product Market Review 2013 (ECFIN, 2013). The latest year for which the AE indicator can be calculated for Germany is 2014. Notice that architecture and en‐ gineering is combined as the Eurostat data on productivity per firm size class do not allow for a separation between the two sub-sectors. V How to Assess the Economic Impact of Regulation 246 Labour productivity and employment share per firm size class in Germany's and UK's legal services reflects a situation of malfunctioning markets because of weak competitive forces. In a competitive environment the most productive firms gain the largest employment shares. Barriers to competition can prevent reallocation of resources, enabling inefficient firms to survive while hampering growth of the efficient companies. These facets can be summarised by the indicator on allocative efficiency (AE) presented in Figure 3. This indicator measures the extent to which the most productive firms have the largest market share.7 Germany is presented together with a number of other EU countries, depending on data availability. Figure 2: Labour productivity and employment share per firm size class in Germany's and UK's legal services Source: ECFIN calculations using Eurostat data. Labour productivity is expressed in 1000 euros, and employment share is in %. Negative numbers of the AE index point at forces in the economy preventing competition from working properly, such as excessive regulation, rent-seeking, ineffective procurement, and clientelism. The graph shows that there are substantial inefficiencies in Germany's legal activities sector, while also the accounting and architecture & engineering sector show signs of underperformance. Figure 3: AE in professional services (2014) 7 A more elaborate description of the allocative efficiency indicator can be found in Product Market Review 2013 (ECFIN, 2013). The latest year for which the AE indicator can be calculated for Germany is 2014. Notice that architecture and engineering is combined as the Eurostat data on productivity per firm size class do not allow for a separation between the two sub-sectors. 0 50 10 0 15 0 la bo ur p ro du ct iv ity 2-9 10-19 20-49 50-249 GE250 DE, Legal activities, 2014 0 20 40 60 80 10 0 la bo ur p ro du ct iv ity 2-9 10-19 20-49 50-249 GE250 UK, Legal activities, 2014 0 10 20 30 40 50 m ar ke t s ha re 2-9 10-19 20-49 50-249 GE250 DE, Legal activities, 2014 0 10 20 30 40 m ar ke t s ha re 2-9 10-19 20-49 50-249 GE250 UK, Legal activities, 2014 Source: ECFIN calculations using Eurostat data. Labour productivity is expressed in 1000 euros, and employment share is in %. Negative numbers of the AE index point at forces in the economy prevent‐ ing competition from working properly, such as excessive regulation, rentseeking, ineffective procurement, and clientelism. The graph shows that there are substantial inefficiencies in Germany's legal activities sector, while also the accounting and architecture & engineering sector show signs of underperformance. Figure 5.2.2: V.2 Economic impact of comp tition-friendly deregulation 247 AE in professional services (2014) Allocative efficiency is computed using a sector-level variant of the productivity decomposition developed by Olley and Pakes (1996): ? ? ? = ∑ ? ? ? ? ? ? ? ∈? ? = 1 ? ? ∑ ? ? ? ? ∈? ? + ∑(? ? ? − ? ? ? ̅̅ ̅̅ )(? ? ? − ? ? ? ̅̅ ̅̅ ) ? ∈? ? ⏟ ? ? where Pnt is labour productivity (in logs) of industry n in year t, Sn is the number of firm size classes s in industry n, ? st is the market share of firms within size class s, and bars indicate industry-level averages. Source: ECFIN calculations using Eurostat data. 3 Product market regulations and impact of reforms The above-mentioned inefficiencies (relatively high mark-ups and low allocative efficiency) can be due to restrictive product market regulations. The regulatory level in legal, accounting, architectural and engineering services can be described by the OECD Product Market Regulation composite indicator (in the following, PMR indicator), whose value spans from 0 to 6 (a low value corresponds to light regulation). This indicator is an average of two more detailed sub-indicators assessing the level of entry and conduct regulation (see Table 1 for a description of their components), and whose values range from 0 to 6 as well. Typically market entry regulations are rules on areas of reserved activity, qualification requirements such as formal certificates of qualifications (i.e. academic degrees, professional examinations), quotas on the number of practitioners, and registration or membership in a professional body. Conduct regulations refer to restrictions on forms of business, restrictions on inter-professional co-operation, regulation on advertising, and regulation on prices and fees (fixed prices, minimum and/or maximum prices etc.). Table 1: Entry and conduct regulation indicators Entry regulation Exclusive or shared exclusive rights The number of service providers is restricted, and the services can only be provided under an exclusive or -.3 -.2 -.1 0 .1 mean of AE DE ES FR NL DK UK Legal activities -.6 -.4 -.2 0 .2 mean of AE EL BG PT ES HU IT DE BE FI CY FR DK NL UK Accounting activities -.3 -.2 -.1 0 .1 mean of AE IT PL HU BE RO ES DE FI SE FR NL UK DK Architecture and engineering Source: ECFIN calculations using Eurostat data. Product market regulations and impact of reforms The above-mentioned in fficiencies (relatively high mark-ups and low al‐ locative efficiency) can be due to restrictive product market regulations. The regulatory level in legal, accounting, architectural and engineering services can be described by the OECD Product Market Regulation com‐ posite indicator (in the following, PMR indicator), whose value spans from 0 to 6 (a low value corresponds to light regulation). This indicator is an average of two more detailed sub-indicators assessing the level of entry and conduct regulation (see Table 5.2.1 for a description of their compo‐ nents), and whose values range from 0 to 6 as well. Typically market entry regulations are rules on areas of reserved activity, qualification require‐ ments such as formal certificates of qualifications (i.e. academic degrees, professional examinations), quotas on the number of practitioners, and registration or membership in a professional body. Conduct regulations re‐ fer to restrictions on forms of business, restrictions on inter-professional Figure 5.2.3: 3 V How to Assess the Economic Impact of Regulation 248 co-operation, regulation on advertising, and regulation on prices and fees (fixed prices, minimum and/or maximum prices etc.). Entry and conduct regulation indicators Entry regulation Exclusive or shared exclu‐ sive rights The number of service providers is restricted, and the services can only be provided under an exclusive or shared right Education requirements Requirement of a university degree, profession‐al examinations, etc. Quotas Restrictions by quotas on the number of practis‐ing professionals Compulsory chamber membership Membership in a professional organization is compulsory in order to provide the service Conduct regulation Regulations on the form of business Specific legal forms requirement Regulations on inter-pro‐ fessional cooperation Restrictions on cooperation between profession‐ als Regulations on advertising Restrictions on advertising Regulations on prices and fees Fixed prices, minimum, maximum prices and non-binding reference prices Source: OECD. As shown in Table 5.2.2, the level of entry regulation is higher than conduct regulation. Furthermore, we find that the PMR conduct indicator has decreased during the period 2008-2013 in a larger number of coun‐ tries, while fewer countries have undertaken reforms reducing entry regu‐ lation. Inspection of the OECD's Product Market Regulation indicator for pro‐ fessional services reveals that Germany has a relatively strict regulatory framework, cf. Figure 5.2.4. For example, the PMR in legal activities equals 3.56 in Germany and 0.79 in the UK. The best performing EU countries in terms of the sectoral PMR indicator on professional services are Sweden (0.55), Finland (0.62), and Denmark and the UK (both 0.82). Additional calculations from the European Commission (Directorate-Gen‐ eral for Internal Market, Industry, Entrepreneurship and SMEs) find that Sweden and the UK are the best performing EU countries in terms of overall restrictiveness of professional services regulation. In the remainder we will use the scores for the UK and the EU average as reference values. Table 5.2.1: V.2 Economic impact of competition-friendly deregulation 249 Summary statistics on entry and conduct regulation indica‐ tors for the four professions in the 19 EU countries covered by the OECD PMR PMR Entryregulation PMR Conduct regulation 2008 2013 2008 2013 Legal ac‐ tivities Mean 3,66 3,67 2,59 2,32 Median 4,08 4,04 2,38 2,38 Number of countries that decrease PMR index between 2008-2013 7 8 Accoun‐ tancy Mean 3,51 3,38 1,15 0,76 Median 3,83 4 1,13 0,75 Number of countries that decrease PMR index between 2008-2013 5 7 Architec‐ ture Mean 2,82 2,87 0,94 0,70 Median 3,42 3,58 0,50 0,00 Number of countries that decrease PMR index between 2008-2013 5 8 Engineer‐ ing Mean 2,12 2,11 0,61 0,42 Median 2,17 2,50 0,00 0,00 Number of countries that decrease PMR index between 2008-2013 5 8 Source: Canton, Ciriaci and Solera (2014). Table 5.2.2: V How to Assess the Economic Impact of Regulation 250 PMR indicator in professional services (2013) Source: OECD. Figure 5: PMR indicator in professional services (total) over time, UK and Germany Source: OECD. Graph 5 shows the development over time in the PMR indicator for the four professional services combined8, for the United Kingdom and Germany. The graph shows a reduction of the gap notably between 1998 and 2003, but this convergence process was not maintained, and progress since 2003 has been slow. 8 This is based on an unweighted average of the four professions, cf. the PMR page at the website of the OECD. 0 1 2 3 4 5 P M R SE F I U K D K IT N L EE FR C Z ES S I IE D E M T AT C Y SK L T PT P L BG L U R O LV BE E L H U H R Legal activities 0 1 2 3 4 PM R D K LT BG I E M T SE F I U K EE I T N L SK A T C Z EL D E R O H R SI ES C Y FR H U PT BE LU P L Accounting activities 0 1 2 3 4 PM R FI N L S E D K IE U K E E M T LT E S IT LV C Z SI B E AT H U EL D E S K PL C Y PT FR LU H R Architecture 0 1 2 3 4 PM R BE D K FI FR N L SE U K IE M T EE L T PT D E C Z ES H U IT S I LV AT E L PL SK C Y LU H R Engineering 0,00 0,50 1,00 1,50 2,00 2,50 3,00 3,50 4,00 4,50 1998 2003 2008 2013 United Kingdom Germany Source: OECD. PMR indicator in professional services (total) over time, UK and Germany Source: OECD. Figure 5.2.4: Figure 5.2.5: V.2 Economic impact of competition-friendly deregulation 251 Graph 5 shows the development over time in the PMR indicator for the four professional services combined101, for the United Kingdom and Ger‐ many. The graph shows a reduction of the gap notably between 1998 and 2003, but this convergence process was not maintained, and progress since 2003 has been slow. To conclude this section, it has been found that product market regu‐ lation in professional services is relatively strict in Germany. In the previ‐ ous section we have illustrated that at the same time mark-ups are relative‐ ly high while allocative efficiency is mediocre. The quantitative relation‐ ship between product market regulation and these two performance indica‐ tors has been established in various studies, which we shall use next to analyse the potential impact of structural reforms.102 Potential impact of structural reforms: Closing-the-policy-gap approach A common way to analyse the potential impact of reform is a so-called closing-the-gap approach. For example, suppose a country has an employ‐ ment rate of 60%, while it has a target of 70%. In the closing-the-gap ap‐ proach the potential impact of structural reforms is calculated by assuming that the country reaches the 70% employment target. The somewhat con‐ troversial feature of such a closing-the-gap approach is that it is silent on the policy action needed to achieve the target. In this chapter we therefore adopt a slightly different approach, the "closing-the-policy-gap" approach, in which the potential impact is analysed when the country adopts good policy practices. Table 5.2.3 and 5.2.5 show the estimated impacts of a closing-the-poli‐ cy-gap simulation.103 As benchmarks we use both the UK (as a good per‐ 4 101 This is based on an unweighted average of the four professions, cf. the PMR page at the website of the OECD. 102 While empirical studies typically control for other explanatory variables, it is ad‐ mittedly difficult to robustly establish causality. There are actually also theoreti‐ cal arguments why and how regulation would have an impact on performance, for example because the reallocation of productive resources is (at least to some extent) associated with firm entry and exit, and these business dynamics are in turn related to policies facilitating market entry and exit. 103 Most closing-the-gap approaches use performance gaps, for example in terms of reaching employment levels or R&D investments similar to the best performing country. V How to Assess the Economic Impact of Regulation 252 former) and the EU average (Tables 5.2.3A & 5.2.5A refer to first bench‐ mark and Tables 5.2.3B & 5.2.5B refer to second benchmark). Regulation and mark-ups Table 5.2.3 presents estimated mark-up reductions of a closing-the-policygap scenario, where it is assumed that Germany would have the level of the PMR in professional services as realised in the UK (Table 5.2.3A) or EU average (Table 5.2.3B). Using the associated reduction in the PMR in combination with the results in Thum-Thysen and Canton (2015) would then predict a reduction of the mark-up in professional services by 9.4% pps.104 The mark-up in professional services would then fall from 20% to 11% in Germany, thereby almost completely eliminating the performance gap vis-à-vis the UK, with a mark-up in professional services of 10%. Mark-up reductions of a simulated reform of professional services in Germany (benchmark: UK) PMR in professional services in DE 2.65 PMR in professional services in UK 0.82 Change in PMR in a closing-the-policy-gap scenario -1.83 Impact on mark-up -0.094 Mark-up in DE 0.20 Mark-up in DE in a closing-the-policy-gap scenario 0.106 Mark-up in UK 0.10 Source: ECFIN calculations using OECD PMR data and econometric results in Thum- Thysen and Canton (2015). (i) Table 5.2.3A: 104 Thum-Thysen and Canton (2017) estimate the effect of product market regulation on mark-ups in selected professional services using firm-level data. The effect is in the same order of magnitude as in Thum-Thysen and Canton (2015). V.2 Economic impact of competition-friendly deregulation 253 Mark-up reductions of a simulated reform of professional services in Germany (benchmark: EU average) PMR in professional services in De 2.65 PMR in professional services – EU average 2.27 Change in PMR in a closing-the-policy-gap scenario -0.39 Impact on mark-up -0.02 Mark-up in DE 0.20 Mark-up in DE in a closing-the-policy-gap scenario 0.18 Source: ECFIN calculations using OECD PMR data and econometric results in Thum- Thysen and Canton (2015). The advantage of the closing-the-policy-gap approach using the PMR in‐ dicators is that it enables the identification of concrete issues for policy consideration in a reform discussion.105 To illustrate this, Table 5.2.4 shows a few questions in the PMR survey from the OECD, and the an‐ swers published for Germany and the UK respectively, for the 2013 wave. In other words, this benchmarking with the best performers in the EU helps to identify potential bottlenecks in the regulatory framework put in place. Examples of differences in regulatory framework between Germany and the UK in legal activities Examples of questions in PMR survey DE UK For how many tasks does the legal profession have an exclusive or shared exclusive right? 9 2 Entry requirements in the legal profession – If relevant compulsory practice is required, how many years duration? 2 years 1 year Are there restrictions on inter-professional cooperation (e.g. partnerships, associations, joint ventures)? – Legal profession co-operation al‐ lowed between comparable li‐ censed profession‐ als all forms of co-op‐ eration allowed Source: OECD. Table 5.2.3B: Table 5.2.4: 105 As mentioned before, this would not be possible in a closing-the-performancegap approach. V How to Assess the Economic Impact of Regulation 254 Regulation and allocative efficiency In Table 5.2.5, results are used from an ECFIN study on the econometric relationship between product market regulation and allocative efficiency (cf. Canton et al. 2014).106 For legal activities, the closing-the-policy-gap assumption implies a predicted impact on business churn of 4.84 pps., which in turn is associated with an improvement in allocative efficiency of 0.16. This is equal to an increase of average labour productivity in the sec‐ tor by 12.7%.107 In other words, this would be the predicted reform impact when Germany's regulatory framework in legal activities were to converge to the one in the UK. Returning to the earlier mentioned data on average labour productivity, this reform would shift the annual value added per worker from 60,000 euro to 67,620 euro. Obviously, this is a radical re‐ form generating a very strong improvement of sectoral performance, which will also be macro-relevant. A similar exercise for the other two sub-sectors delivers a productivity gain of 3.7% for accounting activities and 8.2% for architecture and engineering. Some comments are in order. The relatively small reform benefit ob‐ tained for accounting activities is due to the fact that the performance in the country which is used here as the benchmark (the UK) is not particu‐ larly strong. The country with the least restrictive regulatory framework is Denmark, with a PMR of 0.96. If Germany would reach the Danish level of the PMR for accounting activities, the labour productivity gain is esti‐ mated to be almost 10%. Secondly, the simulated reforms here are substantial, while econometric results can (rather) be used for predicting the impact at the margin, i.e. for small changes in the reform variables. In other words, the numbers in the table should be treated with some caution. (ii) 106 Technically, the analysis develops a two-stage approach, where the first-stage es‐ timates the impact of regulation on business churn, and the predicted value for business churn from the first-stage is then used as an explanatory variable for al‐ locative efficiency in the second-stage. 107 As the AE impact refers to the change in the logarithm of labour productivity, the growth rate is obtained as exp(x)-1 with x=0.16 in this example. To be on the conservative side, this growth rate has been scaled down by a factor 0.73, in line with empirical results in ECFIN (2013) where an increase in AE by 1%-point was found to correspond with an increase in the level of labour productivity of 0.73%. Also, as adjustment takes time, a gradual phasing in of this shock is as‐ sumed (5 years) in the QUEST simulations. V.2 Economic impact of competition-friendly deregulation 255 Thirdly, a comparison between the results of the closing-the-policy-gap approach and the closing-the-performance-gap approach shows that imple‐ Productivity gains of a simulated reform of professional services in Germany (benchmark: UK) Legal activities Accounting activ‐ ities Architecture and engineering PMR in DE 3.56 2.60 2.219 PMR in UK 0.79 1.75 (1) 0.365 Change in PMR in a closingthe-policy-gap scenario -2.77 -0.85 -1.854 Impact on business churn 4.84%-point 1.49%-point 3.24%-point Impact on AE 0.16 0.049 0.107 DE's AE before the reform -0.27 -0.08 -0.04 DE's predicted AE after the reform -0.11 -0.03 0.07 AE in UK 0.06 0.11 0.04 Impact on labour productivi‐ ty (%) 12.7% 3.7% 8.2% Note: (1) Best performer is Denmark but for sake of consistency we use the UK as the benchmark country. Source: ECFIN calculations using OECD PMR data and econometric results in ECFIN (2013) & Canton et al. (2014). Productivity gains of a simulated reform of professional services in Germany (benchmark: EU average) Legal activities Accounting activ‐ ities Architecture and engineering PMR in DE 3.56 2.60 2.219 PMR – EU average 3.36 2.27 1.67 Change in PMR in a closingthe-policy-gap scenario -0.20 -0.33 -0.54 Impact on business churn 0.35%-point 0.58%-point 0.95%-point Impact on AE 0.012 0.019 0.031 Impact on labour productivi‐ ty (%) 0.8% 1.4% 2.3% Source: ECFIN calculations using OECD PMR data and econometric results in ECFIN (2013) & Canton et al. (2014). Table 5.2.5A: Table 5.2.5B: V How to Assess the Economic Impact of Regulation 256 mentation of best-practice policies in Germany would indeed substantially reduce the performance gap, but would not fully eliminate it, in legal and accounting activities, while the performance gap would completely disap‐ pear in architecture and engineering. This can be seen from a comparison of the rows "DE's predicted AE after the reform" and "AE in UK" in Table 5.2.5A.108 For example in legal activities, the predicted allocative efficien‐ cy after the reform in Germany would be -0.11, while it is 0.06 in the UK. Negative numbers for allocative efficiency imply that the less productive firms manage to attract larger employment shares than the more produc‐ tive firms. In levels, the reform would predict that in Germany's architec‐ ture and engineering activities the average annual value added per em‐ ployee would increase from about 63,300 euro to 68,500 euro. Finally, the PMR indicator has its own limitations, and may for exam‐ ple not fully reflect the country-specific situation. For example the Ger‐ man Trade and Crafts Code (GTCC) could imply formal and informal in‐ stitutional barriers which may not be captured in the PMR. Work has been done to measure the scope of the GTCC at sectoral level (cf. Prantl and Spitz-Oener 2014), but their paper unfortunately does not mention which sectors are most heavily influenced by the GTCC. We will come back to this issue in the concluding section. Economy-wide effects: Simulations with QUEST As we have seen above, reforms in the professional services can be ex‐ pected to raise productivity and lower profit margins (price mark-ups) in these sectors. The following provides an assessment of the potential macroeconomic implications. This work is based on simulations with a 3region (Germany, rest of EA, rest of world) version of the European Com‐ mission's QUEST model with exogenous technological progress. Another variant of this model, the semi-endogenous growth version of the QUEST model, which includes an R&D production sector, has been used exten‐ sively for assessing the potential impact of structural reforms and gives comparable results with respect to the policies discussed here (Roeger et al. 2008, ECFIN 2013b). While some measures can directly be translated 5 108 We have only performed this exercise with regard to the UK performance. There‐ fore the level of AE before and after the reform is not shown in Table 5.2.5B. V.2 Economic impact of competition-friendly deregulation 257 into model parameters, in other cases the translation is done through inter‐ mediary indicators that are then translated into model parameters in a sec‐ ond step. This is notably the case for product market reforms, which have been quantified as changes in the OECD’s PMR indicators and subse‐ quently translated into mark-up and productivity shocks (cf. Section III). The model distinguishes between tradable and non-tradable sectors, where output from the different activities is used for final demand and as inter‐ mediate input to other producers. Both final goods and intermediates pro‐ duced by the tradable sector are traded internationally. A detailed descrip‐ tion of the model structure can, e.g., be found in Vogel (2014). The simulations use the econometric estimates for the labour productiv‐ ity gains and mark-up reductions from the previous section as input. The labour productivity and mark-up effects are scaled by the value added shares of the professional services to obtain aggregate labour productivity and mark-up shocks for simulation with QUEST.109 The data for value added are taken from the Eurostat Structural Business Statistics database. In Germany the shares amount to around 1.1% for the legal services sec‐ tor, 1.4% for the accounting sector and 2.4% for the architecture and engi‐ neering sector. As part of professional services is tradable, the reform is not confined to the non-tradable sector of the economy but spread over tradables and non-tradables alike. In addition to the joint impact (Table 5.2.6), the ef‐ fects of labour productivity increase and mark-up decline are also shown separately to illustrate their relative contribution (Tables 5.2.7-8). The labour productivity and mark-up effects are phased in gradually over a pe‐ riod of 5 years, reflecting the fact that the effects of reforms tend to need time to materialise fully. The results in Table 5.2.6 suggest GDP (level) gains of about 1% com‐ pared to the non-reform baseline in the long term that materialise gradual‐ ly. Consumption and investment increase; the investment increase is more pronounced to sustain a higher capital stock associated with higher returns on capital. Employment remains nearly unchanged. The impact of the re‐ form on the trade balance is very modest, however, due to countervailing 109 Due to the simplified sectoral aggregation, the parametrisation of input-output linkages in tradable and non-tradable production uses average values across the activities assigned to the two sectors, which does not account for the particular importance of professional services for downstream industries as discussed above. V How to Assess the Economic Impact of Regulation 258 positive income (more net imports) and competitiveness (more net ex‐ ports) effects; the impact of trade volume adjustment (more net exports) on the trade balance is further mitigated by countervailing price effects (lower production costs, and relative price of German goods has to decline for absorption of the additional output). Productivity improvement and mark-up reduction spread across tradable and non-tradable sectors Table 6: Productivity improvement and mark-up reduction spread across tradable and non-tradable sectors Comparing Tables 7-8 suggests that, given the estimated size of the reforms, the GDP gain relates predominantly (to around 3/4th in the long term) to the price mark-up reduction. Employment and investment react more strongly to the price mark-up reduction as it lacks the dampening impact of higher productivity on factor demand. The demand increase in the case of labour productivity improvement is more consumption driven. Both measures have very modest trade balance effects. Table 7: Productivity improvement spread across tradable and non-tradable sectors Table 8: Mark-up reduction spread across tradable and non-tradable sectors Finally, we have simulated the effect of the regulatory framework via the mark-up- and the allocative efficiency-channels separately, and the total effect reported in Table 6 is basically the sum of the effects reported in Table 7 and 8. This yields prudent results as the estimated effects could be stronger if we would take into account the effects of the interlinkage between the two channels.16 QUEST does not capture this interlinkage because it does not feature firm heterogeneity with endogenous entry and exit. 16 Note that mark-ups and allocative efficiency could be intertwined as it can be argued that a reduction in mark-ups may lead to lower productivity firms exiting the market. This would in turn improve allocative efficiency through a reallocation of resources to more productive firms and to a further increase in growth (Schiantarelli, 2008). Year 1 2 3 4 5 6 7 8 9 10 20 50 Real GDP 0.04 0.16 0.31 0.46 0.60 0.69 0.74 0.77 0.79 0.81 0.96 1.13 non-tradables 0 0.07 0.18 0.3 0.4 0.48 0.52 0.54 0.56 0.58 0.72 0.88 tradables 0.08 0.24 0.4 0.56 0.69 0.78 0.82 0.84 0.86 0.89 1.09 1.3 Employment -0.01 0.01 0.05 0.08 0.10 0.10 0.10 0.09 0.09 0.08 0.07 0.07 Consumption -0.09 -0.08 0.02 0.14 0.25 0.34 0.41 0.45 0.47 0.49 0.61 0.73 Investment 0.45 1.00 1.43 1.75 1.99 2.12 2.17 2.17 2.15 2.13 2.01 1.93 Trade balance 0.01 0.01 0.01 -0.01 -0.02 -0.04 -0.05 -0.05 -0.06 -0.06 -0.03 0.02 Note: Results for GDP, consumption and investment are % deviations and results for the trade balance are percentage-point deviations of net trade to GDP from prereform levels. Year 1 2 3 4 5 6 7 8 9 10 20 50 Real GDP 0.04 0.08 0.12 0.16 0.20 0.23 0.24 0.24 0.25 0.25 0.26 0.28 non-tradables 0.04 0.09 0.12 0.16 0.2 0.23 0.24 0.25 0.25 0.25 0.26 0.27 tradables 0.03 0.07 0.12 0.17 0.22 0.26 0.27 0.27 0.27 0.27 0.29 0.31 Employment 0.01 0.01 0.00 0.00 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 Consumption 0.07 0.12 0.15 0.18 0.21 0.23 0.25 0.26 0.26 0.27 0.28 0.28 Investment 0.01 0.05 0.09 0.13 0.16 0.19 0.20 0.20 0.19 0.19 0.17 0.17 Trade balance 0.00 0.00 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 0.00 0.00 Note: Results for GDP, consumption and investment are % deviations and results for the trade balance are percentage-point deviations of net trade to GDP from prereform levels. Year 1 2 3 4 5 6 7 8 9 10 20 50 Real GDP 0.00 0.08 0.19 0.30 0.40 0.46 0.50 0.52 0.54 0.55 0.70 0.85 non-tradables -0.04 -0.02 0.05 0.13 0.2 0.25 0.28 0.3 0.31 0.33 0.46 0.6 tradables 0.05 0.17 0.28 0.38 0.47 0.52 0.55 0.57 0.59 0.61 0.79 0.99 Employment -0.02 0.00 0.04 0.08 0.11 0.12 0.11 0.10 0.09 0.09 0.08 0.08 Consumption -0.16 -0.20 -0.14 -0.05 0.04 0.11 0.16 0.19 0.20 0.22 0.33 0.44 Investment 0.44 0.96 1.34 1.62 1.82 1.93 1.97 1.97 1.96 1.94 1.84 1.76 Trade balance 0.01 0.01 0.01 0.00 -0.02 -0.03 -0.04 -0.05 -0.05 -0.05 -0.03 0.01 Note: Results for GDP, consumption and investment are % deviations and results for the trade balance are percentage-point deviations of net trade to GDP from prereform levels. Comparing Tables 5.2.7-8 suggests that, given the estimated size of the re‐ forms, the GDP gain relates predominantly (to around 3/4th in the long term) t the price mark-up reduction. Employment and investment react more strongly to the price mark-up reduction as it lacks the dampening impact of higher productivity on factor demand. The demand increase in the case of labour productivity improvement is more consumption driven. Both measures have very modest trade balance effects. Productivity improvement spread across tradable and nontradable sectors Table 5.2.6: Table 5.2.7: V.2 Economic impact of competition-friendly deregulation 259 Mark-up reduction spread across tradable and non-tradable sectors Finally, the total effect reported in Table 5.2.6 is basically the sum of the effects of the two elements reported in Table 5.2.7 and 5.2.8. This yields prudent results as the estimated effects could be stronger if we would take into account the effects of the interlinkage between the two channels.110 QUEST does not capture this interlinkage because it does not feature firm heterogeneity with endogenous entry and exit. 6 Concluding remarks This study has presented an analysis on the economic impact of competi‐ tion-friendly deregulation in Germany's professional services. The clos‐ ing-the-policy-gap approach has shown that reforms in the services sector can generate non-trivial macroeconomic benefits. It should be stressed that the presented numbers refer to potential economic benefits. Ideally we would also have presented expected benefits from actually implemented reform measures, along the lines of ECFIN (2016), but it was not possible to carry out such an exercise because of limited reform progress in Ger‐ many. Our analysis indicates that professional services in Germany feature rel‐ atively strict product market regulation, relatively high mark-ups and that allocative efficiency in these sectors could be improved. Our results fur‐ Table 5.2.8: 110 Note that mark-ups and allocative efficiency could be intertwined as it can be ar‐ gued that a reduction in mark-ups may lead to lower productivity firms exiting the market. This would in turn improve allocative efficiency through a realloca‐ tion of resources to more productive firms and to a further increase in growth (Schiantarelli, 2008). V How to Assess the Economic Impact of Regulation 260 ther suggest that product market reforms in the respective sectors could have an important impact on productivity growth, output and investment. Quantifying the impact of reforms is not a straightforward exercise, and important assumptions have to be made regarding the empirical frame‐ work and the macroeconomic model. The strategy adopted in this chapter has been to combine the use of a DSGE model, QUEST, in combination with additional econometric work on the relationship between product market regulation and economic performance. The PMR indicator from the OECD is widely used to measure the intensity of product market regu‐ lation, but is for the moment only available until 2013. The European Commission therefore also started to develop alternative indicators on product market regulation. In particular the European Commission has published an indicator on regulation intensity in professional services, building on the mutual evaluation of regulated professions, and validated by national authorities (cf. European Commission 2017). This indicator provides an extensive coverage of the most important restrictions, fo‐ cussing on seven professions (accountants, architects, lawyers, civil engi‐ neers, patent agents, real estate agents, and tourist guides). This indicator will be issued every two years, and could be used for future work. In addi‐ tion, work is ongoing regarding the development of an indicator measur‐ ing restrictiveness of regulations and performance of the retail sector. Next to the reform discussions in the Member States, there is also scope for stepping up work at EU level. We would like to mention in particular the Services Directive, which also covers business services (with some ex‐ ceptions such as notarial services). Several studies on the economic impact of this Directive have been carried out. According to Monteagudo et al. (2012), reforms by Member States since the introduction of the Services Directive until end-2011 could generate 0.8%-1.8% additional EU GDP. However, reform progress has slowed down over recent years. Only about 0.1% (out of 1.8%) has been realised through national reforms adopted over the period 2012-2014 (European Commission, 2015b). Further work could be done to extend the analysis. For example, Thum- Thysen and Canton (2015) also take a closer look at two different types of product market regulation in the professional service sector, and in partic‐ ular whether results differ across entry and conduct regulations. The ana‐ lysis shows that entry regulations seem to matter more than conduct regu‐ lations, which turn out to have an insignificant effect. An increase in tight‐ ness of entry regulations tends to increase the mark-up. As we have seen above, entry regulations also showed the slowest reform progress in the V.2 Economic impact of competition-friendly deregulation 261 past, so this seems a particularly relevant area for stepping up reform ef‐ forts. References Aghion, P.; Bloom, N.; Blundell, R.; Griffith, R.; Howitt, P. (2002): Competition and innovation: An inverted U relationship, NBER Working Paper no. 9269 Boone, J. (2008): A new way to measure competition, The Economic Journal, 118 (August), 1245-1261 Canton, E.; Ciriaci, D.; Solera, I. (2014): The economic impact of professional services liberalisation, European Economy Economic Paper no. 533, ECFIN Causa, O.; de Serres, A.; Ruiz, N. (2014): Can growth-enhancing policies lift all boats? An analysis based on household disposable incomes, OECD Economics Depart‐ ment Working Paper no. 1180, OECD Publishing, Paris Ciriaci, D.; Palma, D. (2015): To what extent are knowledge intensive business ser‐ vices contributing to manufacturing?, Economic Systems Research (forthcoming) Di Cagno, D.; Meliciani, V. (2005): Do inter-sectoral flows of services matter for pro‐ ductivity growth? An input/output analysis of OECD countries. Economics of Inno‐ vation and New Technology, 3, 149–171 ECFIN (2013): Product Market Review 2013: Financing the real economy, European Economy 8|2013, ECFIN ECFIN (2013b): The growth impact of structural reforms, Quarterly Report on the Eu‐ ro Area, 12(4), European Commission ECFIN (2015): The euro area services sector, Quarterly Report on the Euro Area, 14(2), European Commission, 7-17 ECFIN (2016): The economic impact of selected structural reform measures in Italy, France, Spain and Portugal, European Economy Institutional Paper no. 23, ECFIN European Commission (2015): Country Report Germany 2015, SWD(2015) 25 final/2 European Commission (2015b): Assessment of the economic impact of the Services Directive; Update of the 2012 study European Commission (2016): Country Report Germany 2016, SWD(2016) 75 final European Commission (2017): On reform recommendations for regulation in profes‐ sional services, Commission Staff Working Document, SWD(2016) 436 final Koumenta, M.; Pagliero, M. (2017): Measuring prevalence and labour market impacts of occupational regulation in the EU, Commissioned by Directorate-General for In‐ ternal Market, Industry, Entrepreneurship and SMEs Molnar, M.; Bottini, N. (2010): How large are competitive pressures in services mar‐ kets? Estimation of mark-ups for selected OECD countries, OECD Economic Stud‐ ies, OECD, Paris Monteagudo, J.; Rutkowski, A.; Lorenzani, D. (2012): The economic impact of the Services Directive: A first assessment following implementation, European Econo‐ my Economic Paper no. 456, ECFIN V How to Assess the Economic Impact of Regulation 262 Olley, G.S.; Pakes, A. (1996): The dynamics of productivity in the telecommunications equipment industry, Econometrica, 64(6), 1263-1297 Prantl, S.; Spitz-Oener, A. (2014): Interacting product and labor market regulation and the impact of immigration on native wages, Paper University of Cologne, Hum‐ boldt-University Berlin Roeger, W.; Varga, J.; in ‘t Veld, J. (2008): Structural reforms in the EU: A simulationbased analysis using the QUEST model with endogenous growth, European Econo‐ my Economic Paper no. 351, ECFIN Schiantarelli, F. (2008): Product market regulation and macroeconomic performance: A review of cross-country evidence, Boston College Working Papers in Economics no. 623 Thum-Thysen, A.; Canton, E. (2015): Estimation of service sector mark-ups deter‐ mined by structural reform indicators, European Economy Economic Paper no. 547, ECFIN Vogel, L. (2014): Nontradable sector reform and external rebalancing in monetary union: A model-based analysis, Economic Modelling, 41(C), 421-434 Thum-Thysen, A.; Canton, E. (2017): Estimating mark-ups and the effect of product market regulations in selected professional services sectors: A firm-level analysis, European Economy Discussion Paper no. 46, ECFIN V.2 Economic impact of competition-friendly deregulation 263

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References

Abstract

‘How Can We Boost Competition in the Services Sector?’ is a key question in the process of creating a more effi-cient economic environment in Germany. This book contains a collection of conference contributions on service sector reforms from members of academic institutions, ministries, the EU Commission and other organisations. The conference consisted of a keynote on the importance and implementation of structural reforms in Europe and two panels that dealt with the evaluation of past reforms in the services sector and the potential scope and effects of further reforms.

Since the 1990s, productivity growth in Germany and other Member States of the European Union has been significantly lower than in the US. The development of productivity growth in the services sector is estimated to account for two thirds of this widening gap. The European Commission advocated reforms in the services sector in its country-specific recommendations for Germany. At a conference in Berlin in July 2016, experts from various fields presented and discussed studies on service sector reforms.

With contributions by

Oliver Holtemöller, Brigitte Zypries, Joaquim Nunes de Almeida, Dirk Palige, Henrik Enderlein, Stefan Profit, Davud Rostam-Afschar, Paolo Mengano, Oliver Arentz, Erik Canton, Jochen Andritzky

Zusammenfassung

„Wie können wir den Wettbewerb im Dienstleistungssektor stärken?“ Dies ist eine Schlüsselfrage für eine größere Leistungsfähigkeit des ökonomischen Umfelds in Deutschland. Dieses Buch versammelt Konferenzbeiträge von Mitgliedern wissenschaftlicher Einrichtungen, von Ministerien, der EU-Kommission und anderen Organisationen zu Reformen im Dienstleistungssektor. Die Konferenz umfasste einen Eröffnungsvortrag zur Bedeutung und Durchführung von Strukturreformen in Europa und zwei Gesprächsforen zur Bewertung vergangener Reformen im Dienstleistungssektor und zur möglichen Reichweite sowie zu den möglichen Auswirkungen weiterer Reformen.

Die Zunahme der Produktivität ist seit den 1990er Jahren sowohl in Deutschland als auch in anderen Ländern der Europäischen Union deutlich geringer als in den USA. Es wird geschätzt, dass die Entwicklung des Produktivitätszuwachses im Dienstleistungssektor für zwei Drittel dieses zunehmenden Abstandes verantwortlich ist. Die Europäische Kommission spricht sich in ihren länderspezifischen Empfehlungen zu Deutschland für Reformen in diesem Sektor aus. Auf einer Konferenz im Juli 2016 in Berlin stellten Experten aus unterschiedlichen Bereichen Studien zu solchen Reformen vor und diskutierten deren Ergebnisse.

Mit Beiträgen von

Oliver Holtemöller, Brigitte Zypries, Joaquim Nunes de Almeida, Dirk Palige, Henrik Enderlein, Stefan Profit, Davud Rostam-Afschar, Paolo Mengano, Oliver Arentz, Erik Canton, Jochen Andritzky