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Oliver Holtemöller (Ed.)

How Can We Boost Competition in the Services Sector?

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

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How Can We Boost Competition in the Services Sector? Oliver Holtemöller [ed.] How Can We Boost Competition in the Services Sector? Oliver Holtemöller [ed.] The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data are available on the Internet at http://dnb.d-nb.de ISBN 978-3-8487-4676-7 (Print) 978-3-8452-8902-1 (ePDF) British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. ISBN 978-3-8487-4676-7 (Print) 978-3-8452-8902-1 (ePDF) Library of Congress Cataloging-in-Publication Data Holtemöller, Oliver How Can We Boost Competition in the Services Sector? Oliver Holtemöller (ed.) 270 p. Includes bibliographic references. ISBN 978-3-8487-4676-7 (Print) 978-3-8452-8902-1 (ePDF) 1st Edition 2017 © Nomos Verlagsgesellschaft, Baden-Baden, Germany 2017. Printed and bound in Germany. This work is subject to copyright. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage or retrieval system, without prior permission in writing from the publishers. Under § 54 of the German Copyright Law where copies are made for other than private use a fee is payable to “Verwertungs gesellschaft Wort”, Munich. No responsibility for loss caused to any individual or organization acting on or refraining from action as a result of the material in this publication can be accepted by Nomos or the editor. Table of Contents List of Figures 7 List of Tables 11 Preface 15 IntroductionI 17 Overall Productivity and Product Market Regulation (Oliver Holtemöller) I.1 17 Competition in the Services Sector (Richard Kühnel)I.2 23 The Practical ViewII 25 Brigitte ZypriesII.1 25 Joaquim Nunes de AlmeidaII.2 30 Dirk PaligeII.3 36 Which Structural Reforms for Europe? (Henrik Enderlein)III 43 Past Reforms in the Services Sector and their EffectsIV 87 Introduction (Stefan Profit)IV.1 87 Entry regulation and entrepreneurship: a natural experiment in German craftsmanship (Davud Rostam- Afschar) IV.2 89 Structural Reforms in Transportations: Dynamics and Sectorial Spillovers (Paolo Mengano) IV.3 134 DiscussionIV.4 170 5 How to Assess the Economic Impact of Regulation – Recent Developments in Europe and Germany and Outlook to the Next Step V 177 Services liberalisation in Germany: Overview and the potential of deregulation (Oliver Arentz) V.1 177 Economic impact of competition-friendly deregulation in Germany's professional services (Erik Canton) V.2 241 Discussion (Jochen Andritzky)V.3 264 Conclusions (Oliver Holtemöller)VI 269 Table of Contents 6 List of Figures Figure 1.1: Productivity in the US and in Europe 17 Figure 1.2: Product market regulation 18 Figure 1.3: Product market regulation: international evidence 19 Figure 1.4: Professional services regulation 19 Figure 1.5: Firm dynamics in the US and in Europe 20 Figure 1.6: Sectoral contributions to labour productivity 21 Figure 3.1: Lost years for growth in advanced economies 46 Figure 3.2: In some euro-area economies recovery has come to a halt 47 Figure 3.3: Sectoral divergence in wage growth in the euro area 50 Figure 3.4: Counting key reform recommendations: in total more than 230 54 Figure 3.5: Consensus on reform priorities for euro-area countries is less than 40% 55 Figure 3.6: There were three times as many country recommendations for labour markets than product markets 56 Figure 3.7A: Consensus reform lists: unfinished business and next generation 57 Figure 3.7B: Consensus reform lists: where the countries are 57 Figure 4.1.1: Progress in structural reforms in Germany 87 Figure 4.1.2: National regulation of specific professions 88 7 Figure 4.2.1: Self-employment in treatment groups and control group: number of self-employed craftsmen in B1, A1, A2, and AC occupations in thousands 96 Figure 4.2.2: Self-employment rates in treatment groups and control group: percentage share of self-employed among B1, A1, A2, and AC occupations 97 Figure 4.2.3: Craftsmanship and entrepreneurship policies: total, unsubsidized, and German self-employed craftsmanship in thousands 101 Figure 4.2.4: Entries into and exits from self-employment and their difference among B1-occupations, left ordinate number in thousands, right growth rate in percent 107 Figure 4.2.5: Entries into and exits from self-employment and their difference among AC-occupations, left ordinate number in thousands, right growth rate in percent 107 Figure 4.2.6: Entries into and exits from self-employment and their difference among A2-occupations, left ordinate number in thousands, right growth rate in percent 108 Figure 4.2.7: Entries into and exits from self-employment and their difference among A1-occupations, left ordinate number in thousands, right growth rate in percent 109 Figure 4.3.1: Composition of indicator of regulations 153 Figure 4.3.2: The dynamics of inputs and output 155 Figure 4.3.3: The dynamics of labour costs 156 Figure 4.3.4: The dynamics of productivity 158 Figure 4.3.5: The dynamics of resources allocation 159 List of Figures 8 Figure 4.3.6: The dynamics of competition 161 Figure 4.3.7: The dynamics of inputs and output 163 Figure 4.3.8: The dynamics of labour costs 164 Figure 4.3.9: The dynamics of productivity 164 Figure 4.3.10: The dynamics of resources allocation 165 Figure 4.3.11: The dynamics of concentration 165 Figure 4.3.12: Duration of policymakers’ mandates 166 Figure 5.1.1: Proportional use of domestic services 181 Figure 5.1.2: Share of gross value added by economic sectors in Germany 182 Figure 5.1.3: Increase of the gross value added and of employment in the domestic services sectors 183 Figure 5.1.4: Gross value added and net operating surplus in the area of business services 184 Figure 5.1.5: Export ratio in the sector of business services 186 Figure 5.1.6: The manufacturing sectors proportion of the gross value added by international comparison 187 Figure 5.1.7: Services sector employees in the German manufacturing sector 189 Figure 5.1.8: Intermediate inputs purchased by the manufacturing sector 190 Figure 5.1.9: Business services purchase by the manufacturing sector 191 Figure 5.1.10: Value based proportion of intermediate inputs from the services sector for the production of another value unit of domestic manufacturing production 192 List of Figures 9 Figure 5.1.11: Intermediate inputs purchased by the services sector 193 Figure 5.1.12: OECD Indicator on regulation in professional business services 195 Figure 5.1.13: OECD Indicator on regulation for accounting, legal, architecture and engineering 196 Figure 5.1.14: OECD Services Trade Restrictiveness Index 197 Figure 5.1.15: Net operating surpluses in selected sectors of the economy 198 Figure 5.1.B1: Net operating surplus in the area of business services in an international comparison 236 Figure 5.1.B2: Gross operating surplus in the area of domestic business services 237 Figure 5.2.1: Mark-ups (MUP) in professional services in 2013 245 Figure 5.2.2: Labour productivity and employment share per firm size class in Germany's and UK's legal services 247 Figure 5.2.3: AE in professional services (2014) 248 Figure 5.2.4: PMR indicator in professional services (2013) 251 Figure 5.2.5: PMR indicator in professional services (total) over time, UK and Germany 251 Figure 5.3.1: Employment and productivity 265 Figure 5.3.2: Value added in selected industries 266 List of Figures 10 List of Tables Table 3.1: The top three reform priorities for euro-area countries 67 Table 3.A1: Overview of country reform recommendations 68 Table 3.A2: Overview of euro-area reform recommendations 78 Table 3.A3: Reform priorities by countries 79 Table 4.2.1: The natural experiment 93 Table 4.2.2: Weighted averages by treatment and control groups in pre- and post-reform (2002–2004; 2005–2009) samples 110 Table 4.2.3: Estimation results of self-employment state and transition probabilities 113 Table 4.2.4: Probabilities of entry into self-employment (in %): difference-in-differences 115 Table 4.2.5: Probabilities of exit from self-employment (in %): difference-in-differences 117 Table 4.2.6: Probabilities of being self-employed (in %): difference-in-differences 119 Table 4.2.7: Treatment effects on entry into self-employment and on the share of self-employed for subgroups (in %): difference-in-differences 121 Table 4.2.8: Stock of businesses at the end of the year 126 Table 4.2.9: Self-employment rates in treatment groups and control group by year 127 11 Table 4.2.10: Estimation results of self-employment state and transition probabilities 128 Table 4.2.11: Timing sensitivity: Logit estimation results of selfemployment state probabilities 129 Table 4.2.12: Robustness: Logit estimation results of selfemployment state probabilities 130 Table 5.1.1: Effects on whole economy 207 Table 5.1.2: Effects on manufacturing sector 207 Table 5.1.3: Econometric estimation results for different deregulation scenarios 220 Table 5.1.A1a: Base model OECD Indicator, effects on valueadded in whole economy 226 Table 5.1.A1b: Base model OECD Indicator, effects on valueadded in manufacturing sector 227 Table 5.1.A2a: OECD Indicator & control for output, effects on value-added in whole economy 228 Table 5.1.A2b: OECD Indicator & control for output, effects on value-added in manufacturing sector 228 Table 5.1.A3a: Base model net surplus, effects on value-added in whole economy 229 Table 5.1.A3b: Base model net surplus, effects on value-added in manufacturing sector 230 Table 5.1.A4a: Net surplus & control for output, effects on valueadded in whole economy 230 Table 5.1.A4b: Net surplus & control for output, effects on valueadded in manufacturing sector 231 List of Tables 12 Table 5.1.A5a: Approach one: effects of hypothetical reductions in regulation in the production sector NACE 74 Rev. 1.1 “other business activities” on value-added, linear approximation based on the estimation results of the models A2a and A2b 233 Table 5.1.A5b: Approach two: effects of hypothetical reductions in regulation in the production sectors NACE M69 rev 2 “legal and accounting activities” and NACE M71 Rev. 2 “architectural and engineering activities” on value-added, linear approximation based on the estimation results of the models A2a and A2b 234 Table 5.2.1: Entry and conduct regulation indicators 249 Table 5.2.2: Summary statistics on entry and conduct regulation indicators for the four professions in the 19 EU countries covered by the OECD PMR 250 Table 5.2.3A: Mark-up reductions of a simulated reform of professional services in Germany (benchmark: UK) 253 Table 5.2.3B: Mark-up reductions of a simulated reform of professional services in Germany (benchmark: EU average) 254 Table 5.2.4: Examples of differences in regulatory framework between Germany and the UK in legal activities 254 Table 5.2.5A: Productivity gains of a simulated reform of professional services in Germany (benchmark: UK) 256 Table 5.2.5B: Productivity gains of a simulated reform of professional services in Germany (benchmark: EU average) 256 Table 5.2.6: Productivity improvement and mark-up reduction spread across tradable and non-tradable sectors 259 List of Tables 13 Table 5.2.7: Productivity improvement spread across tradable and non-tradable sectors 259 Table 5.2.8: Mark-up reduction spread across tradable and nontradable sectors 260 List of Tables 14 Preface This book summarizes the results of the conference “How can we boost competition in the services sector?” that took place on July 6, 2016 in Berlin. The conference was organized by the Halle Institute for Economic Research (IWH) on behalf of the Representation of the European Com‐ mission in Germany. Productivity growth in recent years has been rather weak in Germany and also in other continental European countries. Barriers to entry in some services sectors may be one factor explaining the productivity gap be‐ tween Germany and the USA, for example. The European Commission has been hinting at this point for several years, and there have been al‐ ready some reforms in Germany aiming at lowering barriers to entry in some services sectors. At the conference “How can we boost competition in the services sector?” reforms in the services sectors have been discussed from various perspectives. The book consists of six parts. After an introduction in part I, part II is devoted to the practical view on service sector reforms. It documents the contributions of representatives of the German Government, the European Commission, and the German Confederation of Skilled Crafts. In part III, an overview of the European economic reform agenda and the role of ser‐ vice sector reforms within the general agenda is given. Part IV contains contributions on past reforms in Germany and their economic effects. Part V consists of contributions that focus on expected effects of potential fu‐ ture reforms. Finally, part VI concludes. Many persons have helped to make the conference a success. I am grateful to Rahel Künkele, Stefanie Müller and Felix Pohle for their orga‐ nizational work, and I thank Andreas Schmalzbauer for his effort in putting together the individual contributions in one coherent manuscript. Finally, the financial support by the Representative of the European Com‐ mission in Germany is gratefully acknowledged. Of course, I am responsi‐ ble for all remaining errors and shortcomings of this book. Berlin, July 6, 2016 Oliver Holtemöller 15 Introduction Overall Productivity and Product Market Regulation (Oliver Holtemöller) Professor Dr Oliver Holtemöller, Martin-Luther-University Halle-Witten‐ berg and Halle Institute for Economic Research (IWH) “How can we boost competition in the services sector?” is a topic that has been attracting the attention of the media, of politicians and of scientists for some time now. Productivity in the US and in Europe Source: Ameco The ultimate goal of boosting competition is to foster economic growth and, hence, welfare. Compared to the US, productivity growth has been I I.1 Figure 1.1: 17 rather weak in Germany and in other continental European countries in re‐ cent years (figure 1.1). A couple of studies have analyzed why productivity growth has been higher in the USA than in Europe. Van Ark, O’Mahony and Timmer (2008) study the period from 1995 until 2006, which is very interesting because the gap widens there, as figure 1.1 shows; more recently, it does not diverge so much. During that period between 1995 and 2006, produc‐ tivity grew in the USA by 2.3 percent, whilst in the EU-15 only by 1.5 percent. Van Ark et al. point primarily at the knowledge economy as the main source for the differences but also at the high level of regulation of labour and product markets. What does regulation of product markets mean? The OECD has made a suggestion for breaking down product market regulation into various cat‐ egories (figure 1.2). Product market regulation Source: Koske et al. (2015) The three categories are direct influence of the state on businesses, imped‐ iments to entrepreneurship and impediments to international trade and in‐ vestment. Overall, Germany exhibits a medium degree of product market regulation (figure 1.3). Figure 1.2: I Introduction 18 Product market regulation: international evidence Source: Data source: Koske et al. (2015), graph by IWH Professional services regulation Source: Data source: Koske et al. (2015), graph by IWH The UK and the USA have the lowest levels of regulation; however, the distance between Germany on the one hand and the UK and the USA on Figure 1.3: Figure 1.4: I.1 Overall Productivity and Product Market Regulation (Oliver Holtemöller) 19 the other hand is not particularly large. For services, though, the differ‐ ences are much bigger (figure 1.4). In the UK and in the USA, the extent of regulation in the services sec‐ tors is substantially lower than in Germany and in some other continental European countries. What explains the large difference? What can be done to improve flexibility in Germany? There are also other indicators which support the view that regulation in some special areas may contribute to low productivity growth. The ease of doing business indicator of the world bank, for example, reveals that Germany ranks only on mediocre places for the sub-indicators starting business, register property and pay taxes. All these factors play a role in explaining the substantially lower degree of firm dynamics in Europe compared to the USA. Firm dynamics in the US and in Europe Source: Bravo-Biosca (2011) Figure 1.5 shows the differences in the frequency distribution of firms be‐ tween the USA and Europe, sorted by shrinking, remaining static or ex‐ panding firms. In the USA, there are many firms that shrink, but there are also many being newly established and many expanding. In Europe, a lot of firms neither expand nor shrink, they are static. The more dynamic en‐ Figure 1.5: I Introduction 20 vironment in the USA may be supportive for innovations and therefore may be one piece in the productivity puzzle. The difference in productivity growth can mainly be attributed to the services sector for the period in which the difference in productivity be‐ tween the USA and Germany widens (figure 1.6). Sectoral contributions to labour productivity Source: Uppenberg (2011) Between 1995 and 2008, market services explain most of the gap in pro‐ ductivity growth. Against this background, it is important to better understand productivi‐ ty growth in the services sectors. More competition and more flexibility may be one way to increase productivity growth in the German services sectors. References Ark, B. van; O’Mahony, M.; Timmer, M. P. (2008): The Productivity Gap between Eu‐ rope and the United States: Trends and Causes, Journal of Economic Perspectives 22(1), 25-44 Bravo-Biosca, A. (2011): A look at business growth and contraction in Europe. Nesta Working Paper No. 11/02 Figure 1.6: I.1 Overall Productivity and Product Market Regulation (Oliver Holtemöller) 21 Koske, I.; Wanner, I.; Bitetti, R.; Barbiero, O. (2015): The 2013 Update of the OECD’s Database on Product Market Regulation: Policy Insights for OECD and Non-OECD Countries, OECD Economics Department Working Papers, No. 1200, OECD Pub‐ lishing Uppenberg, K. (2011): Economic Growth in the US and the EU: A Sectoral Decompo‐ sition, EIB Papers 16(1), 18-51 I Introduction 22 Competition in the Services Sector (Richard Kühnel) Richard Kühnel, Representative of the European Commission in Germany I will not introduce the European Commission; I believe that in times such as these, we have made it to the media almost every day. It is not always a good sign, but it expresses that in times like these, we need European an‐ swers to the big issues of our times. As we all know, we are in a stage of permanent crisis management. It started in 2008 with the financial crisis, which kept engulfing Europe time and again in different waves, then there was migration and now the British referendum. Those crises are so impolite to come more or less at the same time, or quickly one after another, that we never really get the chance of getting out of crisis mode. Though apart from the crisis mode, for us as Commission and Union it is very important that we do not lose sight of the long-term agenda for a reform process for Europe. Because on the day that the crises will break, whenever it will come, we will ask ourselves and certainly also the population of Europe what we have done for being able to meet global competition that we are facing, whether we want to or not. It is very important to recognise the signs of time and to give the requisite answers. The services sector certainly is a sector where, as Europe, we ought to be in a catching-up process in order to keep up with the global pace. And within Europe, that applies just as much to Germany. I hope we will not be stepping on anyone’s toes, when we look at that in some more detail today. Because, notwithstanding all the economic power that Germany radi‐ ates, in the services sector not everything is as it should be, also in the way that we look at it. Therefore, within the framework of our country-specific recommendations, we point out every year again that more needs to be done in the services sector in Germany. And today we are here to provide some analytical support to the discussions and to help us understand better what the impediments are – you have already touched upon some of those impediments, professor. Of course, we can see that Germany is very well regulated in that re‐ gard. We know – there are many sensitivities – of the master’s diploma, the craftsmen’s regime, etc. We understand all that, but one ought to ask oneself: Compared to other sectors of the German economy and also com‐ I.2 I.2 Competition in the Services Sector (Richard Kühnel) 23 pared to other services sectors in other European member states, is all that still necessary? And analysing that a little is an important task that may not be put off all the time. My modest contribution, my empirical field study is also my feeling, now that I have lived in your beautiful country for two years: Pre‐ cisely in the services sector, insufficient services offered on the supply side correlate with low service expectations on the customer side. I am sure that we have enough material here and also the graphs that you have shown, professor, form a basis for the discussion, I believe. I be‐ lieve that Mrs State Secretary did not exactly agree with every graph. Per‐ haps one should also scrutinise a little how things are presented and de‐ veloped, but for us it is an important process. A colleague has come from Brussels, Joaquim Nunes de Almeida, who is right now ensuring that we, as Commission, make progress in the ser‐ vices sector. A services directive and services passport are on the agenda. Therefore, the discussion that we will have with you today will also pro‐ vide very important input for us, because obviously we do not want to for‐ mulate our policies, our proposals and our recommendations in a political vacuum, but rather in a permanent process of exchange, at the medium stages also with science and guiding intellectual forces, as is happening to‐ day. I am looking forward to an exciting and stimulating discussion and ex‐ press my thanks particularly also to Mrs State Secretary Zypries for join‐ ing us here, for speaking a few introductory words and paint us the situa‐ tion from the point of view of the German Ministry of Economic Affairs. Particularly in this reform process, which we are trying to implement as Commission during the European Semester, the German Ministry of Eco‐ nomic Affairs is a very important partner and I believe that in many ques‐ tions indeed we do share the same or at least a similar opinion. The recommendations that we proffer are not to be understood as nega‐ tive criticism or as patronisingly lifted index finger, but as contribution to a political reform process that is in the interest of the whole of Europe and certainly also in the interest of the member states and, in this case, in the interest of Germany. I Introduction 24 The Practical View Brigitte Zypries Brigitte Zypries, Parliamentary State Secretary, Federal Ministry for Eco‐ nomic Affairs and Energy (BMWi) When we are talking in Germany about deregulation in the services indus‐ try, then we are essentially talking about professional services. But you have now touched upon many other topics as well: For example, the question about productivity gains of companies, the question about how to register a businesses, how does one handle the cadastral administration, how does one make fiscal declarations – without a doubt, we would all quickly agree that there is room for improvement in Germany. But what about the matter that you have raised now, Mr Kühnel, the situation with the Meister degree: Would it really make sense to deregulate the sector, so that a Meister degree would no longer be needed? What would then hap‐ pen to our dual education system, which we export with great success to all over the world. We must look at things carefully. There are also some historical issues that one could take into consideration. For example, the topic of equality in co-determination. Twenty years ago, everyone told us that in Germany the economy was in bad shape because we applied equal‐ ity in co-determination. But today, everyone knows that equality in co-de‐ termination is one of the guaranties for success of the social market econo‐ my. Another topic surely is the one of the publicly owned banks, in other words, the Sparkassen or savings banks. Ever since I started working, the issue has been that the European Commission wishes to put an end to the German system of public savings banks. It has already been an issue twen‐ ty years ago, when I was with Gerhard Schröder in the State Chancellery in Lower Saxony. But today we may say that our savings banks have sur‐ vived the financial crisis rather well, in other words, they do actually make sense. Talking about services: I believe that when we talk about changing the way that services are rendered, we must talk about smart and digital ser‐ vices, and we should not so much concern ourselves with whether we should actually have registers in Germany or not. The digitization is an II II.1 25 important key factor for the success of services and for the SMEs who ren‐ der them. We should mainly focus on this. Nevertheless, it is right for the Commission to say that it wants to dis‐ cuss everything that could be an obstacle for cross border services. Just like the Commission we believe that the internal market for services should be further strengthened. However, this certainly must be discussed in individual cases. Personally, I do not believe that our German architects do not build in France and the United Kingdom, just because we have the HOAI (honorarium code for architects and engineers) here in Germany. But I do rather believe that they do not build there (and vice versa), either because they do not speak the language and/or because they are not famil‐ iar with the contract legislation prevailing there. I think the actual impedi‐ ments are that we do not have uniform European contract law or at least some broad similarities. This is what makes it hard for some people to work across borders. And I strongly believe that deregulation will lead to large companies, such as big law firms and architectural offices. Those big firms can more easily afford to employ specialists, who can deal with these aspects. But one should then ask oneself, whether this is what is wanted. Do we really want the very small offices with two, three or four employees to close down or get absorbed by big firms? Do we want a deregulation which ac‐ tually leads to “monopolisation” or at least oligopolies? This would not be my idea of a sensible commercial development. The services sector is rather important in our economy, as you all know. Seventy percent of all value creation occurs in the services sector and it employs three quarters of the entire German workforce. A significant part of that what we refer to as services comprises inputs for other industrial sectors. The major points of criticism of the Commission concerns mostly the professional services. In Germany, professional services are seen as in‐ dependently exercised activities in the fields of science, authoring and ed‐ ucation. It is defined that way in the Income Tax Act, and by that defini‐ tion we have more than 1.3 million self-employed members of these pro‐ fessions in Germany. With us, many of the professions are governed by so-called codes of conduct and that is the stumbling block that is at issue here. These professions are architects, physicians, lawyers, fiscal consul‐ tants, auditors, notaries. However, employment is developing rather well in Germany. We have a growing number of self-employed as well as employees in the sector of the professional services; a growing number of new business activities in II The Practical View 26 Germany are established in the field of professional services, though the number of employees with mandatory social insurance has also risen by 3.7 % during the past year. We may have a rather high level of regulations, compared to some other countries. The Commission is now of the opinion that the professional ser‐ vices cannot develop their full potential on account of the laws as well as the regulations promulgated by professional associations or chambers. However, the existing regulations are not a purpose by themselves, but rather they serve a particular regulatory purpose that must be justified un‐ der constitutional categories (proportionality and freedom of choice of oc‐ cupation). I have myself looked for three years after legislation affecting solicitors and barristers at the Federal Constitutional Court. Any restric‐ tion on the free choice and exercise of occupation has to be justified and proportionate. And we find that precisely the professional services have regulations which serve to protect an important common good. In the case of physicians, it is rather obvious that this is about health care. The solici‐ tor or barrister is a constitutionally recognised body of judicature: He or she guarantees access to justice and as body of judicature they hold a spe‐ cial position in the legal system. Auditors carry out the legally prescribed audits of annual accounts. Those professional services do indeed differ from other services, precisely through their orientation on a common good. This clearly is the legitimisation of the regulations. Obviously, the regulated fees do also serve to protect consumers, because they have the comfort of knowing that they can consult a solicitor who does not after‐ wards send excessive invoices. The same is true for architects, who are bound by minimum and maximum fee levels. The Federal Constitutional Court holds that those regulated standardisa‐ tions are also an assurance of quality and most of all of an assurance of independence in exercising the profession. Any legislation is only justified when it is necessary and required. Therefore the legislator must test again at every juncture to what extent times have changed, leading to the need for a change of legislation. Now, we have seen the European Union’s initiative for transparency and are verifying it also within the framework of our regulations. Follow‐ ing those verification activities, we have submitted our action plan to the Commission at the beginning of the year and presented in it some consid‐ erations for amending particular professional rules. And in any case we have plans for relaxing the rules on exercising a range of professions and have, indeed, already implemented some of those. They affect primarily II.1 Brigitte Zypries 27 the professions that are closely linked with the economy, exercised by so‐ licitors, patent attorneys, fiscal consultants and auditors. The market for auditing annual accounts is being opened up further for audit firms, regis‐ tered in the EU. The legal form requirements have been relaxed. By now, it is no longer forbidden in Germany to run a veterinary practice, incorp‐ orated as a legal person. Other reforms concern the mandatory ongoing education of physicians and medical specialists and right now legislative proceedings are under way in the German Second Chamber for unifying and newly organising the occupational training of health workers and nurses. The legislative proceedings are under way, albeit against the strong opposition from paediatricians. So you can see, the Federal Government is already taking the legal oc‐ cupational arrangements seriously and is also making the case for mod‐ ernisation and adjustment of the regulations where necessary. But we also believe that such justified and proportionate regulations must be kept in place in order to ensure the quality of apprenticeship places. The same goes if it serves the assurance of appropriate consumer protection. As you probably all know, there is a particular problem with the fee regulation for architects and engineers, because currently an infringement proceeding is under way. The Commission is criticising us for having min‐ imum and maximum wages for architects and engineers, as laid down in the HOAI. The Federal Ministry of Economic Affairs will defend the HOAI in this proceeding, because we cannot see any infringement of the services directive or of the freedom of establishment. From the point of view of consumer protection it makes sense to pre‐ serve the fees arrangement, since it gives the principal the certainty that he is not being cheated because verifiable, fixed maximum and minimum prices exist. Therefore, a principal with low income is not forced to make use of the services of a cheap but bad architect. Regarding fiscal consul‐ tants we have agreed to a conversion to non-binding prices. This means that, in principle, the fees table is maintained but it will only be applied if no other arrangements have been agreed upon. Furthermore, it means that it is possible to deviate from the laid down fees table, which meanwhile is also the case in the area of legal counselling fees. I see this as quite a clever solution: Consumers have a guideline for what they have to pay, but can deviate from it if they can agree on something else. Professor Holtemöller, you have started with quoting a study of how regulations affect the development of productivity. In our experience, the available data make comparison of regulations with those in other coun‐ II The Practical View 28 tries relatively difficult. The causes, statements on cause and effect, are usually fairly vague and it is not so clear what is actually being measured. One could also ask whether that opening up would really lead to an in‐ crease in productivity. We know that in the United Kingdom, the limita‐ tions on capital participations in legal counselling services have been lift‐ ed. It has led to much bigger chanceries. But whether it has also led to lower prices did not become clear to us. Empirical data ought to be col‐ lected. Indeed, the mere fact that bigger units are being formed does not necessarily mean that prices will fall. I believe it should be questioned whether we want such oligopolies in the field of architecture. Well, you will notice straightaway that I am distinctly sceptical about it. Nevertheless, I do not wish to deny either that even in our ministry there are people who certainly have different opinions in this regard, as indeed have also some members of the Federal Government. It is important here to conduct empirical research into what might actually be the result of deregulating. Would it lead to larger units? What would be the effect on prices or the effect on choice of occupation? Of particular importance to us in Germany is, what would happen to the dual education system and what would happen to the Meister degree and to qualified training? I be‐ lieve that your conference today will make an important contribution to us focussing on these questions. I wish you further fruitful exchange of ideas. II.1 Brigitte Zypries 29 Joaquim Nunes de Almeida Joaquim Nunes de Almeida, Director DG Internal, Market, Industry, En‐ trepreneurship and SMEs (GROW), European Commission State Secretary, Ladies and Gentlemen, thank you for the invitation and for organising this event on this very relevant topic: competition in ser‐ vices and the way forward to make this sector more competitive. It is a pleasure for me to be here this morning and to share with you some thoughts on how we can together tackle this challenge. Germany’s economy relies mainly on a strong manufacturing sector, which exports its products throughout Europe and the rest of the World. Why should we therefore worry about services? First of all because the services sectors are becoming an increasingly large part of all advanced economies. Secondly because services still offer untapped growth poten‐ tial. Let’s examine the situation. The share of value added from services keeps on growing. It is approaching 75% of the total value added of the EU economy. But it is not just the growing size. Services matter because of their increasing integration with the rest of the economy. The frontiers between services and manufacturing and industry are becoming blurred. Most manufacturing companies are providing services with the products they are offering: 80% of German manufacturers offer services in addition to their products. And these range from basic services like after-sales ser‐ vice to fully integrated solutions for their customers. Manufacturers also rely heavily on service providers to develop products and related services. Digitisation also plays a key role in this integration and is now every‐ where. In fact, 40% of the value added of a good manufactured in the EU stems from services. Some service providers are also manufacturers, pro‐ ducing sensors and connected devices to deliver their services. There are partnerships between manufacturers and service providers right along the value chain. Because of these links, any underperformance in the services sector drags down the entire economy, including the competitiveness of manufacturers operating on global markets. And ladies and gentlemen, frankly we could do much better on services in Europe and in Germany right now. The productivity of the EU economy is just 70% of the productivity of the US economy. This gap has been growing for almost 20 years. In Germany, labour productivity has grown II.2 II The Practical View 30 more than in the Euro area since 2000. However, within sectors, labour productivity growth has been particularly weak in business services, retail and in financial and insurance activities. In business services and retail the German labour productivity growth has been negative or close to zero for more than a decade which ranks Germany amongst the worst performers. And we are not seizing the full potential from cross-border service provi‐ sion. Intra-EU trade in services accounts for approximately 6% of GDP while it is over 21% for manufactured products. In some services, such as construction services, cross-border trade in the EU is extremely low and it accounts for less than 1% of the turnover of the sector. In some business services such as architects, engineers and accountants, very few com‐ panies are using the Single Market. And these are mainly large companies. We also believe that much more can be done to increase the integration of the retail sector at the EU level. This is a sector that accounts for almost 10% of the EU economy and 13% of employment. A key reason is that there are still too many restrictions to trade and cross-border in services. The level of restrictions within the EU remains considerably above the OECD average. These restrictions are particularly important in business services. On the basis of a Commission in-depth as‐ sessment from 2015 Germany ranks fourth amongst the EU countries with the most restrictive regulation in business services. Not fourth best. Fourth worst. These regulatory restrictions refer notably to restrictive authorisa‐ tion requirements, restrictions on legal form, shareholding and multidisci‐ plinary activities, insurance requirements and tariff restrictions. These bar‐ riers are particularly prevalent in business services such as architects, lawyers, accountants, tax advisers, and engineers. But also in regulated professions more widely. Regulated professions are present throughout the economy. When we think of construction, we have craft professions and specialised engineers. And the health sector is composed of doctors, nurs‐ es and all sort of medical specialists. They account for 22% of those em‐ ployed in the EU. That means almost 50 million people. In Germany, a third of all employed work in regulated profession, the highest of all Member States. An EU-wide survey carried out last year showed that wage premiums between regulated and unregulated professions are 4% on average but can be as high as 19% in some occupation groups. There are too many internal and cross-border barriers to the access to certain profes‐ sional activities. Academics estimate that, there could be between 3 and 9 per cent more people working in a given profession if those access re‐ quirements were made less stringent. They also conclude that regulation is II.2 Joaquim Nunes de Almeida 31 associated with about one third less foreign-born workers (EU and non- EU) in the occupation. Ladies and gentlemen, why do I say all of this? Why does the European Commission focus so much on services policy and the need for reform, e.g. in the European Semester and in the Country-Specific reform Recom‐ mendations that we issue every year, not least to the German government? Because removing regulatory barriers in services would lead to cheaper services and more choice for consumers, without undermining services quality. Because removing regulatory barriers in services would create more opportunities for new services firms to be set up. Assessments show that where regulatory barriers are lower, more new firms are set up. Be‐ cause removing regulatory barriers in services would increase the compet‐ itiveness of the services sector since productivity would go up as a result of a more efficient allocation of resources. And because this would in‐ crease the competitiveness of globally operating manufacturing businesses with it. A number of restrictions are also present in the retail sector. Retailers face persisting barriers to market entry created by certain retail establish‐ ment conditions such as rules regulating the location and size of shops as well as burdensome and complex authorisation processes. Sometimes, these restrictions are not appropriate and proportionate to the public policy objectives pursued. They may have the effect of unduly protecting incum‐ bent retailers or the current under-performing market structure. Our as‐ sessment of the effects of restrictions on establishment of new shops shows that higher levels of restrictions are coupled with lower levels of competition in the sector. Ladies and gentlemen, the question remains: how can we turn around this situation and improve the competitiveness of services? I believe ac‐ tion is needed on two levels. At Member State level. And at EU level. Let me cover each of these in turn. Member States have a major responsibility to remove unjustified barri‐ ers and cut the red tape. And many Member States have already done so. For example, in Greece, there was a major liberalisation of a number of professions in 2011. This led to lower prices for consumers, and more start-ups. But more can be done across Europe. In this year’s Country- Specific Recommendations adopted in May as part of the European Semester the Commission has again targeted the lack of structural reforms and competition-friendly measures in services as an area for improvement for Member States. In our recommendations specifically addressed to Ger‐ II The Practical View 32 many, we call upon the German government to 'step up measures to stimu‐ late competition in the services sector, in particular in business services and regulated professions'. This recommendation is based on detailed legal and economic analyses of the German services sector. Some of this work will be presented by my Commission colleague this afternoon. Important‐ ly, the German government agreed with this Recommendation when it was discussed and formally approved by Member States in the EU Council. In some cases, action at national level is not enough. We need to take EU action. In last year's Single Market Strategy, we issued a limited list of targeted and practical actions. I will highlight a few of those directed to‐ wards services. On regulated professions, a key action is to provide guid‐ ance for Member States on their reform needs, what we also call “profes‐ sion specific recommendations”. The purpose is to recommend to Member States to review those regulatory aspects in their internal frameworks which we consider as too burdensome, inefficient or outdated. The ulti‐ mate objective is for Member States to have regulation in place which is fit for purpose, protects but also serves consumers. And this can be achieved through a close cooperation and exchange of views, ideas, expe‐ riences and recommendations between the Commission and the Member States concerned. These recommendations will be based on a factual ana‐ lysis of regulation in specific professions based on information provided by Member States themselves. In order to assist in the discussions, an in‐ dicator measuring the intensity of regulation of specific professions is cur‐ rently in development by the Commission for that purpose. The recom‐ mendations will take account of specific national contexts. This is there‐ fore a real bottom up approach. It is also a differentiated approach. We are not aiming at a "one size, fits all" regulatory model nor at promoting a copy of one model throughout the EU. National and professional differ‐ ences are part of our regulatory heritage and constitute, to a great extent, our common richness. Nonetheless, drawing the lessons from our respec‐ tive experiences and adopting what is best and at the same time more ad‐ justable to what the others are doing, is not only good practice but also reaping the benefits of our path together. We expect to publish our first guidance by the end of this year. A second action on regulated professions is about an initiative to estab‐ lish an analytical framework or "Proportionality Test" to help Member States to review existing regulations or when proposing additional regu‐ lation of professions. We want to put in place minimum common criteria to evaluate the regulatory requirements on professions. The proportionali‐ II.2 Joaquim Nunes de Almeida 33 ty test will be based on existing case law. It will take into account econo‐ mic considerations. And it will ensure comparability across the EU in the way that proportionality assessments are conducted. It will not impose any new reporting obligations for Member States. We will deliver this propor‐ tionality test by the end of this year. An online public consultation is run‐ ning until mid-August. A third action announced in the Single Market Strategy is the "Services Passport". We intend to put in place an electronic procedure helping ser‐ vice providers in their expansion into another Member State. This should clarify the information requirements, as well as procedural steps the com‐ pany has to comply with when going abroad. The idea is to define a clear process, whereby an authority in the home Member State acts as a contact point for the service provider and interacts with a coordinating authority in the host Member State. In this way we also aim to build a relation between home and host Member States, based on more trust and increased commu‐ nication between the two. In addition, the Single Market Strategy also announced action to ad‐ dress regulatory obstacles. We will focus on regulatory obstacles in key business services and the construction sector including requirements on in‐ surance for companies going cross-border. An online public consultation on these actions is running until end-July. For the retail sector, we will de‐ liver best practices for facilitating retail establishment and reducing opera‐ tional restrictions in the single market. They will show how it is possible to pursue legitimate public policy objectives such as urban planning with‐ out disproportionate restrictions on market access. And in order to make existing rules established under the Services Directive work better in prac‐ tice, we will reform the procedure whereby Member States share informa‐ tion on changes to national legislation. We want to establish a true consul‐ tation process whereby Member States, the Commission and stakeholders can exchange views and best practices on draft national measures. As you can see, these actions are not about Europe introducing new regulation. This is about better regulation. It is about making an intelligent use of existing tools. It is about all of us reviewing whether we need regu‐ lation and whether the best suited means have been chosen in order to pro‐ tect legitimate public interest objectives while giving entrepreneurs and services providers the space and freedom they need to do what they are best at: get on with their job. We can only succeed if the Member States agree to these goals and take the necessary steps to address the outstand‐ ing issues. And we can only succeed in partnership. What we are doing at II The Practical View 34 EU level is designed to stimulate greater reform in Member States. It is about seeing the potential of more productive, more integrated, more effi‐ cient services market as our mutual gain. Today’s conference is a great op‐ portunity to raise the awareness of the need to act in favour of more com‐ petitive services markets. Academic research brings quality and facts to the political debate. This is very much needed. This is not about emotions. This is about securing the right conditions to deliver jobs and economic growth for the single market, for Germany. This is why your perspective and input are so valuable. II.2 Joaquim Nunes de Almeida 35 Dirk Palige Dirk Palige, Director Zentralverband des Deutschen Handwerks, ZDH (The German Confederation of Skilled Crafts), Director Deutscher Handwerkskammertag After the economic and financial crisis, the European Commission has, within the framework of its Europe 2020 strategy, set its mind on the cre‐ ation of sustainable and unifying growth. Quite rightly, important pillars make effective investments in education, research and innovation. More‐ over, the services sector has come to the fore. It is being assumed that more competition and more economic growth can be achieved through deregulation. Essentially, an Anglo-American approach to regulation is se‐ lected for Europe, which is supported through economic argumentation. The core question really is how many rules do we need in the field of commercial law, in order to ensure fair competition. Particularly during the past several years, the word ‘regulation’ has acquired a negative con‐ notation. The impression is often given that regulation would secure par‐ ticular interests at the expense of other interests. On the other hand, dereg‐ ulation is being put on a par with the creation of new freedoms, economic growth and innovation. Such a point of view does not really stroke with reality. For example, nobody seriously denies that deregulation of the financial markets in the USA in the 80s and 90s must be seen as the main cause of the economic and financial crisis. It led to the granting of massive loans and the devel‐ opment of a real estate bubble. Many EU countries and the economy are today still suffering from the negative consequences all over the world of the misguided deregulation policy. Looking at the United States as a blueprint for European economic policy, the following ought to make us think: According to an economic study (Grullon et al. 2015), the number of companies listed on the stock exchanges all over the USA has more than halved within a mere 20 years. Inherently to that, intensity of compe‐ tition diminished, leaving the corporate profits of the remaining market participants to rise. I think it is more than just an indication that the basis assumption that liberalisation would automatically or inevitably lead to more competition and innovation, is not right. On the contrary, it could lead to diminishing competition, as is becoming apparent in the USA. II.3 II The Practical View 36 And this leads me to my first theory: Modern national economies need an efficient regulatory framework. What that should look like could in‐ deed differ, when looking at the various member states of the EU. Econo‐ mic structures and general framework conditions are often too heteroge‐ neous for measuring everything by one yardstick, for applying one model. Too many European specifications undermine the adjustment flexibility of the member states. It is therefore necessary to seriously reflect again on the principles of subsidiarity and proportionality of legislative and non-le‐ gislative measures in Europe. That is particularly also necessary for bol‐ stering the acceptance of the European integration process amongst the population. Today’s event is about formulating the question of improving competi‐ tion in the services sector on the basis of economic analyses. Economic considerations could be useful before legislative measures are taken as well as for subsequent evaluation of enacted laws. In Germany, not only the competent ministries analyse the effects of new legal regulations, but the Normenkontrollrat [Regulatory Control Council] does so as well, as committee of independent experts, but we must nonetheless always be aware that economic approaches have their limitations and therefore can and may always only be one element of the comprehensive decision-mak‐ ing process. The reason is mainly that the database for assessing concrete questions is often inadequate. Moreover, explanatory models covering multiple factors are needed for precisely showing only the rudiments of the complex reality of life. I would like to clarify this assessment with the help of some examples and thereby also touch on studies that are mentioned time and again in conjunction with the current strategy for services in the internal market. Primarily, it concerns the matter of regulating occupations, which is now controversially discussed for two and a half at the European level and is also a topic during today's event. Let me first emphasise that the theory, regulation mentioned in conjunc‐ tion with it would lead to segregating of markets and therefore to higher prices, is simply not applicable in this absolute form. In September 2014, the European Commission proposed a study on the economic effects of deregulation in the sector of professional services. Legal counsellors were looked at, inter alia. On the basis of an assessment of the intensity of mar‐ ket regulation and economic dynamism as indicators, the professions were compared in five selected EU member states. The result was that the Ger‐ man legal services sector was assessed as being the most highly regulated, II.3 Dirk Palige 37 whilst the United Kingdom was mentioned as a positive example of the contrary, because of its lower level of regulation. But is the German mar‐ ket for legal counsellors really more segregated than the British one, as the results seem to suggest? Looking over a longer period, the number of legal counsellors increased sevenfold from 1970 until today. In the United Kingdom, the growth was distinctly more moderate. The basic assumption that less regulation would lead to more intense competition and more mar‐ ket participants is not confirmed – at least not according to those figures. And it is additionally claimed that a higher level of regulation would lead to higher prices. In terms of legal counselling services, country re‐ ports of the World Bank provide useful clues. Under the title “Ease of Do‐ ing Business”, the World Bank has published comprehensive location analyses. Inter alia, the cost of enforcing rights was determined on the ba‐ sis of model cases. If one were to compare Germany and the United King‐ dom in the country reports of the World Bank, the fees for legal counsel in a fictitious case with identical amount in litigation would be 6.6 percent in Germany against 35 percent in the United Kingdom. It seems to suggest that legal counselling services are significantly more expensive in the United Kingdom than in Germany. And this is not an exceptional example. And still, the standard argu‐ ments of economic theory are always joined with the statement that high requirements to occupation would lead to price increases. In the USA, pro‐ fessor Kleiner, who lately also cooperated on a study for the European Commission, has dealt with the topic. Census data of 2006 led professor Kleiner to findings of a four percent increase in wages, because of licens‐ ing. In 2010, a representative telephone survey conducted in all states of the USA arrived at an increase in wages of 15 percent, because of licens‐ ing. Depending on the database that was used, the result deviates by 375 percent. Another example: On the occasion of the forum on the internal market, the European Commission presented in May 2016 a study that came to completely different findings than as recently as 2014. The same scientists (Kourmenta/Pagliero) investigated price increases because of regulation and came to 17.2 percent for skilled craftsmen. Two years earlier, no price increases had been noticeable for the regulated professions. Perhaps the difference can be explained from the fact that for the current study the re‐ sults of a telephone survey in Germany have been used, whilst in 2014, micro data of the European Labour Force Survey had been used. A study for the United Kingdom of 2011 only noted wage increases for profession‐ II The Practical View 38 al services because of existing regulation, but did not detect any for crafts‐ men’s services. In reality, the bandwidth of the findings only show how unreliable the investigations are and how little meaning they have. Especially the example of the legal counsellors mentioned in the begin‐ ning clearly shows that, notwithstanding a high level of regulation, inten‐ sive competition with favourable prices could exist for services. And then, in the member states of the European Union the approaches to regulation differ considerably in terms of flexibility. In the field of crafts, we have a conceivably generously scoped right of entering occupations. In the crafts that are subject to permissioning, only the operations manager, not neces‐ sarily the owner, must possess a pertinent professional qualification. That may be a Meister degree. In any case, occupations can be entered with any a Meister degree equivalent professional qualification, regardless of where in the world the qualification has been obtained. As such, a Syrian refugee can exercise the function of operations manager with the professional qualification that he obtained in his own country, just as any EU citizen can. In this regard, our rules are clearly more accommodative than the recognition rules that apply throughout the EU, because we apply the recognition rules equally to all people, not matter their nationality and no matter where in the world they have obtained their professional qualifica‐ tion. I do not know of any other country with such generous arrangements. After all, only particularly significant activities of a craft are subject to permissioning, so that skills that can be easily acquired can be exercised by anybody, without the need for proof of professional qualification. The model stands out through its high degree of flexibility. It permits intensive competition in services. And that intensive competition is also reflected in the following figures: In crafts, around one third of companies have a low equity ratio of less than ten percent. Only every fifth company has a solid equity ratio of 30 percent and higher. Those figures are worse than for the economy as a whole. Here, almost half of all companies are considered to be solidly financed. Apparently, the pressure from competition is greater in crafts than in the economy as a whole, so that many companies do not manage to build solid equity rations. Because of the difficult financial pos‐ ition of many craft businesses, almost 4,000 businesses have gone bankrupt every year in the construction sector alone, in spite of the gener‐ ally good economic position during the past two years. And finally we ob‐ serve that about 10 percent of businesses in the crafts trade, are not subject to mandatory turnover tax. It means that their taking have been less than 17,500 euros during the previous year. It all shows how difficult the eco‐ II.3 Dirk Palige 39 nomic environment is, in which crafts businesses are exposed to competi‐ tion. The theory keeps cropping up all the time that, in conjunction with regulation, mobility within the internal market would be impaired. Whilst it is ignored that, in Europe, we have regulations in place governing the recognition of professional qualifications, since more than fifty years. Al‐ ready from the beginning, the regulations are based on automatic recogni‐ tion. A British study published in 2014 on proliferation of professional regulations in the EU and the effects of it on the labour market does in‐ deed confirm that existing regulations in the United Kingdom governing access to occupations, do not have a negative impact on immigration. The reason would be, according to the authors, that the European rules on recognition of professional qualifications do actually work and would fa‐ cilitate migration. The findings of the study confirm the experience in the crafts trade. In September 2014, the European Commission published a study on the effects of liberalisation in the services sector. One of the au‐ thors is holding a presentation today in Panel 2. The study comes to the conclusion that relaxation of the overall regulatory intensity has increased the rate of companies entering and leaving the market (churn rate). It is interesting to note that the authors attribute this mainly to relaxation in regulating behaviour. However, according to the study there is no empiri‐ cal evidence that relaxation of access regulations would lead to similar ef‐ fects. Let me summarise it as follows: The discussion on regulation is a spuri‐ ous debate! Deregulation does not in itself lead to more economic dy‐ namism and growth in the internal market. Let me sketch in conclusion in which sectors the crafts trade, as core of the SMEs in Germany with their approximately one million businesses, sees the particular challenges in terms of internal market policy: Mobility of qualified employees must be increased in Europe. In the crafts trade alone, many thousands of apprenticeship positions remained unfilled during the past year, although we would have liked to fill them with young people from other EU countries. Even trained specialists do not find their way to us in adequate numbers. That is astonishing, because with a currently rather low unemployment rate of 5.9 percent there is vir‐ tually full employment and good opportunities exist in the labour market. A leap into self-employment would also be attractive, whilst we even offer special advisory instruments for those establishing their own existence, from which EU nationals as well as our own citizens could profit, of II The Practical View 40 course. Apparently, language barriers and cultural differences and perhaps also diffuse fears create such a big impediment that indeed also young people make insufficient use of the rights of mobility in the internal mar‐ ket. There, we must be proactive and create a concrete framework of sup‐ port instruments. And language learning must also be promoted in the countries of origin. Someone, who has already acquired basic knowledge of the language of the country he wishes to go to, will find that integration into the labour market and into society is going to be very much easier. In Europe, we must invest more in education and meet demand more accurately in terms of qualifications. The ability to compete international‐ ly with companies from non-member states will be decisive for the future and for prosperity in Europe. And there, good choices are available. In its New Skills Agenda for Europe of 10 June on educational policy, the Euro‐ pean Commission announced that it would improve the attractiveness of occupational education, jointly with the member states and Europe’s social partners. It should be first choice for young people. Learning based on work should be strengthened at all levels. Two-pronged apprenticeship is explicitly mentioned as an exemplary component. That development, which could also be a valuable contribution to reducing youth unemploy‐ ment that still prevails in many EU countries, must definitely be contin‐ ued. We must actively participate in shaping the technical transformation – key word: digitalisation – by which many service sectors will be strongly affected over the next several years. Precisely SMEs must be given stronger support in the areas or research and development as well as trans‐ fer of know-how. And finally: Europe’s motto “In varietate concordia” appropriately ex‐ presses its strength. Retroflection will be necessary. Because of the differ‐ ent conditions in Europe, the member states need individual solutions for improving their competitiveness. The economic structures very too much for being able to be loosened from above. And that does indeed also apply to the question of which professions ought to be regulated in the individu‐ al member states and must be made subject to permissioning. References Grullon, G.; Larkin, Y.; Michaely, R. (2015): The Disappearance of Public Firms and the Changing Nature of U.S. Industries II.3 Dirk Palige 41 Which Structural Reforms for Europe?1 (Henrik Enderlein) Prof Dr Henrik Enderlein, Vice President and Professor of Political Econ‐ omy at the Hertie School of Governance and Director of the Jacques De‐ lors Institut – Berlin Dr Anna auf dem Brinke, Research Fellow at the Jacques Delors Institut - Berlin Executive Summary The euro area still suffers from low growth rates, macroeconomic imbal‐ ances and divergence. Therefore, the European Commission, the ECB, the IMF, and the OECD have all called for more structural reforms in the euro area. Adding up all recent key reform recommendations by the European Commission and the OECD alone amounts to more than 200 recommen‐ dations for the 19 euro-area countries. In this jungle of recommendations setting the right priorities is impor‐ tant. This policy paper presents an approach on how to use the long list of reform recommendations. It provides a structured summary of the key re‐ form recommendations for the euro area, puts forward three reform priori‐ ties for each euro area country and presents an overview of the reforms on a single page. Such a procedure is necessarily controversial. But we want to bring some clarity and structure into a debate that is all over the place. We arrive at three key conclusions: First, product-market reforms with a focus on enhancing the Single Market should be the top priority now. They have the highest short-term gains, can be implemented in good and bad economic times, have the largest effects on potential growth and can contribute significantly to the functioning of the euro area. III 1 A previous version of this article has been published here: auf dem Brinke, A.; En‐ derlein, H. (2017): How to make sense of the structural reform lists for the euro area, Policy Paper 184, Jacques Delors Institut - Berlin. 43 The second reform priority should be to boost investment as the euro area suffers from a significant investment gap. Countries with fiscal space should directly invest in education, research and investment. Investments here count as reform in the sense that they change the structure of the economy. Third, the high rates of unemployment in many euro-area countries are a source of concern. However, labour market reform should be implement‐ ed with great care: They can have transitional costs in the short term and benefits may take longer to materialize. Moreover, some of the reforms do not work well in times of weak economic growth and there are potentially powerful veto players to counter reform efforts. In addition, product-mar‐ ket reforms can go a long way in increasing employment and restoring competitiveness. If labourmarket reforms are implemented, reforms should have a demand-side component to stabilize the economy, such as investment in education, vocational training, ALMPs and life-long learn‐ ing. The timing and method to implement reforms need to take into account the broader economic circumstances as well as distributional effects and social cohesion. Our key take-home point is that not the most frequently mentioned reforms should be implemented, but the ones that fulfil the ob‐ jectives of increasing growth and improving the functioning of the euro area also in difficult economic times. What are structural reforms and why are they important? What are structural reforms? There is a lot of disagreement about the term “structural reforms”. Many prefer not to use it as it is considered to reflect a certain ideological orien‐ tation. We argue that the term can be meaningfully applied as long as it is well-defined. For us, structural reforms are all government-driven reforms that improve the functioning of the economy with the aim of leading to higher long-term GDP. Whether higher GDP should be an objective in it‐ self is of lesser relevance here. We consider a higher GDP to be generally positive as long as negative externalities are properly taken into account. But the debate about structural reforms should not be a debate on whether higher GDP is good, but how to get there, should higher GDP be desired. In the euro area context, an improved functioning of the single currency 1 1.1 III Which Structural Reforms for Europe? (Henrik Enderlein) 44 area thanks to structural reforms would also fall under our definition as we would expect euro area GDP to increase as a consequence in the longer term. Typical structural reforms fall into the area of labour markets, product markets and the financial sector, as well as taxation and public sector re‐ forms. At their best, structural reforms may be budget-neutral or even save money. These features have led some to argue that structural reform rec‐ ommendations are conceptually empty or “[s]afe advice. No one knows what it means. If economy grows: I told you. If it stalls: You didn’t do structural reform.”2 The quote by Kaushik Basu, Professor of Economics at Cornell University and former Chief Economist of the World Bank, highlights both the power and confusion surrounding the concept of struc‐ tural reform: When it comes to economic policy, structural reforms are of‐ ten synonymous with sound economic policy. But how do we recognize a good structural reform when we see it? Clearly, when looking at the long lists of reform recommendations (that put forward hundreds of reforms for euro area countries alone) it seems that governments should know what to do. At the same time, the imple‐ mentation gaps are significant: Only a handful of reforms have been im‐ plemented in the last years.3 On almost half of the key recommendations there has been no progress at all. This could be due to the context of eco‐ nomic crisis. Indeed, even strong proponents of structural reforms such as the IMF now recommend paying more attention to the macroeconomic context, see Duval et al. (2016), OECD (2016a) and Sanchez et al. (2016). There has been a notable shift from focusing on what one might call the traditional reform agenda to more emphasis on the difference between bad and good economic times, the role of the demand-side, and social cohe‐ sion. In this context, making reform recommendations and prioritising them has become even more challenging. This paper explains why structural reforms are important for the euro area from a theoretical standpoint. Second, it analyses more than 200 key reform recommendations and collapses them into two summary reform lists with five areas of reform in each list. Third, with the help of insights from empirical research it identifies three reform priorities for each euroarea country. 2 See tweet of Kaushik Basu, Professor of Economics at Cornell University and for‐ mer World Bank Chief Economist, on 7 April 2016 at 10:33 pm. 3 For recent evaluations see OECD (2015a) and Hradisky (2016). 1 What are structural reforms and why are they important? 45 Why structural reforms are important for growth The recovery after the crisis has been slow and the euro area is stuck in a difficult situation: low growth, low inflation and high unemployment. In terms of potential output most advanced economies have not recovered from the crisis: potential growth is still below pre-crisis levels (Duval et al. 2016). Figure 3.1 reproduces estimates from the IMF. Lost years for growth in advanced economies4 Source: Duval et al. 2016, Figure 3.1. Growth rates in the euro area are still too low. As figure 3.2 shows, some countries have not recovered from the crisis. Of the 19 euro-area members four have still lower GDP per capita in 2016 than in 2008. The Baltic States and also Germany have grown faster; France and Spain have wit‐ nessed a slower recovery; Greece and Italy are on a downward trend. 1.2 Figure 3.1: 4 Figure 3.1 shows potential output growth and its components for advanced economies. III Which Structural Reforms for Europe? (Henrik Enderlein) 46 Not surprisingly, unemployment rates in November 2016 stood at 9.8 percent on average.5 Again this conceals the vast differences within the euro area: Spain’s unemployment is just below 20 percent, while Ger‐ many’s unemployment rate amounted to a little more than 4 percent. On top of that, inflation is still low: The annual HICP inflation rate for De‐ cember 2016 stood at 1.1%.6 In some euro-area economies recovery has come to a halt7 Source: Eurostat (variable namq_10_pc), authors’ calculation. While structural reforms, shifting aggregate supply, can in theory lead to a tendency for prices to fall, the general growth dynamic triggered by re‐ forms is of paramount importance, especially in the context of a highly ac‐ commodative monetary policy. As the ECB often argues, the currently Figure 3.2: 5 Eurostat, unemployment rate by sex and age, monthly average, seasonally adjusted estimate. 6 ECB, Selected Indicators for the Euro Area. 7 Figure 3.2 shows quarterly unadjusted chained GDP per capita for selected coun‐ tries (2008Q1=100). 1 What are structural reforms and why are they important? 47 supportive demand-side conditions should be used by governments for structural reforms. The positive economic effects of reforms work through three main channels: (i) employment, (ii) productivity, and (iii) potential output in the long-run.8 Most reforms have spill-over effects across more than one of these areas, but one can categorize them broadly into these three cat‐ egories. First, there are a number of reforms that have direct effects on employ‐ ment. We simply describe these reform areas here without making a nor‐ mative assessment whether such reforms are desirable. – Reforms that lower the reservation wage, such as the harmonization of employment protection legislation (EPL) for temporary and permanent workers, tax reforms of second-earner penalties, a reduction of the labour tax wedge, a reduction of high and unconditional unemploy‐ ment benefits, a revision of early retirement schemes and pension re‐ forms that increase the pension age and offer more flexible transition periods into retirement. – Reforms that allow labour market outsiders to enter the market and thus increase the overall labour supply, such as the provision of child care for parents, language classes for migrants, vocational training for young individuals, life-long learning programs for the elderly and ac‐ tive labour market policies (ALMP) for the unemployed. These re‐ forms can increase the labour market participation especially of wom‐ en, elderly people, migrants or workers, whose skills are no longer in demand due to structural change. Second, there are structural reforms that are directly targeted at increasing productivity: – Reforms to reduce barriers to entry to increase competition and lower prices such as the opening of closed professional services, harmoniza‐ tion of regulations and reduction of regulatory barriers and red tape. – Reforms to increase market efficiency through digitalization, facilitat‐ ed by increasing competition in the telecoms sector leading to more ICT investment, harmonizing spectrum allocation and allow for EU- 8 For some recent empirical evidence see for instance: Andersen et al. (2014); Duval et al. (2016); ECB (2015a); ECB (2015b); Varga and in ‘t Veld (2014). III Which Structural Reforms for Europe? (Henrik Enderlein) 48 wide auctions for licenses, and encourage EU-wide standards for con‐ nected factories. – Reforms that increase the skill-level, such as investment into earlychildhood education, school and university funding, vocational training and R&D funding. Third, some reforms have direct effects on the growth potential: – Reforms that increase competitiveness in trade such as making the wage-bargaining system responsive to changes in productivity, in‐ crease of competition in product and service markets that lower prices. – Reforms that improve the efficiency of the taxation process, such as enforcing tax compliance to increase the tax base, shifting taxation from labour to more growth friendly taxes such as environmental tax, and reducing government administration and expenditure where possi‐ ble. – Reforms that reduce uncertainty in the market and thereby increase in‐ vestment such as an overhaul of the judicial system and bankruptcy regulations, as well as reduction of regulatory uncertainty. Taken together, these theoretical arguments for more structural reforms in the euro area to increase growth, both directly and indirectly, are com‐ pelling. Given the weak recovery after the crisis, there is room for re‐ forms. Why structural reforms matter for the euro area In addition, structural reforms are important for the functioning of the euro area. There are two main reasons for this (cp. Rubio 2014): First, there are still large macroeconomic imbalances in the euro area and the economies are set on a trajectory of divergence: Business cycles are not synchronized as different empirical studies have shown (de Haan et al. 2007; Giannone et al. 2009; Ferroni and Klaus 2015). Inflation differentials and the com‐ petitiveness divide have fallen since the crisis but remain significant (auf dem Brinke et al. 2015). Figure 3.3 depicts differences in unit labour costs across selected sec‐ tors in the euro area. It shows that the largest wage growth differentials did not occur in manufacturing or construction, but in the service sectors, in‐ cluding financial and insurance services, sales services and business sector services. The finding that wage growth in the sheltered sectors was much 1.3 1 What are structural reforms and why are they important? 49 larger than in the exposed sector and that the sheltered sector is mainly composed of the service sector is confirmed by other research (Johnston 2012; Hanzl-Weiss and Landesmann 2016). Sectoral divergence in wage growth in the euro area9 Source: OECD Dataset: Productivity and ULC by main economic activity (ISIC Rev. 4, International Standard Industrial Classification of All Economic Activities), au‐ thors’ calculation. These imbalances pose a problem for the common monetary policy of the European Central Bank. It sets only one interest rate for the whole euro area. If business cycles in the euro area are not synchronised, this interest rate will be too high for countries that are currently in an upswing, exacer‐ bating the boom, and too low for a country in recession, deepening the slump (Enderlein 2005). The second reason for why structural reforms are important for the euro area rests on optimal currency area theory. The architects of the Economic and Monetary Union knew that market integration was not only a desired by-product of monetary integration, but a necessary component. The real Figure 3.3: 9 Figure shows differences in unit labour cost growth in the euro area 19 (no data for Malta and Cyprus) for selected economic activities, based on standard deviation in wage growth, 1995=0. III Which Structural Reforms for Europe? (Henrik Enderlein) 50 exchange rate channel is thereby of crucial importance (Enderlein et al. 2012, Dullien et al. 2009): If one euro area country grows faster than the others, expectations adjust and workers will ask for higher wages. Higher wages will translate into higher prices. Inflation rises. This reduces the competitiveness vis-à-vis the trading partners. The real exchange rate ap‐ preciates. Exports fall, while imports increase. In the next wage-setting round, wages will be cut. This will reduce aggregate domestic demand. In‐ flation falls. The economy is back in equilibrium. In other words: the real exchange rate channel corrects imbalances after an asymmetric shock. For the real exchange rate channel to work, markets have to be fully in‐ tegrated. Wages and prices should not be sheltered from competition. In‐ complete markets, sheltered sectors and a high share of non-tradable prod‐ ucts hamper the functioning of the real exchange rate channel. Structural reforms that increase the responsiveness of prices and wages to the market stabilize the euro area.10 They reduce inflation differentials and the com‐ petitiveness divide. In theory, structural reforms can help to improve the functioning of the euro area (auf dem Brinke et al. 2016). Among them are: – Reforms that facilitate the cross-border integration of product markets such as harmonization of regulation, opening up sheltered sectors, deregulating closed professions and reduction of red tape. – Reforms that increase the flexibility of wages and employment such as wage bargaining on plant-level and employment protection legislation reform that allow employers to react to upswings and downturns of the economy, reforms that increase labour mobility such as benefit porta‐ bility and degree recognition. – Reforms that help economies to recover after a recession by increasing investment such as public private partnerships, reduction of regulatory uncertainties and public spending on infrastructure and education. Economic theory provides a strong case for euro-area countries to imple‐ ment structural reforms both to get the growth engine back on track and to improve the functioning of the common currency area: Growth rates are still low and potential growth has not yet recovered. The euro area is an imperfect currency area with an inefficient allocation of existing re‐ 10 For more on how structural reforms could feature in a reform agenda for the euro area see Enderlein et al. (2016). 1 What are structural reforms and why are they important? 51 sources. Falling productivity growth, already before the crisis, and weak investment both public and private are widespread. At the same time, the working age population in Europe is shrinking. The current generation ready to enter the labour market may be the best educated so far (at least in terms of years spent in education) but high youth unemployment rates pay testimony to how badly Europe is failing to integrate them into the labour market. The next section looks at the recommendations on the ta‐ ble. What are the recommendations? How to make sense of laundry lists The four most important actors in the field of structural reforms in the eu‐ ro area – the European Commission, ECB, IMF, and OECD – call for more reforms. There is almost an abundance of reform recommendations. As a result, these laundry lists may seem too complex to produce mean‐ ingful policy results. While the number of structural reform recommenda‐ tions may be high and confusing, this section attempts to identify clear policy priorities. It proceeds in three steps: First, this section starts with a frequency count: How many reform rec‐ ommendations are there for each country? This shows which countries have the largest reform backlog and are in need of reform. Second, it ex‐ amines whether there is consensus when it comes to the key reform rec‐ ommendations.11 This allows us to identify a smaller number of reform priorities for each country and the euro area as a whole. Third, the reforms are grouped into five areas (product market, financial sector, labour mar‐ ket, taxation and public sector) distinguishing again between consensus and non-consensus reform recommendations. Based on this we can identi‐ fy areas where reforms are most needed and compare reform patterns across countries. In short, this section tries to condense the more than 200 2 2.1 11 For each country we compare the recommendations of the latest OECD Economic Surveys (published between 2014 and 2016) with the Country Reports 2016 of the European Commission (published in February 2016 and based on the 2015 CSR cycle). These two series have been selected because they provide a European and international perspective, produce regularly systematic reform recommendations, and have directly comparable key recommendations. III Which Structural Reforms for Europe? (Henrik Enderlein) 52 reform recommendations into two short lists of five reform areas each. The first list summarizes reforms that should have already been imple‐ mented: unfinished business. The second list comprises next-generation reforms that are more forward-looking. Deriving consensus reform lists There are many different publications that demand more reforms. To com‐ pare two consistent sets, this paper focuses on two reoccurring publication series: the OECD Economic Surveys and the country-specific recommen‐ dations of the European Commission.12 Taken together the most recent key recommendations add up to 236 reforms for the euro-area countries. Figure 3.4 shows the breakdown of numbers by countries. Not surprising‐ ly, the most reform recommendations were issued for the euro area (20) as a whole. The countries with the longest lists of key reforms were Greece (16), Slovakia (16), Portugal (15) and Latvia (14). The fewest recommen‐ dations were received by Germany, Estonia and Luxembourg (9 each), as well as Belgium (8).13 The frequency count shows that all countries have scope for structural reforms, and that the countries, which still have not fully recovered after the crisis, have received a longer list. How much do key reform priorities overlap? While in terms of general diagnostics, the difference between the main actors is more in emphasis than in substance, the actual reform recommendations overlap by less than 40 percent. Because the European Commission and the OECD are in regu‐ lar contact about their reform recommendations one could have expected a greater overlap. Yet at the same time, they have tended to set different pri‐ orities in their recommendations. 2.2 12 See appendix for a complete list of all references by country. 13 Malta has very few recommendations (3), partly because it is not covered by the OECD. 2 What are the recommendations? 53 Counting key reform recommendations: in total more than 230 Sources: Based on the latest reform recommendations from the country studies in the latest OECD Economic Surveys and the CSRs in the country reports from February 2016 by the European Commission (please see appendix for details), compiled by au‐ thors. The two countries still under a macroeconomic adjustment program, Cyprus and Greece, have the highest number of consensus reform recom‐ mendations, as figure 3.5 depicts. This is due to the fact that both coun‐ tries have been under a macroeconomic adjustment programme with a de‐ tailed Memorandum of Understanding and have received more recommen‐ dations than in the CSRs. But also for Italy (7) and Lithuania (7) there is a consensus on what has to be done next. For Spain there is more disagree‐ ment with only 2 key reforms that are advocated by both the OECD and the European Commission. Countries with fewer reform recommendations in total have larger overlap, as can be seen in the cases of Germany (6) and Belgium (6). Figure 3.4: III Which Structural Reforms for Europe? (Henrik Enderlein) 54 Consensus on reform priorities for euro-area countries is less than 40% Sources: Based on the latest reform recommendations from the country studies in the latest OECD Economic Surveys and the CSRs in the country reports from February 2016 by the European Commission (please see appendix for details), compiled by au‐ thors. Reform recommendations can be sorted into five areas. Figure 3.6 shows the number of key reform recommendations by areas. Most reform recom‐ mendations concern the labour market (73), followed by public sector re‐ forms (65), which include all reforms that alter how the public sector works including investment, social benefit reforms, public employment re‐ forms and reforms of the judicial service. Fewer recommendations fall in‐ to the areas of taxation (29), the financial sector (25) and the product mar‐ ket (24). There are almost three times as many labour market reform rec‐ ommendations than product market reform recommendations. Figure 3.5: 2 What are the recommendations? 55 There were three times as many country recommendations for labour markets than product markets Source: Based on the latest country reform recommendations from the country studies in the latest OECD Economic Surveys and the CSRs in the country reports from Febru‐ ary 2016 by the European Commission (please see appendix for details), compiled by authors. In a last step, let us look at reform contents.14 One can see that although all countries receive tailored advice, the recommendations themselves are not that different. It is possible to identify two distinct reform lists: unfin‐ ished-business and next-generation reforms. The list of unfinished busi‐ ness should be completed, and if possible, coupled with reforms from the next-generation list. Most countries can follow one of the reform blueprints: seven countries from the euro area should focus on their unfin‐ ished business first, seven other countries should fully embark on the nextgeneration reform measures. For five countries, there could be a mix with elements from both lists. Figures 3.7A and 3.7B provides a short and sim‐ ple overview of all reform recommendations by area and country.15 Figure 3.6: 14 See appendix tables 3.A1 and 3.A2 for the complete list of all reform recommen‐ dations, and table 3.A3 for a summary of the consensus reform recommendations. 15 See appendix tables 3.A1 and 3.A2 for the complete list of all reform recommen‐ dations, and table 3.A3 for a summary of the consensus reform recommendations. III Which Structural Reforms for Europe? (Henrik Enderlein) 56 Consensus reform lists: unfinished business and next gener‐ ation Consensus reform lists: where the countries are Source: Authors. Figure 3.7A: Figure 3.7B: 2 What are the recommendations? 57 The unfinished-business list consists of policies that can be implemented even if there is no or little fiscal space because public deficit and debt are too high. The five recommendations are to increase competition in the product market, to improve the resolution of non-performing loans and bankruptcy procedures, to help bring wage growth in line with productivi‐ ty by installing an effective framework for wage bargaining, and reducing EPL, broadening the tax base and enforcing tax compliance and reduce public debt. These reforms are still relevant for Belgium, Cyprus, Finland, Greece, Ireland, Italy and Luxembourg. While these reforms may make sense from a theoretical perspective, how to implement them remains a puzzle. In addition, we have a list of new reform recommendations. The con‐ crete reform measures are to increase competition in the service market, especially by deregulating closed professional services, improving access to finance (particularly for SMEs), integrating outsiders (including young and old workers, women and immigrants) into the labour market by offer‐ ing more targeted training through vocational schemes and ALMPs, re‐ ducing the labour tax wedge and shifting taxation to a consumption or en‐ vironmental tax, and finally (if there is fiscal space) increasing investment into education, research and infrastructure. Austria, Estonia, Germany, Latvia, Malta, the Netherlands and Slovakia could primarily turn to the next-generation list. According to the analysis, France, Lithuania, Portugal, Slovenia and Spain are clearly in-between the two lists and need reforms from both. France should follow the unfinished business list when it comes to labour market policies and public debt, and follow the next-generation list with regards to the product market and taxation. Lithuania should integrate out‐ siders into the labour market but at the same time also broaden the tax base and fight tax evasion. Portugal needs to alleviate poverty and scaleup the ALMPs. Slovenia has to tackle its non-performing loan problems in the banking sector and facilitate restructuring, while at the same time ad‐ dress the problem of integrating long-term unemployed and low-skilled in‐ dividuals into the labour market. Spain still has to restructure and privatize banks, but should also work on increasing competition in the service sec‐ tor. To sum up, although there is still some unfinished business which needs to be taken care of, countries may concentrate, where possible, on the next generation list because these reforms are forward-looking, and focus on how to regulate the new economy including the digital sector, be innova‐ III Which Structural Reforms for Europe? (Henrik Enderlein) 58 tive and integrate the younger generations into the labour market. Reforms on that list have a demand-side component and help to stimulate growth in the euro area. The focus of these reforms it to push out the production pos‐ sibility frontier and to move from consolidation to stimulation of the econ‐ omy. Still, unfinished-business reforms remain important and their imple‐ mentation a challenge. Where possible, we might think about how to cou‐ ple them with reforms from the next-generation list. This is what the next section is about. How to prioritize structural reforms? Growth effects There is a great degree of uncertainty regarding the short-term and medi‐ um-term effects of structural reforms. Empirical results are not easy to compare as they use different data and methodology. Still, we can identify three important criteria for evaluating the growth effect of structural re‐ forms: The time horizon (short-term, medium-term and long-term effects), the economic conditions (normal, good or bad times), and sequencing and package deals. First, it almost goes without saying that reform effects on growth get larger over time. Most reforms have transitional costs in the beginning. For example, simulations show that in the first five years growth rates will be less than two percent higher but after five years they can be higher than two percent (Andersen et al. 2014). Estimates suggests that after 50 years euro-area GDP will by somewhere between 12 and 17 percent higher, if structural reforms have been implemented, than compared to a baseline scenario (Andersen et al. 2014; Varga and in ‘t Veld 2014). Labour-market reforms, in particular reforms of the unemployment in‐ surance and employment protection legislation, tend to have small (or even negative effects) in the early years of implementation (Andersen et al. 2014). By contrast, a reduction of the labour tax wedge and an increase of ALMPs have already a sizeable effect in the short run because they also have a demand-side component (Duval et al. 2016). When comparing growth effects in the long run of different reforms when implemented si‐ multaneously (Andersen et al. 2014), calculations suggest that the largest growth gains can be made with reforms in the non-tradable sector, such as the service sector, with about 4.2 percent deviation in GDP from the base‐ 3 3.1 3 How to prioritize structural reforms? 59 line, followed by reforms in the tradable sectors (3.0 percent) and tax re‐ forms (1.2 percent). All labour-market reforms have an effect smaller than 1 percent. These effects are, of course, depended on a variety of factors. There is, nonetheless, agreement that labour markets and product markets are the two most important reform areas when it comes to growth effects. Second, reforms have different effects on growth depending on the overall condition of the economy, as the IMF shows (Duval et al. 2016): In times of low growth, some structural reforms can have significant negative results. For instance, a revision of unemployment benefits and employ‐ ment protection legislation can further decrease demand and prolong the recession. It will also affect low-income households disproportionality and may raise inequality (Causa et al. 2015). By contrast, structural reforms that have a Keynesian component, such as investing in vocational training and ALMP or reducing the tax wedge can increase wages and thereby help to sustain or increase demand. It has been shown, for instance, that boost‐ ing ALMP in particular can increase both equality and efficiency (Cournède et al. 2016). This means that some structural reforms are better left for good economic times. Product-market reforms work well in good and bad economic climate. Structural reforms have also a budgetary effect: Policies that have a Keynesian component may cost money in the short run, even if the effect on the public budget is neutral or even positive in the long run. Policies such as cutting unemployment benefits or reforming pensions may reduce budgetary pressures (Bouis et al. 2012) but also reinforce the slump. There is a thin line between choosing reforms that do not deepen the recession but also do not strain the public budget. Some reforms can have a neutral effect on the budget and work in good and bad times (combining the find‐ ings from IMF 2016 and OECD 2012): tax reforms such as reducing the labour tax wedge and shifting from direct to indirect taxation and productmarket reforms. Third, sequencing and package deals are important. Simulations suggest that the growth effect of product-market reforms and labour-market re‐ forms is larger over time if they are implemented simultaneously because many reforms are complementary (Andersen et al. 2014; ECB 2015a). Front-loading may also be politically easier as package deals can be com‐ promises between different political parties and stakeholders. Research suggests further that product-market reforms should be implemented prior to labour-market reforms because product-market reforms increase em‐ ployment and help to absorb potential losers of labour-market reforms III Which Structural Reforms for Europe? (Henrik Enderlein) 60 (Blanchard and Giavazzi 2003). The estimations also show that the effects on growth will be larger for the euro-area periphery countries than for the core (Andersen et al. 2014). The empirical evidence in a nutshell: All structural reforms have a posi‐ tive effect on growth in the medium or long run. This effect gets larger over time. Some reforms have a negative effect in the short run and in par‐ ticular during a recession. Reforms should be front-loaded but still se‐ quenced: Product-market reforms should always be implemented prior to labour-market reforms, and labour-market reforms with an embedded stimulus should be prioritized. There is no consensus on whether productmarket reforms or labour-market reforms will have larger growth effects in the long run, but there is general agreement that these two areas are the most important ones for structural reforms in the euro area. Countries in the euro-area periphery will reap larger growth benefits from reforms than countries in the geographic core. Contribution to euro area stability In addition to contributing to growth, structural reforms may also help to increase the adjustment capacity of the euro area, as also the ECB has ar‐ gued (Praet 2015). In this view, euro-area countries should focus on prod‐ uct market reforms because they improve the real exchange rate channel and thereby promote cyclical convergence (auf dem Brinke et al. 2016). Here, the most promising reforms are opening up sheltered sectors for competition by facilitating market entry, opening up professional services and integrating the service sector, as well as harmonizing regulations espe‐ cially in the digital sector (Enderlein et al. 2017) and reducing regulatory uncertainty. Thus, completing the European Single Market should be on top of the euro-area reform agenda. This also shows that the reform recommendations judged by the num‐ bers do not set the right emphasis. Instead of treating labour-market and product-market reforms as equals, there should be a clear focus on prod‐ uct-market reforms. Labour-market reforms, financial sector reforms, tax‐ ation reforms and public-sector reforms are also important but from an economic perspective – both theoretically and empirically – product-mar‐ ket reforms are more important. Recent analyses agree that product market reforms should have priority. This assessment is also shared by the ECB and the IMF. The ECB con‐ 3.2 3 How to prioritize structural reforms? 61 cluded: “More product-market reforms should be considered the highest priority at the current juncture.” (ECB 2016a) And the IMF summed up its findings with the key point: “Product-market reforms should be imple‐ mented forcefully (…).”(Duval and Furceri 2016) The fact that there are by far more labour-market reform recommendation than product-market ones blurs these clear policy messages. Political feasibility There are very few good economic reasons for delaying structural reforms, as Mario Draghi, the president of the ECB put it in June 2016 (Draghi 2016), but many understandable political ones. The political feasibility of structural reforms is indeed disputed. Jean-Claude Juncker, then the Prime Minister of Luxembourg and the President of the Eurogroup, famously said “We all know what to do, but we don’t know how to get re-elected once we have done it.” (The Economist 2007) The political economy of reforms is at the heart of the problem: there are national and euro-area lev‐ el considerations as well as the question of whether there is fiscal space for reforms. First, structural reforms can be politically painful and governments, which implement structural reforms, are less likely to win re-election. It follows that structural reforms should be implemented early into the elec‐ toral cycle so that the benefits of reforms already occur during the legisla‐ tion. In addition, governments should aim for low-hanging fruits, i.e. re‐ forms that offer “quick-wins” in the short run (Enderlein and Pisani-Ferry, 2014). These reforms may also help to increase the acceptance of more de‐ manding reform packages later. The empirical evidence, however, also shows that reformist govern‐ ments are not always punished. The electorate may also reward politicians for necessary reforms and for overcoming a reform backlog (Buti et al. 2008). Announcing structural reforms now and implementing them later may work, if the commitment is seen as credible. If financial markets work well and the changes are priced immediately into the market, transi‐ tional costs will be smaller and short-lived. The recent period has shown again that countries are more likely to re‐ form in times of crisis. However, a crisis may become so severe that some structural reforms are not the optimal policy response given their possible short-term costs and only medium to long-term gains. The reform back‐ 3.3 III Which Structural Reforms for Europe? (Henrik Enderlein) 62 lash in Greece and Spain is a case in point and shows that during a severe economic crisis, further reform measures must be implemented with great care. One difficulty in the current situation despite low interest rates and low oil prices is that global demand remains weak and cannot readily off‐ set a fall in domestic demand. The social consequences of reforms have often been an afterthought in the debate. However, they should feature in the equation from the begin‐ ning. Fighting poverty and inequality in the short-run may take precedence over other reform agendas. Labour-market reforms that impose high costs on the losers (if only in the short run) should be avoided during recession. Reforms that lead to wage cuts in the short run, will further reduce de‐ mand, may lead to poverty, and could worsen the slump (Eggertson et al. 2014). Trust in institutions can be an important predictor for reform success. Even reforms that have negative effects in the short run can erode social trust and hinder future reforms. This may lead to a vicious cycle: As citi‐ zens lose trust in Europe in the face of rising unemployment rates in some member states, reforms become impossible to implement and the deadlock remains. It follows from this that only structural reforms with a positive short to medium-term effect should be implemented when trust is low to prepare the grounds for more far-reaching reforms. Second, and in addition to national political considerations, euro-area countries must follow the rules of the Stability and Growth Pact (SGP): the deficit-to-GDP ratio may not exceed 3 percent and the debt-to-GDP ra‐ tio may not be larger than 60 percent. The SGP does provide for flexibility to allow countries to reform even if that entails deviating from the medi‐ um-term objectives.16 These reforms must be major, have a direct effect on the public budget over the long run, be announced ex-ante and then have to be fully implemented (European Commission 2015a). Does the SGP constrain or incentivize reform? The empirical evidence is mixed. A comparison of the implementation record17 for the CSRs of 2014 and 2015 shows that the euro-area member states are not systemati‐ 16 For the legal framework, see Article 5 of Council Regulation No 1466/97 for members states under the preventive arm of the SGP, and Article 2 of Council Regulation No.1467/97 for countries under the corrective arm of the SGP. 17 Comparing implementation records is methodologically not easy. Consider for in‐ stance that endogenous change in the form institutions adapting to a new economic environment without passing legislation, may lead to similar results than newly 3 How to prioritize structural reforms? 63 cally worse in implementing structural reforms (Hradisky 2016). Earlier work, however, finds that non-euro-area countries have been more active when it comes to single-market rules implementation (Monti 2010). Con‐ trary, other empirical evidence suggest that the euro area has facilitated product-market reforms but not labour-market reforms in the 2000s (Alesina et al. 2008).The ECB concluded that labour-market reforms have been implemented while product-market reforms lag behind (ECB 2016a). Thus, there seems to be no consistent pattern of whether euro-area mem‐ bership has contributed or hindered the feasibility of reforms. What is clear is that if rules worked, the structural reform implementa‐ tion record would look different. How to incentivize reforms remains a key question. Positive conditionality seems like a promising avenue. In‐ vestment may also be coupled to the successful implementation of struc‐ tural reforms (see for instance Enderlein et al. 2014). Third, there is the question of whether reforms are feasible given the availability of fiscal space. Countries on a sustainable public debt path with no excessive deficit should in principle be able to finance reforms. The most commonly measures are the debt-to-GDP ratio and the cost of servicing the debt. But judging the availability of fiscal space is not easy. The European Commission so far has been more cautious than the OECD when it comes to the availability of fiscal space. In November 2016, how‐ ever, it announced that the euro area would benefit from a positive fiscal stance (European Commission 2016a). The relation between fiscal space and structural reforms could become a chicken and egg problem: To create fiscal space, one needs to reduce the debt, increase the growth rate and maintain low interest rates. Reducing the debt level entails consolidating fiscal policies, while increasing the growth rates in weak economic climate, which requires investments. Get‐ ting the sequencing right will therefore be important: Without fiscal space, reforms should be budget neutral or save money in the medium term. As soon as there is some fiscal space, reforms should have a demand-side component and aim at increasing future growth rates. The current monetary situation has had a positive and negative effect on fiscal space. On the one hand, the low (and sometimes negative) inflation rates have not helped to reduce the debt burden. On the other hand, quanti‐ implemented reforms. More reforms are not necessarily a sign of a well-function‐ ing economy. III Which Structural Reforms for Europe? (Henrik Enderlein) 64 tative easing by the ECB has led to lower interest rates which have re‐ duced the cost of borrowing, and thereby opened the field for more invest‐ ment. The verdict is still out on whether quantitative easing will incen‐ tivize or disincentives more structural reforms. The ECB has repeatedly argued that it is already doing all it can to fa‐ cilitate reforms. In this view, the euro area economies are missing a crucial window of opportunity to implement reforms. Yet at the same time, its monetary stance may also contribute to sustain the current situation and may have prompted member states to postpone difficult reforms. To sum up the evidence: In terms of political feasibility, reforms should be implemented early in the electoral cycle and there should be package deals. When bundling reforms, policy-maker should pay attention to com‐ bining quick-win reforms with reforms that may have transitional costs or take longer to show economic benefits. While it may be easier to imple‐ ment reforms during an economic boom, there may be more public sup‐ port for a reform agenda during an economic downturn. However, during a severe recession, governments should avoid reforms that have large transitional costs and reduce disposable income. Judging whether there is fiscal space for reforms is difficult as it depends not only on the nominal amount of debt, but also growth rate forecasts and interest rate developments. In general, debt levels in the euro area remain high, even in the presence of quantitative easing. Reforms that are budget neu‐ tral should be prioritized. Conclusion: The euro area reform priorities on a single page This paper has tried to bring some clarity into the often confusing discus‐ sion about structural reforms. To conclude, we make the attempt to sum‐ marise the reform priorities in a single graph. Such a representation might be controversial, but could contribute to making the discussions more straightforward and transparent. We proceed in two steps: First, we recall the five important insights on how to identify the right structural reforms: (A) Reforms with significant transitional costs should be avoided during bad economic times. (B) Most reforms are complemen‐ tary and joined implementation yields larger effects. (C) Product-market reforms should be implemented prior to labour-market reforms. (D) If there is fiscal space or in other words, not an unsustainable public debt 4 4 Conclusion: The euro area reform priorities on a single page 65 and deficit, reforms should include a demand-side component. (E) Front‐ loading and package deals can be politically easier. Second, on the basis of these rules we identify three content-based reform priorities: – 1. Product-market reforms should be the top priority now. They have the highest short-term gains, can be implemented in good and bad eco‐ nomic times, have the largest effects on potential growth and can con‐ tribute significantly to the functioning of the euro area. For the euro area single-market reforms are the most rewarding ones. Here, servicesector reforms are of key importance because the service sector re‐ mains fragmented despite the enormous growth potential: it employs more than 70 percent of the total labour force (OECD 2016b) and pro‐ duces 74 percent of value added in the euro area (ECB 2016b). The Service Directive of 2006 was projected to increase GDP in the whole European Union by more than 1 percent of which only a fraction has been realized so far (see for instance Monteagudo et al. 2012; Fernández Corugedo and Pérez Ruiz 2014). Deregulating closed pro‐ fessions and opening up sheltered sectors, as well as supporting the Digital Single Market by reconsidering the country of origin rule and harmonizing regulation of the 28 countries might be good steps in the right directions. – 2. Boosting investment to increase the growth potential while provid‐ ing also an accommodating demand context is a second priority. In‐ vestments can but do not necessarily have to be public investments. Countries with fiscal space should directly invest in education, re‐ search and infrastructure. Investments here count as reform in the sense that they change the structure of the economy. There are, how‐ ever, also ways and means to foster investment when public finances are tight: These are measures to reduce regulatory uncertainty and thereby foster long-term investments such as tackling the resolution of non-performing loans and revising bankruptcy procedures. Reducing regulatory uncertainty builds trust in the markets. Completing the sin‐ gle market will also have direct positive effects for private investment as it will increase returns to investments in countries with small and weak demand, if access to the entire single market is guaranteed. – 3. Labour-market reforms need to continue but with some change in focus because they tend to have transitional costs in the short term, III Which Structural Reforms for Europe? (Henrik Enderlein) 66 benefits take longer to materialize, some of the reforms do not work well in times of weak economic growth and there are potentially powerful veto players to counter reform efforts. Reforms to harmonize employment protection legislation and integrate outsiders in the labour market should be implemented. If possible, reforms should have a de‐ mand-side component to stabilize the economy, such as investment in education, vocational training, ALMPs and life-long learning. Productmarket reforms can also go a long way in increasing employment and restoring competitiveness. Table 3.1 shows how the reform priorities for each euro-area country could be summed up on a single page. As a final take-home message we advocate that not the most frequently mentioned reforms should be imple‐ mented, but the ones that fulfil the objectives of increasing growth and im‐ proving the functioning of the euro area also in difficult economic times. The top three reform priorities for euro-area countries investments. Countries with fiscal space should directly invest in education, research and investment. Investments here count as reform in the sense that they change the structure of the economy. There are, however, lso w ys and means to fos er inv stment when public finances are tight: These are measures to reduce regulatory uncertainty and thereby foster long-term investments such as tackling the resolution of non-performing loans and revising bankruptcy procedures. Reducing regulatory uncertainty builds trust in the markets. Completing the single market will also have direct positive effects for private investment as it will increase returns to investments in countries with small and weak demand, if access to the entire single market is guaranteed. - Labour market reforms need to continue but with some change in focus because they tend to have transitional costs in the short term, benefits take longer to materialize, some of the reforms do not work well in times of weak economic growth and there are potentially powerful veto players to counter reform efforts. Reforms to harmonize employment protection legislation and integrate outsiders in the labour market should be implemented. If possible, reforms should have a demand-side component to stabilize the economy, such as investment in education, vocational training, ALMPs and life-long learning. Product market reforms can also go a long way in increasing employment and restoring competitiveness. Table 1 shows how the reform priorities for each euro-area country could be summed up on a single page. As a final take-home message we advocate that not the most frequently mentioned reforms should be implemented, but the ones that fulfil the objectives of increasing growth and improving the functioning of the euro area also in difficult economic times. Table 1: The top three reform prio ities for eu o-a ea countries #1 Complete the Single Market #2 Boost investment #3 Increase employment Belgium Cyprus Finland Greece Ireland Italy Luxembourg Increase competition in product market • Open up sheltered sectors • Remove barriers to entry • Move to service sector reforms Reduce regulatory uncertainty • Improve resolution of non-performing loans • Improve bankruptcy procedures Bring wage growth in line with productivity growth • Take national situation into account • Harmonize EPL • But stabilize demand France Lithuania Portugal Slovenia Spain Increase competition in service sector • Open up sheltered sectors • Deregulate closed professions • Integrate the Digital Single Market Reduce regulatory uncertainty • Improve resolution of non-performing loans • Improve bankruptcy procedures Reduce dualism by integrating outsiders into the labour market • Harmonize EPL • Increase spending on vocational training, ALMPs, child care, lifelong learning Austria Estonia Germany Latvia Malta Netherlands Slovakia Increase competition in service sector • Open up sheltered sectors • Deregulate closed professions • Integrate the Digital Single Market Increase public and private investment • Increase public investment in education, research and infrastructure • Encourage public-private partnerships • Improve access to finance also for SMEs Reduce dualism by integrating outsiders into the labour market • Enable young, woman, unemployed, underemployed and migrants to increase labour supply • Increase spending on vocational training, ALMPs, child care, lifelong learning le 3.1: 4 Conclusion: The euro area reform priorities on a single page 67 Appendix Overview of country reform recommendations Table shows reform consensus of the key recommendations by the OECD and the European Commission (COM). Country Reform priority OECD COM Consensus Ger‐ many Increase investments in education and research Yes18 Yes19 Yes Increase investments in infrastructure Yes Yes Yes Implement incentives for later retirement Yes Yes Yes Increase competition in the service sector Yes Yes Yes Integrate refugees and migrants (training and labour market easing) Yes No No Deregulate professional services Yes Yes Yes Address regulatory biases or privatize in areas such as Landes‐ banken, car manufacturing, network industries Yes No No Integrate women better into the labour market also by lowering secondary earner penalties Yes Yes Yes Comprehensive application of environmental/ energy taxes Yes No No France Limit spending in government and administration, especially local government Yes20 Yes21 Yes Ensure wage development in line with productivity gains No Yes No Reduce labour tax wedge Yes No No Coordinate minimum wage development in accordance with employment objectives No Yes No Increase competition in the service sector esp. professional ser‐ vices Yes Yes Yes Implement more investment-friendly business regulation Yes Yes Yes Simplify and improve tax system, shift to consumption based taxation Yes Yes Yes Introduce more efficient environmental tax Yes No No Lower taxes on corporate income No Yes No Reduce EPL of open-ended contracts, allow for more flexible work hours Yes Yes Yes Tie unemployment benefits to activation and adjust benefit du‐ ration Yes No No Improve vocational training system Yes No No Table 3.A1: 18 OECD (2016c). 19 European Commission (2016b). 20 OECD (2015b). 21 European Commission (2016c). III Which Structural Reforms for Europe? (Henrik Enderlein) 68 Country Reform priority OECD COM Consensus Italy Limit spending in government and administration Yes22 Yes23 Yes Improve tax compliance, simplify tax system Yes Yes Yes Improve infrastructure No Yes No Reform public administration and civil justice system No Yes No Reform corporate governance rules of banks No Yes No Address non-performing loans problem / improve insolvency procedures Yes Yes Yes ALMP Yes Yes Yes Simplify labour contracts Yes Yes Yes Increase female participation in the labour market (better care infrastructure) Yes No No Tie unemployment benefits to activation Yes No No Effective framework for collective bargaining No Yes Yes Allow for plant level wage bargaining Yes No No Enhance competition in public and private sector (local public services, banking, network, regulated professions, retail) Yes Yes Yes Spain Restructure and privatize savings banks Yes24 Yes25 Yes Improve cost-effectiveness in healthcare sector No Yes No Ensure wage development in line with productivity gains No Yes No Increase competition in the service sector, professional ser‐ vices Yes Yes Yes Remove business regulation barriers for large firms No Yes No Shift from labour to consumption, environment and real estate taxes Yes No No Broaden corporate tax base, eliminate special regimes for SMEs Yes No No Improve insolvency procedures Yes No No Improve ALMP, employment agency Yes No No Improve vocational training system Yes No No Strengthen innovation and research, e.g. in universities Yes No No 22 OECD (2015c). 23 European Commission (2016d). 24 OECD (2014a). 25 European Commission (2016e). Appendix 69 Country Reform priority OECD COM Consensus Belgium Limit spending in government and administration Yes26 Yes27 Yes Ensure wage development in line with productivity gains Yes Yes Yes Broaden tax base and lower tax rates Yes Yes Yes Shift from labour tax to consumption, environment and real es‐ tate taxes Yes Yes Yes Raise retirement age Yes Yes Yes Improve education and labour market integration for disadvan‐ taged groups including migrants Yes Yes Yes Reduce financial disincentives to work No Yes No Promote more efficient and equitable housing, make better use of housing in urban areas, improve social housing Yes No No Austria Curb expectations of government guarantees in the banking sector, implement resolution directive Yes28 No29 No Address vulnerabilities of financial sector in foreign exposure and insufficient asset quality No Yes No Make regional governments more cost-efficient Yes No No Shift from labour tax to consumption, environment and real es‐ tate taxes Yes Yes Yes Increase effective retirement age Yes No No Increase labour market participation of elderly No Yes No Foster more competition in services, lower entry barriers Yes Yes Yes Improve education and labour market integration for disadvan‐ taged groups including migrants Yes No No Increase female participation in the labour market by improv‐ ing child care and abolishing tax disincentives Yes Yes Yes More family friendly work places in the public sector Yes No No Ireland Broaden tax base by shifting taxes to immovable assets, reduc‐ ing allowances for capital income, and aligning corporate tax system Yes30 Yes31 Yes Improve cost-effectiveness of healthcare system Yes Yes Yes Accelerate resolution of non-performing loans via court system Yes Yes Yes Improve responsiveness of housing supply, avoid home buyer subsidies Yes No No 26 OECD (2015d). 27 European Commission (2016d). 28 OECD (2015e). 29 European Commission (2016e). 30 OECD (2015f). 31 European Commission (2016f). III Which Structural Reforms for Europe? (Henrik Enderlein) 70 Country Reform priority OECD COM Consensus Strengthen monitoring by the Central Bank of Ireland, make central credit registry operational No Yes No Set up more agile, relevant and gender-inclusive vocational training scheme Yes No No Provide support to disadvantaged schools Yes No No Improve ALMP by reforming employment services, better training for long-term unemployed Yes No No Increase incentives to work including withdrawal of benefits, enforce obligations for unemployed Yes Yes Yes Improve access to quality child care, esp. for low-income groups Yes Yes Yes Nether‐ lands Strengthen tax base, reduce mortgage interest relief and phaseout lower VAT rate Yes32 Yes33 Yes Revise tax incentive and ensure social security coverage for self-employed Yes No No Reduce contributions to pension scheme in the early years of working life No Yes No Ease regulation on private supply of rental housing Yes Yes Yes Improve access to social housing Yes No Foster investment in renewable energy Yes No No Increase public support for R&D Yes Yes Yes Enhance credit access for SMEs, foster competition of credit provision, consider credit register for companies Yes No No Improve education and labour market integration for disadvan‐ taged groups Yes No No Raise quality of early childhood education Yes No No Foster general skills in vocational training Yes No No Enhance entrepreneurial skills of small companies Yes No No Ease EPL to facilitate prevalence of permanent contracts Yes No No 32 OECD (2016d). 33 European Commission (2016g). Appendix 71 Country Reform priority OECD COM Consensus Portugal Improve public service efficiency, reduce number of civil ser‐ vants Yes34 No35 No Increase transparency of PPPs at local and regional level No Yes No Improve resilience of financial sector, esp. timely and consist‐ ent recognition of losses, develop stress test framework, and provisional capital requirements Yes No No Address corporate debt overhang and efficiency of debt re‐ structuring No Yes No Enhance competition in the non-tradable sector, e.g electricity Yes No No Promote wage-bargaining at firm level Yes No No Align wages and productivity taking into account wide dispari‐ ty of productivity No Yes No Strengthen R&D by improving links between researchers and private sector, tax credits for R&D Yes No No Better targeting of social safety net, raise benefit levels of min‐ imum income support Yes Yes Yes Make unemployment benefits independent of age and widen coverage Yes Yes Yes Scale-up ALMP Yes Yes Yes Scale-up adult education and training Yes No No Improve medium-term sustainability of pension scheme No Yes No Safeguard financial sustainability of state-owned enterprises No Yes No Improve tax compliance and efficiency of tax administration No Yes No Finland Curb public expenditure growth Yes36 Yes37 Yes Open retail sector, transport and construction for effective competition Yes Yes Yes Improve work incentives, reduce and shorten duration of un‐ employment benefits, enforce mandatory job search Yes No No Limit use of early exit pathways to retirement Yes Yes Yes Shift from (low-income) labour taxes to consumption, environ‐ ment and real estate taxes Yes No No Improve R&D cooperation between businesses and universi‐ ties Yes No No Encourage female labour market participation by reducing du‐ ration of parental leave and home-care allowance Yes No No Strengthen mediating role of the state in wage-setting process on local level Yes No No 34 OECD (2014b). 35 European Commission (2016h). 36 OECD (2016e). 37 European Commission (2016i). III Which Structural Reforms for Europe? (Henrik Enderlein) 72 Country Reform priority OECD COM Consensus Strengthen vocational training and development of job relevant skills of young people, old workers and long-term unemployed Yes Yes Yes Increase productivity and cost-effectiveness in the provision of public services, including municipal structure, healthcare and social services No Yes No Greece Enhance administrative capacity Yes38 Yes39 Yes Strengthen public financial management and public procure‐ ment No Yes No Broaden tax base and strengthen tax administration through more autonomy and more resources Yes Yes Yes Strengthen tax compliance and fight tax evasion No Yes No Improve bankruptcy framework, improve resolution of nonperforming loans Yes Yes Yes Strengthen governance and independence of state intervention of banks No Yes No Create fiscal space for more comprehensive social safety net and ALMP Yes No No Fight poverty by guaranteeing minimum income, school meal program, and housing assistance Yes Yes Yes Fight undeclared work No Yes No Modernize public employment service Yes Yes Yes Strengthen vocational training No Yes No Conclude pension reform, also review special regimes and in‐ troduce basic pension Yes Yes Yes Ease regulation in network industries Yes Yes Yes Reduce rigidities in product markets No Yes No Reduce backload of cases in the judiciary system Yes No No Improve cost-effectiveness of healthcare system No Yes No 38 OECD (2016f). 39 Key deliverables from the 2015 Memorandum of Understanding (MoU). Please note that Greece has not received CSRs because it is under a stability support pro‐ gramme. The MoU recommendations are more detailed. Here they have been con‐ solidated to allow for a comparison to the other reform recommendations. Appendix 73 Country Reform priority OECD COM Consensus Cyprus Stabilize, restructure and recapitalize the banking sector NA40 Yes41 Yes42 Step up supervision of financial services and strengthen antimoney laundering framework NA Yes Yes Broaden tax base for indirect and direct taxes NA Yes Yes Cut wages of public sector employees NA Yes Yes Improve targeting of social transfers by tightening means-test‐ ed criteria NA Yes Yes Raise retirement age and limit use of early retirement NA Yes Yes Raise efficiency of healthcare system NA Yes Yes Improve cost-effectiveness of public administration NA Yes Yes Privatize SOEs NA Yes Yes Lift entry barriers and operation restrictions in service sector NA Yes Yes Improve functioning of housing market, also reduce backlog of title deeds NA Yes Yes Diversify energy mix NA Yes Yes Estonia Improve labour market participation by implementing Work Ability reform No Yes43 No Raise incentives to work through measures targeting low-in‐ come earners and narrow gender pay gap Yes44 Yes Yes Improve vocational training scheme Yes Yes Yes Improve framework for R&D Yes Yes Yes Expand access to European transport and energy networks Yes No No Strengthen insolvency procedures Yes No No Raise revenues from property taxes Yes No No Reduce costs borne by workers of compulsory private pension scheme, reduce exceptions in public pension scheme Yes No No Prioritize spending on ALMP, infrastructure and education Yes No No 40 The OECD does not cover Cyprus in its Economic Surveys Series or any compa‐ rable recommendation format. 41 European Commission (2013). 42 Cyprus is only covered in detail by the MoU but because it is a country under pro‐ gramme, all reforms are here ranked as consensus reforms. 43 European Commission (2016j). 44 OECD (2015g). III Which Structural Reforms for Europe? (Henrik Enderlein) 74 Country Reform priority OECD COM Consensus Latvia Improve vocational training Yes45 Yes46 Yes Increase offers for work-based learning Yes Yes Yes Concentrate public support for research and innovation on li‐ mited number of specialization areas No Yes No Reduce high tax wedge for low-income earners and shift taxes to sources less detrimental for growth Yes Yes Yes Increase employability of unemployed No Yes No Ensure targeting of social assistance benefits Yes Yes Yes Improve cost-effectiveness and accessibility of healthcare sys‐ tem No Yes No Improve efficiency of the judicial system No Yes No Improve public service legislation to strengthen conflict of interest legislation No Yes No Reduce entry-barriers, red tape and simplify licensing in prod‐ uct markets Yes No No Improve governance of SOEs Yes No No Improve connection of energy network with EU Yes No No Improve tax compliance and tackle tax fraud Yes No No Improve resilience of financial sector and strengthen moni‐ toring Yes No No Lithua‐ nia Broaden the tax base Yes47 Yes48 Yes Improve tax compliance and fight tax evasion Yes Yes Yes Improve labour market relevance of education Yes Yes Yes Improve performance of healthcare system Yes Yes Yes Reduce high tax wedge for low-income earners and shift taxes to sources less detrimental for growth including environment and property tax Yes Yes Yes Improve pension adequacy No Yes No Improve coverage and adequacy of unemployment insurance Yes Yes Yes Strengthen ALMP to increase employability of unemployed, and improve capacity of employment agency Yes Yes Yes Promote life-long learning Yes No No Increase the role of workplace training Yes No No 45 OECD (2015h). 46 European Commission (2016k). 47 OECD (2016g). 48 European Commission (2016l). Appendix 75 Country Reform priority OECD COM Consensus Make teaching profession more attractive through higher wages and investment in teacher development Yes No No Promote participation in pre-primary education Yes No No Strengthen innovation of domestic firms Yes No No Luxem‐ bourg Broaden tax base to consumption, property tax and environ‐ ment tax No Yes49 No Limit early retirement and increase retirement age No Yes No Reform wage-setting system to ensure wages evolve with pro‐ ductivity No Yes No Strengthen financial service monitoring Yes50 No No Strengthen resolution procedures, undertake resolvability as‐ sessments of banks Yes No No Improve effectiveness of R&D spending Yes No No Improve quality of school education Yes No No Promote environmentally friendly policies including public transport and petrol taxes Yes No No Introduce spending review mechanism and consider introduc‐ ing a spending ceiling Yes No No Malta Improve education system, also reduce early school leaving, promote attainment of basic skills No 51 Yes52 No Increase statutory retirement age No Yes No Improve credit access for businesses including small and mi‐ cro-enterprises No Yes No Slovakia Improve cost-effectiveness of the healthcare sector No Yes53 No Improve tax compliance Yes54 Yes Yes Improve ALMP, education and training to tackle long-term un‐ employment Yes Yes Yes Develop vocational training system Yes No No Strengthen female employment through care provision Yes Yes Yes Improve education system by making teaching as profession more attractive and provide better training No Yes No Increase participation of Roma children in education and child care Yes Yes Yes 49 European Commission (2016m). 50 OECD (2015i). 51 The OECD does not cover Malta in its Economic Survey Series or any comparable recommendation format. 52 European Commission (2016n). 53 European Commission (2016o). 54 OECD (2014c). III Which Structural Reforms for Europe? (Henrik Enderlein) 76 Country Reform priority OECD COM Consensus Invest in infrastructure, improve administrative procedures for permits, and transport network including rail and road Yes Yes Yes Improve public procurement, also increase competition in pub‐ lic tenders Yes Yes Yes Implement spending ceilings to reinforce budgetary discipline Yes No No Strengthen public administration capacity including co-ordina‐ tion, human resource management, management of EU funds, capacity of local governments Yes No No Reduce regulation in professional services & retail trade Yes No No Improve efficiency of judicial system Yes No No Create incentives for innovation spending Yes No No Develop rental housing market and limit support to house own‐ ers Yes No No Make sure minimum wage implementation does not damage employment Yes No No Slovenia Improve wage-setting system also for minimum wage No Yes55 No Address long-term unemployment by increasing employability of low-skilled Yes56 Yes Yes Limit incentives for early retirement and increase retirement age Yes Yes Yes Tackle non-performing loan problems in the banking sector and facilitate swift restructuring and resolution of companies Yes Yes Yes Improve risk monitoring in banks No Yes No Improve access to credit for SMEs No Yes No Improve efficiency in judicial system No Yes No Increase cost-efficiency in education, public administration and local government Yes No No Privatize SOEs Yes No No Adopt credible fiscal rules (supervised by financial council) Yes No No Increase efficiency in the health sector Yes No No Ease licensing for opening new businesses Yes No No Support innovation, promote collaboration between major stakeholders in innovation policy Yes No No 55 European Commission (2016p). 56 OECD (2015j). Appendix 77 Overview of euro-area reform recommendations Table shows reform consensus of the key recommendations by the OECD and European Commission’s (EC) country-specific recommendations (CSRs). Reform priority OECD COM Consensus Reform employment protection legislation No Yes57 Increase active labour market policies No Yes Promote lifelong learning strategies and increase adult skill level No Yes Offer adequate income support during labour market transi‐ tion No Yes Strengthen single market for services and deregulate profes‐ sional services No Yes Reducing high tax wedge and shift to consumption or envi‐ ronment taxes No Yes Create investment-friendly business regulation No Yes Reduce public administration inefficiencies No Yes Improve access to finance for SMEs, esp. via capital markets No Yes Improve job market relevance of education and training, and cooperation with stakeholders No Yes Speed up and facilitate resolution of NPLs where they create serious economic disturbances, also by raising capital sur‐ charges Yes58 No Establish asset management companies at EU level Yes No Reduce risk in the banking sector Yes No Implement a European Deposit Insurance Scheme Yes No Harmonize banking resolution in Europe Yes No Finance higher-risk projects through EFSI Yes No Increase targeted public support to investment Yes No Enhance framework conditions for private investment Yes No Adopt national expenditure rules Yes No Ensure that the application of the debt reduction rule of the Stability and Growth Pact does neither hinder recovery nor structural reforms Yes No Table 3.A2: 57 European Commission (2015b). 58 OECD (2016h). III Which Structural Reforms for Europe? (Henrik Enderlein) 78 Re fo rm p ri or iti es b y co un tr ie s O ve rv ie w o f a ll co ns en su s r ef or m s b as ed o n ta bl e 3. A1 . Pr od uc t m ar ke t Fi na nc ia l s ec to r La bo ur m ar ke t Ta xa tio n Pu bl ic se ct or A us tr ia Fo ste r m or e co m pe tit io n in se rv ic es , l ow er e nt ry b ar ri‐ er s N on e In cr ea se fe m al e pa rti ci pa ‐ tio n in th e la bo ur m ar ke t b y im pr ov in g ch ild c ar e an d ab ol ish in g ta x di sin ce nt iv es Sh ift fr om la bo ur ta x to co ns um pt io n, e nv iro nm en t an d re al e sta te ta xe s N on e Be lg iu m N on e N on e En su re w ag e de ve lo pm en t in li ne w ith p ro du ct iv ity Ra ise re tir em en t a ge Im pr ov e ed uc at io n an d la bo ur m ar ke t i nt eg ra tio n fo r d isa dv an ta ge d gr ou ps in cl ud in g m ig ra nt s Br oa de n ta x ba se a nd lo w er ta x ra te s Sh ift fr om la bo ur ta x to co ns um pt io n, e nv iro nm en t an d re al e sta te ta x Li m it sp en di ng in g ov er n‐ m en t a nd a dm in ist ra tio n C yp ru s Pr iv at iz e SO Es Li ft en try b ar rie rs a nd o pe r‐ at io n re str ic tio ns in se rv ic e se ct or St ab ili ze , r es tru ct ur e an d re ca pi ta liz e th e ba nk in g se ct or St ep u p su pe rv isi on o f f i‐ na nc ia l s er vi ce s a nd str en gt he n an tim on ey la un de rin g fra m ew or k Ra ise re tir em en t a ge a nd lim it us e of e ar ly re tir em en t Br oa de n ta x ba se fo r i nd i‐ re ct a nd d ire ct ta xe s Cu t w ag es o f p ub lic se ct or em pl oy ee s Im pr ov e ta rg et in g of so ci al tra ns fe rs b y tig ht en in g m ea ns -te ste d cr ite ria Ra ise e ffi ci en cy o f h ea lth ‐ ca re sy ste m Im pr ov e co stef fe ct iv en es s of p ub lic a dm in ist ra tio n Im pr ov e fu nc tio ni ng o f ho us in g m ar ke t, al so re du ce ba ck lo g of ti tle d ee ds D iv er sif y en er gy m ix Ta bl e 3. A3 : Appendix 79 Pr od uc t m ar ke t Fi na nc ia l s ec to r La bo ur m ar ke t Ta xa tio n Pu bl ic se ct or Es to ni a N on e Ra ise in ce nt iv es to w or k th ro ug h m ea su re s t ar ge tin g lo w -in co m e ea rn er s a nd na rro w g en de r p ay g ap Im pr ov e vo ca tio na l t ra in in g sc he m e N on e N on e Im pr ov e fra m ew or k fo r R& D Fi nl an d O pe n re ta il se ct or , t ra ns po rt an d co ns tru ct io n fo r e ffe ct ‐ iv e co m pe tit io n N on e Li m it us e of e ar ly e xi t p at h‐ w ay s t o re tir em en t St re ng th en v oc at io na l t ra in ‐ in g an d de ve lo pm en t o f j ob re le va nt sk ill s o f y ou ng pe op le , o ld w or ke rs a nd lo ng -te rm u ne m pl oy ed N on e Cu rb p ub lic e xp en di tu re gr ow th Fr an ce In cr ea se c om pe tit io n in th e se rv ic e se ct or Im pl em en t m or e in ve st‐ m en t-f rie nd ly b us in es s re gu la tio n N on e Re du ce E PL o f o pe nen de d co nt ra ct s, al lo w fo r m or e fle xi bl e w or k ho ur s Si m pl ify a nd im pr ov e ta x sy ste m , s hi ft to c on su m p‐ tio n ta x Li m it sp en di ng in g ov er n‐ m en t a nd a dm in ist ra tio n G er m an y In cr ea se c om pe tit io n in th e se rv ic e se ct or D er eg ul at e pr of es sio na l se rv ic es N on e In te gr at e w om en b et te r i nt o th e la bo ur m ar ke t Im pl em en t i nc en tiv es fo r la te r r et ire m en t N on e In cr ea se in ve stm en t i n ed u‐ ca tio n In cr ea se in ve stm en t in in fra str uc tu re a nd re ‐ se ar ch G re ec e Ea se re gu la tio n in n et w or k in du str ie s Im pr ov e ba nk ru pt cy fr am e‐ w or k, im pr ov e re so lu tio n of no npe rfo rm in g lo an s Co nc lu de p en sio n re fo rm , al so re vi ew sp ec ia l r eg im es an d in tro du ce b as ic p en sio n Br oa de n ta x ba se a nd str en gt he n ta x ad m in ist ra ‐ tio n th ro ug h m or e au to no ‐ m y an d m or e re so ur ce s En ha nc e ad m in ist ra tiv e ca ‐ pa ci ty Fi gh t p ov er ty b y gu ar an te e‐ in g m in im um in co m e, sc ho ol m ea l p ro gr am , a nd ho us in g as sis ta nc e M od er ni ze p ub lic e m pl oy ‐ m en t s er vi ce III Which Structural Reforms for Europe? (Henrik Enderlein) 80 Pr od uc t m ar ke t Fi na nc ia l s ec to r La bo ur m ar ke t Ta xa tio n Pu bl ic se ct or Ir el an d N on e A cc el er at e re so lu tio n of no npe rfo rm in g lo an s v ia co ur t s ys te m In cr ea se in ce nt iv es to w or k in cl ud in g w ith dr aw al o f be ne fit s, en fo rc e ob lig a‐ tio ns fo r u ne m pl oy ed Br oa de n ta x ba se b y sh ift ‐ in g ta xe s t o im m ov ab le a s‐ se ts, re du ci ng a llo w an ce s fo r c ap ita l i nc om e, a nd al ig ni ng c or po ra te ta x sy s‐ te m ) Im pr ov e co stef fe ct iv en es s of h ea lth ca re sy ste m Im pr ov e ac ce ss to q ua lit y ch ild c ar e, e sp . f or lo w -in ‐ co m e gr ou ps It al y En ha nc e co m pe tit io n in pu bl ic a nd p riv at e se ct or A dd re ss n on -p er fo rm in g lo an s p ro bl em , i m pr ov e in ‐ so lv en cy p ro ce du re s In cr ea se A LM P Si m pl ify la bo ur c on tra ct s In sta ll ef fe ct iv e fra m ew or k fo r c ol le ct iv e ba rg ai ni ng Im pr ov e ta x co m pl ia nc e an d sim pl ify ta x sy ste m Li m it sp en di ng in g ov er n‐ m en t a nd a dm in ist ra tio n La tv ia N on e N on e Im pr ov e vo ca tio na l t ra in in g In cr ea se o ffe rs fo r w or kba se d le ar ni ng Re du ce h ig h ta x w ed ge fo r lo w -in co m e ea rn er s a nd sh ift ta xe s t o so ur ce s l es s de tri m en ta l f or g ro w th En su re ta rg et in g of so ci al as sis ta nc e be ne fit s Li th ua ni a N on e N on e Im pr ov e la bo ur m ar ke t r el ‐ ev an ce o f e du ca tio n Im pr ov e co ve ra ge a nd a de ‐ qu ac y of u ne m pl oy m en t i n‐ su ra nc e St re ng th en A LM P to in ‐ cr ea se e m pl oy ab ili ty o f u n‐ em pl oy ed , a nd im pr ov e ca ‐ pa ci ty o f e m pl oy m en t a ge n‐ cy Br oa de n th e ta x ba se Im pr ov e ta x co m pl ia nc e an d fig ht ta x ev as io n Re du ce h ig h ta x w ed ge fo r lo w -in co m e ea rn er s a nd sh ift ta xe s t o so ur ce s l es s de tri m en ta l f or g ro w th in ‐ cl ud in g en vi ro nm en t a nd pr op er ty ta x Im pr ov e pe rfo rm an ce o f he al th ca re sy ste m Lu xe m ‐ bo ur g N on e N on e N on e N on e N on e M al ta N on e N on e N on e N on e N on e Appendix 81 Pr od uc t m ar ke t Fi na nc ia l s ec to r La bo ur m ar ke t Ta xa tio n Pu bl ic se ct or N et he rl an ds N on e N on e N on e St re ng th en ta x ba se , r ed uc e m or tg ag e in te re st re lie f a nd ph as eou t l ow er V AT ra te Ea se re gu la tio n on p riv at e su pp ly o f r en ta l h ou sin g In cr ea se p ub lic su pp or t f or R& D Po rt ug al N on e N on e M ak e un em pl oy m en t b en e‐ fit s i nd ep en de nt o f a ge a nd w id en c ov er ag e Sc al eup A LM P N on e Be tte r t ar ge tin g of so ci al sa fe ty n et , r ai se b en ef it le v‐ el s o f m in im um in co m e su pp or t Sl ov ak ia N on e N on e Im pr ov e A LM P, e du ca tio n an d tra in in g to ta ck le lo ng te rm u ne m pl oy m en t St re ng th en fe m al e em pl oy ‐ m en t t hr ou gh c ar e pr ov i‐ sio n Im pr ov e ta x co m pl ia nc e In cr ea se p ar tic ip at io n of Ro m a ch ild re n in e du ca tio n an d ch ild c ar e In ve st in in fra str uc tu re , i m ‐ pr ov e ad m in ist ra tiv e pr oc e‐ du re s f or p er m its , a nd tra ns po rt ne tw or k in cl ud in g ra il an d ro ad Im pr ov e pu bl ic p ro cu re ‐ m en t, al so in cr ea se c om pe ‐ tit io n in p ub lic te nd er s Sl ov en ia N on e Ta ck le n on -p er fo rm in g lo an pr ob le m s i n th e ba nk in g se ct or a nd fa ci lit at e sw ift re str uc tu rin g an d re so lu tio n of c om pa ni es A dd re ss lo ng -te rm u ne m ‐ pl oy m en t b y in cr ea sin g em ‐ pl oy ab ili ty o f l ow -s ki lle d Li m it in ce nt iv es fo r e ar ly re tir em en t a nd in cr ea se re ‐ tir em en t a ge N on e N on e Sp ai n In cr ea se c om pe tit io n in th e se rv ic e se ct or , p ro fe ss io na l se rv ic es Re str uc tu re a nd p riv at iz e pr iv at e ba nk s N on e N on e N on e So ur ce s: Ba se d on th e re fo rm re co m m en da tio ns b y th e O EC D a nd E ur op ea n Co m m iss io n (a s ci te d ab ov e al so in th e ap pe nd ix ), co m pi le d by a ut ho rs . 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(2015): Structural reforms and long-run growth in the euro area, Intervention at the 43rd Economics Conference of Österreichische Nationalbank Rubio, E. (2014): Promoting Structural Reforms in the Euro Area: What For and How?, Policy Paper No. 119, Notre Europe – Jacques Delors Institute Sánchez, A.C.; de Serres, A.; Yashiro, N. (2016): Reforming in a difficult macroeco‐ nomic context, OECD Economics Department Working Papers No. 1297, OECD Publishing The Economist (2007): The Quest for Prosperity, 15 March 2007 Varga, J.; in ‘t Veld, J. (2014): The potential growth impact of structural reforms in the EU – a benchmarking exercise, European Commission: European Economy, Econo‐ mic Papers No 541 III Which Structural Reforms for Europe? (Henrik Enderlein) 86 Past Reforms in the Services Sector and their Effects Introduction (Stefan Profit) Dr Stefan Profit, Deputy Director-General Macroeconomic Development, Analysis and Projections, Federal Ministry for Economic Affairs and En‐ ergy (BMWi) In this part, we will focus on past reforms in the service sector and their effects. Progress in structural reforms in Germany Source: Service Sector Regulation Indicators, OECD (own representation) Figure 4.1.1 shows that we have experienced significant reforms in the service sector in Germany over the past 20 years. The solid lines are Ger‐ man, the dashed lines are OECD averages. The red colour line is 1995, the green colour line is 2013. What you see is that we have deregulation in all areas. If you look at the comparison with the OECD average, we are be‐ IV IV.1 Figure 4.1.1: 87 low average in many areas. But not in professional services where we’re slightly above average. We are also slightly above average in postal ser‐ vice and in retail where I think numbers are difficult to interpret, because a lot of the issues in that field are in the responsibility of the Länder. The second talk we will have is on the transport sector and structural reforms. It adds very well to Henrik Enderlein’s talk which was, in gener‐ al, on political economy issues of structural reforms. The example here is transportation. Paolo Mengano holds a master’s degree from Bocconi Uni‐ versity in Milan, is currently a consultant with the World Bank on global productivity issues and is also a junior researcher in the Competitiveness Research Network CompNet which contains very interesting data that has been used by the ECB and is going to be hosted and continued by IWH. Paolo will apply these data and present his work on Product Market Deregulation in the transport sector. National regulation of specific professions Source: Regulated professions database, EU Commission The contribution by Davud Rostam-Afschar is on the crafts sector, partic‐ ularly on the reforms in Germany in the 2000s. I put up two example occupations here just to show two things: We do not only have different regulations in occupations across countries, but also across crafts professions in Germany. It is a quite heterogeneous pic‐ ture, which sometimes makes interpretation difficult. We will have Davud Rostam-Afschar give a presentation on a natural experiment. As you can see in the maps we have a lot of heterogeneity, and heterogeneity is good for researchers because they can make use of it and infer evidence about the effects of reforms, which he does in the paper. Figure 4.1.2: IV Past Reforms in the Services Sector and their Effects 88 Entry regulation and entrepreneurship: a natural experiment in German craftsmanship59 (Davud Rostam-Afschar) Dr Davud Rostam-Afschar, University Stuttgart-Hohenheim Abstract This paper uses the 2004 amendment to the German Trade and Crafts Code as a natural experiment for assessing the causal effects of this reform on the probabilities of being self-employed and of transition into and out of self-employment. This is achieved by using repeated cross-sections (2002–2009) of German microcensus data. I apply the difference-in-differ‐ ences technique for three groups of craftsmen which were subject to dif‐ ferent intensities of treatment. The results show that the complete exemp‐ tion from the educational entry requirement has fostered self-employment significantly by substantially increasing the entry probabilities, while exit rates have remained unaffected. I find similar, though weaker relative ef‐ fects for the treatment groups that were subject to a reduction of entry costs or a partial exemption from the entry requirements. Moreover, I con‐ sider effect heterogeneity within each of the treatment groups with respect to gender and vocational training, and show that the deregulation of entry requirements has been most effective for untrained workers. Introduction How does entry regulation influence entrepreneurship? In an attempt to answer this question, many different kinds of regulation, such as the regu‐ lation of product and labor markets, have been investigated. The theoreti‐ cal predictions of the effects of these kinds of regulations are ambiguous. On the one hand, the public choice theory argues that regulations lead to socially inefficient outcomes, while on the other hand the public interest IV.2 1 59 Rostam-Afschar, D. (2014): Entry regulation and entrepreneurship: a natural ex‐ periment in German craftsmanship, Empirical Economics, 47(3), 1067–1101. IV.2 Entry regulation and entrepreneurship 89 theory of regulation claims that regulations serve to cure market failures. With a focus on entrepreneurship, Branstetter et al. (2013) predict that a reform which reduces the fixed costs of setting up a business leads to an increase in the number of firms as well as in employment but the addi‐ tional firms will have entrepreneurs with relatively lower entrepreneurial ability. This study further shows that these firms will be smaller and have a lower probability of survival. Empirical evidence tends to support the view that various implementa‐ tions of entry regulation have detrimental effects. Most of these studies re‐ ly on aggregate data from many countries, as in the influential work by Djankov et al. (2002) and subsequently in research by Klapper et al. (2006); Ciccone and Papaioannou (2007), and van Stel et al. (2007). In ad‐ dition, evidence based on microdata (cf. Bruhn 2011; Ardagna and Lusardi 2010, 2009; Branstetter et al. 2013) enforces the conclusion that lower en‐ try costs increase entry into (formal) entrepreneurship. Moreover, there is a set of studies that, while not directly focusing on entrepreneurship, investigates the effects of entry regulation with microda‐ ta, including, e.g., Bertrand and Kramarz (2002); Sadun (2008); Viviano (2008). In an important contribution, Bertrand and Kramarz (2002) evalu‐ ate a commercial zoning regulation implemented via regional zoning boards in French retailing. This study finds that greater entry regulation reduced employment growth in the retail sector, while concentration and prices increase. Other work connected to this study investigates the effects of product market deregulation for industry dynamics (Aghion et al. 2009; Cetorelli and Strahan 2006; Kerr and Nanda 2009). From studying a deregulation of the French banking industry in the 1980s, one of the find‐ ings in Bertrand et al. (2007) corroborates the notion that less state inter‐ vention is associated with increased firm entry and exit rates. Briefly, the empirical literature almost unanimously comes to the conclusion that entry regulation in its various forms restrains entrepreneurship and similarly other economic outcomes. One particularly interesting implementation of entry regulation is the requirement of the Meister degree in German craftsmanship, as required by the German Trade and Crafts Code (HwO) for registration as an en‐ trepreneur. Prantl and Spitz-Oener (2009) and Prantl (2012) explicitly con‐ sider the entry requirement for craftsmanship to discuss regulatory effects in the wake of German reunification in 1990. The aim of this study is to evaluate a change in the regulatory require‐ ments empirically. It contributes to the literature on entry regulation and IV Past Reforms in the Services Sector and their Effects 90 entrepreneurship by providing evidence of the causal effects of entry regu‐ lation, exploiting this change to the HwO as a natural experiment. Dating back to the late nineteenth century, this latter entry requirement, called Meister (see Sect. 2), underwent a dramatic change: the amendment to the HwO in January 2004 decreased the number of occupations in which craftsmen were required to hold a Meister degree in order to start a busi‐ ness from 94 to 41. Moreover, the entry requirements for the remaining 41 occupations were relaxed. To the best of my knowledge, this is the first paper to use this setting as a natural experiment. The reform was the result of a passionate debate in which proponents of the entry requirement (e.g., German Confederation of Skilled Crafts 2003) cited market failures resulting from information asymmetries and external effects, while opponents (e.g., German Deregulation Commission 1991; German Monopolies Commission 1998, 2002) objected, in the spirit of the public choice theory, that these regulations would lead to greater ineffi‐ ciencies. The government justified the regulation primarily as a means to prevent health related dangers. This argument, in turn, was itself contro‐ versial because there was no agreement as to whether the costs of regu‐ lation would outweigh the costs incurred by careless craftsmen doing haz‐ ardous jobs, for example barbers or chimney sweeps. Focusing on entrepreneurship, in addition to credit constraints (e.g., Evans and Jovanovic 1989, Blanchflower and Oswald 1998, Hurst and Lusardi 2004, Fossen 2011), the entry requirement is regarded as a key impediment to starting a business. For instance, Holtz-Eakin and Rosen (2005) point to the entry requirement as a disincentive to taking up selfemployment in German craftsmanship. To shed some light on the effects of this regulation on entrepreneurship, I use repeated cross-sections (2002–2009) of German microcensus data on self-employment to proxy for business creation. I apply the difference-indifferences (DID) approach to estimate the effects of the policy change for three distinct occupational groups on the probability of self-employment, as well as the probability of transitioning into and out of self-employment. The empirical results provide evidence that the probability of being self-employed increased in line with the amendment to the HwO. The strongest relative increase significantly raised the probability of self-em‐ ployment to a level more than 40 % higher than a hypothetical situation without the reform for an occupational group with a relatively low propen‐ sity to engage in entrepreneurship. This group, hereafter referred to as the group of B1-occupations, has been completely exempted from the entry IV.2 Entry regulation and entrepreneurship 91 requirement. The reform also seems to have increased the probability of being self-employed for professions that experienced only a reduction of or a partial exemption from the entry requirement. The effects for these groups are also positive, although weaker. The analysis shows further that these increases resulted from increasing the probability of entry, while the probability of exit from self-employment has remained virtually unaffect‐ ed by the policy change. The reforms seem to have affected individuals across professional qualifications differently; the deregulation of entry has been most effective for the group of untrained workers who are disadvan‐ taged in the labor market. Below, in Sects. 2 and 3, respectively, I describe the institutional frame‐ work of the natural experiment and outline the empirical approach. In Sects. 4 and 5, I describe the data and discuss the results. Section 6 con‐ cludes. The amendment to the German Trade and Crafts Code in 2004 as a natural experiment Over the course of time, three key institutions of German craftsmanship have emerged: the small proof of competence (Kleiner Befähigungsnach‐ weis), the greater proof of competence (Großer Befähigungsnachweis), and the register of self-employed craftsmen (Handwerksrolle). The small proof of competence restricted the training of apprentices to craftsmen who held a Meister certificate, though such a degree was not required to start a business. However, the greater proof of competence mandated that craftsmen obtain a Meister certificate for both activities, to train and to have a new business listed in the register. Since 1965, legislation has distinguished between restricted regular craftsmanship (Vollhandwerke), which requires a greater proof of compe‐ tence, and unrestricted trades similar to crafts (Handwerksähnliche Gewerbe), referred to in this text as A-occupations and B2-occupations, respectively. In this study, the focus is on craftsmen in A-occupations who remained regulated by a form of the greater proof of competence, in con‐ trast to those in B2-occupations. The Meister title is the highest professional degree in craftsmanship. To attain it, a person must complete several levels of training and pass exami‐ nations. Having obtained the qualification level called Geselle, a crafts‐ man could be employed in a business or continue on to a Meister degree. 2 IV Past Reforms in the Services Sector and their Effects 92 Full-time courses to prepare for the Meister exam take 1–3 years, and the occupation-specific overall costs range, according to the Chambers of Crafts and Trade, from 4,000 to 10,000 Euros. The Meister exam tests both occupation-specific skills and general education in business and com‐ mercial knowledge, as well as law. Moreover, the exam contains a peda‐ gogical component, as holding a Meister degree makes the craftsman eli‐ gible to train apprentices. Those who have passed the examination and started a business are recorded in the register; though in rare exceptional cases, some people may be recorded in the register without a Meister de‐ gree. In the situation immediately prior to the amendment to the HwO in 2004, the options available to a crafts-person were to get hired in a busi‐ ness or to set up a business after having obtained the Meister degree. This analysis exploits this reform to assess the causal effects of entry regulation on entrepreneurship. In the next section, I describe how the different com‐ ponents of this reform altered the options available to a craftsman, and de‐ fine treatment groups and a control group accordingly. The natural experiment Before Requirement After Requirement A (Meister) AC (Meister) A (Meister) A1 (Altgeselle) A (Meister) A2 (Altgeselle, no requirementa) A (Meister) B1 (no requirement) B2 (no requirement) B2 (no requirement) Notes: This table describes the requirement before and after the reform in descending order of a priori supposed intensity of entry regulation. The control group comprises pre- and post-reform occupations that turned out to belong to the AC-occupations. Each treatment group includes pre- and post-reform occupations that turned out to be‐ long to the B1-, A1-, and A2-occupations, respectively. The occupational groups B1, A1, A2, and AC are defined to be mutually exclusive. However, non-craft occupations and B2-occupations within these groups are not always discriminable due to data pro‐ tection, and have been excluded from the analysis where possible. The main results re‐ main unchanged when these occupations are included in the samplea For A2-occupa‐ tions, no requirement is imposed after the reform if a prospective entrepreneur com‐ mits to limit the range of the activities of his firm to tasks that can be learned within 3 months Table 4.2.1: IV.2 Entry regulation and entrepreneurship 93 Empirical specification Definition of the treatment and control groups How did the reform alter the options available to a craftsman? After the reform, a crafts-person could choose to seek employment in a business, re‐ gardless of her obtained professional degree, just as before the reform. The choice to start a business on her own, in contrast, was facilitated by the amendment to the HwO. The amendment came into effect on January 1, 2004, in the context of a series of reforms aimed at the German social sys‐ tem and labor market called Agenda 2010. It defines certain occupational groups which are subject to different degrees of regulation. I matched each reported occupation of an individual in the German microcensus with the respective occupation listed in the law, with examples of these vocations provided below. From this information, I was able to construct four occu‐ pational dummies that reflect the different intensities of the treatment, as outlined in Table 4.2.1. The deregulation of the Meister degree requirement, which is the main element of the policy change, generated a group of 53 B1-occupations by dividing up the former 94 A-occupations. After the reform, craftsmen be‐ longing to the group of B1-occupations were allowed to start businesses without a Meister degree, but still had to demonstrate their ability to train apprentices. These B1-occupations represent the treatment group that was deregulated most, referred to as B1-craftsmen. This category includes tile and mosaic layers, coppersmiths, turners, tailors, millers, and photogra‐ phers. The remaining 41 A-occupations comprise three more groups: AC, A1, and A2. The AC group is comprised of strictly regulated occupations that remained subject to virtually the same requirements as before the policy change; they had already needed a mandatory Meister certificate to enter entrepreneurial activities. These vocations serve as the control group. They include chimney sweeps, optometrists, hearing aid audiologists, or‐ thopedic technicians, and dental technicians. The remainder of the A-occupations had their entry restrictions loos‐ ened by receiving permission to start a business without a Meister degree after having reached the level of an Altgeselle, i.e., by having proven 6 years of work experience as a Geselle, four of these in a decision-making position, in his or her prospective occupation. This Altgesellen rule de‐ fines the third treatment group (A1-occupations) which includes profes‐ 3 3.1 IV Past Reforms in the Services Sector and their Effects 94 sions such as roofers, surgical instrument makers, gunsmiths, plumbers, gas and water fitters, joiners, and pastry cooks. Workers in A1-occupations can start a business without providing proof of any qualification, provided they commit to limiting the range of their activities to tasks that can be learned within 3 months. This partial exemp‐ tion from the already reduced entry regulation aims particularly at sup‐ porting the establishment of small businesses. However, for a prospective entrepreneur who plans to carry out the full range of activities, obtaining vocational training according to the Altgesellen rule is still mandatory. In‐ dividuals in occupations that use this so-called easy-job-rule are grouped separately into the A2 group (cf. Müller 2006), including masons and con‐ creters, painters and varnishers, metalworkers, motor vehicle body and ve‐ hicle construction mechanics, bike mechanics, information electronics technicians, vehicle technicians, and butchers. In summary, the three treatment groups are described in descending or‐ der of their expected treatment intensity: the B1-, A2-, and A1-occupa‐ tions, while the AC-occupations are used as the control group. Having de‐ fined the three treatments and the control group, I describe in the follow‐ ing the development of the level of self-employment and self-employment rates for these groups. Trends in craftsmanship Between 2002 and 2009, the period relevant for this analysis, the number of self- employed craftsmen remained stable in the control group, while this number increased in the treatment group that has experienced the strongest treatment, i.e., the B1-occupations (see Figure 4.2.1), after the reform in 2004. This growth pattern can also be observed for the A1 and A2 groups, though it is less pronounced. In contrast to the B1 group’s al‐ most monotonic increase, the number of A2 craftsmen reverted to its prepolicy level. The number of A1 craftsmen also declined from 2007 to 2008 but nevertheless remained at a substantially higher level than before the reform. These facts may indicate that the reform had a positive impact on the self-employment rate in the treatment groups. 3.2 IV.2 Entry regulation and entrepreneurship 95 Self-employment in treatment groups and control group: number of self-employed craftsmen in B1, A1, A2, and AC occupations in thousands Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Figure 4.2.2 depicts the time trends in the self-employment rates, defined as the ratio of the number of self-employed craftsmen to the number of both self-employed and employees in the treatment groups and the control group, respectively. Figure 4.2.1: IV Past Reforms in the Services Sector and their Effects 96 Self-employment rates in treatment groups and control group: percentage share of self-employed among B1, A1, A2, and AC occupations Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Before the policy change in 2004, the differences between the time trends of the treatment groups and the control group remained steady. In subse‐ quent years, however, the differences between the self-employment rates of each of the treatment groups and the control group decreased substan‐ tially. This may again support the hypothesis that the 2004 reforms in‐ creased the probability of self-employment for the treatment groups. Note that the dip in the share of self-employed craftsmen in AC-occupations is due to a temporary increase in the number of employees. See Sect. 5.4 for a robustness check that shows that the results are not driven by this fluctu‐ ation. Interestingly, the trajectory prior to the treatment is very similar for craftsmen compared to non-craftsmen; in my sample, the rate of self-em‐ ployed among working persons raised from 11.17 % in 2002 gradually to 12.00 % in 2004. In 2005 this figure peaked at 12.44 % and remained thereafter relatively steady around 12 % (see Table 4.2.9). One explanation Figure 4.2.2: IV.2 Entry regulation and entrepreneurship 97 for this development might be the substantial increase in the number of self-employed in East-Germany. Identification of causal effects The empirical strategy outlined here exploits the reform of the regulatory framework of entrepreneurial craftsmen in 2004 as a natural experiment. To this end, I calculate the differences in the changes in average outcomes of employment status choices across each treatment group both before and after the reform. I then measure the changes in average outcomes of em‐ ployment status decisions of the control group before and after the reform. The differences in these changes is known as the DID estimator, and rep‐ resents the average treatment effects on the treated group (ATT) (e.g., Blundell and Costa Dias 2009). I use data from 2002 to 2009 for the three occupational groups (B1, A1, A2) subject to different intensities of regulation changes, as detailed in Sect. 3.1. These three groups are used as the treatment groups (cf. Meyer 1995) while the group of AC-occupations is used as the comparison group. To determine the ATT with the DID approach means specifically comparing the difference in the average self-employment probability of each of the three treatment groups before and after the reform with the av‐ erage self-employment probability of the AC-occupation group before and after the reform. Therefore, for this 8-year period, I have been able to quantify the ef‐ fects of the reform on the probability of self-employment. The main hypo‐ thesis, based on the theory of public choice, suggests that the policy change could have influenced the self-employment rate negatively or not at all. However, the direction of the effect depends on how the new policy has caused the entry and exit rates to change. Generally, an increase in the self-employment rate could result from either a higher entry rate, a lower exit rate or both. However, an increase could also result from a higher exit rate, which in turn is exceeded by an even higher entry rate. Another pos‐ sibility is that the self-employment rate overall remains unchanged if the policy shifts the entry rate as well as the exit rate equally in the same di‐ rection or has no effect at all. Therefore, with this analysis, I investigate not only the probability of being self-employed but also the probability of entry into and exit from self-employment. 3.3 IV Past Reforms in the Services Sector and their Effects 98 Identifying the ATT using the DID approach requires the assumption that the treatment groups and the control group are subject to common trends. This implies that macro shocks exert the same effects on both groups. For example, a sudden decrease in the interest rate should influ‐ ence trades related to health and hygiene, which are common among the AC group, just as it does the building and construction trades, which are part of the A2 group. If this is true, a hypothetical trend without a reform in the treated group would parallel the trend in the control group in the post-policy period. Otherwise, it would be unclear whether differences be‐ tween these groups are caused by the reform or by other factors. Section 5.4 provides evidence in favor of the identifying common trend assump‐ tion. Furthermore, this setting does not seem to be susceptible to what is a frequent concern in natural experiments. That is, the problem of self-selec‐ tion should not exist, because the different treatment groups are distin‐ guished by a law that was proclaimed for the first time in March 2003 (cf. Müller 2006), resulting in a relatively short time for workers to adjust and change occupations. Work in a specific vocation in craftsmanship, like individual character‐ istics, changes little over time. In the sample used for the estimation, 73.85 % of the individuals in B1-occupations had been working in their current occupation for 3 years or more in 2004 and 72.80 % in 2008. For the other groups of craftsmen, this figure is larger. Self-employed crafts‐ men tend to be less likely to change occupations. Again, the B1 group was the most dynamic, though in this group 83.42 % had run their business for 3 years or more in 2004 and 82.18 % in 2008. Therefore, adjusting behav‐ ior in expectation of the reform should not challenge the identification of the ATT parameter. Moreover, after the announcement of plans for the amendment to the HwO, a controversy arose with an unpredictable out‐ come. It was therefore not known what intensity of treatment each occupa‐ tion would receive before the reform actually came into being. Consider‐ ing this unpredictability, it seems unlikely that craftsmen would have changed jobs in anticipation of the effects caused by complicated new rules. Regarding changes between groups, the situation after the regulations were eased is somewhat different, as the B2-occupations could be substi‐ tuted for similar B1 or A-occupations more easily, which means that the compositions of the treatment and control groups might change systemati‐ cally. For instance, changing from a B2-occupation to engage in self-em‐ IV.2 Entry regulation and entrepreneurship 99 ployment in a B1-occupation might have been harder for an individual not having obtained the required degree before the reform. Conversely, a craftsman trained in a B1-, or A-occupation might have been more likely to move into an occupation from the B2-vocations because she wants to set up a business before the reform. This would bias the estimate of the treatment if these changes occur in anticipation of the reform. Moreover, the analysis includes a set of observable, time-varying co‐ variates and other characteristics to control for the potential for systematic differences in the populations over the two periods. I assume that changes in unobserved factors are the same between the treatment and control groups. Other entrepreneurship policies Some other major policies may also have interfered with the effects of the policy change. These are the enlargements of the European Union (EU) in 2004 and 2007 as well as some subsidies for entrepreneurship. The first relevant enlargement of the EU based on the 2003 Treaty of Accession took place in 2004, when ten countries became new member states. Moreover, the 2007 enlargement of the EU based on the 2005 Treaty of Accession saw Bulgaria and Romania join the EU. Although Germany restricted its labor market from workers from these 12 new member states, exceptions were granted to specific groups. Most impor‐ tantly, a person was permitted to engage in entrepreneurship immediately after her state of origin became member of the EU. Other important policy instruments include subsidies to entrepreneurs, such as the transitional allowance (Überbrückungsgeld, 1986–2006), the start-up subsidy (Existenzgründungszuschuss [EXGZ], 2003–2006), the entrance grant for entrepreneurs (Einstiegsgeld für selbständige Tätigkeit, since 2005), and another start-up subsidy (Gründungszuschuss, since 2006) (cf. Caliendo and Steiner 2005, Caliendo and Künn 2011). The years in which each of the programs was adopted and the year of its aboli‐ tion is given in parentheses. According to Baumgartner et al. (2006), the EXGZ in particular had significant effects on entrepreneurship, and thus could confound the main analysis. Although there are no reliable numbers, a surmise based on Müller (2006) would imply that just 2.93 % of the A-businesses established in 2004 received the EXGZ, and 2.13 % in 2005. For B1-businesses, less 3.4 IV Past Reforms in the Services Sector and their Effects 100 than 5.79 % of the start-ups in 2004 and 3.58 % in 2005 were subsidized by the EXGZ. This suggests that we should not be too concerned about the effects of these subsidies. Craftsmanship and entrepreneurship policies: total, unsub‐ sidized, and German self-employed craftsmanship in thou‐ sands Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Figure 4.2.3 shows three graphs from 2002 to 2009: the development of total self- employed craftsmanship, the number of craftsmen who did not report receiving SPP payments (a dummy for public payments for self-em‐ ployed), and the number of German self-employed craftsmen. All three se‐ ries experienced a substantial increase after the amendment to the HwO came into effect. The number of self-employed craftsmen jumped from 518,163, measured a year before the reform, to 579,036 in 2005 and then to 584,494 in 2006. This enormous change is also documented for the stock of businesses, with data taken from the register of craftsmen. Disre‐ garding the B2-occupations, these figures equal, in each year, approxi‐ mately 90 % of the stock of businesses reported in Table 4.2.8 which con‐ firms how well these occupations are represented in the data. Note that Figure 4.2.3: IV.2 Entry regulation and entrepreneurship 101 this result holds after accounting for the actual stock of businesses, which is approximately 15 % lower than the reported stock. Together with the number of self-employed craftsmen, the graphs for unsubsidized, self-employed craftsmen and for German self-employed craftsmen evolve almost uniformly over time, though the effects of the 2007 enlargement of the EU is clearly visible. This suggests again at least that the subsidies did not affect the number of self-employed craftsmen systematically. However, to identify the effect of the amendment to the HwO separately from these policies, I include a dummy indicating EU cit‐ izenship and its interaction with the post-policy period in most of the spe‐ cifications. Moreover, in Sect. 5.3, I discuss the results, first by excluding all non-German craftsmen and then by excluding all craftsmen that receive any subsidy. Estimation procedure In estimating the effects of the reform for all treatments with repeated cross-sections from 2002 to 2009, all three treatment groups are included jointly in the regression models to yield more precise estimates. I present estimates of logit models using the maximum likelihood esti‐ mator in much of the rest of the paper, because predicted probabilities are not bounded by 0 and 1 and the partial effects of independent variables are constant in the linear probability model (LPM). However, I also employed LPMs for all of these specifications and the results remain essentially the same. In an LPM, the ATT equals the coefficient of the interaction term be‐ tween the treatment and the post-policy dummy. This interaction effect re‐ flects the comparison of the changes in predicted probabilities before and after the reform for the treatment and control groups. In a logit model, the outcome variable is assumed to be determined by the logistic function, and thus the model is nonlinear. In turn, the coeffi‐ cient of the DID interaction cannot be interpreted as the ATT, and the ef‐ fects of the reform must be computed as differences of predicted probabil‐ ities. The corresponding standard errors for the predicted probabilities can be obtained by applying the delta method. The dependent variable Yi for observation i is a binary variable that in‐ dicates self-employment in the stock models, and transition into or out of self-employment in the flow models. The conditional expectation of the 3.5 IV Past Reforms in the Services Sector and their Effects 102 binary outcome equals the probability Prob(·). In the main specification, given as Eq. (1) below, the regressors dPosti, d Oi, and Xi are included in zi, where dPosti is a dummy variable for individuals observed in the postpolicy period;60 d Oi = d B1i, d A1i, d A2i indicates an individual’s affilia‐ tion to one of the treatment groups; and X is the vector of control vari‐ ables. The specification includes interaction terms between the respective treatment group indicators and the post-policy dummy. Moreover, 0,  δω,  βω , and β4 , along with ω  =  B1,  A1,  A2 , represent the respective coeffi‐ cients or vector of coefficients, and β0  is a constant. Prob Yi  =  1 dPosti,  dOi,  Xi  = 1 1 + e−zi   with zi = β0 + δ0dPosti + βB1dB1i + βA1dA1i + βA2dA2i + δB1dB1i · dPosti + δA1dA1i  · dPosti + δA2dA2i · dPosti + Xiβ4 .   (1) In addition to dummies for the years 2003, 2004, 2006, 2007, 2008 and 2009, all models include in X variables for the following individual char‐ acteristics: age and its square, and dummy variables indicating gender, type of secondary schooling and professional qualification, nationality, re‐ gion of residence, the size of the respondent’s city of residence, marital status, number of dependent children, the branch of craftsmanship, the oc‐ cupation, and a constant. The included indicator d EU shows the citizen‐ ship of foreigners in an EU member state, and is included along with its interaction with the post-policy period, to separate the effects of the en‐ largements of the EU from the effects of the amendment to the HwO, as discussed in Sect. 3.4. Controlling for these characteristics is important for two reasons. First, the determinants of self-employment may have changed over the time. Second, including these control variables allows to obtain the estimate δω  more efficiently. The estimation sample consists of all craftsmen in a given year in the models for which the dependent variable is the self-employment probabili‐ 60 The post-policy period could be defined as the period from 2004 to 2009. How‐ ever, the data from 2004 refer to the beginning of this year, which basically repre‐ sents the status quo ante, so the post-policy period in the main specifications in‐ cludes only the years 2005 and 2009. Results from a specification where the postpolicy period is defined from 2004 to 2009 or 2004 is dropped are shown in Table 4.2.11. The post-policy dummy equals 1 for both years, which prevents the inter‐ action effect from differing in the post-policy periods. A more flexible specifica‐ tion is presented in Table 4.2.12 and discussed in Sect. 5.4. IV.2 Entry regulation and entrepreneurship 103 ty. The same population is used in the entry models. Note that employ‐ ment status in the previous year, used for the construction of the transition variables, is queried retrospectively, and it is not mandatory to respond. In contrast, the indication of the current employment status, which is used for the transition variables and the stock variable, is found in the mandatory section of the questionnaire. Moreover, some unemployed or inactive persons do not report a profes‐ sion, and it is thus unclear what proportion of these groups participates as a reserve in the labor market for craftsmen. Because the analysis excludes those who do not report an occupation, the results reflect an approxima‐ tion of the probability of entering self-employment from dependent em‐ ployment, unemployment, or inactivity, because not all potentially selfemployed persons are included in the estimation sample. In contrast, the estimation sample of the exit models comprises self-em‐ ployed craftsmen in the previous year. Therefore, it is the population that possibly could exit from self-employment within the given year. With this sample, it is appropriate to estimate the probability of exit, because the de‐ pendent variable clearly indicates whether a person is not self-employed after 12 months, but instead is an employee, unemployed, or inactive. Apart from these differences in the estimation population and the depen‐ dent variables, the econometric framework is identical in the stock models and the flow models. Data and descriptives Sample design This analysis uses data from the German microcensus (Mikrozensus), which is provided by the Federal Statistical Office. This official, represen‐ tative yearly household survey is comparable to the Current Population Survey in the United States and the Labour Force Survey in the United Kingdom. The German microcensus is a 1 % sample of all households in Germany. A subsample of 70 % or approximately 494,000 observations per year, is selected at random and provided to researchers as a scientific use file by the Federal Statistical Office. The large sample size is crucial to this analysis, because less than 10 % of the population are craftsmen. Most questions are compulsory; therefore, the German microcensus, a mandato‐ 4 4.1 IV Past Reforms in the Services Sector and their Effects 104 ry census, guarantees a low rate of item non-response and ensures that en‐ trepreneurs are adequately represented. This analysis uses pooled cross-sections of the German microcensus from 2002 to 2009. The years before 2002 are not considered for several reasons. First, effects of other policy changes, e.g., the amendment to the HwO from 1998, could still be significant at the beginning of 2001, inso‐ far as the process of adjusting expectations and changing occupations in response to the reform took some time. Second, training in some tradition‐ al occupations, such as blacksmiths and turners, ceased as of August 2002, superseded by more modern training structures with new fields of special‐ ization. However, Müller (2006) shows empirical evidence that suggests that these changes had no substantial effect on the transition rates. To avoid confusion due to these influences, I excluded the year 2001 from the analysis. Table 4.2.11 shows that the estimates from the main specification using the years 2001 to 2009 remain similar if 2001 is included. Other re‐ sults including 2001 are available on request. The transition variables reflect questions from the supplementary pro‐ gram that ask retrospectively for a person’s employment status in the year before the interview. Note that the supplementary questions were only posed to a 45 % random subsample of the microcensus up until 2004. Since the number of observations is still quite large, this does not influ‐ ence further analysis. However, this program is non-mandatory and there‐ fore non-response is higher. Indication of status as self-employed is used to measure entrepreneur‐ ship in German craftsmanship, because the HwO refers explicitly to selfemployment. While the majority of self-employed craftsmen run non-in‐ corporated businesses, the term self-employment can cover also incorp‐ orated businesses. The Appendix provides a description of how the key variables are constructed. The reader should keep in mind that indication of status as self-employed is based on self-assessment and thus is rather a proxy for the true number of self-employed. Because the focus of this study is on entrepreneurship among German craftsmen, I restrict the sample as follows, reporting the average number of dropped observations per year in parentheses: I exclude all individuals younger than 18 years, or older than 65 years (177,740). People whose employment status choice is determined by different factors are also omit‐ ted from the sample to avoid distortions. Thus, civil servants (11,978), ap‐ prentices (7,885), soldiers (968), conscripts (730), persons in education, or those drafted in the previous year (13,531 and 336, respectively), as well IV.2 Entry regulation and entrepreneurship 105 as all remaining non-craftsmen (254,571), are excluded. Moreover, family workers (1,981) helping in a family business are not included in the sam‐ ple, because they are not entrepreneurs in the sense that they run their own businesses. This process leaves me with a sample of about 25,000 obser‐ vations per year, which represent about 4 million craftsmen in the German population. To complete the picture, the following section shows how the transition variables used in the estimation evolved over time, and de‐ scribes the characteristics of the occupational groups. Descriptives Figure 4.2.4 shows how the number of B1 entries increased tremendously after 2004, returned to a somewhat lower level in 2006, peaked in 2007 and reverted in 2008, but still remained higher than in the period before the reform. The exits remained constant for a time, before declining in the aftermath of the policy change. Note that the balance (defined as entry-ex‐ it) exhibits a similar, though less wiggly, path than the number of self-em‐ ployed craftsmen in Figure 4.2.3, which implies that most of the variation stems from this particular group. The two peaks in 2005 and 2007 might reflect the effects of the enlargements of the EU on the entry rate on top of the effects of the reform to the HwO. A comparison of the path of the growth rate, measured as the annual change in the number of self-em‐ ployed craftsmen in percentage, and the balance shows how large the nonresponse bias in the transition variables is, since both variables should contain the same information. Indeed, in almost all of the graphs in Figs. 4.2.4, 4.2.5, 4.2.6, and 4.2.7, the growth rate seems to resemble the pattern of the balance, though only very roughly. Figure 4.2.5 illustrates that nei‐ ther the entries into nor the exits from the AC-occupations exhibit any sin‐ gularity until 2006. The subsequent peak might again stem from the en‐ largement of the EU. The path of the growth rate and balance correspond. Apparently, the numbers of entries and exits are both rather small. For sensitivity tests correcting for rare events see Sect. 5.4. 4.2 IV Past Reforms in the Services Sector and their Effects 106 Entries into and exits from self-employment and their differ‐ ence among B1-occupations, left ordinate number in thou‐ sands, right growth rate in percent Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Entries into and exits from self-employment and their differ‐ ence among AC-occupations, left ordinate number in thou‐ sands, right growth rate in percent Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Figure 4.2.4: Figure 4.2.5: IV.2 Entry regulation and entrepreneurship 107 In Figure 4.2.6, the transition variables do not exhibit any major oscilla‐ tion. In the post-policy period, the growth rate increases substantially and then slows down, but the balance contrasts with this development. Entries into and exits from self-employment and their differ‐ ence among A2-occupations, left ordinate number in thou‐ sands, right growth rate in percent Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) The series of transitional variables for A1-occupations, depicted in Figure 4.2.7, show that the entries increase modestly, whereas the exits remain roughly constant. Here, the balance series and the growth rate also show an increase in 2005 and a subsequent decrease in 2006. Again, entries peak in 2007. Figure 4.2.6: IV Past Reforms in the Services Sector and their Effects 108 Entries into and exits from self-employment and their differ‐ ence among A1-occupations, left ordinate number in thou‐ sands, right growth rate in percent Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Now that we know how the dependent variables developed, I will describe some of the characteristics of the four occupational groups included in the vector of control variables. Furthermore, I will show the share of self-em‐ ployed craftsmen among all craftsmen in each group, and the share of selfemployed craftsmen in each group among all self-employed craftsmen in Table 4.2.2 as weighted averages from the pooled cross-sections from both the pre-policy period (2002–2004) and from the post-policy period (2005– 2009). In all three treatment groups, the share of self-employed is higher after the reform than before, while this figure seems to remain constant in the control group. Again, this points to a positive effect of the reform. Figure 4.2.7: IV.2 Entry regulation and entrepreneurship 109 Weighted averages by treatment and control groups in preand post-reform (2002–2004; 2005–2009) samples B1 A1 A2 AC Pre Post Pre Post Pre Post Pre Post Self-employed (%) 7.87 9.69 15.96 17.67 12.89 14.05 19.94 19.47 Female (%) 58.81 58.97 16.90 17.59 3.08 2.82 41.24 43.80 Age (a) 42.77 43.66 38.97 39.82 39.46 40.14 38.99 40.13 East (%) 16.47 17.77 21.50 21.70 23.44 23.28 17.71 17.41 Nationality German (%) 80.89 80.60 90.17 90.66 90.84 90.50 95.95 96.14 EU (%) 4.64 6.36 3.57 3.98 3.04 3.98 1.80 1.90 Non-EU (%) 14.46 13.03 6.26 5.36 6.12 5.52 2.25 1.96 Professional qualification University (%) 1.08 1.31 0.78 0.99 0.25 0.41 1.05 0.71 UASa (%) 0.94 1.13 1.23 1.34 0.53 0.55 1.52 1.54 Meisterb (%) 5.64 5.24 17.99 17.64 16.37 17.41 27.23 28.85 Gesellec (%) 54.32 59.21 65.67 70.15 69.96 72.70 62.46 65.11 None (%) 31.09 32.60 8.50 9.41 7.04 8.45 2.38 3.51 Non-response (%) 6.92 0.52 5.84 0.47 5.85 0.49 5.37 0.28 Secondary school Abiturd (%) 4.88 5.78 4.74 5.44 2.65 3.23 13.98 18.06 Othere (%) 84.00 85.73 89.58 91.78 91.47 93.92 82.02 81.39 None (%) 5.76 7.33 1.54 2.01 1.52 2.12 0.22 0.21 Non-response (%) 5.36 1.16 4.14 0.76 4.36 0.73 3.78 0.34 Children under 16 (#) 0.72 0.64 0.68 0.61 0.65 0.61 0.59 0.55 Married (%) 70.50 68.26 60.01 57.36 60.14 57.81 57.68 57.99 City size >500,000 (%) 14.30 14.81 10.89 11.96 10.16 11.25 11.78 13.83 20,000–500,000 (%) 44.93 46.77 38.80 42.05 37.93 41.10 43.09 44.70 ≤20,000 (%) 40.77 38.42 50.31 45.99 51.91 47.65 45.13 41.47 % of all self-employed craftsmen 24.11 27.20 46.92 46.67 23.13 21.27 5.84 4.86 Observations 28,188 47,002 27,424 44,675 16,733 25,553 2,792 4,302 Notes: All numbers are weighted by survey weights provided by the microcensus. Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) a University of Applied Sciences b The Meister-craftsman degree certifies the highest professional qualification in craftsmanship. c The Geselle degree can be obtained by completing an apprenticeship. Table 4.2.2: IV Past Reforms in the Services Sector and their Effects 110 d Abitur refers to the higher secondary school degree that qualifies a student for univer‐ sity admission in Germany. e Other secondary school refers to a secondary school degree that does not qualify a student for university admission in Germany, typically obtained at a Realschule or a Hauptschule. A remarkable difference between the treatment groups is that the A2 group has almost no female workers, while the majority of B1 jobs are done by women. Another interesting point is that individuals working in a B1 vocation rarely engage in self- employment compared to the other groups. This is accounted for in the estimation by including the binary variables dOi . Moreover, it is noteworthy that persons working in a B1occupation are on average less qualified, as around 1/3 reports no profes‐ sional qualification. Further, the share of craftsmen that served as apprentices, and thus held the vocational degree Geselle, is substantially higher for the post-policy period across all four groups. However, even though the documented in‐ creases are large, in particular for the (B1- and) A1-occupations, one should be cautious about attributing this to the effects of the Altgesellen rule as the changes might simply reflect the fact that the survey response probability increased after the reform. Section 5.3 picks up on this in a de‐ tailed discussion of heterogeneous effects with respect to gender and dif‐ ferent levels of vocational training. Results Did the 2004 amendment to the HwO have the intended effects? Accord‐ ing to the plain DID results from an LPM using pooled cross-sections from 2002 to 2009, shown in the second column of Table 4.2.3, the answer for the B1-occupations is yes. A glance at the coefficient of the interaction term reveals that the reform increased the probability of entering self-em‐ ployment significantly, by 0.79 percentage points. This result does not change significantly when year and branch dummies and further control variables are added (third column of Table 4.2.3). Moreover, including the A1- and A2-occupations in the sample shows that while the A2-occupations seem not to be significantly affected (fourth column), the probability of entering self-employment is 0.69 percentage points higher for the A1-occupations. Note the large significant coefficient of the interaction of the EU dummy and the post-policy period, underlin‐ 5 IV.2 Entry regulation and entrepreneurship 111 ing the importance of controlling for the enlargements of the EU. This co‐ efficient shows that the 2004 enlargement of the EU raised the probability of entry by 1.52 (1.22) percentage points according to column three (four). In Sect. 5.3, I demonstrate that the principal results remain unchanged af‐ ter all non- German craftsmen are excluded from the sample. Table 4.2.10 presents the same specifications as used in Table 4.2.3, employing logit models. The estimates tell a consistent story: the signs of the interaction terms are the same across models, and, apart from the coef‐ ficient of the interaction between the post-policy dummy and the indicator for A2-vocations and between the post-policy and the EU dummies, the same interactions are statistically significant. Here, the functional form might help to identify the coefficients of the treatment interactions more precisely, whereas the coefficient of the post-policy period’s interaction with the EU dummy becomes insignificant at the 10 % level in column four of Table 4.2.10. While entry probabilities increased, the reform may have raised exit probabilities in the same way. This finding would be consistent with the view that a major portion of new entrepreneurs in the post-policy period use fly-by-night tactics, i.e., they set up a company, do business for a short period and then disappear suddenly. However, the results reported in col‐ umn five of Table 4.2.10 suggest rather that the policy change generated quite a sustainable number of start-ups. The negative, though highly in‐ significant point estimates for the interaction terms of the B1-occupations point to an interpretation that exit probabilities remained constant or may even have fallen in the post-policy period. For the A1 and the A2 group, the coefficients are negative and insignificant as well. Similarly, the corre‐ sponding LPM estimates shown in column five of Table 4.2.3 are insignif‐ icant throughout. Higher entry probabilities and roughly steady exit probabilities would imply that the stock of self-employed craftsmen should be higher after the reform. And indeed, the last column of Table 4.2.10 presents estimates that are in line with the earlier findings. The interaction term of being selfemployed has a significant positive coefficient for both the B1- and A1vocations, the coefficient for the A2 group is also positive, though in‐ significant. The results of the LPM presented in column six of Table 4.2.3 are again consistent with the logit estimates. IV Past Reforms in the Services Sector and their Effects 112 Estimation results of self-employment state and transition probabilities LPM Entry LPM entry LPM entry LPM exit LPM self-employed dB1 × dPost 0.0079*(0.0043) 0.0070* (0.0042) 0.0077* (0.0041) −0.0285 (0.0240) 0.0227* (0.0118) dA1 × dPost 0.0069*(0.0039) −0.0103 (0.0145) 0.0266** (0.0101) dA2 × dPost 0.0055(0.0038) −0.0067 (0.0136) 0.0161 (0.0110) dEU × dPost 0.0152**(0.0060) 0.0122** (0.0052) −0.0585 (0.0395) 0.0539*** (0.0164) dB1 −0.0161*(0.0081) −0.0012 (0.0058) −0.0019 (0.0050) 0.0330*** (0.0116) 0.0094 (0.0167) dA1 0.0060(0.0038) −0.2727*** (0.0137) 0.0407*** (0.0063) d A2 −0.0303***(0.0038) 0.0758*** (0.0106) 0.0133 (0.0105) dPost −0.0036(0.0037) −0.0005 (0.0038) −0.0018 (0.0036) −0.0182 (0.0123) −0.0083 (0.0088) dEU 0.0007(0.0038) 0.0034 (0.0036) 0.0039 (0.0449) 0.0200* (0.0106) Constant 0.0280***(0.0066) 0.0128 (0.0091) 0.0337*** (0.0083) 0.7161*** (0.0420) −0.2571*** (0.0470) Year dummies yes yes yes yes Occ. Dummies yes yes yes yes Branch dummies yes yes yes yes Controls yes yes yes yes Adj-R2 <0.01 0.03 0.02 0.08 0.26 Observations 64,842 64,842 154,940 17,211 196,669 Notes: Robust standard errors, clustered by occupation, are given in parentheses below the coefficients of the linear probability model (LPM). Controls included are age and its square, and dummy variables indicating gender, type of secondary schooling and professional qualification, nationality, region of residence, the size of the respondent’s city of residence, marital status, number of dependent children, citizenship of foreign‐ ers in an EU member state and its interaction with the post-policy period. Moreover, year dummies for 2003, 2004, 2006, 2007, 2008, and 2009, and indicators for the branch of craftsmanship, for the occupation, as well as a constant are included. Signifi‐ cance of the logit coefficients is indicated at the 10 %/5 %/1 % level by asterisks (*/**/ ***). Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Table 4.2.3: IV.2 Entry regulation and entrepreneurship 113 Treatment effects on transition probabilities To ascertain the quantitative effect of the amendment on the probability of entry and exit, I first predict the respective probabilities of a person with average characteristics before and after the reform, using the estimates from the preferred logit models reported in Table 4.2.10. Having obtained these, in a second step I calculate their differences. For the entry probabili‐ ties the results are reported in Table 4.2.4. The expected probabilities for each of the three treatment groups and for the control group before the re‐ form are shown in columns two to five of the first row, with their standard errors below. The same figure for the period after the reform is shown in columns two to five of the third row. The last three columns of row one and three report the differences in the expected probabilities of each of the treatment groups and the control group before and after the reform. Columns two to five of the last two rows in the upper panel present the differences in the same occupational group before and after the reform along with their standard errors. Finally, the last three columns show the difference in these differences, i.e., the cross differences. The lower panel shows how the counter-factual cross differences are obtained (see Puhani 2012). While the row displaying the expected proba‐ bilities before the reform is identical to the corresponding row in the upper panel, the expected probabilities for the post-reform period are predicted to constrain the reform’s effect to zero. Then, at the bottom of the table, the average treatment effects on the treated, i.e., the differences in the ac‐ tual cross differences from the upper panel and the counter-factual cross differences from the lower panel, are reported, in both absolute and rela‐ tive terms. The first thing that leaps out is that the probability of engaging in en‐ trepreneurship for individuals of the B1 group is substantially lower than that of the other occupational groups before the reform. From this compa‐ rably lower level, the entry probability resulting from the reform increased by 0.15 % points. This economically relevant effect is also statistically sig‐ nificant, with a standard error of 0.04 (p value <0.01). The probability of entering self-employment would have been 0.40−0.15 = 0.25 in the hypo‐ thetical situation without a reform. This shows that the entry probability has been increased dramatically with the reform; its relative effect amounts to 60.00 %. Effects of this kind are found in the A1- and A2-professions, too. The former group experienced an increase in the probability of entry of 0.56 5.1 IV Past Reforms in the Services Sector and their Effects 114 percentage points. This increase is significantly different from zero, with a standard error of 0.26 (p value 0.03). Consequently, this suggests that the opportunity to start a business without the Meister certificate provided by Probabilities of entry into self-employment (in %): differ‐ ence-in-differences B1 A1 A2 AC ΔB1 ΔA1 ΔA2 Panel A Before reform 2004 0.25*** (0.02) 1.86*** (0.16) 2.38*** (0.20) 3.73**** (0.49) −3.48*** (0.50) −1.88*** (0.45) −1.35*** (0.42) After reform 2004 0.40*** (0.02) 2.39*** (0.12) 3.01*** (0.16) 3.68*** (0.30) −3.28*** (0.31) −1.29*** (0.22) −0.67*** (0.19) Δ Between after and before reform 2004 0.14*** (0.02) 0.53*** (0.18) 0.63*** (0.21) −0.06 (0.48) 0.20 (0.48) 0.59 (0.47) 0.69 (0.49) Panel B Before reform 2004 0.25*** (0.02) 1.86*** (0.16) 2.38*** (0.20) 3.73*** (0.49) −3.48*** (0.50) −1.88*** (0.45) −1.35*** (0.42) After reform 2004 0.25*** (0.04) 1.83*** (0.25) 2.35*** (0.33) 3.68*** (0.30) −3.43*** (0.30) −1.85*** (0.30) −1.33*** (0.29) Δ Between after and before reform 2004 0.00 (0.03) −0.03 (0.24) −0.04 (0.31) −0.06 (0.48) 0.05 (0.45) 0.03 (0.24) 0.02 (0.17) Panel C Difference-in-differences 0.15*** (0.04) 0.56** (0.26) 0.67** (0.34) Relative difference-in-differences 60.00 30.60 28.63 Notes: Panel A shows the expected probabilities for the treatment groups (B1, A1, A2) and for the control group (AC) of a person with average characteristics before and after the reform, rounded to two decimal places. Moreover, it depicts the differences in the expected probabilities and the difference in these differences, i.e., the cross differences. The next part of the table shows how the counter-factual cross differences are obtained using the expected probabilities for the post-reform period, which result when the re‐ form’s effects are restricted to zero. Panel C reports the ATT, i.e., the differences in these cross differences. The relative differences in differences are computed, respec‐ tively, as the fraction of the treatment effect and the expected probability in the postpolicy period subtracted by the treatment effect. The same calculation, based on the av‐ erages of the respective probabilities among actual persons in the data instead of the expected probabilities of a person with average characteristics, yields similar results and is available upon request Cluster (occupation) robust standard errors calculated by the delta method are in parentheses. Asterisks (*/**/***) denote significance at the 10 %/5 %/1 % level Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Table 4.2.4: IV.2 Entry regulation and entrepreneurship 115 the Altgesellen rule has been used extensively in this group. The results further show that the craftsmen in A2-occupations responded to the reduc‐ tion and partial exemption of the entry barrier with an increase of 0.67 percentage points, which is significant with a standard error of 0.34 (p val‐ ue 0.05). In relative terms, the reform increased the entry probability of the A1 group by 30.60 %, while for A2-occupations, the entry probability was 28.63 % higher than the hypothetical situation without the reform. How sustainable are these entries? In Table 4.2.5, I present results that support the hypothesis that the amendment of the HwO did not signifi‐ cantly alter the probability of exit from self-employment. The reform’s ef‐ fect for the B1-occupations is −1.77 percentage points, with a standard er‐ ror of 3.19. This negative effect is insignificant (p value 0.58). Similarly, the effect of −0.22 percentage points for A1-vocations is highly insignifi‐ cant, with a standard error of 0.38 (p value 0.57). Thus, more sustainable business entries could be established after the deregulation. The results suggest that this is due to the reform, and support the findings in Prantl (2012) that this entry regulation suppressed long-living entrants. For A2occupations, the treatment effect of −0.11, though insignificant with a standard error of 0.37 (p value 0.76), points to a rather small decrease in the exit rate caused by the amendment. In fact, the point estimate is even positive once 2009 is excluded from the sample. One reason for this could be that in this group fly-by-night strategies might be more common. These, in turn, could be encouraged by the combination of the Altgesellen rule and the partial exemption for small businesses. For instance, splitting a firm up into one that runs the main business and another that serves as an ancillary business makes it easy to once more absorb the smaller one when it becomes convenient. However, on top of the fact that none of the effects on the exit probabilities is significant, the relative effects are rather small using the sample up to 2006 or 2008. Including 2009, they are −17.00, 20.37, and −11.83 % for the B1-, A1-, and A2-vocations, respectively. Treatment effects on self-employment probabilities As discussed above, the higher entry rates, together with constant exit rates, should raise the stock of self-employed persons. In fact, Table 4.2.6 shows that after accounting for the counter-factual situation without the reform, a person with average characteristics in a B1-occupation is 0.41 percentage points more likely to engage in entrepreneurship. This effect is 5.2 IV Past Reforms in the Services Sector and their Effects 116 significant, with a standard error of 0.11 (p value <0.01). The effect on the A1-occupations is larger. The probability of being self-employed in‐ Probabilities of exit from self-employment (in %): differencein-differences B1 A1 A2 AC ΔB1 ΔA1 ΔA2 Panel A Before reform 2004 19.69*** (3.23) 2.24*** (0.30) 1.94*** (0.29) 0.67*** (0.16) 19.02*** (3.21) 1.57*** (0.31) 1.27*** (0.31) After reform 2004 8.64*** (0.92) 0.86*** (0.07) 0.82*** (0.10) 0.32*** (0.04) 8.33*** (0.93) 0.54*** (0.08) 0.50*** (0.10) Δ Between af‐ ter and before reform 2004 −11.05*** (2.92) −1.38*** (0.36) −1.13*** (0.34) −0.35* (0.19) −10.70*** (2.88) −1.03*** (0.37) −0.78** (0.38) Panel B Before reform 2004 19.69*** (3.23) 2.24*** (0.30) 1.94*** (0.29) 0.67*** (0.16) 19.02*** (3.21) 1.57*** (0.31) 1.27*** (0.31) After reform 2004 10.41*** (3.31) 1.07*** (0.36) 0.93*** (0.35) 0.32*** (0.04) 10.09*** (3.28) 0.75** (0.33) 0.61** (0.31) Δ Between af‐ ter and before reform 2004 −9.28** (3.81) −1.16*** (0.43) −1.01*** (0.36) −0.35* (0.19) −8.93** (3.64) −0.81*** (0.26) −0.66*** (0.19) Panel C Difference-in-differences −1.77 (3.19) −0.22 (0.38) −0.11 (0.37) Relative difference-in-differences −17.00 −20.37 −11.83 Notes: Panel A shows the expected probabilities for the treatment groups (B1, A1, A2) and for the control group (AC) of a person with average characteristics before and after the reform rounded to two decimal places. Moreover, it depicts the differences in the expected probabilities and the difference in these differences, i.e., the cross differences. The next part of the table shows how the counter-factual cross differences are obtained using the expected probabilities for the post-reform period, which result when the re‐ form’s effects are restricted to zero. The Panel C reports the ATT, i.e., the differences in these cross differences. The relative differences in differences are computed, respec‐ tively, as the fraction of the treatment effect and the expected probability in the postpolicy period subtracted by the treatment effect. The same calculation, based on the av‐ erages of the respective probabilities among actual persons in the data instead of the expected probabilities of a person with average characteristics, yields similar results and is available upon request Cluster (occupation) robust standard errors calculated by the delta method are in parentheses. Asterisks (*/**/***) denote significance at the 10 %/5 %/1 % level Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Table 4.2.5: IV.2 Entry regulation and entrepreneurship 117 creased significantly by 2.80 percentage points, with a standard error of 1.08 (p value 0.01). A more flexible specification reported in Table 4.2.12 shows that this large effect is driven mainly by the years 2007, 2008 and 2009. Given that these years are relatively far from the date of the amend‐ ment to the HwO, one should be careful to attribute this effect to the re‐ form. Still, a marginally insignificant effect of 1.23 percentage points (p value 0.89) is observed when the years 2007, 2008 and 2009 are excluded (cf. Rostam-Afschar 2010). Further, the treatment effect for the A2-voca‐ tions including all years is 2.10 percentage points. This effect does not achieve statistical significance at the 10 % level with a standard error of 1.42 (p value 0.14). Note that the probability of being self-employed is substantially smaller for the B1-vocations in the first place. Therefore, the relative effect of 41.41 % is the largest compared to the other groups of craftsmen. For the A1-vocations the relative effect amounts to 20.59 % and to 14.21 % for the A2-professions. Heterogeneous treatment effects Who are these new entrepreneurs in craftsmanship? In this section, I take a closer look at the heterogeneity of treatment effects. This helps to deter‐ mine individual subgroups within the treatment groups on which the re‐ form had the greatest impact. Individuals, who are disadvantaged in terms of labor market opportunities, such as craftsmen with- out any profession‐ al qualification and female craftsmen, might see self-employment as a way out of unemployment (cf. Caliendo and Künn 2011). From Table 4.2.2, we know that treatment group B1, which ultimately showed the strongest rela‐ tive increase in the post-policy period, comprises more craftsmen without qualification, as well as more female craftsmen, compared with the other treatment groups. Thus, I expect the effects of the policy change to be highest for craftsmen with the above-mentioned characteristics in the B1 group. If the higher entries documented previously for the A1- and the A2-oc‐ cupations reflect the effects of the Altgesellen rule, this would be the re‐ sult of more Geselle- qualified craftsmen engaging in entrepreneurship. Thus, I expect that the largest effect for the groups of A1- and the A2-vo‐ cations will be observed for the subsample with this level of professional qualification. 5.3 IV Past Reforms in the Services Sector and their Effects 118 Moreover, I split the sample by nationality and by indication of having received public payments to show that the effects of the amendment to the Probabilities of being self-employed (in %): difference-in-dif‐ ferences B1 A1 A2 AC ΔB1 ΔA1 ΔA2 Panel A Before reform 2004 1.04*** (0.07) 14.21*** (0.71) 15.44*** (0.93) 22.62*** (1.99) −21.58*** (1.98) −8.41*** (1.59) −7.18*** (1.47) After reform 2004 1.40*** (0.06) 16.40*** (0.70) 16.88*** (0.95) 21.73*** (1.99) −20.33*** (1.98) −5.34*** (1.43) −4.85*** (1.41) Δ Between after and before re‐ form 2004 0.36*** (0.09) 2.19*** (0.76) 1.44 (1.22) −0.89 (1.47) 1.25 (1.46) 3.08** (1.48) 2.33 (1.69) Panel B Before reform 2004 1.04*** (0.07) 14.21*** (0.71) 15.44*** (0.93) 22.62*** (1.99) −21.58*** (1.98) −8.41*** (1.59) −7.18*** (1.47) After reform 2004 0.99*** (0.10) 13.59*** (1.15) 14.78*** (1.35) 21.73*** (1.99) −20.74*** (1.95) −8.14*** (1.44) −6.95*** (1.32) Δ Between after and before re‐ form 2004 −0.05 (0.08) −0.62 (1.00) −0.66 (1.07) −0.89 (1.47) 0.84 (1.38) 0.27 (0.46) 0.23 (0.39) Panel C Difference-in-differences 0.41*** (0.11) 2.80*** (1.08) 2.10 (1.42) Relative difference-in-differences 41.41 20.59 14.21 Notes: Panel A shows the expected probabilities for the treatment groups (B1, A1, A2) and for the control group (AC) of a person with average characteristics before and after the reform rounded to two digits after the decimal point. Moreover, it depicts the dif‐ ferences in the expected probabilities and the difference in these differences, i.e., the cross differences. The next part of the table shows how the counter-factual cross differ‐ ences are obtained using the expected probabilities for the post-reform period, which result when the reform’s effects are restricted to zero. The Panel C reports the ATT, i.e., the differences in these cross differences. The relative differences in differences are computed, respectively, as the fraction of the treatment effect and the expected probability in the post-policy period subtracted by the treatment effect. The same cal‐ culation, based on the averages of the respective probabilities among actual persons in the data instead of the expected probabilities of a person with average characteristics, yields similar results and is available upon request. Cluster (occupation) robust standard errors calculated by the delta method are in paren‐ theses. Asterisks (*/**/***) denote significance at the 10 %/5 %/1 % level Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Table 4.2.6: IV.2 Entry regulation and entrepreneurship 119 HwO are not distorted by the effects of other policies that potentially af‐ fect entrepreneurs. Table 4.2.7 shows the results of repeating the logit estimations from the main analysis for different subsamples, and then obtaining the absolute and the relative treatment effects. The first two columns present findings when the sample is restricted to German craftsmen and to craftsmen who indicated having not received substantial public payments (SPP). Appar‐ ently, for both subsamples the estimated coefficients are almost always slightly smaller compared with the overall results. This is true for the probabilities of entering self-employment and the probabilities of being self-employed. The probabilities of exit from self-employment are again insignificant (not reported, available on request). As the magnitudes and the significance of the effects are roughly the same, I conclude that the main results are not confounded by the enlargements of the EU or by sub‐ sidies for entrepreneurs. The next two columns display the treatment effects for female and male craftsmen. Surprisingly, the reform turns out not to have been effective for the entry probability of female craftsmen. Instead, the effects on the prob‐ abilities of entering self-employment are all positive and significant for male craftsmen. Moreover, the probabilities of exit are again highly insignificant for fe‐ male and male craftsmen of all vocational groups apart from females working in B1-occupations; their treatment effect does not fail signifi‐ cance at the 10 % level (p value 0.07). Here, the results indicate that the reform decreased the probabilities of exit from self-employment by 7.24 percentage points with a standard error of 3.98 implying a substantial rela‐ tive reduction, namely of 58.45 %. This means that a reduction of exits, together with a constant entry rate, increased the stock of female crafts‐ men. Indeed, the probability of being self-employed seems to be higher for female B1-craftsmen after the reform. This fact is intriguing, since the re‐ form should affect entries as it deregulates entry barriers but not exits. However, this result could stem from indirect effects of the deregulation, as the reform changed the competitive environment. To investigate this further is left to future research. Turning to the effects on the share of self-employed in the bottom part of Table 4.2.7, a different pattern is apparent for both sexes. For male craftsmen from the A2 group, the increases in the entry probabilities are not accompanied by a significant rise in the probabilities of being self-em‐ ployed. For females in this group, the entry probability seems to have been IV Past Reforms in the Services Sector and their Effects 120 unaffected, while the self-employment probability seems to have been in‐ creased, though not significantly. This could be due to increased exit rates although the positive point estimates are insignificant as well and very small. However, for females as well as for males in the B1- and A1-occu‐ pations, the treatment effects on the share of self-employed achieve signif‐ icance at the 10 % level (p values <0.01, 0.04, 0.04 and 0.01). Thus, while the evidence is not strong that both female in all and male craftsmen in the Treatment effects on entry into self-employment and on the share of self-employed for subgroups (in %): difference-indifferences Sample German Unsubsi‐ dized Female Male No quali‐ fication Geselle Meister Treatment effects on entry into self-employment DIDB1 0.13*** (0.03) 0.13*** (0.03) −0.01 (0.06) 0.36*** (0.12) 0.23*** (0.06) 0.16*** (0.05) 0.07 (0.46) Relative DIDB1 57.90 68.18 −8.16 55.92 806.97 78.09 4.61 DIDA1 0.57** (0.26) 0.64*** (0.21) −1.34 (1.08) 0.62*** (0.20) 1.43* (0.79) 0.81*** (0.21) −2.33 (1.51) Relative DIDA1 32.25 43.27 −52.10 57.46 354.18 93.87 −30.87 DIDA2 0.66** (0.33) 0.60** (0.25) 0.00 (0.01) 0.57** (0.26) 6.40*** (2.44) 0.89*** (0.33) −1.87 (1.49) Relative DIDA2 30.01 32.38 0.00 39.23 573.94 71.37 −26.56 Treatment effects on the share of self-employed DIDB1 0.34*** (0.10) 0.34*** (0.10) 0.56*** (0.16) 0.51** (0.24) 0.50*** (0.12) 0.32 (0.20) 0.88 (0.55) Relative DIDB1 35.70 37.71 114.38 24.59 77.55 29.79 18.39 DIDA1 2.64** (1.05) 2.48** (1.14) 7.33** (3.55) 1.63** (0.65) 2.29 (1.77) 2.20** (1.12) 2.61 (2.33) Relative DIDA1 18.71 19.55 53.66 13.84 29.52 28.20 4.49 DIDA2 1.73 (1.37) 1.82 (1.41) 11.33 (9.42) 0.87 (0.86) 3.22 (2.58) 1.86 (1.37) 3.05 (2.62) Relative DIDA2 11.58 13.87 44.43 7.00 32.22 21.14 6.04 Notes: The treatment effects are based on the expected probabilities for a person with average characteristics. The relative differences in differences are computed as the fraction of the treatment effect and the expected probability in the post-policy period, subtracted by the treatment effect, respectively. Cluster (occupation) robust standard errors calculated by the delta method are in paren‐ theses. Asterisks (*/**/***) denote that a difference-in-differences is significantly different from zero at the 10 %/5 %/1 % level Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Table 4.2.7: IV.2 Entry regulation and entrepreneurship 121 A2 group experienced the intended effects of the reform, the results sug‐ gest that the increases reported in Tables 4.2.4 and 4.2.6 for the B1- and A1-occupations stem largely from male craftsmen engaging more often in entrepreneurship. The last three columns show the results obtained by splitting up the sample by professional qualification. The results show a clear picture: The amendment to the HwO had a positive effect on the entry probabilities of untrained craftsmen across all three treatment groups. These increases in entries also raised the probability of being self-employed for each of the groups. This implies that these businesses survived for some time. While the latter effects are insignificant for the A1- and A2-vocations, they are highly significant for the B1-occupations. Therefore, the expectation that craftsmen without professional qualifi‐ cation entered entrepreneurship more often in the B1-occupations is sup‐ ported by the results. Furthermore, the reform encouraged craftsmen who hold a Geselle de‐ gree to enter entrepreneurship. This was the purpose of the Altgesellen rule, and the objectives of this policy seem to have been accomplished. However, the fact that these entries could not increase the probability of being self-employed significantly, except for A1-vocations, favors the view that some of these new entrepreneurs used fly-by-night strategies. For example, a Meister could ask one of his Altgesellen to set up an ancil‐ lary business to drive a rival out of the market. The last column shows that for Meister craftsmen the reform had, as expected, no significant effect at all. Specification and sensitivity tests To assess the validity of the assumptions on which the DID approach is based, and to gage the robustness of the findings in this analysis, the logit models of the probability of being self-employed and of the transition probabilities are reestimated, varying the estimation sample, the definition of variables, and the specification. Column one in Table 4.2.11 shows the results of estimating the same specification as in the main analysis, in which the year 2001 is included. Obviously, the size and significance of the estimates are similar to those reported in Table 4.2.10. Hence, using this sample does not distort the main results. However, I decided to exclude 2001 from the sample be‐ 5.4 IV Past Reforms in the Services Sector and their Effects 122 cause a “placebo test” discussed below indicates significant coefficients of the interaction between a placebo reform dummy and the A1- and A2-vo‐ cation dummies, respectively. In columns two and three, I display the results when the year 2004 is omitted from the sample and when it is defined as belonging to the postpolicy period, respectively. Recall that the post-policy period was defined as being from 2005 to 2009 in the main analysis. I do this because up until 2005 the last week of April was usually the reference week of the survey, and the amendment to the HwO came into effect at the beginning of 2004. Apparently, dropping the year 2004 does not change the results a great deal, while defining 2004 as part of the post-policy period reduces the esti‐ mates somewhat. This shows that individuals needed some time to adjust to the new policy, as argued above. Next, in columns four to six, I scrutinized whether influences other than the actual treatment of the treatment groups were present but did not influ‐ ence the comparison group. Such influences would have confounded the analysis. In most settings, there is no way to test for these influences di‐ rectly, so placebo tests are based on the idea of reestimating the models while pretending that the policy event took place in a year prior to the ac‐ tual policy change. First, the post-policy period indicator is redefined to represent the period from 2003 to 2004, as if the policy change had taken place in late 2002. Second, the logit model for the probability of being self-employed is reestimated without the actual post-policy period to avoid measuring the true effect of the reform. These steps are repeated for a placebo policy reform in late 2003. In column four, the coefficients for the interaction terms turn out to be significant for the B1- and A1-occupations when the estimation sample in‐ cludes the year 2001— which is why the main analysis was based on the sample from 2002 to 2009. The interaction coefficients in columns five and six are insignificant, which would not be the case if confounding fac‐ tors existed before the policy change. Therefore, assuming this result ex‐ tends to the post-policy period, the validity of the identifying assumption of the DID analysis receives support. Furthermore, I examine the assumption of common trends more explic‐ itly by replacing the post-policy period dummies in the interactions with time dummies and all interactions involving the post-policy period dum‐ my with interactions using time dummies instead. Correspondingly, I in‐ cluded interactions between the branch dummies and time dummies. The results (see Table 4.2.12) are in line with the prior findings shown in Table IV.2 Entry regulation and entrepreneurship 123 4.2.10 that provided evidence that the probability of being self-employed increased significantly for B1-occupations; the coefficients of the interac‐ tions of the B1-dummy with year dummies from the post-policy period are individually positive, significant and of similar magnitude throughout. In‐ terestingly, the coefficients for the interactions in the A1-occupations are increasing in size and statistical significance over time. This suggests that the effects of the reform presented in Table 4.2.6 emerged only after some time for the A1-occupations. This is consistent with the picture in Figs. 4.2.1 and 4.2.2 where the lines representing the A1-occupations change slower than those of the B1-occupations. The fact that only very few entries are observed compared to non-en‐ tries could lead to a different problem highlighted in King and Zeng (2001). This study shows that applying the standard logistic regression po‐ tentially leads to significant distortion of the results as the finite sample bias is amplified by the rare occurrence of events. This should not be a problem because the sample size used should be sufficiently large— for the B1-occupations more than 700 entries are observed. Indeed, the differ‐ ences between the standard logit and a rare events logit model are very small (available on request); the general results of the main analysis re‐ main unchanged. In a further robustness check which is available on request, I collapse the sample by occupation and year. Then, I calculate the differences in dif‐ ferences as in the analysis based on individual data. The coefficient of the interaction between the B1-dummy and the post-policy period dummy of the same specification as in column four of Table 4.2.3 changes from 0.0077 (0.0041) to 0.0073 (0.0054). Running the specification of column six where the rate of self-employment is the dependent variable, the coef‐ ficient of the same interaction has a standard error of 0.0118 on the indi‐ vidual and of 0.0146 on the occupational level. The point estimate is 0.0179 on the occupational level. Moreover, I run regressions restricting the sample to individuals above various ages to see whether conditioning on vocational training could bias the results. The idea is that craftsmen who achieved their qualification ob‐ jectives long ago do not condition their decision to obtain a Meister degree on the desire to be an entrepreneur. Otherwise they would have had enough time to obtain the Meister degree if they had wanted to. On aver‐ age, since 2002 craftsmen have obtained the Meister degree at an age be‐ low 30, according to the Chambers of Crafts and Trade. Less than 7 % of the craftsmen that passed the Meister exam were above 40 years old in IV Past Reforms in the Services Sector and their Effects 124 2006/7. Restricting the sample to craftsmen older than 30, 35, and 40, I obtained treatment effects that are significant but slightly larger than those obtained from the entire sample. Complete estimation results are available on request. Summary and conclusions In pursuit of an answer to how the amendment to the HwO in 2004 influ‐ enced entrepreneurs in German craftsmanship, this paper evaluates the ef‐ fect of this reform on the probability of entering self-employment and of exiting from self-employment. Evidence is provided concerning how the probability of being self-employed changed as a result of the reform for three treatment groups that experienced different degrees of deregulation. Among other modifications, these legislative changes exempted the group of B1-craftsmen altogether from the requirement of passing a Meister ex‐ amination for admission to entrepreneurship, while for the A1- and A2-oc‐ cupations the entry requirement has been reduced; a lower level of voca‐ tional training has been required since the reform. This is known as the Altgesellen rule. Moreover, the amendment exempted a portion of the A1occupations from the Altgesellen rule under the condition of limiting busi‐ ness to simple activities that frequently take the opportunity to establish small businesses. This defines the A2 group. Apart from these deregula‐ tions, the HwO also provides a natural comparison group, because for some professions, the entry requirement remained mandatory. According to the legislation, four distinct occupational groups can be identified in the data from the German microcensus from 2002 to 2009. These groups are exploited within this setting in a natural experiment. The results of a DID analysis provide evidence that the probability of being self- employed in‐ creased significantly with the amendment to the HwO among B1- and A1occupations, while the positive effect fails to achieve significance for the A2- vocations. The strongest relative increase amounts to more than 40 %. This occurred in the group of B1-craftsmen that have received the strongest treatment. In A1- and A2-occupations, the results indicate weak‐ er, but still positive relative effects. The analysis shows further that these increases are caused by significant increases to the probabilities of entry across all three groups, whereas the probabilities of exit from self-employ‐ ment remained virtually unaffected by the policy change. 6 IV.2 Entry regulation and entrepreneurship 125 Two key findings that result from an investigation of heterogeneous treatment effects have important policy implications. First, the findings suggest that the increases in the entry probabilities result from male crafts‐ men who are significantly more likely to start businesses after the reform in all occupation groups. There is weaker evidence that, for these groups, the probabilities of being self-employed also increased after the reform. The results for female craftsmen are less clear: the entry probabilities seem not to have been affected at all, while the results for the self-employ‐ ment probabilities point to a positive effect. Second, untrained workers, mainly among the B1- and A2-vocations, have a significantly higher probability of starting a business after the re‐ form. Consequently, the probability of being self-employed is higher for this group, which is disadvantaged in the labor market. Craftsmen of all occupations that completed an apprenticeship also have engaged more in entrepreneurship since the reform, which was the intended effect of the Altgesellen rule. The increase in entries seems to have led to a greater probability of being self-employed for craftsmen trained in an apprentice‐ ship, though the evidence is weak. Interpreting these results, it is important to bear in mind that these re‐ sults focus only on engagement in entrepreneurship, and do not replace an evaluation of the reform in terms of its welfare effects on the German economy. Appendix Stock of businesses at the end of the year A B1 B2 Total 2002 590,146 76,044 177,471 843,661 2003 587,762 74,940 183,886 846,588 2004 595,309 102,568 189,216 887,093 2005 600,287 129,591 192,805 922,683 2006 603,443 149,981 193,474 946,898 2007 603,757 166,015 191,434 961,206 2008 602,605 175,557 188,526 966,688 2009 Data not available heretofore Notes: Müller (2006) argues that the actual stock of businesses is about 15 % lower than the reported stock due to registered but non-active businesses. Source: Own calculations based on Müller (2006) and data provided by the German Confederation of Skilled Crafts Table 4.2.8: IV Past Reforms in the Services Sector and their Effects 126 Self-employment rates in treatment groups and control group by year B1 A1 A2 AC WP 2002 7.88 15.20 12.41 19.26 11.17 2003 7.54 15.80 12.92 19.68 11.56 2004 8.20 16.98 13.38 20.91 12.00 2005 9.32 17.22 13.96 20.81 12.44 2006 9.48 17.39 14.20 18.49 12.27 2007 9.73 17.76 13.83 20.46 12.11 2008 9.78 17.24 13.69 19.30 11.95 2009 9.87 18.66 14.51 18.13 12.13 Percentage share of self-employed among B1, A1, A2, and AC occupations and per‐ centage share of self- employed among working persons (WP) Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Table 4.2.9: IV.2 Entry regulation and entrepreneurship 127 Estimation results of self-employment state and transition probabilities Logit entry Logit entry Logit entry Logit exit Logit self-em‐ ployed dB1 × dPost 0.4556*** (0.1466) 0.4152*** (0.1446) 0.4630*** (0.1440) −0.2057 (0.3426) 0.3528*** (0.1071) d A1 × dPost 0.2719* (0.1427) −0.2270 (0.3657) 0.2205** (0.0907) d A2 × dPost 0.2571* (0.1440) −0.1331 (0.4098) 0.1579 (0.1099) dEU × dPost 1.1145** (0.5305) 0.4527 (0.2855) −0.8180 (0.5496) 0.5809** (0.2667) dB1 −0.8704* (0.4738) 0.1464 (0.1935) −2.7259*** (0.1749) 3.5941*** (0.2985) −3.3255*** (0.1234) d A1 −0.7175*** (0.1290) 1.2221*** (0.2482) −0.5682*** (0.0852) d A2 −0.4634*** (0.1157) 1.0784*** (0.2652) −0.4706*** (0.0795) dPost −0.1400 (0.1310) 0.1150 (0.1951) −0.0309 (0.1346) −0.7154** (0.3469) −0.0709 (0.0831) dEU −0.1224 (0.5657) 0.1646 (0.2094) −0.2910 (0.5718) 0.4252*** (0.1453) Constant −3.5482*** (0.2416) −3.7692*** (0.7454) −1.4658*** (0.4525) −1.4618 (0.8993) −2.2017*** (0.5096) Year dummies yes yes yes yes Occ. dummies yes yes yes yes Branch dummies yes yes yes yes Controls yes yes yes yes Log likelihood −5,346.12 −4,577.49 −13,667.83 −2,159.01 −54,391.46 Pseudo-R2 <0.01 0.15 0.10 0.20 0.30 Observations 64,842 64,842 154,940 17,211 196,669 Notes: Robust standard errors, clustered by occupation, are given in parentheses below the coefficients of the logit models. Controls included are age and its square, and dum‐ my variables indicating gender, type of secondary schooling and professional qualifi‐ cation, nationality, region of residence, the size of the respondent’s city of residence, marital status, number of dependent children, citizenship of foreigners in an EU mem‐ ber state and its interaction with the post-policy period. Moreover, year dummies for 2003, 2004, 2006, 2007, 2008, and 2009, and indicators for the branch of craftsman‐ ship, for the occupation, as well as a constant are included. Significance of the logit coefficients is indicated at the 10 %/5 %/1 % level by asterisks (*/**/***) Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Table 4.2.10: IV Past Reforms in the Services Sector and their Effects 128 Timing sensitivity: Logit estimation results of self-employ‐ ment state probabilities Self-em‐ ployed: timing (2001–2009) I Self-em‐ ployed: timing 2004 ropped (2002–2009) II Self-em‐ ployed: timing 2004 as post (2002–2009) III Self-em‐ ployed: Placebo re‐ form in 2002 (2001–2004) IV Self-em‐ ployed: Placebo re‐ form in 2002 (2002–2004) V Self-em‐ ployed: Placebo re‐ form in 2003 (2002–2004) VI dB1 × dPost 0.4505*** (0.1029) 0.3853*** (0.1055) 0.3173*** (0.0839) 0.2432* (0.1427) 0.0829 (0.1373) 0.1087 (0.1163) dA1 × dPost 0.3183*** (0.0895) 0.2533*** (0.0850) 0.2295*** (0.0667) 0.2878** (0.1401) 0.1433 (0.1309) 0.1133 (0.0938) dA2 × dPost 0.2139** (0.1079) 0.1818* (0.1105) 0.1476* (0.0879) 0.2032 (0.1414) 0.1370 (0.1397) 0.0788 (0.0924) dEU × dPost 0.6124** (0.2497) 0.6695*** (0.2529) 0.5106** (0.2485) 0.2622 (0.1617) 0.3116* (0.1813) 0.2640 (0.1900) dB1 −1.0689*** (0.2088) −1.0644*** (0.2093) −0.9379*** (0.2159) −1.1287*** (0.2103) −1.0182*** (0.2296) −1.0017*** (0.2265) dA1 1.7002*** (0.2000) 1.6872*** (0.2046) 1.7793*** (0.2013) 1.6867*** (0.2032) 1.7667*** (0.2283) 1.8234*** (0.2108) dA2 −0.5579*** (0.0709) −0.5403*** (0.0841) −0.4517*** (0.0665) −0.6524*** (0.0891) −0.4838*** (0.1110) −0.4168*** (0.0645) dPost −0.0953 (0.0778) −0.0996 (0.0730) −0.1750*** (0.0593) −0.1052 (0.1364) −0.0492 (0.1261) −0.0258 (0.0898) dEU 0.4142*** (0.1370) 0.3323*** (0.1216) 0.5428*** (0.1302) 0.3276** (0.1317) 0.2344 (0.1482) 0.3574*** (0.1243) Constant −4.5595*** (0.4784) −4.4227*** (0.4945) −4.4666*** (0.4845) −4.8397*** (0.4515) −4.8152*** (0.4603) −4.8564*** (0.4536) Year dum‐ mies yes Yes yes Yes yes yes Occ. dum‐ mies yes Yes yes Yes yes yes Branch dummies yes Yes yes Yes yes yes Controls yes Yes yes Yes yes yes Log likeli‐ hood −60,898.75 −47,945.16 −54,411.65 −25,907.46 −19,434.86 −19,435.57 Pseudo-R2 0.30 0.30 0.30 0.32 0.31 0.31 Observa‐ tions 223,241 172,664 196,669 101,709 75,137 75,137 Notes: Robust standard errors clustered by occupation are given in parentheses below logit coefficients. Controls included are age and its square, and dummy variables indi‐ cating gender, type of secondary schooling and professional qualification, nationality, region of residence, the size of the respondent’s residence city, marital status, the num‐ ber of children, citizenship of foreigners in a member state of the European Union and Table 4.2.11: IV.2 Entry regulation and entrepreneurship 129 its interaction with the post-policy period. Moreover, year dummies and indicators for the branch of craftsmanship, for the occupation, and a constant are included. Significance of the logit coefficients is indicated at the 10 %/5 %/1 % level by asterisks (*/**/***) Source: Own calculations based on the scientific use file of the German microcensus (2001–2009) Robustness: Logit estimation results of self-employment state probabilities Self-employed: B1 Self-employed: A1 Self-employed: A2 dO × d2003 −0.0010 (0.1596) 0.0875 (0.1567) 0.0747 (0.1773) dO × d2004 0.2407 (0.1664) 0.1582 (0.1746) 0.1383 (0.1942) dO × d2005 0.4233*** (0.1608) 0.2287 (0.1626) 0.1826 (0.1912) dO × d2006 0.4283** (0.1824) 0.2445 (0.1762) 0.1815 (0.1968) dO × d2007 0.4755*** (0.1356) 0.3556*** (0.1324) 0.2027 (0.1667) dO × d2008 0.4566*** (0.1638) 0.3337** (0.1401) 0.1501 (0.1960) dO × d2009 0.5520*** (0.1957) 0.4807*** (0.1541) 0.3297* (0.1781) Notes: Robust standard errors, clustered by occupation, are given in parentheses below logit coefficients. Controls included are age and its square, and dummy variables indi‐ cating gender, type of secondary schooling and professional qualification, nationality, region of residence, the size of the respondent’s city of residence, marital status, the number of dependent children, citizenship of foreigners in an EU member state and its interaction with the post-policy period. Moreover, year dummies and indicators for the branch of craftsmanship, for the occupation, and a constant are included. The log-like‐ lihood value is −54,322.07, the pseudo-R2 0.3, and the number of observations 196,669. Significance of the logit coefficients is indicated at the 10 %/5 %/1 % level by asterisks (*/**/***) Source: Own calculations based on the scientific use file of the German microcensus (2002–2009) Description of key variables – Entrepreneur: Are you working as self-employed (with or without em‐ ployees)? This definition includes non-incorporated self-employed as well as incorporated self- employed. 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Small Business Economics 28(2–3), 171–186 Viviano, E. (2008): Entry regulations and labour market outcomes: evidence from the Italian retail trade sector. Labour Economics 15(6), 1200–1222 IV.2 Entry regulation and entrepreneurship 133 Structural Reforms in Transportations: Dynamics and Sectorial Spillovers (Paolo Mengano) Paolo Mengano, Bocconi University Abstract This paper empirically investigates the short-run and long-run effects of implementing deregulation in the Transportation sector and the spillover effects in the Manufacturing sector. Exploiting the novel CompNet database and the OECD’s database on Product Market Regulations, this paper adopts a Panel SVAR methodology on a sample of 16 European countries over a period of 12 years. The transition dynamics in the sectori‐ al economy caused by a sector-specific change in regulation are very simi‐ lar to the ones generated by a modification of the national legislation: re‐ forms have recessionary effects on the economy in the short-run despite being expansionary in the long-run. The spillover effects in the Manufac‐ turing sector lead to contractions in the economy that are more moderate than the ones occurring in the Transportation sector, and take place only with a delay of one year. Introduction “Structural reforms are, in my view, best defined as policies that permanently and positively alter the supply-side of the economy. This means that they have two key effects. First, they lift the path of potential output, either by raising the inputs to production – the supply and quality of labour and the amount of capital per worker – or by ensuring that those inputs are used more efficient‐ ly, i.e. by raising total factor productivity (TFP). And second, they make economies more resilient to economic shocks by facilitating price and wage flexibility and the swift reallocation of resources within and across sectors.” [Mario Draghi, Sintra 2015] Structural reforms play a central role in governments’ tool-kit as they are complementary to monetary policies and represent an efficient approach to recover from recessionary periods. IV.3 1 IV Past Reforms in the Services Sector and their Effects 134 Indeed, policies aimed at deregulating market can increase the Gross Domestic Product by increasing investments and improving employment allocation across firms as well as by stimulating the competition on the market, thus enhancing innovation and productivity. Furthermore, they can amplify the mechanisms targeted by monetary policy by boosting the eco‐ nomic expansion and avoiding short-run costs. Therefore, after the recent financial crisis, these policies have gained much more attention. Although governments have undertaken important steps in this direction, there re‐ mains room for stronger convergence across European countries in the de‐ gree of market regulation. The main reason is that politicians are still re‐ luctant to liberalize the markets due to the temporary “costs” of structural reforms. According to the common perception, implementing reforms might temporary lead to a reduction in employment and to a decrease in the number of firms operating in the markets. Those may represent strong dis‐ incentives as politicians are usually more oriented towards the short-term. On contrary to the political world, the academic community has always recognized the importance of structural reforms and has investigated their effects extensively. Nonetheless, the focus of the analyses conducted was laid almost exclu‐ sively on the aggregate impacts on the national economy. Only few studies have instead investigated the micro effects of structural reforms. Against this background, this paper aims at further shedding light on the granular dynamics triggered by markets deregulation and thereby pro‐ vides a substantial contribution to the ongoing debate. More precisely, it addresses the following questions: What are the effects of sector-specific reforms and what are the spillover effects to other sectors? In particular, how do key variables such as employment and firms’ investments respond to deregulation shocks in the short-run and in the long-run? The micro effects of structural reforms are analysed using the Competi‐ tiveness Research Network (CompNet) firm-level-based database and the OECD’s database on Product Market Regulations in a Panel SVAR frame‐ work. Constrained by data availability, this paper investigates the effects of market deregulation in the Transportation sector (downstream sector) and the spillovers in the Manufacturing sector (upstream sector). The sam‐ ple considered covers 16 European countries for a period of 12 years. The results suggest that labour market rigidity and investments reduc‐ tion are the main drivers of the initial recessionary period faced by the re‐ formed sector. Moreover, this paper provides empirical evidences that IV.3 Structural Reforms in Transportations 135 deregulation in the downstream sector also affects the upstream sector. It finds that the latter is affected by “lagged spillover effects” that have con‐ tractionary effects on the sectorial economy. Yet, the recessionary period in the upstream market is less pronounced than in the reformed sector and it is followed by an expansionary period in the long-run. Literature Review Being the most decisive governmental instrument for intervening on the markets, structural reforms have always played a key role in the academic debate, as proved by the long series of researches published. Indeed, since the ’50s there has been a long and new strand of the literature that began dealing with the need and, most important, the effects of deregulation in both the product and the labour market. This included remarkable contri‐ butions both from an economic perspective61 and from a law perspec‐ tive62. This strand of literature analysed two main features of deregulation. First, it documented the effects of the reforms implemented during the 20th century and provided a theoretical framework to analyse their effects. The second feature was that the focus was laid mostly on the long-run ef‐ fect of reforms. With the contemporaneous success of the “theories of growth”, the main emphasis was on the drivers of the divergence during the expansion of modern economies. Policies, reforms and institutions were accounted as one of the main causes. Due to the scarceness of data, empirical studies were realized mostly on the US economy. Further remarkable analyses were conducted also on the Russian economy that, after the fall of the Soviet Union, experienced a broad economic revolution in terms of both the agents on the market and the structure of the market itself. Yet, the prominence of the empirical 2 61 For instance, interesting contributions were provided by Averch and Johnson (1962), Bailey et al. (1994), Blanchard and Wolfers (2000), Boeri, Nicoletti and Scarpetta (1999), Boyer (1987), Coe and Snower (1997), Fernandez and Rodrik (1991), Gersbach (2000 and 2003), Gilles (1993), Joskow and Rose (1989), Mc‐ Donald and Solow (1981), Neven, Roller and Zhang (1999), Nordhaus (1990), Winston (1993 and 1998). 62 For instance, significant contributions were provided by Levine (1975 and 1981), Marshaw (1979), Rutledge (1955) and Schwartz (1972). IV Past Reforms in the Services Sector and their Effects 136 works analysed the labour market institutions, which were easier to docu‐ ment in terms of data. Following the seminal contribution of Blanchard and Giavazzi (2003), it is state of the art that reforms lead to “short-term pain” and “long-run gains”. This work is still a cornerstone in the economic literature. In their work, Blanchard and Giavazzi confirm the beneficial effects of structural reforms on the economy in reducing and redistributing rents. But, most important, building an ad hoc macroeconomic model and divid‐ ing the period considered into short-run and medium-/long-run, they as‐ sess the existence and importance of distribution and transitionary effects after the implementation of reforms. Indeed, they are able to capture the short-run effects that translate either in the potential shrink of incumbent firms, if the deregulation affects the product market, or in lower unem‐ ployment, if the deregulation affects the labour market. Since this seminal contribution, a growing literature has studied the top‐ ic of structural reforms and market deregulation with specific emphasis on the short-term and long-term dynamics. It is possible to identify two dif‐ ferent streams in this literature according to the methods adopted to repre‐ sent and simulate structural reforms. The first trend relies on the assumption that the main channel in which structural reforms and deregulation affects the aggregate economy is via the composition and distribution of economic rents. Both in the product and in the labour market. This affects directly the price levels and the allo‐ cation of inputs and outputs as well as market efficiency and innovation. Along these lines, the most recognized way of measuring economic rents is through mark-ups or price-cost margins, i.e. the difference between prices and marginal costs – the distance from the perfect competition. As a consequence, in macroeconomic theories, structural reforms are modelled as an exogenous one-time cut in firms’ mark-ups. The main finding within the first strand is that the removal of structural imperfections to the functioning and to the free entrance in the markets would positively affect the economic growth. This should immediately re‐ sult in an efficient internal market. In addition, encouraging research and innovation, deregulation should lead to higher productivity and employ‐ ment levels in the national economy. Finally, structural reforms in the mar‐ kets are designed to increase competition and enhance firms’ productivity, triggering lower prices thus stimulating the internal demand and reducing the inflation. IV.3 Structural Reforms in Transportations 137 Adopting sharp decrease in mark-ups estimates as proxy for reforms, significant contributions have been provided, among others, by Coppens and Vivet (2004), Bayoumi et al. (2004), Griffith et al. (2006), Eggertsson et al. (2014), Gomes et al. (2013) and Varga et al. (2014), which imple‐ mented new theoretical and empirical approaches to investigate the effects of structural reforms. Coppens and Vivet (2004), for example, analysing the Belgian telecom‐ munications sector, which was largely deregulated in the late 90’s, find that liberalizing formerly regulated markets would result in lower prices and higher productivity levels. They identify as main driver for this phe‐ nomenon the declining importance of economies of scale in the supply chain. Although they had a crucial role in the industrialized economy of the 20th century, their role has been replaced with innovations thus the adoption of new technologies. Indeed, with the technology advancements, higher level of productivity became reachable independently from the size of the firm. Therefore, they affirm that a free market, which would guarantee tougher competition, would lead to levels of productivity unreachable with monopolistic competition or with the absence of continuous stimulus for innovation. Moreover, with lower barriers to entry, the number of firms operating in the markets would increase and this would have positive ef‐ fects in terms of job creation and employment. Along these lines, Bayou‐ mi et al. (2004) and Griffith and Harrison (2004) have very similar and in‐ teresting results. Empirically estimating firms’ mark-up to proxy econo‐ mic rents, they model structural reforms as a one-time reduction in the lat‐ ter. They find that deregulation in the market affects the national economy both in a direct and in an indirect way. The direct effects are due to the reduction in the production costs and the removal of barriers to entry, which reflect directly on the overall productivity level on the market. On the other side, indirect effects are driven by three main efficiencies: alloca‐ tive efficiency, productive efficiency and dynamic efficiency. The Alloca‐ tive efficiency effect consists in the erosion of incumbents’ market power as a result of tougher competition. This ultimately leads to lower firms’ mark-ups. In the resulting less concentrated economic environment, inputs are used more efficiently and, therefore, the allocation of goods and ser‐ vices is improved. Moreover, the least productive firms are then forced to exit the market causing an immediate increase in the average level of pro‐ ductivity. The productive efficiency effect entails that firms are incen‐ tivized to re-organize their work in a more efficient way in order to in‐ IV Past Reforms in the Services Sector and their Effects 138 crease their production and their productivity levels. As a consequence, wastes of resources and inefficiencies on the market should rapidly dimin‐ ish. The last dynamic efficiency effect guarantees that in the attempt of en‐ hancing the productivity levels, both research and innovation are boosted to move forward the modern technological frontier. Finally, they also af‐ firm that the mix of these positive effects might take time to materialize and this, in the short-run, would result in a contraction of the economy. In a more recent work, Eggertsson et al. (2014) explore the short-run link between structural reforms and the interest rate set by the European Central Bank (ECB). Given the relevance and the timing of their work, the analysis aims at providing a solid background for political action taken in order to recover from the international economic and financial crisis. To answer their research question, they build a standard dynamic stochastic general equilibrium model calibrated to match salient features of the Euro‐ pean Monetary Union economy. Surprisingly, they find that deregulating the market during a period of crisis – with the ECB setting the interest rate at the Zero Lower Bound – might even yield to a deepening of the preexisting recession. The two main drivers that they identify are the further decrease in the inflation and the increase in the real rates. Moreover, con‐ sidering the role of expectations in the model, the outcome may be even worse with people expecting the reforms to be temporary. Hence, they un‐ derline the necessity of having an accommodating monetary policy in or‐ der to avoid the negative effects of implementing structural reforms in a ZLB environment. In another work, Gomes et al. (2013) try to enlarge the target of the in‐ vestigation by performing an analysis on the effect of deregulation in product and labour markets both from a national and an international per‐ spective. Adopting a multi-country dynamic general equilibrium model for the Euro Area, they study the effects of reforms in Germany. To shed light on the international transmission mechanisms, they are able to disentangle the effects on the German domestic economy and the effects on the rest of the Euro Area. Furthermore, to complete their analysis, they present an al‐ ternative scenario simulating reforms in Portugal and, again, examining the effects in the national economy and in the rest of the Euro Area. Final‐ ly, they confirm that the tougher competition in the market resulting from structural reforms would lead to an increase in the long-run output. More‐ over, focusing on the divergence of the European economies, they assess that coordination between countries in the implementation of structural re‐ IV.3 Structural Reforms in Transportations 139 forms would homogenize their economic performances, in terms of both price competitiveness and real activity. Varga et al. (2014), always within this first strand of the literature and so designing structural reforms as a one-time reduction in firms’ markups, further investigate the intertemporal effects of structural reforms. Us‐ ing a semi-endogenous growth model they analyse deregulation in South‐ ern European countries (Italy, Spain, Portugal and Greece). They find that deregulation in the market leads to a larger demand for inputs of produc‐ tion and, thus, to a better allocation of resources on the market by theoreti‐ cally simulating reforms in the final goods sectors in their model. Al‐ though beneficial in the long-run, they confirm that deregulation, on aver‐ age, has a temporary negative impact on the national GDP, and more gen‐ erally on the national economy, in the first years in the aftermath of the reforms. On the other hand, the second stream adopts another way of analysing the deregulation of markets. This relies upon ad hoc indicators of product and labour market regulation. In the last years, as an answer to the grow‐ ing interest in studying the underlying structure of the market, several in‐ stitutions have focused on the production of indicators in order to give a trustful representation of the level of regulation. Those indicators collect records and information mainly from national laws and surveys filled out by governments, regulators and active individuals on the markets. Perhaps the most important contribution in this sense has been provided by the OECD, which created a series of indicators that is widely recognized and used in the recent economic literature. Furthermore, exploiting these novel data, the OECD has published a long series of methodological papers pre‐ senting interesting insights on the regulatory scenarios both in OECD countries and in non-OECD countries.63 In addition, relevant stylized facts and econometric-founded results emerge from their analyses. For instance, Boylaud and Nicoletti (2001) analysing specifically the Retail sectors find that a steady deregulation trend has undergone in the 80’s and 90’s in the OECD countries, mainly in the Food sector. Furthermore, they recognise a tendency to reintroduce stricter regulation for large outlets, mainly in European countries. According to their empirical findings, this should pre‐ vent efficient market dynamics, such as the exit of unproductive firms and 63 For the series of OECD’s papers please refer to: Nicoletti et al. (2000), Boylaud and Nicoletti (2001), Conway et al. (2005), Conway and Nicoletti (2006), Wölfl et al. (2009), Wölfl et al. (2010) and Koske et al. (2015). IV Past Reforms in the Services Sector and their Effects 140 the entrance of more productive ones thus preventing productivity en‐ hancement. In turn, this would result in a less competitive environment, lower employment growth and higher prices for the consumers. More recently, Wölfl et al. (2010) highlights a negative relation be‐ tween Product Market Regulation (PMR) and GDP per capita. Extending the time series of the PMR, that is computed every five years, by adopting Bayesian Model Averaging (BMA) techniques, they are able to identify the PMR trends as one of the main reason for the divergence in the econo‐ my performance of countries so similar for other characteristics. Also, they link the diverse effects of the market regulations on the economy growth to the level of economic development on the country. Having test‐ ed for the heterogeneity of the parameters, they calculate thresholds ac‐ cording to the methodology developed by Hansen (1999) to separate the level of economic development of the countries. Their empirical results suggest that a strict regulation hampers economic growth more in de‐ veloped countries than in developing countries. This is very much in lines with Chang (2011). A large number of researches adopting these indicators, both for direct empirical testing and for model calibrations, have been published in the recent past thereafter providing very interesting contributions to the eco‐ nomic knowledge of the effects of structural reforms. Among others, the main contributions might be found in Nicoletti and Scarpetta (2003), Cette et al. (2014) and the novel series of papers by Cacciatore, Duval, Fiori and Ghironi. In their preeminent work, Nicoletti and Scarpetta investigate the scope and depth of cross-country differences in terms of pro-competitive regu‐ lation and privatization policy in the OECD area. Despite a general dereg‐ ulatory trend, they find that convergence in regulatory setting is still lack‐ ing. The main reason is in the pace of reforms and the different policy ori‐ entation in the OECD countries. In addition, in a complementary analysis, they attempt to link this regulatory divergence to the cross-country hetero‐ geneity in terms of GDP growth investigating the correlation of reforms with output and economic growth. This enables them to assess that lower barriers to entry and state control lead to faster innovation and develop‐ ment of technologies. Moreover, they find strong empirical evidences sug‐ gesting that less regulated market brings productivity enhancements and efficiency gains to the national economy. On the contrary, limitations to market entry might cause scare adoption of new technologies and a reduc‐ tion in both the competitive pressure and in the technological spillovers. IV.3 Structural Reforms in Transportations 141 A novel approach has been performed by Cette et al. (2014) which, combining the OECD product market indicators with the EU KLEMS mi‐ cro-database, attempt to investigate the micro channels underlying the im‐ plementation of structural reforms. The novelty of their work relies on the analysis of the impact of deregulation directly on production prices and wages. Considering a multi-products productivity function, they show the country/sector inefficiency produced by heterogeneous levels of regu‐ lation. Exploiting the power of micro-data, they create a model which is able to catch the differences among service sectors and manufacturing sec‐ tors and among downstream industries and upstream industries. Moreover, the workers are also divided in high skilled and low skilled, as standard procedure in the literature. Introducing the price and wage channels, they show that reforms positively affect sector level and country level produc‐ tivity. Thereafter they also show that, in particular in the European coun‐ tries, the productivity enhancements deriving from a more accommodating regulatory practise might be very high. Nonetheless, to see the effects materialising, a minimum period of five years should be considered and effects would be heterogeneous between countries. Recently, Cacciatore, Duval, Fiori and Ghironi provided signifi‐ cant contributions to this literature with a novel series of papers.64 They offer very useful and interesting results to base our understanding of the effects and the transition dynamics generated by the implementation of structural reforms. To study the effects of product and labour market liberalization, Caccia‐ tore and Fiori (2016) first build a real business cycle model with endoge‐ nous product creation and labour market frictions. Within this new theo‐ retical framework, they find that the markets undergo important transition dynamics in the aftermath of deregulation. First they find that individual reforms – reforms targeting only at the product market or at the labour market – have recessionary effects on the national economy in the shortterm. Afterwards, they assess that joint deregulation in both the good and the labour market reduce significantly the temporary “costs” generated by individual reforms. Finally, they affirm that policymakers should exploit the interdependence of policies in order to increase national welfare and efficiency in implementing structural reforms, since joint deregulation 64 Please refer to Cacciatore, Fiori and Ghiorni (2013), Cacciatore, Duval, Fiori and Ghironi (2015) and Cacciatore and Fiori (2016). IV Past Reforms in the Services Sector and their Effects 142 moderates the level and the volatility of wedges and distortions in agents’ equilibrium decisions. Later, Cacciatore, Fiori and Ghiorni (2015) extend the theoretical model to a two- country monetary union framework. This is in order to include monetary policy analysis in the study and to provide a more complete pol‐ icy advise. Shifting the focus on the monetary policy, they discover that implementing the optimal monetary policy in a highly regulated market leads to different outcomes compared to a low regulated industry. They are able to show that, despite welfare gains from the Ramsey-optimal policy are sizable, the Ramsey allocation requires significant departures from price stability both in the long run and over the business cycle. Further‐ more, they assess that an expansionary policy would significantly reduce transition costs. Lastly, they prove that deregulation reduces static and dy‐ namic inefficiencies in the markets. Lastly, Cacciatore, Duval, Fiori and Ghironi (2015) transform the for‐ mer model into a New Keynesian small open economy framework. Doing so, they are able to enhance the understanding of the effects of structural reforms on trade activities and international competitiveness indicators. Their results suggest that reforms do not generate significant deflationary pressure. This way the inability of monetary policy to deliver large interest rate cuts in their aftermath either because of the zero bound on policy rates or because of membership in a monetary union may not be a relevant ob‐ stacle to reform. Therefore, concerns about the zero lower bound on inter‐ est rates (or inability to use independent monetary policy in a monetary union) should not be viewed as stumbling blocks on the way to increased market flexibility. Differently, they find that alternative simple monetary policy rules do not have a large effect on transition costs. Methodology We estimate a Panel Structural Vector Autoregressive (Panel SVAR) mod‐ el in order to capture the dynamics in the sector of Transportations and the spillover effects in the Manufacturing sector produced by structural re‐ forms. In this section, the data preparation, the model specification and the robustness check implemented are presented. 3 IV.3 Structural Reforms in Transportations 143 Data preparation All the data considered are taken in natural logarithms to homogenize and facilitate the analysis. Indeed, this transformation allows to reduce the noise deriving from the variables that are extremely heterogeneous in terms of levels (for instance the Real Value Added produced in the Ger‐ man Manufactory sector has a different scale compared to the Finnish or the Slovenian one). Preserving the relations among the variables, the loga‐ rithmic form also increases the cross-country comparability of the sample. In order to control and disregard potential trends in the series, the Ho‐ drick-Prescott filter (decomposition) has been adopted. This method com‐ prehends an algorithm that decomposes the time series into its trend plus a cyclical component. Initially proposed by Hodrick and Prescott (1997), the filter estimates the trend component, τt , and computes the cyclical part as the difference between the original series, yt , and its trend, i.e.: yt = τt + ct  (1) To calculate τt , the following equation has to be minimized, ∑t = 1 T yt − τt 2 + λ∑2 T − 1 τt + 1 − τt − τt − τt − 1 2  (2) The first term is the sum of the squares of the deviation of the series, yt  from its trend,τt . The second term is a penalization for the variation of the growth rates in the trend component. Indeed, depending on the value as‐ signed to the parameter λ , which multiplies the sum of the squares of the trend component's second differences, reflects the penalty of incorporating fluctuation into the trend. In order to have deviations from the steady state in the Impulse Responses, an infinity penalty has been assigned to the trend component. This way, with λ ∞ , the change in the trend is con‐ stant, so the resulting trend is linear. Panel VAR Following the methodology proposed by Cacciatore and Fiori (2016), we adopted a Panel SVAR model with two lags to perform the analysis. This enables to have the representation of the joint dynamics of the variables under analysis and to exploit the past behaviours of the data in order to obtain their responses to deregulation shocks. A Panel SVAR approach 3.1 3.2 IV Past Reforms in the Services Sector and their Effects 144 seemed particularly suited to address the research questions given that it captures the interdependencies among the variables of interest, does not impose unrealistic restrictions, can easily incorporate variation in coeffi‐ cients and shocks over time, and most important accounts for heteroge‐ neous dynamics across observation grouped by specific characteristics, i.e. country and sector. In formula, the Panel SVAR can be written as: B0yit = B1yit − 1 + B2yit − 2 + f i + gt + uit   (3) where yit is the n x 1  vector of all the endogenous variables with i  indicat‐ ing the country and t   the year; yit − 1 and yit − 2  are the n x 1  vectors of the lagged endogenous variables; B0 , B1  and B2  are the n x n  coefficient matri‐ ces of the present and past observations of yit ; f i  and gt represent, respec‐ tively, country fixed effects, accounting for unobserved, time-invariant cross-country heterogeneity, and year fixed effects, accounting for the presence of common shocks across countries; uit is the vector of error terms that follows a white noise process. It is possible then to rewrite equation (3) dividing each side by B0−1 : yit = Φ1yit − 1 + Φ2yit − 2 + ci + dt + ϵit   (4) where Φi = B0−1Bi with i =1,2 (5) ϵit = B0−1uit  (6) ci = B0−1 f i  (7) dt = B0−1gt  (8) in order to get the vector autoregressive representation of a dynamic struc‐ tural system. Therefore, the VAR can be considered as the reduced form of a general dynamic structural model. The coefficient estimation is performed by a simple OLS procedure. Due to the shortness of the time series, each coefficient is restricted to be the same across country. Moreover, the model is designed according to the assumption of legislative delays in the effective implementation of the structural reforms, i.e. the VAR is assumed to be recursive. Beside fulfill‐ ing the legislative delays assumption, this procedure identifies the struc‐ ture of the model by constructing an error term in each equation that is IV.3 Structural Reforms in Transportations 145 uncorrelated with the other errors. Hence, this provides a valid back‐ ground for employing a simple OLS estimation65. We adopted the Cholesky decomposition to orthogonalize the variancecovariance matrix, thus the shocks. This method consists in decomposing a positive definite matrix into the product of a lower triangular matrix and its conjugate transpose: Ω = PP′  (9) Now, considering Ω  – the variance-covariance matrix of u  – to be a real symmetric positive definite matrix, there exists a unique lower triangular matrix A , with 1s along the principal diagonal, and a unique diagonal ma‐ trix D  with positive entities along the principal diagonal such that: Ω = ADA′  (10) According to this decomposition, D  is a diagonal matrix whose element j, j   is the variance of u . Dividing it in D1/2 D1/2 , where D1/2  is the diago‐ nal matrix whose element j, j   is the standard deviation of u , we can write equation (10) as: Ω = AD1/2D1/2A′  (11) Adopting now the Cholesky decomposition, we can define P ≡ AD1/2  in order to get: Ω = PP′  (12) P  is a n x n  lower triangular matrix with the standard deviation of u . Following these methodologies, we can express the model in terms of the orthogonal shocks ηt = P−1uit  which is constant across country: B L yit = f i + gt + uit = f i + gt + Pηt  (13) Impulse responses to orthogonalized shocks can be then formulated as: ∂yit + s ∂η jt = Ψispj  (14) where, denoting pj  the j -th column of P  and Ψis  the n x n  matrix of coeffi‐ cients of the s -th error term in the MA ∞   representation of the Panel 65 See Stock and Watson (2001) and Kilian (2013) for more detail on recursive VARs. IV Past Reforms in the Services Sector and their Effects 146 VAR model66, the element in the row j  of Ψispj identifies the response of an increase in η j  in t   for the value of the j -th variable at time t + s  holding all other η− j  constant. Although the Cholesky decomposition has been criticized67, there is a solid economic explanation for its adoption in this exercise. Indeed, the lower triangular matrix allows to keep the first-ordered variable exoge‐ nous. This way, ordering the regulatory variable first, it is possible to have the regulation exogenous from the rest of the model, that, given the re‐ silience of the policy maker to act only driven by the current economic conditions, is a perfectly reasonable assumption. Furthermore, being inter‐ ested in simulating deregulation in one sector (Transportation) and identi‐ fying the spillover effects in another (Manufacturing), the lower triangular matrix allows to have direct effects from the Transportation sector to the Manufacturing one and not vice versa. Before computing the impulse responses, the bias-corrected bootstrap intervals as proposed by Kilian (1998) was implemented. Indeed, despite the panel dimension of the sample, the time series remain very short. It has been shown that VAR estimates might yield to inaccuracy due to short time series. Among the several corrections proposed, the “bootstrap-afterbootstrap” guarantees the minimum bias in the estimation. It consists in a 2-step technique where, in the first step, the bias term is approximated in first order, and, in the second step, the bootstrap is repeated including the previous estimates. The validity of this method holds for VAR models es‐ timated in levels, as deviation from a linear trend, and in first difference. Robustness In order to prove the robustness of the results obtained in the analysis, we have estimated all the results also with a first-difference Panel SVAR on the same set of variables. In formula: B0∆ yit = B1∆ yi, t − 1 + B2∆ yi, t − 2 + ∆ gt + ∆ uit  (15) 3.3 66 See Chapter 10 of Hamilton (1994) for the formal derivation of the MA(∞) repre‐ sentation of VAR models. 67 In particular, for imposing a “causal chain” rather than learning about causal rela‐ tionships from the data. See Kilian (2013) for an extensive discussion on draw‐ backs of applying the Cholesky decomposition to VAR models. IV.3 Structural Reforms in Transportations 147 Country fixed effects are not included given that ∆ f i = 0 . Although the magnitude of the responses might differ, the patters seem to be very consistent, therefore proving the validity of the results shown. Moreover, considering the shock on the regulatory variable in firstdifference provides a better approximation for a permanent shock, such as a structural reform, further improving the legitimacy of the exercise per‐ formed. All the impulse responses of the first-difference Panel SVAR are pre‐ sented in the Annex A. Data To perform the analysis, the data considered was taken from two different sources: the firm-level-based CompNet database and the OECD’s database on Product Market Regulation. The CompNet firm-level-based database68 The recent economic literature rejects the hypothesis of the representative firm in modelling the economy. Indeed, it is now well recognized that each firm is different from the others and might have very diverse reac‐ tions to specific events. Also, from a macro perspective, the analysis of aggregate figures and mechanisms might benefit from the micro founda‐ tion of theories and studies. In light of the firms’ heterogeneity, the role of micro-data is crucial in order to analyse and investigate the economy. However, micro-data are subject to two major constraints. First, they are usually confidential. Either this is due to the firms that do not want to share their balance sheets data or to the institutions collecting the data which are not allowed to disseminate this information. Second, due to a number of reasons, for instance different currency, purchasing powers or accounting standards, the micro-data often are not suitable with crosscountry comparisons. This, of course, represents a substantial limitation for any kind of analysis. 4 4.1 68 For further information on the CompNet database, please refer to Lopez-Garcia et al. (2015). IV Past Reforms in the Services Sector and their Effects 148 The Competitiveness Research Network (CompNet), established in 2012, represents the answer of the European System of Central Banks to the need of granular data. The Network investigates the topic of competi‐ tiveness at three different levels: micro, macro and inter-regional dimen‐ sion. One, and probably the key, result of CompNet is the firm-level-based database built assembling the firm-level data provided by almost 20 European countries. To solve the confidentiality issue regarding the firm-level data, CompNet adopted the so-called “distributed micro-data approach” developed by Bartelsman et al. (2004). Along these lines, every participating country69 receives a common computer program that extracts the relevant information from the population of firms in the national database and aggregates them in such a way to preserve confidentiality. This way, the common methodology harmonizes industry coverage, time span, raw variable definitions, estimation techniques and sampling proce‐ dures. The code then produces a number of indicators and variables, based on firm-level data, that are suitable to perform analysis across-industry and across- country. The final database includes two different samples: the full sample and the 20E sample. The full sample is computed creating the indicators based on all the data retrieved from the National Central Banks (or National Sta‐ tistical Institutes). Although, the data is harmonised and cleaned from out‐ liers, no further data cleaning procedure is performed. Differently, the 20E sample includes indicators computed on data on firms with at least 20 em‐ ployees. Given the different data coverage across countries and the exis‐ tence in some countries of reporting thresholds in terms of either number of employees or turnover, considering such firms allows to improve the homogeneity of the sample. Furthermore, a population re-weighting pro‐ cedure is implemented. This includes re-weighting the number of firms in the sample with the official number retrieved from Eurostat. With this pro‐ cedure, it is possible to have a more realistic representation of the firm population in every country and the data coverage results more accurate. For all the remaining limitations of the database in terms of coverage and data comparability, please refer to Lopez-Garcia et al. (2015). The data used in the analysis covers a sample of 16 European countries, namely Austria, Belgium, Croatia, Estonia, Finland, France, Germany, 69 Country’s participation might be determined by the National Central Bank (NCB), the National Statistical Institute (NSI) or both. IV.3 Structural Reforms in Transportations 149 Hungary, Italy, Lithuania, Poland, Portugal, Romania, Slovak Republic, Slovenia and Spain, for a period of 12 years (2001-2012). To study the sectorial effects of structural reforms, data for 2 1-digit sectors – Trans‐ portation and Manufacturing70 – are considered. The data used refers only to the so-called 20E sample. As explained above, this sample includes on‐ ly the firms with at least 20 employees and guarantees higher representa‐ tiveness and better comparability. The variables used are, in order of analysis: – Real Value Added: defined initially as nominal turnover – raw materi‐ als and then converted in real terms multiplying it for the ratio of a sector-specific value added deflators provided by Eurostat over a sector-specific Purchasing Power Parity indicator provided by the Groningen Growth and Development Centre. – Employment: defined as the number of employees engaged in each firm. – Number of firms: defined as the number of firms included in the database. – Labour costs: defined as the gross employee compensation. – Total Factor Productivity (TFP): estimated according to a revision of Wooldridge (2009) proposed by Galuscak and Lizal (2011). This esti‐ mation comprehends an implementation of Olley and Pakes (1996) and Levinsohn and Petrin (2003) methodologies in a Generalized Method of Moments (GMM) framework, controlling for capital measurement error. The regression used in order to obtain the firm-level TFP is: rvat = β0 + β1kit + β2ki t − 1 + β3mi t − 1 + β4ki t − 12 + β5mi t − 12 + β6ki t − 13   +β7mi t − 13 + β8ki t − 1 mi t − 1 + β9ki t − 1 mi t − 12 + β10ki t − 12 mi t − 1 + γYeart  +ωLi t − 1   (16) All variables are expressed in logarithmic form. Materials inputs are measured by mi t .  Since labour and TFP are simultaneously deter‐ mined, while capital takes time to build, labour is instrumented by its first lag. All the interaction terms between capital and materials are in‐ cluded to control for non-linearities. Moreover, a full set of year dum‐ mies is included to control for sector-specific trends. The estimation is 70 According to the NACE Rev. 2 classification, Manufacturing comprehends sectors 10-35 (without sector 19 which is not included in the CompNet database) while Transportation includes sectors 49-53. IV Past Reforms in the Services Sector and their Effects 150 performed via a GMM following Wooldridge (2009) clustering stan‐ dard errors at the firm-level. Once obtained the estimates, TFP is computed as the residual of the difference between the real value added and the fitted values for real capital, labour and a year trend (all in logs): TFPit = rvait − β0 + β1kit + γYeart + ωLi t − 1   (17) – OP gap: computed as initially proposed by Olley and Pakes (1996). It is an indicator of allocative efficiency measured by industry-level co‐ variance between productivity and size. It is retrieved by decomposing the productivity of an industry as follows: yst = ∑i ∊ Sθitωit = ω̅it + ∑i ∊ S θit − θit ωit − ω̅it ) (18) where yst  is the weighted average of firm-level productivity in industry s  at time t   with shares of industry size as weights. θit  and ωit  represent, respectively, size and productivity of firm i  at time t  . θit  and ω̅it  denote the average size and productivity of industry s  at time t  , respectively. S  is the set of firms in sector s . The decomposition splits the weighted average industry productivity in two components: the unweighted mean productivity and the covariance between productivity and size. The second term captures the allocative efficiency in industry s  at time t   since it reflects the extent to which firms with productivity higher than the average have larger market shares. In the literature, the most common specification for computing this indicator comprehends labour productivity as firm’s productivity and labour, measured as number of employees, as firm’s size. – Price-cost Margin: defined as (turnover – variable costs)/turnover. Turnover represents incoming revenue from goods and services and variable costs consist of wage bill (including other benefits) and cost of materials and services (e.g., subcontractors, electricity and fuels). In theory, this indicator should measure the difference of prices and marginal costs. Given the empirical difficulties of retrieving this infor‐ mation from balance sheets, turnover and variable costs are adopted as proxy. The price-cost margin (PCM) is a non- parametric measure of market power and can be used to represent the concertation in the mar‐ ket. A low value of the PCM indicates a very competitive market – close to perfect competition – while high levels of PCM represent a market with few firms and prices set very high from the marginal costs – closer to the idea of monopolistic competition. IV.3 Structural Reforms in Transportations 151 OECD’s database on Product Market Regulations71 It is now accepted by the economic community that competitive markets guarantee the best development for the national economy. As a conse‐ quence, pro-competition regulation in product markets and restrictions to monopolistic behaviours might help boosting the growth. Acknowledging these economic gains, governments have gradually removed strict regula‐ tions in product markets over the past decades, reducing state involvement in business sectors, making it easier for entrepreneurs to create firms and to expand them, and facilitating the entry of foreign products and firms. While in some cases regulation was totally abolished, in others it was re‐ placed by better designed legislations which might even result in competi‐ tion enhancements. To provide quantitative analysis and solid economic and econometric support the OECD developed an indicator of Product Market Regulation (PMR) in 1998 to measure national regulations and to track reforms progresses over time in a number of countries. This database has been regularly updated every 5 years, thus in 2003, in 2008 and in 2013. The main economy-wide indicator of Product Market Regulation is provided with a complementary set of indicators that measure regulation at the sector level. Since the beginning, the indicators have become crucial for the OECD’s work as they enrich the information of regulatory practices in OECD countries and ease the investigations on their link with economic perfor‐ mance. They have been integrated in the Going for Growth exercise and OECD Economic Surveys where the OECD uses them to formulate recom‐ mendations for policy reforms. The indicators are also widely used by na‐ tional governments, other international organizations, academia and inter‐ national forums such as the G20. OECD’s database on Product Market Regulation includes a wide set of information on regulatory structures and policies. To collect the data, a questionnaire with around 1400 questions is sent to the governments of the participating countries. The database covers all OECD countries and 21 non-OECD countries. For a number of selected indicators, the explicit questions are complemented with publicly available data in order to create annual time series beginning in the 70’s. As result, the indicators are based 4.2 71 For further information on the OECD’s database on Product Market Regulation, please refer to Koske et al.(2015). IV Past Reforms in the Services Sector and their Effects 152 on “objective” data about laws and regulations as opposed to “subjective” assessments by market participants in opinion surveys. Hence, they cap‐ ture the de jure policy settings. The general country-level indicator of Product Market Regulation is then complemented with a set of indicators that encompasses information by sector. Data are available for seven net‐ work sectors (telecom, electricity, gas post, air transport, rail transport, and road transport) and five services sectors (legal services, accounting ser‐ vices, engineering services, architecture services and retail distribution). The computation of these sector indicators follows a bottom-up approach as indicated in Figure 4.3.1 – only the indicator adopted in the analysis is reported as an example for the bottom-up approach. The majority of the underlying data is included in the computation of the economy-wide indi‐ cator of Product Market Regulation. The component of market structure on the electricity, gas, rail transport, post and telecom sectors, is the only information not incorporated in the economy-wide indicator since the lat‐ ter has a more political nature. The seven indicators of regulation in network sectors are aggregated in‐ to one indicator of energy, transport and communications regulation (ETCR). The four indicators of regulation in accounting, legal, engineer‐ ing and architectural services are aggregated into one indicator of regu‐ lation in professional services. Composition of indicator of regulations Source: Koske et al. (2015) Figure 4.3.1: IV.3 Structural Reforms in Transportations 153 To perform the analysis, we used the indicator of Product Market Regula‐ tion in the Transportation sector for the same countries and period of the data in the CompNet database. Results In this section, the results of the empirical exercise are presented. Every result comprehends an ad hoc set of variables in order to investigate a spe‐ cific driver of the post-reform economy. For parsimonious reasons, the maximum number of variables included in each simulation is seven (plus the controls, i.e. country and year fixed effects). This is in order to prevent a risky decrease in the degrees of freedom of the Panel SVAR model, which would decrease geometrically with every extra variable. Moreover, a so-called “marginal approach” was adopted: meaningful variables such as employment and number of firms are held in all the simulations as a measure of robustness and each simulation includes only an extra variable to further enlarge the scope of the analysis. Baseline specification The first analysis conducted aims at investigating the dynamics of inputs and output. This specification comprehends the two main inputs for the production chain, i.e. employment and number of firms (where number of firms is used as a proxy for investments), and the sectorial output, i.e. real value added. It can be seen that, since the first year after the implementation of struc‐ tural reforms in the Transportation sector, there is a recessionary effect on the whole economy of the sector. Indeed, there is an immediate contrac‐ tion in both inputs and output. Following the theoretical models developed in the novel series of papers by Cacciatore, Duval, Fiori and Ghironi, it can be assessed that these results reflect the combination of the dynamics in employment and investments. From the demand side, the reduction is associated to lower households’ consumption and producers’ investments in order to finance the entry of new firms and new products on the market. From the supply side, with new firms entering the market and the expecta‐ tions of future tougher competition, incumbents downsize investments and employment in order to consolidate their positioning in the market and to 5 5.1 IV Past Reforms in the Services Sector and their Effects 154 further enhance their productivity. In addition, since the new jobs created by the firms entering the market take time to materialize, there will be a temporarily mismatch between labour demand and labour supply resulting in lower unemployment until the workers’ reallocation towards new en‐ trants and growing firms occurs. Furthermore, Figure 4.3.2 shows that, in the aftermath of the deregula‐ tion in the Transportation sector, very interesting dynamics undergo in the Manufacturing sector. Indeed, the latter seems to be affected by “lagged spillover effects” deriving from the implementation of structural reforms in Transportation. The recessionary trend in the Manufacturing sector seems to be very similar to the one in the Transportation sector, but it ap‐ pears deferred by one year and affects the economy of the sector for a shorter period. Figure 4.3.7, in the Annex, shows the robustness check with the same simulation on first- difference variables. The dynamics of inputs and output Notes: Panel SVAR, impulse responses to deregulation shocks. All variables are in per‐ centage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the me‐ dian responses and the two dashed lines denote the 68% confidence intervals. Figure 4.3.2: IV.3 Structural Reforms in Transportations 155 Labour costs To enhance the understanding of the effects of structural reforms, labour costs have been included in the analysis. The dynamics of labour costs Notes: Panel SVAR, impulse responses to deregulation shocks. All variables are in per‐ centage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the me‐ dian responses and the two dashed lines denote the 68% confidence intervals. Labour costs follow the same trend as the employment. As a consequence of the mismatch in the labour market, labour costs, and so wages, experi‐ ence a sharp decrease in the aftermath of the structural reforms. Indeed, the exit of the least competitive and efficient firms from the market and the consequential gradual reallocation of the labour force, leads to a severe contraction of labour costs for the firms in the Transportation sector. Very interesting here is also the dynamic in the Manufacturing sector. Laying the focus on this set of variables, it is possible to see that the Manufactur‐ ing sector is again facing “lagged spillover effects” due to the deregulation in the downstream sector. With a delay of one year, the Manufacturing sector is distressed by a contraction in both employment and labour costs, but in a more moderate scale than in the sector where the structural re‐ 5.2 Figure 4.3.3: IV Past Reforms in the Services Sector and their Effects 156 forms have been implemented. Although, the beginnings of the contrac‐ tions in the two sectors are misaligned, the recovery and further thrive of the economy takes place with the same time horizon in both sectors. This, of course, underlines the existing integration of the two sectors within the national supply chain, and thereafter, the dependence between both. Figure 4.3.8, in the Annex, shows the robustness check with the same simulation on first- difference variables. Productivity To further understand the micro drivers of structural reforms, in this sec‐ tion the attention is laid on the effects on the levels of productivity in both the Transportation and Manufacturing sectors. With the contemporaneous contraction of the two main inputs of the production chain, employment and investments – number of firms –, also the productivity level in the Transportation sector suffers from a tempora‐ ry drop. Despite the fact that the firms forced to exit the market due to the fiercer competition are the least competitive ones, the average productivity decreases in the aftermath of the deregulation. It seems reasonable that, in an economic environment with lower investments and an inadequate labour market, the productivity growth falls. Nonetheless, this decline is less tough than the one in the two inputs. Indeed, the productivity drop is less than proportional to the decrease in employment and in the number of firms. This should be due to the fact that the firms exiting the market are the least productive so their exit should have only very moderate repercus‐ sions on the overall productivity. Therefore, the main cause for the fall in productivity might be identified in the mismatch in the labour market be‐ tween demand and supply created by the slow reallocation of the labour force towards the new firms entering the market. On the other side, in the Manufacturing sector the productivity level has a marked increase in the first year despite experiencing the same contrac‐ tion as in the Transportation sector. This immediate increase in the first year reflects the ability of the upstream sector to benefit instantaneously from the removal of the inefficiencies caused by the high regulation in the downstream sector. Nevertheless, the simultaneous deterioration in both employment and investment leads to a contraction in the average produc‐ tivity level in the Manufacturing sector. 5.3 IV.3 Structural Reforms in Transportations 157 The dynamics of productivity Notes: Panel SVAR, impulse responses to deregulation shocks. All variables are in per‐ centage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the me‐ dian responses and the two dashed lines denote the 68% confidence intervals. From the fourth year after the implementation of the structural reforms, both sectors have an average productivity level higher than before the deregulation. This is a clear signal that lowering barriers to entry leads to a more efficient utilization of the resources available in the market and thereafter to an increase in the national productivity after a temporary re‐ cessionary period. Figure 4.3.9, in the Annex, shows the robustness check with the same simulation on first- difference variables. Resources allocation Having observed that structural reforms have negative effects in the shortterm on the two main inputs of the production chain, in this section a mea‐ sure of allocation of resources among firms is included in the analysis. This is in order to shad light on the employment of resources in a more liberalised market and to assess whether they are allocated towards the most productive firms. Figure 4.3.4: 5.4 IV Past Reforms in the Services Sector and their Effects 158 The dynamics of resources allocation Notes: Panel SVAR, impulse responses to deregulation shocks. All variables are in per‐ centage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the me‐ dian responses and the two dashed lines denote the 68% confidence intervals. The OP gap measures the covariance between inputs and productivity sig‐ nalling whether resources and productivity have the same path on the mar‐ ket. It can be seen from the figure above that, following the deregulation, there is an initial sharp increase in this index in the Transportation sector. This is most likely due to the immediate exit of the least productive firms from the market. Indeed, a less regulated market “forces” the least produc‐ tive firms to exit because of the tougher competition generated by the re‐ moval of barriers to entry. Thereafter, their exit makes more resources available for the firms still active on the market. Despite the reallocation of the labour force being a gradual process, the fact that scarce resources are no longer allocated to non-productive firms leads to an increase in the indicator of resource allocation on the market. Nevertheless, with new firms entering the market and the employment increasing again, the allo‐ cation deteriorates in the fourth year. This is a clear signal that there are more firms operating in the market and investing in inputs so the resources are no longer available only for the most productive firms. The transition dynamics in the Manufacturing sector generated by the spillovers of the deregulation in the Transportation sector lead to a com‐ Figure 4.3.5: IV.3 Structural Reforms in Transportations 159 plete opposite outcome. Figure 4.3.5 shows that in the first years in the aftermath of the reforms there is a large decrease of the OP gap and that it turns out to be positive only starting from the fourth year. Differently from the Transportation sector, in the Manufacturing sector the mechanisms ac‐ cording to which the resources are at disposal of the firms that can use them in the most efficient way weaken, hence the indicator of resources allocation on the market deteriorates. When the economy recovers from the initial contractionary period and benefits from the removal of ineffi‐ ciencies in the access to the market, also the allocation of resources results improved compared to the pre- reform level. Yet, these transitionary effects are not in line with the economic intuitions and might represent the starting point for further researches. Figure 4.3.10, in the Annex, shows the robustness check with the same simulation on first-difference variables. Competition and concentration In this last section, the analysis focuses on the impact of structural reforms on the competition and concentration in the markets. To disentangle these dynamics, the non-parametric measure of price-cost margin has been in‐ cluded in the SVAR model. Given the difficulties of having an accurate empirical measure of market competition, an index determining the differ‐ ence of the price from the firms’ marginal cost is a solid proxy. This indi‐ cator can be interpreted as a measure of the distance of the economy from perfect competition or from monopolistic competition. From Figure 4.3.6, it can be seen that also the effect on concentration is dynamic over the time. Anyway, differently from the dynamics in inputs and output, in labour costs or in productivity presented in the previous sec‐ tions, concentration experienced a three-fold path in the aftermath of re‐ forms. In the first year, the initial reaction to deregulation is very positive for the concentration and leads to a noticeable decrease in firms’ mark-up. This is mainly due to the expectation of fiercer competition in the postreform markets that brings firms to reduce their margins in order to pre‐ serve their competitiveness. The outcome will be the same also in the long-run. Indeed, after the temporary contractions in the economy, the re‐ sulting markets will be characterized by lower firms’ mark-ups compared to the pre-reform environment. 5.5 IV Past Reforms in the Services Sector and their Effects 160 However, it seems that firms are willing to fully exploit the short-term inefficiencies of the market before lowering permanently their margins. Therefore, for a few years after the implementation of structural reforms, firms would set their mark-up very high. Doing so, they take advantage of the temporary contraction in the production of that specific sector. Indi‐ rectly they are exploiting the transitory inadequateness of the labour mar‐ ket and the slow dynamics of the firms entering and exiting the market setting high mark-ups as long as the beneficial effects of the reforms oc‐ cur. On the other side, mark-ups in the Manufacturing sector are less affect‐ ed by the deregulation in the Transportation sector. It is evident that when the recessionary period finishes also the Manufacturing sector will be characterized by lower firms’ margins, but there are no statistically signifi‐ cant temporary effects in the short-run. Figure 4.3.11, in the Annex, shows the robustness check with the same simulation on first-difference variables. The dynamics of competition Notes: Panel SVAR, impulse responses to deregulation shocks. All variables are in per‐ centage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the me‐ dian responses and the two dashed lines denote the 68% confidence intervals. Figure 4.3.6: IV.3 Structural Reforms in Transportations 161 Conclusions The role of structural reforms in liberalizing product markets has recently gained more attention. The financial crisis has highlighted the explicit need for reforms in order to recover from the recessionary period and to boost economic activities. The lack of more traditional supply-side policy instruments suggests that structural reforms in product market are essential for policymakers to raise competitiveness and generate sustained econo‐ mic growth. Exploiting the novel CompNet firm-level-based database and the OECD’s database on Product Market Regulations, this paper analyses the effect of sector-specific structural reforms in a Panel SVAR framework. Indeed, the use of these two database allows to link the granular aspects of the national economy to the sectorial product market regulation in a wide range of European countries. Adopting the methodology proposed by Cac‐ ciatore and Fiori (2016), this analysis attempts to identify the transitionary dynamics triggered by deregulation in the Transportation sector in the short-run and in the long-run. In addition, the focus is also laid on analysing the spillover effects in the Manufacturing sector. The empirical results confirm the conclusion of both Blanchard and Gi‐ avazzi (2003) and Cacciatore and Fiori (2016): structural reforms in the product market lead to a recessionary period despite being expansionary in the long-run. The contribution of this analysis is the empirical proof that this result holds also in a more granular dimension, and, more specifically, in the case of a sector-specific reforms. Indeed, deregulation in the Transporta‐ tion sector brings to misalignments in the labour market and to contrac‐ tions in investments. Moreover, the combination of these two effects gen‐ erates a reduction in the sectorial output, thus in the real value added. In fact, in the long-run, the re-alignment of labour demand and supply, the growing investments and the entrance of new firms brings to a large in‐ crease in the value added that, exceeding the pre-reform levels, leads the economy to thrive. In addition, empirical results show that structural re‐ forms by stimulating the competition in the market enhances the produc‐ tivity growth and the resources allocation among firms. The second main finding is that structural reforms in the Transportation sector generate spillover effects in the Manufacturing sector. Hence, the upstream sector is affected by transition dynamics very similar to the ones in the downstream sector, even without any change in the relative legisla‐ 6 IV Past Reforms in the Services Sector and their Effects 162 tion. Nonetheless, these spillover effects occur only with a delay of one year and they are more moderate than in the reformed sectors. By re-assessing the linkages of each sector of the economy, this analy‐ sis finds that the long-run beneficial effects of the sector-specific reforms interest the whole economy. Furthermore, it proves that these benefits ma‐ terialize approximatively only in the fourth year after the deregulation of the market. Taking into consideration the duration of the mandate of the policymakers in each country in the sample, as reported in Annex B, it seems obvious that they do not have incentives in implementing reforms that would generate beneficial effects on average only after the expiration of the mandate. Further research should be conducted in order to identify how to design or to complement such reforms in order to minimize the short-term costs. Annex Annex A The dynamics of inputs and output Notes: First-difference Panel SVAR, impulse responses to deregulation shocks. All variables are in first-difference and in percentage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the median responses and the two dashed lines denote the 68% confidence intervals. Figure 4.3.7: IV.3 Structural Reforms in Transportations 163 The dynamics of labour costs Notes: First-difference Panel SVAR, impulse responses to deregulation shocks. All variables are in first-difference and in percentage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the median responses and the two dashed lines denote the 68% confidence intervals. The dynamics of productivity Notes: First-difference Panel SVAR, impulse responses to deregulation shocks. All variables are in first-difference and in percentage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the median responses and the two dashed lines denote the 68% confidence intervals. Figure 4.3.8: Figure 4.3.9: IV Past Reforms in the Services Sector and their Effects 164 The dynamics of resources allocation Notes: First-difference Panel SVAR, impulse responses to deregulation shocks. All variables are in first-difference and in percentage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the median responses and the two dashed lines denote the 68% confidence intervals. The dynamics of concentration Notes: First-difference Panel SVAR, impulse responses to deregulation shocks. All variables are in first-difference and in percentage deviations from trend; “_T” and “_M” denote variables in the Transportation sector and in the Manufacturing sector, respectively. The solid line represents the median responses and the two dashed lines denote the 68% confidence intervals. Figure 4.3.10: Figure 4.3.11: IV.3 Structural Reforms in Transportations 165 Annex B Duration of policymakers’ mandates References Averch, H.; Johnson, L.L. (1962): Behavior of the Firm Under Regulatory Constraint. The American Economic Review, 52(5), 1052–1069 Bailey, E.E.; Joskow, P.L.; Niskanen, W.; Noll, R. (1994): Economic Regulation. American Economic Policy in the 1980s, Chapter 6, 367-452 Bartelsman E.; Haltiwanger, J.; Scarpetta, S. 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Let me start with the paper on the crafts reform: It focuses on the issue of entrepreneurship which has been only one goal of the reform, though an important one. Obviously, the reform fostered and supported self-employment, and consequently we observe a substantial increase in entry probabilities in the aftermath of the reform. On the other hand, we see exit rates being more or less unchanged. Actually, the last finding is a bit controversial and is contradicted by other studies, for instance by Bizer et al. (2014). Hence, there is a discussion whether we see an increase in self-employment or whether the newly created firms were only short lived. The evidence is not very clear. However, the authors find a clear increase in entry probabilities and also in self-employment. If we take a broader picture and not only look at entrepreneurship, there is another recent paper by Koch and Nielsen (2016) which partly summarises the literature but also adds some new evidence using IAB data. On the one hand, they find similar results: they also find higher start-up dynamics. On the other hand, they do not find any effect on aggregate employment, innovation, wages or turnover. Therefore the effects of the crafts reform in Germany seem to be fairly mixed. Firm entries seem to have increased, but we do not ob‐ serve much of an effect on a macroeconomic level. Even on training, where there is a discussion of whether the training effort of companies has decreased throughout the reform, the evidence is not clear. What we see is that training has decreased in restricted occupations, but evidence shows that this only happened after 2009, i.e. after a certain time. So it is quite unclear whether this effect was due to the reform. The result is also sensi‐ tive to the data source. Different studies find different results on the train‐ ing evidence. Mr Palige mentioned a study which looked at prices in crafts and different occupations. I found it hard to find evidence on price devel‐ opments or consumer benefits and I think there is some scope for further IV.4 IV Past Reforms in the Services Sector and their Effects 170 research there because enhancing consumer benefit and demand actually was one of the main goals of the reform. Some technical issues concern the selection of control groups. There has been a discussion on whether you can differentiate the data properly. It is a question of whether you grasp the full effect of the reform within the data that you use. Also, there may be an issue of dealing with unobserved heterogeneity and eliminating it completely by applying the difference in difference approach. There are other econometric approaches like match‐ ing which might be worth exploring. A more general issue which has been mentioned by Henrik Enderlein before and others as well is the link with other reforms. I am not only re‐ ferring to the possibility that empirical evidence on the effects of the crafts reform might partly be blurred by the introduction of labour market pro‐ grammes which foster certain forms of self-employment. The crafts re‐ form was part of a larger reform, the Agenda 2010, which implies syner‐ gies in structural reforms that sometimes cannot be grasped by microeco‐ nomic analyses. If you go to judge the crafts reform, you have to look at the broader approach of reforms on product and labour market in general at that time. On the second paper, I would like to mention a few things as well. I think the design is novel and very innovative. It combines new data, the CompNet data, which is very useful because it draws on micro data from different countries and makes it comparable across countries, with the OECD product market regulation indicators. This is a new approach which is potentially very useful. What you find is the Blanchard and Giavazzi (2003) story ‘Short-term Pain, Long-term Gain’ which is well-known and intuitive, and Henrik En‐ derlein already elaborated on it. One useful aspect of the paper is to look at spillovers across the value chain. Very often when we discuss about reg‐ ulated professions we hear the argument that this sector is not so important from a macro view because it is relatively small. It is something that is of‐ ten underestimated. These sectors are very important e.g. for the manufac‐ turing sector because they deliver inputs for production and through this channel impact the competitiveness of our economy, even though they very often are domestic sectors. One or two technical remarks: There is an issue about endogeneity in structural VARs. You do a Cholesky decomposition and impose a causality chain. This could be discussed. Moreover, one issue, I was not sure about is, whether the fact that you model regulation as an autocorrelated process IV.4 Discussion 171 in part drives your results of ‘Short-term Pain, Long-term Gain’. If you look at your graph with the inverse U-shape path of deregulation: You have minus 20 initially, that is the deregulation reform. But then it raises again and becomes positive. This means you implicitly assume a re-regu‐ lation if you like. Also, even if the CompNet data is very useful it would be desirable to have more disaggregated evidence on firm-level data, which is however difficult to compare across countries. Let me mention one or two more general remarks on what we can learn from past reforms. I think we have been presented two approaches here. One is like a birds’ eye view looking at reforms in a whole sector of trans‐ port, not going into detail of which reforms we actually speak about. The second is a case study that uses a real reform, the German crafts reform from the 2000’s and uses it as a natural experiment to infer evidence on the effects of this reform. Beyond these very useful approaches, we see, in my view, very little research regarding product market reforms that focus‐ es on real welfare effects. Most studies focus on certain aspects like job creation, output, training, wages, firm exit and entry but there is very little evidence on consumer benefits. But, what is the advantage for the con‐ sumer from the crafts reform or from transport deregulation? Is there one at all? Actually, if you look at the recital of the German crafts reform act at the time you find formulations like ‘provide customers a broader scope of services’. So that’s actually the goal, that was written down by the Members of Parliament who decided on that the reform. However, I see very little evidence on that; I am not claiming that the consumer benefitted from it, we just don’t know. There are two issues which were already raised by State Secretary Zy‐ pries. First, I think there is the important issue of quality of services. We did a big share of work, particularly the OECD did, on creating product market indicators. However there is little to no evidence on product quali‐ ty. In my view, we should also have quality indicators across countries to compare them with regulation indicators, to be fair. Second, there is an is‐ sue of resilience of institutions, in particular with respect to global chal‐ lenges like digitization, globalisation, demography and other. For the Ger‐ man case, it is very common to delegate certain regulatory issues to the social partners or professional bodies. You can see this mostly in the labour market. As State Secretary Zypries mentioned, in the 90’s the Ger‐ man model of social partners and industrial relations was considered as one of the most important obstacles to competitiveness. Nowadays it is considered one of the greatest advantages. Therefore, I think you have to IV Past Reforms in the Services Sector and their Effects 172 take a broader perspective when looking at regulation, not only focussing a specific regulation but taking account of the regulatory framework of the economy and the specifically the industrial system as a whole. Thank you very much. Dr Davud Rostam-Afschar: The first point is that the finding of non-increasing or only modestly in‐ creasing exit rates is controversial. My research and other research has found that both entries increased and the self-employment rate increased. Now consider a strong increase in exit rates: the finding that the self-em‐ ployment rate increased cannot be reconciled with such a change. How‐ ever, these higher self-employment rates are what the literature consistent‐ ly finds. This could be a short term effect, therefore it is interesting to look at survival rates, which was beyond the scope of my study. However, I provided evidence on the treatment effect in each of the five years after the reform, which were the latest available data of the German micro cen‐ sus at that time - and still there was a significant treatment effect on en‐ tries and the self-employment rate. I do not think, this is a controversial finding. A second point referred to technical issues. Matching techniques for non-experimental settings have recently developed in a fascinating litera‐ ture. However, the setting in my study is quasi-experimental because treat‐ ment and control groups are defined quite randomly by the law. Therefore other concerns seem more important. Finding a good control group is often difficult and you can debate long, whether you can maintain the common trend assumption. Therefore, I did robustness checks and compared alternative definitions of control groups. For instance, I compared the B1 occupations as treated to the control group of all the A occupations and the results turned out to be similar. A different control group candidate would be the B2 occupations but there is too little information on who works in these occupations. Another alterna‐ tive is to use industry occupations that are similar to crafts occupations but again, it is hard to distinguish these occupations. Taming unobserved heterogeneity may be challenging in many settings, however, in a setting where you compare the same person before and after the reform, the person-specific unobserved heterogeneity would drop out if it is unrelated to the reform. Of course, there are many more extensions IV.4 Discussion 173 that future research could investigate. However, I would be surprised, if the results turn out to be different from what I presented. The third point was to consider the effects of the broad package of the agenda 2010. This is accounted for in the difference-in-difference-ap‐ proach, as I check, for instance, whether a startup subsidy for unemployed or the enlargements to the European Union influenced the results. Beyond that, I leave to others to debate the forces that cannot be captured by mi‐ croeconometric methods. Fourth and finally, the reason that Koch and Nielen (2016) do not find employment effects is that in the IAB data, there are no one person com‐ panies. Their investigation of more indicators is a valuable step towards a welfare analysis. However, for such an analysis you need a fully-fledged structural model, and it is hard enough to measure the effect of one indica‐ tor in an unconfounded way given the available amount and quality of da‐ ta. The contribution of my paper and those who use the same methods like Koch and Nielen (2016) is that future research can use the presented re‐ sults to form a structural model from which one can calculate welfare ef‐ fects on consumers. Key variables that are currently not available are the quantity and quality of consumer services. So how can you say more on the effect of the reform on quantity, quality and prices? As has been men‐ tioned, we need more and better data to make an economic policy possible that is founded in facts and evidence instead of ideological quarrels. If you have some money spare for conducting a survey or an experiment I am happy to offer my services to develop and conduct the research. Thank you very much. Paolo Mengano: Thank you for the comments. Regarding the endogeneity issue you raised, concerning also the Cholesky decomposition and the autocorrelation of the regulation, it is something that I have given a lot of attentions. Thus, after obtaining those results, I ran several tests. I have not found anything that will make me doubt their quality. Moreover, as further robustness check, I re-ran the regulation in first differences, exactly to check whether it might change something, and the results still hold. The Cholesky decomposition, it allows me to get exactly what I wanted to look into, i.e. the exogeneity of the regulation and the desired casual chain among the variables of inter‐ est. IV Past Reforms in the Services Sector and their Effects 174 I tried it with other specifications, too. For example, I tried the same ex‐ ercise with sign restrictions. However, lacking a proper theory, I could do it only for my first result as I could use the restrictions from existing mod‐ els. For the other results, I could not do it because I did not know what restrictions to impose. About the welfare effects that you were mentioning, I believe they are extremely important too. I have not done it so far mainly because this would require more degrees of freedom in my model. Adding them now would likely bias all the estimations. The same stands for prices. More‐ over, I haven’t found a good series of data to add at such a granular level. Thank you very much. IV.4 Discussion 175 How to Assess the Economic Impact of Regulation – Recent Developments in Europe and Germany and Outlook to the Next Step Services liberalisation in Germany: Overview and the potential of deregulation72 (Oliver Arentz) Dr Oliver Arentz, Institute for Economic Policy at the University of Cologne Executive Summary The structure of the German economy changed drastically over time. The decline of the proportion of gross value added of the manufacturing sector at the expense of the services sector is often cited as an indicator for this structural change. However, this shift is not necessarily an indication of a decreasing importance of the manufacturing sector, but rather it points to a fundamental change of the gross value added process in manufacturing. Within the manufacturing process, business services and product-related services are growing in importance in development, production, marketing and sales as well as in customer relations and maintenance. With the increasing importance of intermediate inputs of the business services sector the interest in the regulatory framework for the provision of these services and the resulting welfare effect is also increasing. Inap‐ propriate regulation can, inter alia, lead to the waste of resources in the production process and to unexploited innovation potential. Negative ef‐ fects would especially occur in the downstream domestic production ar‐ eas, which compete internationally and, therefore, need competitive ser‐ vices. Conversely, the reduction of unnecessary regulation and trading- V V.1 72 Arentz, O.; Manner, H.; Münstermann, L.; Recker, C.; Roth, S.J. (2015): Services liberalisation in Germany: Overview and the potential of deregulation, Otto-Wolff- Discussion Paper, No. 01b/2015. 177 barriers can release unused growth potential not just in the services sector, but also in the manufacturing sector. The OECD has recorded the level of regulation for selected profession‐ al services since 1998. The indicators of the OECD confirm that substan‐ tial structural reforms have taken place in Germany in the past. Nonethe‐ less, Germany does not have one of the lowest indicator values of EU countries. In addition, other regulation measures like the Service Trade Restrictiveness Indicator also published by the OECD and the level of economic rents suggest further deregulation potential in the professional services sector.This study offers three principles for the identification of potential deregulation targets. First, we recommend the equalisation of dif‐ ferent profession-specific regulations for professions with comparable fields of activity to the currently lowest level of regulation. Second, one can consider the equalisation of state specific regulations within Germany for the same professions to the lowest existing intensity of intervention. Third, ‘gold-plating’ of existing and future EU demands should be avoid‐ ed. The results of the econometric analyses for selected business services carried out as a part of this study confirms the significant impacts on wel‐ fare of past structural reforms on the net value added in the downstream manufacturing production as well as in the overall economy. Furthermore, the discovered interrelationships give rise to positive indications for the expected effects of potential future reforms, which should have growth ef‐ fects particular on the German manufacturing sector. Introduction More than 7 out of 10 employees in Germany work in the services sector. In particular, the business services sector grew dynamically over recent years. Moreover, industrial products include an increasing proportion of services; the division between industry and services is becoming less clear-cut. This can also be shown in the employment structure of the man‐ ufacturing sector, where an increasing amount of employees provide ser‐ vices. Services and industrial products are closely interconnected and de‐ pendent on each other. Since the beginning of the 2000s the EU has in‐ creasingly focused on the services sector. The directive on services in the internal market and the directive on the recognition of professional qualifi‐ cations are cornerstones for the development of the internal market in the 1 V How to Assess the Economic Impact of Regulation 178 services sector. Current efforts focus on reducing market barriers and on thereby creating positive welfare effects. In Germany the debate on services liberalisation is apparently observed rather than actively advanced. Many proposals from Brussels lead to resis‐ tance from lobby groups. But there appears to be room for competitionenhancing deregulation as this study shows. Initially we define the term “service” and give an overview over the German market (chapter 2). In chapter 3 we resume the debate regarding the alleged services gap in Ger‐ many and scrutinise it by further analysis. Next we give an overview over the status quo of regulations in the services sector (chapter 4) and of cur‐ rent steps for services liberalisation (chapter 5). Afterwards we analyse the economic effects of services liberalisation both on a theoretical as well as on an empirical level (chapter 6). In chapter 7 we outline which politicoeconomic resistance against further steps for services liberalisation is to be expected. Finally, we summarise the results and show steps for economi‐ cally reasonable deregulation, which do not seem politically hopeless (chapter 8). The German services market – definition and overview What exactly are services? In the literature the question of how to clearly separate manufacturing and services is intensively discussed. A widespread definition characterises services in contrast to manufacturing as non-material processes. According to this definition, the goal of the ser‐ vices process is to change the condition of a product or a person (Hill 1977). Following this process thinking, services, in contrast to products, cannot be produced in advance as they are not storable until their sale or usage. Rather the processes of creation and of usage have to take place si‐ multaneously. Many services additionally require the presence of the consumer and the interaction with the provider. Examples are consumer-related services like being examined by a doctor, riding a taxi or attending a concert. These services are called time- and place-bound services, as their creation is linked to location and time. Due to the personal nature of the work, it is usually assumed that there is only a minor potential for development or in‐ creases in productivity (Eickelpasch 2012). Another consequence of the necessary simultaneous presence of the services provider and the con‐ 2 V.1 Services liberalisation in Germany 179 sumer is that the tradability of these services over a greater distance is very limited. Due to the appearance and the further development of modern commu‐ nication technologies this simultaneous presence is necessary for fewer and fewer services. Many services become unbound services. Examples are the remote maintenance of equipment or hardware, data teleprocessing or many financial services (Eickelpasch 2012). In contrast to time- and place-bound services, unbound services just like manufactured products are usually tradable over a greater distance. Moreover, in many cases the creation of a service does not have to take place simultaneously to its us‐ age. Some unbound services like manufactured products can therefore be created in advance. For example, the remote maintenance of equipment or technical planning and calculations for a customer can in parts make use of standard components from a provider’s own product portfolio. In the case of unbounded services, increases of productivity similar to the in‐ creases in manufacturing are possible. These increases can mainly be evoked by economies of scale. This short overview shows that a clear dif‐ ferentiation of services and manufacturing among themselves is becoming more and more difficult. For the following analysis of the services sector a functional view seems appropriate: The services and products in the services sector can be classified by considering whether they are meant for final consumption or as an intermediate input for manufacturing or other services (see Figure 5.1.1). Services sectors which are predominantly used as intermediate in‐ puts, are called business services. Examples are advertisement and market research, consultancies, external research providers or whole sale. Busi‐ ness services can be separated from services in tourism, leisure, retail or the public sector, which are created predominantly for the final consump‐ tion and which are part of consumer-related services. V How to Assess the Economic Impact of Regulation 180 Proportional use of domestic services Notes: Last usage of domestic services products, intermediate inputs include manufac‐ turing investments, assumption: domestic usage structure for exported services prod‐ ucts; year 2010 Source: input-output calculations of the German Federal Statistical Office, own calcu‐ lations and illustration. In the context of structural changes of the economy, services have grown in significance in Germany (see Figure 5.1.2). Following the widespread Figure 5.1.1: V.1 Services liberalisation in Germany 181 sectoral partition in a primary sector of initial production, a secondary or manufacturing sector and a tertiary or services sector, about 69 per cent of the domestic gross value is contributed by services. The share of employ‐ ment is even slightly higher with 74 per cent. The manufacturing sector contributes about 26 per cent of gross domestic value and about 19 per cent of employment. However, many occupations in the manufacturing sector today concentrate on services. Therefore, the overall importance of services cannot fully be comprehended by considering the sectoral econo‐ mic structure (see chapter 3). The construction sector is statistically count‐ ed as part of the manufacturing industry and contributes about 5 % to do‐ mestic value and to employment respectively. Share of gross value added by economic sectors in Ger‐ many Note: Before year 1991: former West-Germany. Source: German Federal Statistical Office, own draw based on Eickelpasch (2012). The increase in importance of the services sector is partly due to the in‐ crease of public services e.g. in health care or the social sector. More im‐ portantly, the increase in business services contributed to the increase of the services sector. There is an increasing demand for business input fac‐ tors by other services providers as well as manufacturers accompanying products within their production or the export of products. Since the Ger‐ man reunification in 1991 both the gross value added and the employment Figure 5.1.2: V How to Assess the Economic Impact of Regulation 182 in the area of business services grew the most. Business services firstly consist of knowledge-intense services like legal services, consulting, tax and public accounting, architecture, engineering as well as advertising and market research. Secondly also less knowledge-intense services like secu‐ rity services or rental and leasing activities are counted as business ser‐ vices. Lower increases can be seen in information and communication ser‐ vices or predominantly consumer-related other services. However, the pro‐ portion of financial and insurance services as well as retail, hotel and guest industry and transportation within the domestic economic structure have almost not changed (see Figure 5.1.3). Increase of the gross value added and of employment in the domestic services sectors Note: Time period 1991 until 2013, in per cent, gross value added inflation-adjusted for base year 2010 Source: German Federal Statistical Office, own illustration. There are considerable differences regarding the profitability within the area of business services. The profit to revenue ratio is usually used as a figure of the profitability of a company. In the national input-output calcu‐ lation, the respective sector-specific net operating surplus is reported. The net operating surplus is the operational result after the subtraction of inter‐ mediate inputs, write-offs as well as expenditure on the compensation of employees. For independent companies the net operating result is the mixed income before the subtraction of taxes. Whereas the proportions of Figure 5.1.3: V.1 Services liberalisation in Germany 183 the gross value73 of the output value are slightly below 50 per cent both in knowledge-intense as well as in less knowledge-intense services, consider‐ able differences regarding the net operating surpluses do exist. The sector of knowledge-intense business services made an average net operating surplus of 16 per cent of the production value in 2010 (see Figure 5.1.4). Particularly high surpluses were achieved in the areas of marketing and market research, legal services, consulting as well as architecture and en‐ gineering. In less knowledge-intense services the net operating surplus was considerably lower, namely 6 per cent on average. In the domestic in‐ dustry the net operating surplus was on average 9 per cent in 2010. Gross value added and net operating surplus in the area of business services Notes: Year 2010, in per cent proportional to production value Less knowledge-intense services: retail, transportation, warehousing, renting and leas‐ ing, hiring-out of workers, traveling agencies and events, economic services (among others security). Knowledge-intense services: media and publishing, computer and information ser‐ vices, telecommunication services, financial and insurance services, legal, tax account‐ Figure 5.1.4: 73 The gross value added equals the production value minus the intermediate inputs. After subtracting write-offs you have the net value added. The relevant difference to the net operating surplus is that the compensation for employees is included in the gross value added, whereas the net operating value is the part of the gross val‐ ue added, which a company has at its disposal for investments, capital service, tax‐ es and withdrawals of profit. V How to Assess the Economic Impact of Regulation 184 ing and consultancy services, architecture and engineering, research and development, other liberal professions. Source: Input-output calculations of the German Federal Statistical Office, own calcu‐ lations and illustration. The domestic market is by far the most important market area for services created in Germany. Although the proportion of the services sector of the domestic gross value added is three times larger than the proportion of the manufacturing sector, 85 per cent of all German exports are industrial products. The share of exports in consumer-related services (without pub‐ lic services) like culture and leisure, retail or personal services like hair‐ dressers or laundromats were below 4 per cent in 2010. The main reason is assumed to be the previously mentioned limited tradability of these ser‐ vices, which are linked to the provider. The proportion of exports of busi‐ ness services was slightly higher. On average less than 17 per cent of do‐ mestically created less knowledge-intense services were exported (see Figure 5.1.5). Within the less knowledge-intense services there are, how‐ ever, huge differences. While wholesale and transportation show above average export quotas, place-bound services like security were almost ex‐ clusively created for the domestic market. The services and products of knowledge-intense services providers are increasingly part of the unbound services. Although services provider and customer do not have to be present permanently during the creation process, the export ratio of knowl‐ edge-intense services is only 12 per cent. Within the knowledge-intense services, the areas research and development, information and communi‐ cation services as well as architecture and engineering show an export ra‐ tio above average. The volume of services exported to the rest of the world surmounts the export volume to members of the European Union in many services sec‐ tors. Worth mentioning is the comparison with the entirety of all German goods and services exported in 2010. With a proportion of roughly 60 per cent, there were more exports to member states of the European Union than to the rest of the world. V.1 Services liberalisation in Germany 185 Export ratio in the sector of business services Note: Year 2010, in per cent proportional to the total usage goods in a sector Source: Input-output calculations of the German Federal Statistical Office, own calcu‐ lations and illustration. Services gap – the relationship between the services sector and the manufacturing sector In the debate about the German economic structure it is regularly re‐ marked that Germany has a so called services gap, which could endanger the international competitiveness of the German economy in the long run. The discussion on the alleged services gap is based on the observation that in international comparison, the manufacturing sector still makes up a high proportion of the German economy. In other European economies like France or the United Kingdom the proportion of the manufacturing sector has decreased significantly in recent years, the manufacturing sector cur‐ rently only contributes 13 and 16 per cent of their gross value respectively. In Germany the manufacturing sector’s proportion of the gross value has remained almost constant during the same time period. With an share of manufacturing of about 24 per cent Germany is well above-average com‐ pared to the economies of the European Union or the US (see Figure 5.1.6). Figure 5.1.5: 3 V How to Assess the Economic Impact of Regulation 186 The manufacturing sectors proportion of the gross value added by international comparison Notes: In per cent, years 2000 and 2010; manufacturing sector without the construction sector Source: OECD, own illustration. Sometimes the comparatively large share of the manufacturing sector in the German economy is viewed with criticism. An argument commonly brought forward says that a high share of manufacturing of the gross value added identifies a structural weakness of an economy, since a transition to a modern services society apparently failed74. This judgement is based on the idea that the average gross value added by manufacturing is lower than in services provision, which is particularly disadvantageous for employ‐ ment in countries with a high wage level. The reason is primarily that sim‐ pler jobs with a low gross value added in manufacturing are affected by automation processes or relocations. Simpler services jobs are usually consumer-related and time-related tasks and are therefore barely affected by global relocations. However, simpler services are affected by automa‐ tion processes and rationalisation processes. Examples are the disappear‐ Figure 5.1.6: 74 See the description by Schmidt (2012), whereas the author does not adopt this pos‐ ition. V.1 Services liberalisation in Germany 187 ance of former services jobs like the petrol attendant or the appearance of self-service cash points in super markets. In the debate about Germany’s high share of manufacturing and the al‐ leged services gap the structure of the domestic industry is partially mis‐ judged. Sometimes the notion that the jobs in the manufacturing sector are mostly limited to physical manufacturing and therefore traditional jobs in manufacturing seems to be dominant. Nevertheless, within the manufac‐ turing sector a structural change to servitisation has occurred that is simi‐ lar to overall structural change of the three sectors of the economy. Within the domestic manufacturing sector employment in fabrication decreased for several years, while employment in product-related services like re‐ search and development or customer services are increasing continuously. For an industrial product to succeed in the market it is often not sufficient to solely produce goods. Customers increasingly expect customised solu‐ tions to their problems, which means that product-related services play an increasing role in the value of the product (Eickelpasch 2014, De Baker et al. 2013). This part is in many cases the decisive competitive advantage. Industrial companies are therefore faced with the question whether they want to provide product or sales-related services like development activi‐ ties, sales, customer services or legal services and strategy advice them‐ selves or whether they want to purchase these services from third-party providers. With the currently used statistical classification, the statistically recorded total size of the services sector and manufacturing sector in a country depends on which alternative industrial companies choose (Döhrn et al. 2008). A differentiated view on the services share within the manufacturing sector and therefore on the total economic structure is offered by the em‐ ployment statistic of the German Federal Labour Market Authority. The statistic discloses the primary field of activity for every employee. In this way service tasks within the manufacturing sector can be well recorded (Eickelpasch 2014). In 2013 almost 50 per cent of all employees in the manufacturing sector executed service tasks (see Figure 5.1.6). The largest share of these service tasks were found in the areas internal research and development as well as management and organisation of a company. The third largest area of internally provided services encompasses tasks in ac‐ quisition and sale, in customer services as well as in marketing and prod‐ uct placement. Moreover, in many manufacturing sectors in-house logis‐ tics providers are used. In some export-orientated manufacturing sectors the proportion of services employees is well above the average of the V How to Assess the Economic Impact of Regulation 188 overall manufacturing sector. In the domestic pharmaceutical industry 9 out of 10 employees are services employees, in the chemical industry it is 8 out of 10 employees. In particular, these two examples show how mis‐ leading the statistical classification between the secondary or manufactur‐ ing sector and the tertiary or services sector can be. Services sector employees in the German manufacturing sector Note: Proportion of total employment, year 2013 Source: Employment statistics of the Federal Employment Agency, own calculations based on Eickelpasch (2014), own illustration. Döhrn et al. (2008) assume that industrial companies in the Anglo-Saxon area are more likely to use external services suppliers. German industrial companies rather prefer to control more operations themselves by keeping them in-house. These differences can partly be explained by different cul‐ tural traditions and corporate philosophies, diverging considerations for costs and efficiency as well as the need to prevent external parties insight into the company. However, the hypothesis that industrial companies are unable to find an adequate supply of intermediate inputs for some of the required services and therefore use in-house solutions is also reasonable. Figure 5.1.7: V.1 Services liberalisation in Germany 189 Despite the comparably large services share of the domestic industry, purchased services as intermediate inputs also continuously increase in importance. In 2010 the industrial sector used intermediate inputs in the amount of 1,385 billion Euros. With 368 billion Euros about a quarter of these intermediate inputs came from the services sector (see Figure 5.1.8). Furthermore, a part of the intermediate inputs bought by industrial com‐ panies from other industrial companies are also services. With the produc‐ tion of accompanying services many industrial companies gain specific skills which they not only use for internal purposes. Rather many industri‐ al companies directly appear as services providers themselves and offer their specific skills to third parties. Intermediate inputs purchased by the manufacturing sector Note: Year 2010, in billion Euros Source: Input-output calculations of the German Federal Statistical Office, own illus‐ tration. While the structure of industry-internal input services cannot be measured in detail, the input-output calculations of the German Federal Statistical Office offer a differentiated overview over the intermediate inputs from the services sector. Considering the volume of purchased business services from the services sector, one can see that wholesale has the highest impor‐ tance for the manufacturing sector. The second most important are legal services, tax and public accounting and consulting before transport and lo‐ Figure 5.1.8: V How to Assess the Economic Impact of Regulation 190 gistics. Architecture and engineering firms, other economic services like security services, rental and leasing, labour recruitment and provision of personnel as well as marketing and market research are also of high im‐ portance. The importance of external research and development activities varies significantly between different manufacturing sectors, whereas the industry average is negligible (see Figure 5.1.9). Business services purchase by the manufacturing sector Note: Year 2010, in billion Euros Source: input-output calculations of the German Federal Statistical Office, own calcu‐ lations and illustration. On the basis of the open statistical input-output model of the German Fed‐ eral Statistical Office and thereby considering the external trade relations, Figure 5.1.9: V.1 Services liberalisation in Germany 191 one can understand how many units of a good of a domestic services cre‐ ation are directly and indirectly needed to provide one unit of an industrial good for final usage (Schmidt 2012). The intermediate inputs from the ser‐ vices sector are therefore of particular importance for export-orientated manufacturing sectors like the chemical industry, the construction and me‐ chanical engineering sector as well as the automotive industry (see Figure 5.1.10). For example, 0.43 units of intermediate inputs from the services sector are needed if the production value increases by one unit on a value basis. Value based proportion of intermediate inputs from the services sector for the production of another value unit of domestic manufacturing production Note: Year 2007, on the basis of the statistical input-output-model of the German Fed‐ eral Statistical Office Source: Inverse coefficients of the input-output calculations of the German Federal Statistical Office, own illustration based on Schmidt (2012) On the one hand, as the manufacturing sector is an important recipient of services form the services sector, this demand creates direct growth and employment effects in the services sector. Assuming the services demand‐ ed by the manufacturing sector go along with an identical employment share in the services sector, the demand for industrial products caused em‐ ployment in the amount of 3.8 million employees in the domestic services sector in 2009 (Eickelpasch 2013). Figure 5.1.10: V How to Assess the Economic Impact of Regulation 192 On the other hand, the effects of the services sector in the manufactur‐ ing sector are less direct. The demand for industrial intermediate inputs used for services creation amounted to only 20 per cent of the overall in‐ termediate inputs of 1,084 billion Euros and was, therefore, lower than vice versa, as the services sector receives the major part of its intermediate inputs from other services providers (see Figure 5.1.11). Due to the pur‐ chasing of industrial intermediate inputs by the services sector direct de‐ mand effects, nevertheless, do exist. Furthermore, services intermediate inputs increasingly contribute to the development as well as the produc‐ tion and the distribution process of industrial companies. This suggests that the services sector does not only create demand effects, but also direct effects on the manufacturing sector. Both improvements in quality as well as in cost saving can, for example, positively contribute to the gross value added of the manufacturing sector during the course of deregulation ef‐ forts and the reduction of barriers of trade. A discussion of the supply ef‐ fects of business services on the manufacturing sector can be found in sec‐ tion 6.2. Intermediate inputs purchased by the services sector Note: Year 2010, in billion Euros Source: Input-output calculations of the German Federal Statistical Office, own illus‐ tration. Figure 5.1.11: V.1 Services liberalisation in Germany 193 Empirical survey of the status quo of the regulation in the services sector The regulatory intensity in the services sector can be derived from the to‐ tality of all specific regulatory interventions in the relevant legislation and decrees. An actual evaluation of all relevant sources is almost impossible. Particularly for international comparisons, this procedure would have to be undertaken for all countries. Therefore, empirical research usually re‐ sorts to existing regulatory indicators. The OECD has been measuring the regulations in the non-manufactur‐ ing economy on a sectoral basis in 34 OECD and 22 non-OECD countries every five years since 1998 (OECD 2013, Product Market Regulation Database, www.oecd.org/economy/pmr). Apart from the indicators for network sectors (energy, transportation and communication) and retail the OECD offers an indicator for “professional services”, which covers the professions public and tax accounting, legal, engineering and architecture. The “professional services” are of particular importance as a supplier of intermediate inputs for the manufacturing sector. They are among the five most important professional business services measured by the amount of the intermediate inputs received by the manufacturing sector (see figure 5.1.9). Market entry regulations (e.g. requirements for profession-specific educational qualifications, membership in a chamber) and behavioural regulations (e.g. fee scales, bans on advertisement) are registered for every profession. From these sub-indicators overall indexes are derived for ev‐ ery profession and for professional business services overall. Figure 5.1.12 shows the development of the index values for Germany, Italy, France, the Netherlands and the United Kingdom. The scale reaches from no regulation (zero) to maximum regulation (six). Germany im‐ proved from 4.28 in 1998 to 2.65 in 2013. Thus it appears that in this time period massive deregulations took place. Italy and France show compara‐ ble levels of regulation. The Netherlands and the United Kingdom have OECD values slightly above and below an indicator value of one respec‐ tively, which are the lowest values in Europe. 4 V How to Assess the Economic Impact of Regulation 194 OECD Indicator on regulation in professional business services Note: All professions, including accounting, legal, architecture and engineering Source: OECD indicators of regulation in non-manufacturing sectors (NMR) A glance at the sub-indicators for the professions public and tax account‐ ing, legal, engineering and architecture show improvements for Germany in all areas in the observation period. The strongest deregulation was mea‐ sured for public and tax accountants with an improvement of the indicator value from 5.0 to 2.6. This development was mainly driven by easing the behavioural regulations (e.g. in the area of the fee scales). In the area of legal services the indicator decreased by slightly more than one grade point from 4.8 to 3.6. The underlying deregulation regarded both the be‐ havioural regulations and the market entry regulations. The indicator value for architects decreased from 4.0 to 2.8. Particularly the abolition of be‐ havioural regulations like “Interprofessionelle Zusammenarbeit”75 con‐ tributed to this. Despite the low basic level the values for engineers de‐ crease by more than one grade point from 3.3 to 1.7. This is partly due to Figure 5.1.12: 75 In Germany, “Interprofessionelle Zusammenarbeit” means the cooperation of peo‐ ple of different professions (e.g. lawyers, accountants and doctors/physicians) within one legal form of organization (“Rechtsform”). V.1 Services liberalisation in Germany 195 the abolition of requirements for “Interprofessionelle Zusammenarbeit” and lower qualification requirements. OECD Indicator on regulation for accounting, legal, ar‐ chitecture and engineering Source: OECD indicators of regulation in non-manufacturing sectors (NMR) The OECD first published the Services Trade Restrictiveness Index (STRI) in 2014, which should particularly show the international trade and investment barriers in the examined sectors. The underlying data refers to the current regulations in 34 OECD countries and six big emerging economies. The STRI values range from zero to one. Zero stands for a to‐ tally open and one for a totally closed economy. The STRI and the OECD indicators described above show certain overlaps, but they have different focuses and differ regarding their methodology. Figure 5.1.14 shows the values for Germany and other selected EU countries for engineers and ar‐ chitects as well as for lawyers and public and tax accountants (Grosso et al. 2014a and 2014b). The sub-categories are in accordance with the cat‐ egories, which are used in the international trade agreements. Figure 5.1.13: V How to Assess the Economic Impact of Regulation 196 OECD Services Trade Restrictiveness Index Note: Year 2014 Source: OECD Services Trade Restrictiveness Index Regulatory Database. As the STRI values only exist for one time point, developments cannot be shown. Nevertheless, it generally confirms the image portrayed by the OECD services regulation index. Germany, Italy and France show the highest level of regulation for all professions, whereas Germany tends to have a slightly lower level of regulation than Italy. Lower trade barriers can be found in the Netherlands and the United Kingdom. For all profes‐ sions and countries the requirements for the movement of people are the largest block in the respective regulatory index. Thereby, it has to be con‐ sidered that the OECD also captures the freedom of movement regarding non-EU states. The magnitude of economic rents in a sector of the econo‐ my can be used as an indirect indicator for regulation. The economic rent describes profits, which exceed the usual return on the used factors. Theo‐ ry suggests that these profits go back to a low competitive intensity in the market (Boone 2005). The level of economic rents can be interpreted as an Figure 5.1.14: V.1 Services liberalisation in Germany 197 indirect indicator of anti-competitive regulations. Nevertheless, these indi‐ cators should not be used as the only indicator for regulation since econo‐ mic rents can have other causes like, for example, temporary demand shifts, misuse of market power or higher shares of profit in non-incorp‐ orated firms. Net operating surpluses in selected sectors of the economy Note: Years 1995 until 2007, in per cent proportional to the production value Source: Input-output calculations of the German Federal Statistical Office, own calcu‐ lations and illustration. The net operating surplus from the input-output calculations of the Federal Statistical Office can be chosen as a rough indicator for economic rents. The net operating surplus (or the net mixed income for companies without legal personality) describes the proportion of the gross value added, which a company has at its disposal, e.g. for capital service, to pay taxes or for investments, after subtracting compensation for employees and write-offs. Between 1995 and 2007 the average net operating surplus in proportion to the production value for the whole economy was 10 per cent. In the same time period it increased from 2 to 8 per cent in the manufacturing sector, whereas it decreased from 18 to 14 per cent in the whole services sector. The average net operating surplus also decreased in the area of business services. Nevertheless, both the basis value of 34 per cent and the final value of 28 per cent were above the other aggregates. These values at least do not contradict the hypothesis that the competitive intensity in the area Figure 5.1.15: V How to Assess the Economic Impact of Regulation 198 of business services could also be lower than in the manufacturing sector, due to regulation76. In the context of the services directive there are numerous studies by the EU, which show among other things country-specific information re‐ garding the level of regulation (z. B. Monteguado 2012, European Parlia‐ mentary Research Service 2014). In addition, the European Commission recommends Germany measures to increase the competition in the area of services (EU COM 2014). Endeavours to deregulate the services market The European single market is a key element of the European integration process, whose welfare enhancing effect is commonly acknowledged. The specific design of the four fundamental freedoms (free movement of goods, people, services and capital) is being grappled with on a regular ba‐ sis. Since the early 2000s the European commission increasingly focused on the internal market for services and developed their own strategy for liberalisation. This led to the directive on services in the internal market in 2006. The European commission still sees substantial room for improve‐ ment in the services sector. This is supported by a study for the European Parliament, in which the annual costs of the non-implementation of the in‐ ternal market for services are estimated between 337 and 637 billion Euros (European Parliamentary Research Service 2014). Although such calcula‐ tion can only be used as a rough guide, there are strong theoretical argu‐ ments for further deregulation efforts (also see chapter 6). Generally the country of origin principle applies to goods if there are no common European product standards. The country of origin principle im‐ plies that goods which were manufactured in accordance with the legal standards of its country of origin can be sold in every EU member state, even if the destination country has higher product requirements. Especial‐ ly the European Court of Justice has reemphasised the importance of the country of origin principle ever since the Cassis-de-Dijon ruling on Febru‐ ary 20th 1979 (case 120-78). In the initial draft for the directive on ser‐ vices, which was developed by the former Dutch internal market commis‐ sioner Frits Bolkestein, the country of origin principle was intended as a 5 76 For further information regarding the net operating surplus, see appendix B. V.1 Services liberalisation in Germany 199 constitutive element. This led to massive protests of interest groups in the member states, which in turn led to the fact that the country of origin prin‐ ciple was formally removed from the directive. The resistance against the so called “Bolkenstein-directive” was so strong, that some partly make the draft responsible for the failure of the votes on the common European con‐ stitution in France and the Netherlands (Crespy 2010). Although the country of origin principle for services cannot be politi‐ cally implemented for now, there are currently efforts on the EU level to deregulate services and to strengthen the internal market for services. These efforts are mainly about finding common minimum quality stan‐ dards (e.g. in the form of required qualifications for the access to profes‐ sions), which will be accepted by all member states. This endeavour did not become easier since the last EU enlargement and the increased hetero‐ geneity of the member states. An important step was the passage of the directive on the recognition of professional qualifications in September 2005, which should among other purposes provide services providers with the necessary legal certainty re‐ garding the recognition of professional qualifications in EU member states. The evaluation process, which shall determine whether the goals of the directive have been achieved or whether rectifications should be im‐ plemented, presumably ends in early 2016. The EU commission therefore does a legal scrubbing with the goal to decrease regulations for the access to professions. In a first step all member states were asked to submit all regulations for the access to professions into a central database. However, not all declarations of the member states have been submitted to the com‐ mission so far. In a next step the member states should evaluate the exist‐ ing regulations for the access to professions in a peer-review-process, which should result in a national action plan for every member state. This process will be done in two waves and will presumably last until the end of 2016, whereas first intermediate results are expected in mid-2015. Moreover, the so called High-Level-Group on business services pre‐ sented its final report in April 2014. It includes numerous suggestions how the member states can strengthen business services –e.g. by further deep‐ ening the internal market for services. The High-Level-Group expects a strengthening of business services to lead to impulses for a reindustrialisa‐ tion of the EU. The High-Level-Group sees particularly great potential for increases in wealth in the increasing service orientation of the manufactur‐ ing sector, meaning the combined supply of manufactured goods and adapted services by an industrial company, and the increasing intercon‐ V How to Assess the Economic Impact of Regulation 200 nectedness of technical equipment associated with the keyword industry 4.0. A public German debate on the possibility and benefits of a continued services liberalisation is currently not existent. The few existent debates on services liberalisation in Germany are predominantly facilitated by ini‐ tiatives from Brussels e.g. in the context of the European semester. This passive attitude could not be in the best interest of German citizens, em‐ ployees and companies in the mid- and long-run as the risk exists that deregulation processes and areas will be vastly set in Brussels. As the fol‐ lowing analysis will show, it could very well be beneficial to facilitate a decentralised process from the bottom up, particularly by Germany. Economic effects of services deregulation In economic theory the decrease of regulation which limits access to a market or a profession is associated with the expectation of positive growth effects. However, it is important to notice that the theoretical mod‐ els implicitly rest upon the assumption of a functioning general legal framework. This legal framework guarantees private property, it enables the enforcement of legally valid contracts and it prevents misuse of market power. Only under these conditions can it be theoretically concluded that decisions by market actors made in a system of free competition increase the overall welfare of society. It is assumed that markets perform their al‐ location function efficiently and the state function perfectly as a regulator. The economic models are able to show general cause-and-effect rela‐ tionships. When applying the results to real life cases, one has to consider that both market processes as well as the framework by the state can differ from the theoretical ideal. Market imperfections like asymmetric informa‐ tion or externalities can legitimise state regulation. From an economic per‐ spective, it not only has to be shown convincingly that market imperfec‐ tions make interventions seem desirable, but also that the intended addi‐ tional regulation indeed leads to an increase in welfare. The following analysis will show the theoretical effects of services lib‐ eralisation and will support these results with empirical studies where ap‐ plicable. General effects of services liberalisation can be derived from this analysis. The empirical findings can be used to estimate the significance of the respective effects. Thereby the context of each study also has to be taken into consideration. 6 V.1 Services liberalisation in Germany 201 Direct effects Liberalisations in a sector initially directly influence the supply and price structure in that sector. Due to the abolition of market barriers new com‐ panies can enter the market more easily. Market entries can occur by com‐ panies operating in other markets, foreign companies or start-ups. The threat of potential competition increases the competitive pressure for in‐ cumbent companies even before potential competitors enter the market. This (potential) competition leads to the fact that companies systematical‐ ly evaluate their production process for cost saving opportunities in order to remain competitive. Apart from process innovations the probability that economies of scale (e.g. through mergers) are implemented and economies of scope are used in the production process increases with the level of competition. Economies of scope can result from the simultaneous supply of different products by using synergies during production. An example of this in the services sector could be that constraints for lawyers and tax accountants regarding “Interprofessionelle Zusammenarbeit” are decreased, which leads to the fact that legal and tax accounting services can be provided cheaper by one provider. Moreover, it is possible to use economies of scope by integrating different steps of the chain of economic gross value added. However, it is questionable whether this plays a relevant role in the services sector, as few intermediate inputs are used in the services sector. Although the usage of economies of scope plays a bigger role in the manu‐ facturing sector, in which the sale of physical goods in combination with services is becoming increasingly important in the recent past, as de‐ scribed above. Another effect of the higher level of competition due to deregulation is that companies are forced to consider consumer preferences to a greater extent. Firstly, this means a constant improvement of existing products. Secondly, this tends to lead to more innovation activities, as companies have a higher incentive to develop new products in order to be temporarily protected from competitive pressure as an entrepreneurial pioneer. It can be argued that the opening-up of the telecommunication market in Ger‐ many in the late 1990s led to a variation of existing telecommunication services (e.g. through new rate structures) and contributed to a quick ex‐ pansion of novel products (e.g. digital data transmission) for the wider population. 6.1 V How to Assess the Economic Impact of Regulation 202 The increased use of process and product innovations usually leads to decreasing prices on sales markets.77 Technically speaking the price ap‐ proaches the long term marginal costs. One has to consider that this pro‐ cess does not have a limit point in reality, as further changes are triggered by every innovation. The advantage of a higher level of competition is that suppliers have self-interest to adapt technological breakthroughs more quickly than in closed markets and thereby contribute to their diffusion. There are various pieces of evidence of the theoretically concluded pos‐ itive effects of deregulation in empirical economic research. Griffith et al. (2006) show that the establishment of the European single market led to a significant reduction of the economic rents of providers in the affected in‐ dustries and states. Aghion et al. (2004) use a simulation model on the ba‐ sis of company-specific micro data and prove that existing companies which had to face increasing competition from foreign competitors due to the EU internal market integration, had a higher productivity. They ex‐ plain this by pointing to increased efforts of established companies to dif‐ ferentiate themselves from new competitors. Increases in productivity can explain the withdrawal of less competitive companies less well. For lawyers, accountants, architects and engineers Canton et al. (2014) use econometric methods to estimate the connection between the regulatory intensity, measured by the OECD product market regulatory indicator, and the allocative efficiency as well as the profit rates in the respective sectors for the EU member states. Their results show that deregulation leads to an increase in allocative efficiency and to a decrease in profit rates in the re‐ spective sectors. Regarding the investment behaviour, a study by Alesina et al. (2005) using time series for 21 OECD countries and different regula‐ tory indexes suggests that strict regulation suppresses investments. Griffith et al. (2006) use an econometric analysis in order to examine the connection between efforts for deregulation in product markets in the context of the EU single market and the innovation activities of com‐ panies. Apart from the economic rents as an indicator for the level of com‐ petition, they used other variables to directly measure the level of compe‐ tition e.g. the information of the European commission regarding the im‐ plementation of the internal market directive in the member states. They 77 Innovations can have a price increasing component. This is the case, if innovative behaviour leads to the supply of products and services with a higher quality. Con‐ sumer can then decide, whether they are willing to pay the higher price for the higher quality. V.1 Services liberalisation in Germany 203 conclude that the innovation activities of established companies increased with stronger deregulation, whereas the competitors became less innova‐ tive. They explain this by referring to the fact that the removal of regu‐ lation generally decreases economic rents in the respective market, so that the incentive for innovation decreases for challengers. The incentives for innovation for established companies nevertheless increase, because inno‐ vations enable them to keep at least a part of their old economics rents. Aghion et al. (2006) argue that established companies are incentivised by new competitors to innovate particularly in those sectors, which are al‐ ready competitive by international comparison, as they can thereby escape competition. In contrast, established companies in internationally less competitive sectors react to new competitors with fewer innovative activi‐ ties, as they see no chance to strengthen their competitive position through innovation. It is important to note that it is a complex endeavour to empirically measure the innovative activities of companies in the services sector78. Most studies on innovation activities take the amount of patents or the ex‐ penditure for research and development as an indicator for innovation ac‐ tivities. In many services sectors these indicators play a minor role. Firstly, service processes are rarely patentable – for instance in the form of action guidelines. Secondly, many services are adapted to the wishes and prefer‐ ences of the respective customer on-sight. Patenting does not seem prof‐ itable due to the uniqueness of the innovation. For this reason many ser‐ vices providers cannot declare R&D expenditures, although they might in‐ deed spend substantial resources to develop innovations. Indirect effects Apart from the described direct effects of the reduction of regulations, more indirect effects on upstream and downstream markets are to be ex‐ pected. Companies on downstream markets profit from lower prices dur‐ ing the procurement of its primary products in liberalised markets. They can either buy the current amount for a lower price or they can buy a high‐ er amount for the same price to increase their output. If the process of 6.2 78 Maaß and Führmann (2012) describe the challenge of measuring innovations for small and medium sized companies, to which most services providers belong. V How to Assess the Economic Impact of Regulation 204 market competition functions properly, the general prices on downstream markets should decrease whereas the output increases. This channel is par‐ ticularly important for services, as they are used as intermediate input by industrial companies to a large extent (see Figure 5.1.1). On upstream markets the effects of liberalisation are not as clear. Liber‐ alisation could lead to an increase of the traded quantity and higher prices on the upstream market, if companies on the liberalised market increased their output and therefore received more intermediate inputs. This effect can at least partly be evened out by increased cost saving efforts, if this leads to more cost consciousness in the procurement of its primary prod‐ ucts. The services sector only receives a small proportion of its intermedi‐ ate inputs from other sectors while the vast majority comes from other ser‐ vices providers (see Figure 5.1.11). The effects on upstream markets are difficult to measure and the amount of literature on this is very limited. Strong empirical evidence does however exist for indirect effects on downstream markets: Forlani (2010) measures the competitive intensity of the French services sector by regarding company data. It is thereby as‐ sumed that high economic rents are an indicator for a low level of compe‐ tition. He shows that a low level of competition e.g. due to high regulation requirements has negative effects on downstream markets. Corugedo and Ruiz (2014) examine the multiplier effect of services liberalisation for France, whereas the regulatory figures are taken from Monteagudo et al. (2012). They show that liberalisations have positive effects on down‐ stream companies, which in turn positively affect other companies. More‐ over, the initiated effects in the downstream markets can in turn create more demand for services. Barone and Cingano (2011) use a cross-sectional analysis to examine the connection between the degree of regulation in the services sector, measured by the OECD services regulatory index, and the effects on downstream markets. They show that restrictive regulation in the services sector negatively affects productivity, growth of the gross value added and exports in downstream markets. The negative effect is higher the more in‐ termediate inputs come from the services sector. Based on the methodolo‐ gy of Barone and Cingano (2011), Mocci et al. (2014) show that the re‐ duction of services regulation has positive effects on downstream com‐ panies (particularly from the manufacturing sector). We could prove positive effects of services liberalisation also for Ger‐ many. The methodology is generally equal to the approach of Mocci et al. (2014) and is outlined in detail in the appendix A. Here we only outline V.1 Services liberalisation in Germany 205 the results of the fixed-effects-regression-model. The gross value added of the whole economy79 (table 5.1.1) and the manufacturing sector80 (table 5.1.2) respectively are the dependent variables. The OECD regulatory in‐ dex for “professional business services” weight with the importance of professional business services as a supplier of intermediate inputs in downstream sectors (RegS) serves as the explanatory variable.81 As con‐ trol variables we use the level of regulation in the areas of energy (RegE) and telecommunication (RegT) as well as for sector-specific employment (EMP) weighted by the importance for downstream sectors. Our calculations show that regulation of the services sector, measured by RegS, has a significant effect both on the manufacturing sector as well as the overall economy. Thereby the following relationship is valid: a de‐ creasing value for RegS leads to an increase of the gross value added in the whole economy as well as in the manufacturing sector. Since RegS is a variable composed out of two values, it is hard to interpret the value of the coefficient of RegS. Therefore, we do not go into the degree of the effect. An assessment of the effects of a change of the OECD indicators within the model will be done in chapter 8.2. As our regression model is estimat‐ ed in levels, we standardised the variables to have unit variance so that one can directly compare the estimated coefficients within the same mod‐ el, but not the coefficients of different models. 79 As the whole economy we define all three sectors of the economy (agriculture, manufacturing and services). We exclude the sectors professional services, energy and transportation for which liberalisation effects on the other sectors should be measured. 80 As the manufacturing sector we define all areas of the manufacturing sector except the construction sector as well as mining. 81 Regarding the OECD indicator see section 4. V How to Assess the Economic Impact of Regulation 206 Effects on whole economy OECD indicator & control for output, effects on value-added in whole economy Variable Coefficient Std. err. t-stat. p-value EMP 0.1255 0.0392 3.2039 0.001*** RegS -0.0691 0.0172 -4.0171 0.000*** RegE -0.0646 0.0201 -3.2067 0.001*** RegT -0.0215 0.0089 -2.4211 0.016** Output 0.4279 0.0508 8.4292 0.000*** R2 0.3685 N 49 T 9 Note: This table reports the estimation result using the OECD indicator of regulation in non-manufacturing sectors (NMR) for “Professional services” as a measure of service regulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent variable is ln VA and the sample covers the years 1998-2007. The ex‐ planatory variables are included with one time lag. Effects on manufacturing sector OECD indicator & control for output, effects on value-added in manufacturing sector Variable Coefficient Std. err. t-stat. p-value EMP 0.0991 0.0675 1.4689 0.144 RegS -0.0642 0.0196 -3.2753 0.001*** RegE -0.0531 0.0283 -1.8765 0.062* RegT -0.0166 0.0152 -1.0889 0.278 Output 0.4344 0.0704 6.1684 0.000*** R2 0.4257 N 25 T 9 Note: This table reports the estimation result using the OECD indicator of regulation in non-manufacturing sectors (NMR) for “Professional services” as a measure of service regulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent variable is ln VA and the sample covers the years 1998-2007. The ex‐ planatory variables are included with one time lag. Table 5.1.1: Table 5.1.2: V.1 Services liberalisation in Germany 207 Effects on imports and exports In most cases liberalisation measures increase competition with foreign competitors, as lower market entry barriers make it easier for them to op‐ erate in the country concerned. Generally there are more imported goods in a liberalised market. Whether domestic suppliers will be ousted depends on how successful they are in using process and product innovations to re‐ main competitive. Moreover, deregulations again have indirect effects on imports and exports of companies in downstream markets. Particularly companies, which face international competition, should profit from the resulting cost advantages. Domestic companies facing competition from foreign companies can also benefit directly from deregulation, if the existing regulation entails discriminatory provisions against domestic suppliers. A discrimination against domestic suppliers can for example result, if there are higher regu‐ lation requirements for domestic suppliers, which cannot be applied to suppliers from other EU member states due to reasons connected with EU law. A positive effect on exports can be identified if regulations are abol‐ ished, which particularly obstruct domestic suppliers when competing in‐ ternationally. Monteagudo et al. (2012) simulate the effects of the directive on ser‐ vices on imports and exports of the EU member states. They develop dif‐ ferent scenarios regarding the progress of implementation of the directive on services in the member states and consider the interdependencies of the EU economies. In a first scenario they estimate the effects of the directive on services as it is currently implemented. Thereupon imports increased to a greater extent than exports in Germany. This relation would, however, be reversed if all member states were to implement the directive on services more consequently, namely on the level of the 5 countries with the lowest intensity of regulation. The reason for this should lie in the mutual depen‐ dencies, which should lead to the same results in all member states in case of stronger and particularly comparable liberalisation. Other studies regard the effects of services liberalisation on exports in downstream markets. The already described positive effects on down‐ stream markets improve the international competitiveness of companies operating in these markets. Among others Barone and Cingano (2011) prove this for the OECD countries. Correa-López and Doménech (2014) also show positive effects of services liberalisation for large international companies in Spain. The effects on the exports of small and medium sized 6.3 V How to Assess the Economic Impact of Regulation 208 companies are also positive, but to a smaller extent. Nordas and Kim (2013) show that particularly high technology industries can profit from a liberalisation in the area of business services with regard to exports. Ac‐ cording to the findings of the authors, high quality services in the area of energy, transportation, telecommunication and finance lead to a strength‐ ening and stabilisation of manufacturing exports. Moreover, they find that the higher the stage of development of the economy is the higher are nega‐ tive effects for manufacturing exports due to disproportionate regulation in the services sector. Labour market effects Deregulations lead to a shift of economic activities. Technically speaking resources are reallocated. This induces a process of change for employees. In highly regulated sectors with a low intensity of competition, wages are generally higher than in comparable sectors without regulation (Kleiner and Krüger, 2011), because companies can achieve higher economic rents due to the lack of competitive pressure, which are part of the redistribution mass in wage negotiations. The distribution opportunities are eliminated when regulations are abolished. Wages will therefore generally adjust to wages in comparable unregulated sectors. Nevertheless, it is not implausi‐ ble that the production in the unregulated market increases, which general‐ ly leads to the creation of additional employment. Furthermore, deregula‐ tion can indirectly lead to the above described employment effects on downstream markets. Copenhagen Economics (2005) estimate in a general equilibrium model that EU-wide employment will increase by 0.3 per cent due to the imple‐ mentation of the directive on services. Badinger et al. (2008) find effects of a comparable magnitude using an econometric estimation regarding the economic effects of the directive on services. An often recited argument against deregulation refers to the loss of do‐ mestic employment due to the fact that more goods and services from for‐ eign suppliers will be demanded. This is correct if suppliers are not com‐ petitive and are not sufficiently able to strengthen their competitive pos‐ ition through process and product innovations. Under these conditions the regulation kept jobs in the affected market alive, but on grounds of higher costs for intermediate inputs the employment development in the down‐ stream markets was unfavourable compared to a situation without regu‐ 6.4 V.1 Services liberalisation in Germany 209 lation. The regulation therefore only benefited a small group, while the costs had to be paid by all other employees and consumers of the affected products. All in all it seems reasonable to assume that the abolition of regulation strengthens the international competitiveness of the whole economy and thereby also strengthens the labour market. This is also sup‐ ported by the German experience with the EU eastward expansion. Nu‐ merous studies identify mid- and long-term benefits for the whole econo‐ my after a short period of adjustment (Bug 2011, Baas et al. 2000). Impacts on consumers If deregulation leads to a higher level of competition, consumers profit as a result. These can be companies who purchase affected products as inter‐ mediate inputs or end consumers whose consumption opportunities there‐ by increase. But also products for end consumers which use intermediate inputs from a liberalised market can generally be provided for a lower price. All in all, a broad range of consumers should profit from liberalisa‐ tion activities. A common fear is that the abolition of regulation will decrease the qual‐ ity in the affected market, which would be disadvantageous for the con‐ sumer. But this is only true if the abolition of the regulation leads to a col‐ lapse of the market for high quality products. This case is known in the theoretical literature if the demand side has a significant informational dis‐ advantage (Akerlof 1970): As the consumer cannot observe the quality of the supplied good, they are only willing to pay a price according to the ex‐ pected average quality. For suppliers it is no longer profitable to supply high quality products due to the lack of willingness to pay. This lowers the expected average quality which decreases the willingness to pay even fur‐ ther. Due to this downward spiral the market for high quality products col‐ lapses. References to this scenario are often made to justify regulations in the services sector. Nevertheless, it needs to be shown that a regulation is ca‐ pable and necessary to secure a certain minimum of quality. After all there are often private market alternatives to state regulation (Shapiro 1983), since not only consumers, but also suppliers of a high quality have an interest in overcoming the information problem. Suppliers can, for exam‐ ple, voluntarily use certificates to signal certain quality standards and thereby counteract the market failure. Furthermore, liability law as an ad‐ 6.5 V How to Assess the Economic Impact of Regulation 210 ditional instrument to implement quality standards also offers opportuni‐ ties for action. In order to correspond to the primacy of the freedom to choose an occupation and the contractual freedom within the European community of law, the burden of proof for occupation-specific regulations should generally lie on the side of the regulation. This means it has to be proven that the regulation can prevent a market failure and that it cannot be assumed that less invasive private market alternatives lead to similar re‐ sults. If private alternatives to deal with information problems (and therefore for quality assurance) exist, an abolition of the regulation offers a differen‐ tiation of the quality. Regulations often have the effect of state require‐ ments for a minimum standard. These minimum standards tie suppliers and consumers. Consumers who prefer a low level of quality cannot (legally) acquire it. Only after the abolition of the regulation, suppliers can offer a broad range of different qualities, which enables them to better ful‐ fil consumer preferences. Empirical literature on the relation between (de)regulation and service quality with a focus on business services barely exists. This is due to the fact that quality is difficult to measure. Measurement problems are partic‐ ularly substantial in the services sector, as quality can usually not be ob‐ served and it is not possible to reliably infer from the visible result to the quality of services. Politico-economic considerations for services liberalisation The considerations above have shown that deregulation in the services sector can lead to positive growth effects. Of particular importance are the effects on industrial companies which are facing international competition. They could be strengthened by services liberalisation. Nevertheless, con‐ siderations for services liberalisation often face resistance. In the follow‐ ing, some possible explanations are given. Initially it can be said that the existing regulations could be welfare en‐ hancing, if they are an appropriate measure to prevent a potential market failure. In those cases it is economically reasonable to keep regulation if no equally adequate and less invasive measure exists. Nevertheless, is seems doubtful that this is accurate for all existing regulations. A first in‐ dicator of that is the fact that numerous regulations only exist in some member states (EuZFB 2014). In case of a market failure, it is reasonable 7 V.1 Services liberalisation in Germany 211 to assume that all member states would implement respective regulations. Comparisons between the regulatory regimes of the member states have to be validated further. The chambers of lawyers in Germany, for example, undertake several tasks regarding the national rules governing the profes‐ sions, which are fulfilled directly by the state in the United Kingdom. Irre‐ spective of the question on which level this task is fulfilled, the regulatory intensity of both regimes is comparable. Given an equal regulatory intensi‐ ty, the historic and cultural specifics of the member states should be taken into consideration, as an equalisation of the regulatory regimes is not a purpose in itself, but rather essential if it is needed to achieve welfare benefits. Some services professions provide services which are ascribed to con‐ tribute to general welfare to a large degree irrespective of a possible mar‐ ket failure. Lawyers contribute to the administration of justice, doctors to health care. This context has to be considered when setting the competi‐ tion framework. Nevertheless, even here it has to be proven on a case by case basis how the regulation in question serves the general welfare and why a less invasive regulatory measure does not lead to the intended out‐ come. Thereby it is hard to understand why all services of general (econo‐ mic) interest are generally exempt for EU competition law, although eco‐ nomic research considers welfare enhancing competition to be possible (Jankowski 2014, Kochskämper 2014). Even when taking these concerns into consideration it is generally recognised that numerous regulations remain which are not aimed at pre‐ venting a potential market failure or which are inadequate in preventing it. Nevertheless, resistance against efforts to deregulate even exists in these cases. Particularly in markets with a high intensity of regulation resistance is likely to be high. Here the defence of these regulations justifies special efforts by the affected actors. This reallocation of resources into lobbying can be a non-negligible part of the welfare loss, which is created by the (unjustified) regulation (Tollison 1982). Apart from the amount of the eco‐ nomic regulatory rents, the organisational capability of interest groups plays a great role in preventing deregulation activities. This is advanta‐ geous for interest groups who already have established organisations and communication structures. Examples of this are professional associations, chambers or trade unions. These groups, firstly, have the opportunity to reach and if necessary mobilise their members through existing channels and, secondly, they are integrated into many political decision making pro‐ cesses. These groups enrich the political decision making process with V How to Assess the Economic Impact of Regulation 212 their expertise regarding the conditions of the respective sector of the economy. This close involvement entails the risk that the interest groups lobby for regulation which primarily benefits its members but not the gen‐ eral public. The political dilemma is that possible negative effects in the deregulated sector can easily be attributed and that interest groups can point that out, whereas the general efficiency gains for the whole economy are unclear. The success of deregulation is therefore difficult to market po‐ litically and to convert into electoral support. Gaining electoral support be‐ comes even harder if a decrease of market barriers leads to more foreign suppliers entering the market, which would profit but are not themselves eligible to vote in domestic elections. Approaches for reform for Germany Significant efforts for liberalisation in the services sector were undertaken in the last years. Thereby substantial progress has been made. Neverthe‐ less, there is still potential for further welfare enhancing deregulation ac‐ tivities. Although the directive on the recognition of professional qualifi‐ cations has been put into place82, its implementation is in many cases not consistent considering its goal to create an internal market for services. This is true for the European level and particularly for Germany. The re‐ maining potential consists of various small regulation screws that need to be adjusted in order to make use of the full potential of the process. All of these measures together could contribute to a non-negligible ex‐ tend to the overall economic development. In many cases resistance from occupational groups is to be expected if existing regulatory rents are en‐ dangered. This applies in particular, as most measures should be small steps for which occupational groups and their representatives have an in‐ formation advantage. Overall it should, therefore, be very difficult to at‐ tract the interest of the broad public and to communicate the advantages of the sum of measures. In what follows, we explain a few principles to identify possible areas of deregulation, which firstly suggest economic benefits and which are secondly, politically realizable with limited efforts (see section 8.1). 8 82 The Federal Constitutional Court also forced liberalisations in several fundamental decisions. An example is the decision on 12.12.2006 (Az. 1BvR2576/04), which allows lawyers to take contingency fees under certain conditions. V.1 Services liberalisation in Germany 213 Thereafter, the effects of different scenarios on economic growth are de‐ scribed using an econometric estimation model (see section 8.2). In the long run a critical assessment of all specific regulation would be desirable, which evaluates both the purpose of the regulation regarding its acceptability as well as whether the chosen instrument is capable of achieving the declared goal. Moreover, it should be assessed whether al‐ ternative instruments with a lower regulatory invasiveness are suitable. This assessment has to be done separately for every sector. This cannot be carried out in this study. Approaches for reform Important impact channels for services deregulation are the associated ad‐ vantages for the manufacturing sector and especially for exporting indus‐ trial companies. Therefore, it seems worth focussing on these services sec‐ tors which are particularly often used as intermediate inputs in industrial production. Figure 5.1.9 shows which services providers deliver interme‐ diate inputs to the manufacturing sector. By far the largest source is wholesale, followed by transportation and warehousing. After that the knowledge-intense services legal services and tax accounting services as well as consultancies, under which public accountants are subsumed, as well as architecture and engineering offices follow. In order to identify those areas of business services in which welfareenhancing deregulations are potentially possible we look at the regulatory indicators used in the literature: The OECD regulatory indicators for the knowledge-intense services in the areas legal and tax accounting (including public accounting), as well as architecture and engineering professions for Germany are usually val‐ ues comparable to France and Italy. The values for the Netherlands and for the United Kingdom are, however, considerably lower (see figure 5.1.12 and figure 5.1.13). The Services Trade Restrictiveness Index (STRI) shows similar results (see figure 5.1.14). Furthermore, research by Monte‐ guardo et al. (2012) and Canaton et al. (2014) also point to further poten‐ tial for deregulation in these sectors. As argued in section 4, economic rents, for example measured by the net operational surplus, are often used as an indicator for the intensity of competition. Thereby high economic rents can be a sign for a low level of competition, which can result from anti-competitive regulation. For the 8.1 V How to Assess the Economic Impact of Regulation 214 sectors legal services and tax accounting, consulting as well as architec‐ ture and engineering offices the official statistics in Germany show a value above average compared to other knowledge-intense services (see figure 5.1.4). In combination with the above mentioned regulatory indicators this can be seen as an indicator for possible sectors with potential for deregula‐ tion. Here it has to be considered that the aim is to decrease welfare-reduc‐ ing regulation and not to decrease economic rents to a level considered “normal” for normative reasons, because the owner is also the manager and hence firm profits and labour income accrue to the same person In these professions non-incorporated firms should be the dominant form, which could partly relativize the above-average net operational surpluses. In a first assessment using statistical considerations it can be concluded that deregulation with expected positive effects on economic growth seems possible in the areas of legal and tax accounting (including public accounting) services as well as engineering and architecture offices. Be‐ fore an actual implementation of reform measures, the statistical analysis, which is based on very general assumptions, has to be complemented by a case-specific qualitative analysis. The latter takes the overall context of the regulatory measure into account.83 However, this exceeds the context of this study. After potential areas of possible deregulation were identified in a first step, a second step is to identify promising deregulation measures in those areas. The following three principles may offer some assistance: 1. Equalisation of different profession-specific regulations in comparable fields of activity on the lower level of regulation. 2. Equalisation of different state-specific regulations for single profes‐ sions on the lower level. 3. Implementation of EU guidelines on the suggested minimum level, which means no overachieving of the EU guidelines. 83 For example the indicator value for Germany in the area of legal services is 6 due to the mandated membership in a chamber, whereas the United Kingdom has the best possible indictor value of 0 due to the lack of a the mandated membership in a chamber. This does not take into consideration, that numerous tasks, which are done by the chamber of lawyers in Germany, are undertake by the state in the United Kingdom. The difference in the intensity of regulation is therefore with a huge probability overestimated by the indicator. V.1 Services liberalisation in Germany 215 Particularly the principles 1 and 2 offer the advantage that they do not de‐ mand a complete deregulation of historically grown structures, but instead do not (initially) question their basic justification. Nevertheless, they do offer potential for a reduction of the overall level of regulation. They demand equal regulatory measures or an equal regula‐ tory intensity for comparable regulatory goals. As the reference point is al‐ ways the regulation with the lower intensity of regulation used in a com‐ parable situation in Germany, fundamental concerns and cultural differ‐ ence, which might exist compared to other countries, should not matter. Principle 3 relies upon the fact that a consensus on the underlying regu‐ lation was obtained on the European level which allows foreign com‐ panies to offer their products in Germany. Fundamental concerns against this regulation (e.g. regarding quality) should not appropriate, because Germany has consented the regulation on the EU level. An assessment of the OECD regulatory indicators for professional busi‐ ness services can offer first indications, where the three principles can be applied. Both in the area of legal as well as tax and public accounting ser‐ vices the exclusive right of these professions to be allowed to carry out certain tasks, requirements for educational qualifications, a mandated membership in a chamber and limitations in “Interprofessionelle Zusam‐ menarbeit” negatively affect the indicator. In legal services this is also true for a ban on advertising and a fee scale. With architects are better indicator value are mostly prevented by requirements for educational qualifications, a mandated membership in a chamber, a fee scale and a ban on advertis‐ ing. The indicator for engineers could be improved particularly by changes in the exclusive rights of the profession, the fee scale and the ban on ad‐ vertising. Hereafter a few examples of the principles described above are out‐ lined. They are used as an illustration of the principles. However, concrete deregulation measures in these areas must be analysed on a case by case basis. The “Interprofessionelle Zusammenarbeit” is regulated differently in the respective professional laws (principle 1). Although first steps for equalisation were undertaken in the past, there are still substantial differ‐ ences, which make “Interprofessionelle Zusammenarbeit” difficult (Henssler 2009). The mentioned professions offer similar tasks, which are particularly characterised by the fact that clients must be able to trust in the confidentiality and due diligence requirements of the mandate holder. As this is a constitutive characteristic for all three professions, it is hard to V How to Assess the Economic Impact of Regulation 216 comprehend why the “Interprofessionelle Zusammenarbeit” is obstructed by diverging requirements of the respective professions. Currently the strictest professional law prevails. Therefore, “Interprofessionelle Zusam‐ menarbeit” often is no longer attractive for members of the other profes‐ sions. These limited possibilities for “Interprofessionelle Zusammenar‐ beit” complicate the offer of a comprehensive range of services from a single source in closely related areas of the economy. Possible synergistic effects remain unused. In a further step one can assess whether the cooperation between lawyers, tax and public accountants with other liberal professions like doc‐ tors or engineers in one company can also be simplified. Here the require‐ ments are very different. For example, lawyers are only allowed to work in one company with tax and public accountants. Public accountants nev‐ ertheless, can found a company with people of all occupational profes‐ sions with a right to refuse to give evidence. An explanation for these dif‐ ferent requirements is not evident, particularly since lawyers are generally allowed to work with public accountants. These restrictive requirements prevent, for example, that law firms specialise on questions in medical law and take in a doctor as a partner.84 Another example of the application of principle 1 are shareholding re‐ quirements, which differ substantially between lawyers, tax and public ac‐ countants. While external shareholding is generally prohibited for lawyers, in tax accounting mere capital holdings are permissible for members of professions suitable for association85, if they do not exceed a certain threshold. There are no explicit requirements for public accountants (Henssler 2009). The requirements of “Interprofessionelle Zusammenarbeit” also offer possible starting points for principle 3. The law about an occupational or‐ der of the chartered accountants (WPO) is one example where EU guidelines were implemented in a stricter way than required. Ac‐ cording to § 28 Abs. 1 S. 1 WPO partnerships between members of differ‐ ent professions are only accepted if the majority of the partners are public 84 The Federal Constitutional Court currently examines, whether such prohibitions are constitutional (Vorlagebeschluss des Bundesgerichtshofs vom 16.5.2013 – IIZB7/11). 85 Which professions count as suitable for association, can be seen in the respective professional law. In the case of tax accountants these are other tax accountants, public accountants and law and patent attorneys. V.1 Services liberalisation in Germany 217 accountants. Article 3 para. 4 of the directive 2006/43/EG only demands that the majority of the votes is held by public accountants. An implemen‐ tation of the directive on the minimum level would simplify “Interprofes‐ sionelle Zusammenarbeit” (Henssler 2009). Principle 1 can also be used to analyse pricing, which is designed dif‐ ferently for lawyers, public and tax accountants. Except for public accoun‐ tants the fees in the mentioned professions are regulated by a decree. But the bindingness of these fee scales varies substantially. Generally fee scales are justified by their contribution to quality assurance and by the re‐ duction of information asymmetries for consumers. If that were true, which remains to be proven, it is still unsure, why the bindingness varies between the professions. Particularly since the fee scales for architects and engineers are also justified by the same arguments and they again have different levels of bindingness. An example of principle 2, which sees a possible starting point in equalising different regulations between states, are the requirements for the coverage of professional indemnity insurance for consulting engineers, which differ considerably between states.86 In addition, there are different requirements regarding the permissibility of advertisements (Bericht der Bundesregierung zur Lage der Freien Berufe 2012). Regarding principle 2, one could also assess why doctors, dentists and psychotherapist in Bavaria are not allowed to found corporate enterprises, while this type of company is permissible for the mentioned professions in other states. Unlike in an international comparison, cultural differences and historic path dependen‐ cies cannot provide a sufficient explanation for these differences. If one does not want to shift the legislative competence away from the states, forming a government / federal state working group with the goal to equalise the requirements on a lower regulatory level could be one option. Another possible application of principle 2 can be found in the German “point of single contact” system (PSC). The PSC should provide services providers from EU member states with all the necessary information re‐ quired to be able to offer their products in Germany. Apart from the infor‐ mation function, the PSC should fulfil a mediating function and guide sup‐ pliers from other EU member states through the administration process by coordinating between the companies and the agencies in charge regarding 86 A collection of links on the relevant requirements regarding professional indemni‐ ty insurance for consulting engineers can be found here: (last accessed on January 15th 2015). V How to Assess the Economic Impact of Regulation 218 the necessary procedures. While there is a nationwide single point of con‐ tact in many EU member states, in Germany the design of the PSC lies in the competence of the states, which has led to very different ways of im‐ plementation (Icks et al. 2010). In a working paper by the EU commission (2012), the implementation of the PSC in Germany is considered to be better than average. Nevertheless, Germany is not among the best member states in any category. Moreover, it is pointed out that the quality of the PSC services varies considerably between the states. One conceivable so‐ lution would be a lowthreshold intervention in the form of a voluntary agreement between the states to create best practice guidelines. Apart from the experiences in the states one could include suggestions from EU mem‐ ber states which performed better according to the evaluation of the EU commission. Model based estimation of the welfare effects In order to estimate the effects of further services liberalisation in Ger‐ many on the net operational surplus of professional business service, we did our own econometric calculations. These are based on the model dis‐ cussed in section 6.2 and in the appendix A. Thereby we have developed three scenarios: In a conservative estimation we assume that deregulation measures are undertaken, so that the OECD regulatory indicator in the area of profes‐ sional business services decreases by half a grade point. The optimistic scenario assumes an improvement by one full grade point. Additionally, we show, which effects result from the model and if the indicator value for Germany were to drop to the level of the EU member state with the lowest values (the United Kingdom). The first two scenarios do not seem unrealistic. The third scenario will most likely not be politically feasible for the above stated reasons. Fur‐ thermore, it has to be considered that the model follows a simple linear logic, whereas a variation of the indicator value by one unit always leads to an increase of the gross value added of a certain percentage. Moreover, the forecast uncertainty of values on the edge like in scenario 3 is particu‐ larly high. The following values are therefore rough reference point and not to be considered as exact estimations. 8.2 V.1 Services liberalisation in Germany 219 In the conservative scenario the gross value added of the whole econo‐ my would increase by 0.52 per cent. For the manufacturing sector the in‐ crease would be slightly higher with 0.60 per cent. The optimistic scenario yields an increase of the gross value added in the whole economy of 1.05 per cent and of 1.21 per cent for the manufacturing sector. Assuming the OECD indicator for “professional business services” for Germany would drop to the level assumed in scenario 3, this would, under the assumptions of a linear estimation model, result in an additional gross value added of 2.02 per cent for the whole economy. For the manufacturing sector the in‐ crease would be higher with 2.33 per cent. Econometric estimation results for different deregulation sce‐ narios Effects of hypothetical reductions in regulation in the production sectors NACE M69 rev 2 “Legal and accounting activities” and NACE M71 rev 2 “Architectural and engineering ac‐ tivities” on value added, linear approximation based on the estimation results of the models A2a and A2b Corresponding OECD index value Effect on valueadded whole economy Effect on valueadded manufac‐ turing sector Actual value 2013 OECD index value professional services 2.65 Improvement of OECD index value by half a point 2.15 +0.52% +0,60% Improvement of OECD index value By one point 1.65 + 1.05% +1.21% Improvement of OECD index value level of UK 0.72 + 2.02% + 2.33% Conclusion This study has dealt specifically with the German services sector. First, we outlined the quantitative importance of the services sector in a descriptive part: in the past few decades the contribution of the services sector to the economic output increased. In 2012 one in seven Euros was generated in the services sector. Within the services sector the business services have the highest the growth dynamic. The output of the business services main‐ ly enters the further production process in the form of intermediate inputs. Table 5.1.3: 9 V How to Assess the Economic Impact of Regulation 220 Due to a differentiated statistical analysis of the division of labour be‐ tween sectors we could show that firms, which are counted as part of the manufacturing sector, produce an increasing amount of services. In 2013 on average five in ten employees in the manufacturing sector executed ser‐ vice tasks. In the field of pharmacy and chemistry even eight or rather nine in ten employees executed service tasks. This trend towards the servi‐ tisation of the manufacturing sector finds only little attention in the current debate about the supposed service gap in Germany. Because of the lack of data from other countries, we have only limited possibilities to interpret these findings. But even if we assume that the servitisation in Germany is more advanced than in other countries we can only formulate hypotheses about the causes. Cultural differences could be one reason: the German business structure is heavily influenced by owner-managed firms. We can assume that those businesses have a preference for executing important tasks in-house. A further hypothesis is that an outsourcing of services is blocked by regulations in the services sector. An evaluation of several regulatory indicators leads us to the result that significant liberalisations took place in Germany since the year 2000. They can be explained, inter alia, by the services and professional qualifi‐ cations directives, which contributed to the deepening of the common in‐ ternal market for services on the EU-level. Furthermore, within Germany decisions of the Supreme Court (Bundesverfassungsgericht) led to a re‐ duction of professional regulations. But the analysis of the available data shows that it can be assume that further deregulation potential exists with‐ in the area of the professional services (lawyers, tax and public accoun‐ tants as well as architects and engineering offices). This assumption is supported by the literature review of the evaluation of several statistical regulation measures and newer studies. We introduced three principles for the identification of promising areas for potential deregulations, which on the one hand implicitly acknowledge the historic and cultural background of the existing regulations and on the other hand still allow for liberalisations. The first principle suggests har‐ monisation of different profession specific regulations for comparable pro‐ fessions with similar regulation aims to the lowest existing level. The sec‐ ond principle aims at harmonising the profession specific regulations be‐ tween the German states to the lowest existing level. The third principle is to execute EU guidelines without going beyond the demanded regulations. An important consequence of deregulations in the services sector is the expected positive effects on downstream manufacturing markets. If the V.1 Services liberalisation in Germany 221 prices for business services drop as a result of deregulation, this will con‐ stitute a cost advantage for firms, which depend on those services as inter‐ mediate inputs. Especially firms, which compete on the international-lev‐ el, can thereby improve their competitive position. Furthermore, the con‐ sumers benefit from dropping prices and in the tendency more differentiat‐ ed product offerings. Overall an increase in economic performance can be expected. With the help of an econometric model we estimated the impact of three different deregulation scenarios on the gross value added of the overall economy and the manufacturing sector. In the course of this, we restricted our approach to deregulation of professional services. The re‐ sults show that deregulations of these services, which are heavily used by the manufacturing sector as intermediate inputs, can have significant im‐ pacts on welfare. One should notice that the econometric estimates can on‐ ly serve as a rough orientation, because of the generally associated uncer‐ tainties. Based on the approach suggested by us, policy makers can identify con‐ crete deregulation plans and evaluate their effects on welfare with the help of an individual case analysis. In the course of this, the suggested princi‐ ples can be in general used for all service areas. Due to our approach to focus on business services, we have especially chosen application exam‐ ples from the professional services. Possible further areas of application could for example be seen in services in health and social care or in the network-bound services like transport, energy and telecommunication. Be‐ fore it comes to concrete reforms one should specify and extend our pre‐ sumptions of deregulation potential, which rely on general and statistical considerations, by an individual analysis. This has to be done in order to respect the specific circumstances and to secure that liberalisation leads to an increase in welfare. Appendix Appendix A: Empirical Analysis for Germany In order to quantitatively evaluate the impact of a further liberalisation in the services sector in Germany, we follow the approach of Mocci et al. (2014), which in turn is based on the methodology of Barone and Cingano (2011). Essentially, we apply a fixed effects panel data regression in which sector specific output is regressed on a measure of services liberalisation, V How to Assess the Economic Impact of Regulation 222 some control variables and time dummies. Our regression model aims at gaining a deeper understanding of the effects that services deregulation had in Germany in the past. Based on our findings we draw some conclu‐ sions about the potential effects of a further liberalisation in the services sector. Regression model and data basis The model considers the effects of deregulation in selected services sec‐ tors on the downstream production areas which use the selected services as intermediate inputs. The dependent variable of interest is the sector spe‐ cific gross value added (VA) in real terms, computed from national inputoutput tables provided by Eurostat. The input-output calculations divide the production within an economy into different sectors and give an overview over commodity flows between the sectors.87 Our sample period is limited by the fact that the classification of the sectors as well as the cal‐ culation basis was changed in the year 2008 and that it is not possible to compare the data before and after the re-classification. Therefore, the ana‐ lysis can only be based on data until 2007. However, the last essential ef‐ forts on services deregulation in Germany took place at the beginning of the new century. Therefore, using data up to the year 2007 seems to be ap‐ propriate for analysing the systematic connection between changes of the level of regulation and output growth. In order to measure the effects of deregulation in selected services sec‐ tors, a suitable indicator is needed. Based on Barone and Cingano (2011) as well as Mocci et al. (2014) our basic model uses the OECD regulatory indexes for 1998, 2003 and 2008 as a measure for sector-specific regu‐ lation (see OECD 2013). The OECD indicator measures the extent to which policies promote or inhibit competition in the areas of non-manu‐ facturing-sectors. The indicator covers formal regulations in the areas of state control of business enterprises, legal and administrative barriers to entrepreneurship, barriers to international trade and investment. The indi‐ cator index records values on a scale from 0 to 6, where 6 represents the most restrictive-to-competition regulatory set up. The fact that before the 87 Until the change in the classification system in 2008 the production within an economy was divided according to the NACE Rev. 1.1 (2002) standard into 59 sectors. Our model uses the classification of the NACE 2002 standard. V.1 Services liberalisation in Germany 223 year 1998 no information was available on regulation in the services sec‐ tor further restricts the sample period available for the analysis. In order to obtain annual observations we linearly interpolated the indi‐ cators for the remaining years. The motivation for doing so is that the deregulation did not only take place in the years in which the correspond‐ ing variable is available, but that deregulation is a continuous process. Furthermore, it is far from obvious how long it takes after a deregulating effort has been made until the new policy goes into effect. Mocci et al. (2014) suggest that three years may be an appropriate period, but this is difficult to verify. Most likely, new policies go into effect in a continuous way, as firms adjust slowly to changing regulatory conditions. Some may anticipate these changes and react rather quickly, while others may need a few years to change their behaviour. A disadvantage of the OECD indicators is that they were only compiled for selected business services sectors. Therefore, our model can only grasp the effects of deregulation in those services for which an OECD indicator exists. These are the professional business services architecture, legal, ac‐ counting and engineering. Since our model measures the effects of deregu‐ lation on downstream sectors based on the dataset of input-output calcula‐ tions, it requires a match of the services for which an OECD indicator ex‐ ists with the corresponding productions sector in the input-output calcula‐ tions. Within the classification of the input-output tables, those profession‐ al business services belong to the production sector NACE 74 Rev. 1.1 “other business activities”. In addition to the services of architects, legal professions, accountants and engineers, the production sector NECA 74 Rev. 1.1 also includes services of management consultancy, services of ad‐ vertising and market research, employment activities (temporary work), investigation and security services as well as cleaning services. Nonethe‐ less, the professions with corresponding OECD-indicators represent a large share of the production sector NACE 74 Rev. However, it must be mentioned that the necessary assumption that the existing OECD indicators on professional business services fits for the whole production sector NACE 74 Rev. 1.1 is a drawback of the OECD indicator as a measure for the level of regulation within our model. To overcome this drawback of the OECD indicator, we propose an al‐ ternative measure for the level of regulation based on the argument that ef‐ fective deregulation should increase competitiveness in the deregulated (services) sector, which in turn should result in lower profits. Therefore, we consider the net operating surplus in the NACE 74 Rev. 1.1 sector V How to Assess the Economic Impact of Regulation 224 “other business activities”, which is again obtained from the national in‐ put-output tables, as an alternative measure of deregulation instead of the OECD indicator. In this case, our measure for the level of regulation (the net surplus) matches the entire production sector NACE 74 Rev. 1.1. Using different model variations, we analyse the effects of changes in regulation in the areas of professional business services and the two con‐ trol-groups energy88 and transportation89 on the gross value added in the following downstream production areas: – “Whole economy”: as the whole economy we define all three sectors of the economy (agriculture, manufacturing and services)90. We ex‐ clude the sectors professional services, energy and transportation for which liberalisation effects on the other sectors should be measured. – “Manufacturing sector”: as the manufacturing sector we define all ar‐ eas of the manufacturing sector except the construction sector91. Now let Xs, be the variable measuring deregulation, either the OECD indi‐ cator or the net surplus. In order to obtain a meaningful explanatory vari‐ able, Xs, is weighted by the technical coefficient wj,, which measures the importance of professional services sector s as an input for each sector j. In other words, the technical (input) coefficients wj,, represent direct back‐ ward linkages of each sector j to the professional services sector s. The technical coefficient wj,, is defined as the ratio between the costs of the inputs of service s and the value of the output of sector j. The explanatory variable RegSj, which measures the level of services regulation affecting industry sector j is computed as 88 There are OECD indicators for electricity and gas. The products of these energy services are equivalent to the production of the sector NACE 32 Rev. 1.1 in the in‐ put-output calculations. 89 There are OECD indicators for road-transport, air-transport and railway-transport. The products of these transport services are equivalent to the production of the sector NACE 60 Rev. 1.1 and NACE 62 Rev. 1.1 in the input-output calculations. 90 This excludes the sectors mining of coal and lignite (NACE 10 Rev. 1.1), which has negative gross value added, as well as mining of uranium and thorium ores (NACE 12 Rev. 1.1) and mining of metal ores (NACE 13 Rev. 1.1), in which there is no production. 91 The manufacturing sector includes the sectors NACE 10-37 Rev. 1.1 except for mining of coal and lignite (NACE 10), mining of uranium and thorium ores (NACE 12 Rev. 1.1), mining of metal ores (NACE 13 Rev. 1.1) as well as publish‐ ing, printing and reproduction of recorded media (NACE 22 Rev. 1.1). V.1 Services liberalisation in Germany 225 RegS j, t  = ∑ s wj, s, t ∙ Xs, ts .    The baseline model to be estimated then is lnVA j, t = αj + αt + β1RegS j, t − 1 + β2lnEMPj, t − 1∑k = 1 K βkZk, t − 1 + ϵ j, t,    where Zk,t for k=1,…,K are additional control variables and αj and αt rep‐ resent the fixed effects included to account for unobserved heterogeneity across sectors and time. As additional control variables we consider the weighted OECD deregulation indicators for the transportation (RegT) and the energy (RegE) sectors defined and computed in the same way as for services. The latter two variables are included as control variables in order to avoid an overestimation of the effect of deregulation in the service sec‐ tor, which is likely to be correlated with deregulation in other sectors. Sec‐ tor specific employment (EMP) is obtained from the input-output tables. Model results The estimation of our base model as described above yields the following results: Base model OECD Indicator, effects on value-added in whole economy Variable Coefficient Std. err. t-stat. p-value EMP 0.2615 0.0388 6.7339 0.000*** RegS -0.0791 0.0187 -4.2375 0.000*** RegE -0.1414 0.0195 -7.2407 0.000*** RegT -0.0242 0.0096 -2.5158 0.012** R2 0.2501 N 49 T 9 Note: This table reports the estimation result using the OECD indicator of regulation in non-manufacturing sectors (NMR) for “Professional services” as a measure of service regulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent variable is ln VA and the sample covers the years 1998-2007. The ex‐ planatory variables are included with one time lag. Table 5.1.A1a: V How to Assess the Economic Impact of Regulation 226 Base model OECD Indicator, effects on value-added in manufacturing sector Variable Coefficient Std. err. t-stat. p-value EMP 0.3054 0.0641 4.7642 0.000*** RegS -0.0673 0.0214 -3.1409 0.002*** RegE -0.1472 0.0261 -5.6413 0.000*** RegT -0.0195 0.0167 -1.1681 0.244 R2 0.3089 N 25 T 9 Note: This table reports the estimation result using the OECD indicator of regulation in non-manufacturing sectors (NMR) for “Professional services” as a measure of service regulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent variable is ln VA and the sample covers the years 1998-2007. The ex‐ planatory variables are included with one time lag. All coefficients have the expected signs and are significant. In particular, controlling for regulation levels in other sectors and for employment ef‐ fects, deregulation in the services sectors can be associated with an in‐ crease in gross value added. As our regression model is estimated in lev‐ els, we standardised the variables to have unit variance so that we can di‐ rectly compare the estimated coefficients both within and across all model variations. The interpretation of the coefficients is postponed until the end of the appendix where we predict the effect of hypothetical liberalisation measures on gross value added. Next, we consider some robustness checks of the results. In the Tables 5.1.A2a and 5.1.A2b we consider the same specification as above, but we include the lagged value of the sector specific output as an additional con‐ trol variable. This is done in order to include a variable that captures per‐ sistence in output and changing business cycle conditions. The data on sector specific output is again obtained from the input-output tables. The results shown in Table 5.1.A2a and Table 5.1.A2b confirm the findings from above. However, the estimated coefficient for the regulation in the energy sector changes quite substantially. It seems possible that the vari‐ able RegE partly captures the effect of structural change that is measured by the output variable and that the large (negative) coefficient in Table A1 is partly caused by the omission of that information. This could be ex‐ plained by the presence of an omitted variable bias in tables 5.1.A1a and Table 5.1.A1b: V.1 Services liberalisation in Germany 227 5.1.A1b. The overall fit of the regressions measured by the coefficient of determination R2 and the statistical significance of the coefficient of the output variable suggest the appropriateness of the extended model in ta‐ bles 5.1.A2a and 5.1.A2b. OECD Indicator & control for output, effects on valueadded in whole economy Variable Coefficient Std. err. t-stat. p-value EMP 0.1255 0.0392 3.2039 0.001*** RegS -0.0691 0.0172 -4.0171 0.000*** RegE -0.0646 0.0201 -3.2067 0.001*** RegT -0.0215 0.0089 -2.4211 0.016** Output 0.4279 0.0508 8.4292 0.000*** R2 0.3685 N 49 T 9 Note: This table reports the estimation result using the OECD indicator of regulation in nonmanufacturing sectors (NMR) for “Professional services” as a measure of service regulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent variable is ln VA and the sample covers the years 1998-2007. The ex‐ planatory variables are included with one time lag. OECD Indicator & control for output, effects on valueadded in manufacturing sector Variable Coefficient Std. err. t-stat. p-value EMP 0.0991 0.0675 1.4689 0.144 RegS -0.0642 0.0196 -3.2753 0.001*** RegE -0.0531 0.0283 -1.8765 0.062* RegT -0.0166 0.0152 -1.0889 0.278 Output 0.4344 0.0704 6.1684 0.000*** R2 0.4257 N 25 T 9 Note: This table reports the estimation result using the OECD indicator of regulation in non-manufacturing sectors (NMR) for “Professional services” as a measure of service regulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent variable is ln VA and the sample covers the years 1998-2007. The ex‐ planatory variables are included with one time lag. Table 5.1.A2a: Table 5.1.A2b: V How to Assess the Economic Impact of Regulation 228 A further robustness check was made concerning the choice of lag length, which was varied between 1 and 4 years. This did not qualitatively affect the results. The precise estimated results are not reported but are available from the authors upon request. As mentioned above, a potential alternative measure for services liber‐ alisation is the net operating surplus in the corresponding sectors. An addi‐ tional advantage, besides providing a robustness check of our results, is that we are not restricted in terms of data, so we can use data starting in 1995. Hence, we do not need to rely on a linear interpolation to obtain da‐ ta for the intermediate years. In tables 5.1.A3a and 5.1.A3b we considered the net–surplus in the sector “other business activities”, corresponding to the services covered by the OECD indicator. The control variables are the same as above. The results continue to hold, but the interpretation of the coefficients is difficult without further exploring possible changes our proxy for deregulation may take. To be specific, the explanatory variable RegS is a weighted average of the net surplus. In addition to that, it is un‐ clear what a typical value of this variable is and how much it varies. This also makes a comparison of the coefficients of, e.g., RegS and RegE diffi‐ cult. Furthermore, it is indistinct how much net surplus is affected by deregulation efforts in the services sector. Base model net surplus, effects on value-added in whole economy Variable Coefficient Std. err. t-stat. p-value EMP 0.3855 0.0363 10.6153 0.000*** RegS -0.0918 0.0167 -5.4824 0.000*** RegE -0.0864 0.0121 -7.1303 0.000*** RegT -0.0169 0.0067 -2.5202 0.012** R2 0.2906 N 49 T 12 Note: This table reports the estimation result using the net surplus for the sector NACE 74 Rev. 1.1 “Other business activities” as a measure of service deregulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent vari‐ able is ln VA and the sample covers the years 1995-2007. The explanatory variables are included with one time lag. Table 5.1.A3a: V.1 Services liberalisation in Germany 229 Base model net surplus, effects on value-added in manu‐ facturing sector Variable Coefficient Std. err. t-stat. p-value EMP 0.5030 0.0566 8.8929 0.000*** RegS -0.0707 0.0186 -3.8054 0.000*** RegE -0.1154 0.0185 -6.2570 0.000*** RegT -0.0395 0.0129 -3.0688 0.002*** R2 0.3630 N 25 T 12 Note: This table reports the estimation result using the net surplus for the sector NACE 74 Rev. 1.1 “Other business activities” as a measure of service deregulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent vari‐ able is ln VA and the sample covers the years 1995-2007. The explanatory variables are included with one time lag. Including output as an additional control variable again leads to an im‐ proved model fit in terms of the R2. The coefficient on RegS increases slightly, whereas again the coefficient on RegE decreases significantly (see tables 5.1.A4a and 5.1.A4b). Net surplus & control for output, effects on value-added in whole economy Variable Coefficient Std. err. t-stat. p-value EMP 0.1508 0.0336 4.4906 0.000*** RegS -0.1045 0.0139 -7.5424 0.000*** RegE -0.0356 0.0105 -3.3827 0.001*** RegT -0.0058 0.0056 -1.0446 0.297 Output 0.5695 0.0365 15.6208 0.000*** R2 0.5163 N 49 T 12 Note: This table reports the estimation result using the net surplus for the sector NACE 74 Rev. 1.1 “Other business activities” as a measure of service deregulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent vari‐ able is ln VA and the sample covers the years 1995-2007. The explanatory variables are included with one time lag. Table 5.1.A3b: Table 5.1.A4a: V How to Assess the Economic Impact of Regulation 230 Net surplus & control for output, effects on value-added in manufacturing sector Variable Coefficient Std. err. t-stat. p-value EMP 0.1784 0.0532 3.3567 0.001*** RegS -0.0804 0.0150 -5.3634 0.000*** RegE -0.0368 0.0163 -2.2622 0.025** RegT -0.0155 0.0106 -1.4673 0.144 Output 0.5674 0.0478 11.8832 0.000*** R2 0.5878 N 25 T 12 Note: This table reports the estimation result using the net surplus for the sector NACE 74 Rev. 1.1 “Other business activities” as a measure of service deregulation within the production sector NACE 74 Rev. 1.1 “Other business activities”. The dependent vari‐ able is ln VA and the sample covers the years 1995-2007. The explanatory variables are included with one time lag. In order to estimate the effects of further structural reforms in the area of professional business services a hypothetical improvement of the values of the OECD regulation indicator is assumed. On the basis of the results of our model one can conclude which effects a change in the level of regu‐ lation in the model has on the gross value added in the manufacturing sec‐ tor as well as the gross value added in the whole economy92. We consider three hypothetical scenarios. In a conservative estimation, we assume that the German level of regulation in the professional services improves by half a point. In an optimistic scenario, an improvement by one full grade point is assumed. Additionally, we consider the hypothetical case that the domestic level of regulation in the area of professional ser‐ vices reaches the average level of the leading EU member state, the United Kingdom. In 2013, the average index value for United Kingdom was 0.72. The prediction is complicated by the fact that the OECD-indicators for “professional services” do not cover the entire NACE 74 Rev. 1.1 “other business activities”. There are two possible ways to address this problem. Table 5.1.A4b: 92 The reader should be aware that the following estimates of the effect of a further deregulation have to be interpreted with care, as they rest on the assumption of lin‐ earity. Furthermore, our model does only cover the effects of services deregulation in the area of professional services, which is not whole services sector. V.1 Services liberalisation in Germany 231 For the model estimation based on the OECD indicators we had to as‐ sume that the OECD indicators have validity for the entire production sec‐ tor NACE 74 Rev. 1.1 “other business activities”. If one considers this as‐ sumption acceptable, one could determine the effect of a further deregula‐ tion in the area of professional services on gross value added based on the technical coefficients for the entire production sector NACE 74 Rev. 1.1 “other business activities”. Since the intermediate consumptions for down‐ stream sectors of the entire production sector NACE 74 Rev. 1.1 “other business activities” have a higher volume than the intermediates of the “professional services” architecture, legal, accounting and engineering (covered by the OECD indices), the resulting estimated total effects on gross value added are obviously higher (see table 5.1.A5a). Thus one im‐ plicitly assumes that the other sectors within NACE 74 Rev. 1.1 are sub‐ ject to the same deregulation as the ones covered by the OECD indices. If you follow this first approach, the value for RegS in the case of a hypo‐ thetical change of the OECD-indicator is given by RegS = ∑swj, NACE 74 rev 1,2007 ∙ Xhypothetical OECD index professional services, 2013  The assumption that the OECD indicators for “professional services” have validity for the entire production sector NACE 74 Rev. 1.1 “other business activities” was necessary because of the coarse subdivision of the inputoutput tables until the year of 2008. If such assumptions are not strictly necessary, it might be appropriate to avoid them. As the OECD-indicators are only available for the services of architects, legal professions, accoun‐ tants and engineers, it seems advisable to limit the prediction on the ef‐ fects of further deregulation to these “professional services”. In order to take account of this, we used the technical coefficients for the production sectors NACE M69 rev 2 “legal and accounting activities” and NACE M71 rev 2 “architectural and engineering activities” of the more detailed German input-output table of the year 2008 to determine the importance of deregulation in the area of these four “professional services”. Since the prediction in this case involves a smaller number of services, the resulting estimated total effects on value-added are obviously lower (see table 5.1.A5b). This results from the implicit assumption that the regulation lev‐ el in the remaining service sectors remains unchanged. If you follow our second approach, the value for RegS in the case of a hypothetical change of the OECD-indicator is given by RegS = ∑swj, NACA M69 & M71 rev 2,2008 ∙ Xhypothetical OECD index professional services, 2013  V How to Assess the Economic Impact of Regulation 232 If one assumes the hypothetical values of the OECD indicators for Ger‐ many in 2013, our model yields the following growth rates for the gross value added in the whole economy and in the manufacturing sector de‐ pending on the chosen approach: Approach one: effects of hypothetical reductions in regu‐ lation in the production sector NACE 74 Rev. 1.1 “other business activities” on value-added, linear approximation based on the estimation results of the models A2a and A2b Corresponding OECD index value Effect on valueadded whole economy Effect on valueadded manufactur‐ ing sector Actual value 2013 OECD index value professional services 2.65 Improvement of OECD index value by half a point 2.15 +1.31% +1.41% Improvement of OECD index value By one point 1.65 + 2.63% +2.84% Improvement of OECD index value level of UK 0,72 + 5.08% + 5.48% Table 5.1.A5a: V.1 Services liberalisation in Germany 233 Approach two: effects of hypothetical reductions in regu‐ lation in the production sectors NACE M69 rev 2 “legal and accounting activities” and NACE M71 Rev. 2 “archi‐ tectural and engineering activities” on value-added, lin‐ ear approximation based on the estimation results of the models A2a and A2b Corresponding OECD index value Effect on valueadded whole economy Effect on valueadded manufactur‐ ing sector Actual value 2013 OECD index value professional services 2.65 Improvement of OECD index value by half a point 2.15 +0,51% +0.60% Improvement of OECD index value By one point 1.65 + 1,01% +1.21% Improvement of OECD index value level of UK 0.72 + 2.02% + 2.33% Table 5.1.A5b: V How to Assess the Economic Impact of Regulation 234 Categorising the model results In order to make our model results comparable to Mocci et al. (2014), we estimated the model on the basis of logs and with a three year time lag. The coefficient RegS for Germany is substantially lower in our model spe‐ cifications than the values for Italy published by Mocci et al. (2014). Pro‐ jections for the effects of further deregulation in Germany, which are di‐ rectly methodologically comparable to our approach, are not be found in the literature. Most studies use general equilibrium models for projections, which cover different economic activities. These models are far more complex than our calculations. This offers the advantage to include numerous ef‐ fects into the analysis simultaneously. On the other hand the dependency of the model results on the underlying assumptions increases. Monteagudo et al. (2012) estimate the effects, which were caused by the implementa‐ tion of the services directive and the potential effects, which would result if it were implemented more consistently. Due to lacking data points after the implementation of the services directive, they also have to evade to a hypothetical scenario to calculate the effects related to the implementa‐ tion. The effect sizes of the “what if scenarios” are – if a comparison is valid at all – within the scope of our results. Varga und in ‘t Veld (2014) use the benchmark model of the European Commission in order to esti‐ mate the effects of different reforms. It is assumed that all countries imple‐ ment reforms, which put them on the level of the average of the three “best” EU countries. Due to the structure of the model, they are able to show long term changes. The effects of services liberalisation published by Varga und in ‘t Veld (2014) lie below our estimation. However in this instance a meaningful comparison of both models is once again almost im‐ possible, as – apart from the methodology – the measuring of the regula‐ tory intensity varies and baseline effects are probable. Appendix B: Operating surplus in a national and international comparison In order to categorize the net operational surpluses into selected domestic services sectors, it is useful to do a comparison with European neighbour countries. Figure 5.1.B1 compares the domestic net operational surpluses both with the EU average as well as with the surpluses of the leading neighbour countries in the OECD-NMR-ranking, namely the United King‐ V.1 Services liberalisation in Germany 235 dom and the Netherlands. Comparing the net operational surpluses of the knowledge-intense services sectors, Germany as well as the Netherlands and the United Kingdom lie roughly in accordance with the EU average of 17 per cent. Differences do however exist in the area of the professions in‐ cluded in the OECD-NMR-indicator. In the area of legal, tax accounting and consulting services the domestic net operational surpluses lie roughly on the level of the United Kingdom and the EU average, while the sur‐ pluses in the Netherlands are substantially lower. However in the area of architecture and engineering services the domestic surpluses lie consider‐ ably above those in the Netherlands and the EU average. In the area of fi‐ nancial and insurance services the domestic net operational surpluses are much lower. Net operating surplus in the area of business services in an international comparison Notes: Year 2010, in per cent proportional to production value Knowledge-intense services: media and publishing, computer and information ser‐ vices, telecommunication services, financial and insurance services, legal, tax account‐ ing and consultancy services, architecture and engineering, research and development, other liberal professions. Source: Country-specific input-output calculations, own calculations and illustration On the basis of the data of the input-output calculations a detailed break‐ down of the net operational surpluses, for example within the combined group of legal, tax accounting and consulting services, is not possible. However, a more detailed breakdown for Germany is indirectly possible for Germany through the structure survey of the services sectors of the Figure 5.1.B1: V How to Assess the Economic Impact of Regulation 236 Federal Statistical Office. On the basis of these statistics differentiated val‐ ues for the gross operational surpluses within the professions can be deter‐ mined (see figure 5.1.B2).93 In 2011 the gross operational surplus before subtracting write offs within the class of legal, tax accounting and consult‐ ing services in the area of legal services was about 49 per cent, in the area of public and tax accounting it was roughly 26 per cent, in the area of con‐ sulting services it was roughly 25 per cent and in the administration and management of companies it was roughly 8 per cent. Within the class of architecture and engineering offices the gross operational surplus in the area of architecture offices was roughly 36 per cent and in the area of en‐ gineering offices it was about 16 per cent. Gross operating surplus in the area of domestic business services Note: Year 2011, in per cent proportional to production value Source: Strukturerhebung im Dienstleistungsbereich 2011 (German services structural survey, German Federal Statistical Office), own calculations and illustration References Aghion, P.; Blundell, R.; Griffith, R.; Howitt, P.; Prantl, S. (2004): Entry and Produc‐ tivity Growth: Evidence from Microlevel Panel Data. Journal of the European Eco‐ nomic Association 2 (2-3), 265–276 Figure 5.1.B2: 93 The net operational surplus can be derived from the gross operational surplus after subtracting write offs. Regarding the input-output calculations, one can see that the write offs in the area of legal, tax accounting and consulting services are very low, as the values of the gross and the net operational surplus are almost identical. V.1 Services liberalisation in Germany 237 Aghion, P.; Blundell, R.; Griffith, R.; Howitt, P.; Prantl, S. 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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. 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(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 Discussion (Jochen Andritzky) Dr Jochen Andritzky, Secretary General of the German Council of Econo‐ mic Experts: I was asked to provide some comments and I am happy to do so. I will draw on work that we did at the German Council of Economic Experts. We are an independent policy advisory body located in Wiesbaden. This is work we did for a chapter on analysing productivity developments in Ger‐ many that was endorsed by all members of the Council. I thought it gives a nice frame for the discussion. In Germany, the development of labour productivity has been in partic‐ ular lacklustre. We identified two effects. One goes back to the success of labour market reforms in Germany which has allowed more and more workers with on average lower productivity to enter the economy. Second, an outsourcing process that lifted productivity in Germany during the 90's and early 2000's is coming to an end. V.3 V How to Assess the Economic Impact of Regulation 264 Employment and productivity Source: destatis, own calculations The first chart shows an example. It shows that certain industries – health and care activities, trade and accommodation, consulting – had a strong in‐ crease in employment from 2005 to 2014, while they are on average less productive industries than others. Hence, we had an increase in employ‐ ment particularly in those industries which are relatively less productive. Figure 5.3.1: V.3 Discussion (Jochen Andritzky) 265 Value added in selected industries The second chart shows the outsourcing process. The domestic value added relative to the total value of the product has declined over the last 15 years but that decline seems to have stopped. But there are also other issues. Particularly in Germany, there is a high level of regulations in the services sector. I think there is a broad consen‐ sus that there are efficiency gains to be had by liberalizing service sectors. There are three challenges I want to highlight. First, we are now dis‐ cussing a lot how to integrate migrants, particularly refugees, into the labour market. Refugees that are not fitting in our system because they do not have the German school degree, and it is pretty hard for them to access the German (dual) education system and take up jobs in protected profes‐ sions. Thus the Council has propagated the expanded use of “apprentice‐ ship light”, or "teilqualifizierende Ausbildung”. It would be useful to have more insights on that. The second issue I missed is the idea of ensuring quality standards through self-regulation. Oliver Arentz had a very good point on the con‐ flict of interest that might arise being a public regulator. When we look at mark-ups, we also need to compare prices because the mark-ups we might see might accrue to others. The classical example is the US where quality control is basically achieved through more stringent liability. As we know, the costs of liability in the US are very high. Figure 5.3.2: V How to Assess the Economic Impact of Regulation 266 The third challenge – and I think Henrik Enderlein has already men‐ tioned is – is about who are the losers from the reform and whether and how to compensate them. Erik Canton: Thanks a lot Jochen for these very useful comments. Let me try to respond to them. The question that always comes up is about quality, and my take of this is that we do not know enough about the relation between regu‐ lation and quality. But I am always a bit sceptical about the argument that regulation is necessary to protect quality because to me it is not clear what would be the incentives to deliver high quality when the firm is operating in an environment with low competition. But indeed, we do not know enough about this. The problem is that there are only few studies on this issue, and these studies look at isolated sectors in very specific circum‐ stances and the results are also mixed. I could also mention that regulation is quite a heavy tool so next to regulation there are all other kinds of in‐ struments to make sure that public interests are protected. I recently saw a very interesting presentation by Professor Klein, who also emphasised that regulation is a strong tool for us to safeguard certain interests. And on the political economy aspects, the difficulty here is that many people experi‐ ence small gains (i.e. the clients of the regulated professions) and few peo‐ ple face substantial losses (the professionals). Obviously, the losers resist and speak up, and the winners are silent. So we also have a task to explain better that most people will gain from these reforms in terms of lower prices and also even from higher quality. Of course, the alternative is to come up with some kind of compensation scheme. On outsourcing, we hadn't looked at it in detail, but the observed shift from manufacturing to services is of course also partly due to outsourcing activities. On your first point on labour market regulations and employment, indeed, in some of the reforms we analysed, for example, on employment protection legisla‐ tion, we typically find quite large GDP effects through improved labour productivity, but indeed also in some cases negative employment effects, so it could be that labour market reforms especially when the economy is already in a downturn, have some negative employment effects. V.3 Discussion (Jochen Andritzky) 267 Oliver Arentz: Maybe some additional thoughts. The political economy aspect was the reason for our three very simple principals. We thought that when we say there is a lower level of regulation already in Germany, there is now rea‐ son to take this level and give it to all of the professions, if they are similar enough. The same argument was used by the Bundesgerichtshof, our Fed‐ eral Court in the decision I quoted. To the quality aspect, that is very inter‐ esting because you hear this point very often, but there is no real connec‐ tion between this, between regulation and the quality. For example, the ed‐ ucational requirements are very high for lawyers when they are outsiders and they want to become insiders. They have to fulfil very high education‐ al requirements. After that, there are no further education requirements. And the educational requirements are for me the requirements mostly con‐ nected with the quality aspect; I don't see how fee scales are directly con‐ nected with the quality aspect. V How to Assess the Economic Impact of Regulation 268 Conclusions (Oliver Holtemöller) The contributions to this conference have very relevant and important im‐ plications for both economists and politicians. Economists mostly talk about the effects of deregulation in an oversimplifying way. The simple story economists usually refer to is the following: If there is a lack of com‐ petition, then prices are above marginal costs, and that leads to an ineffi‐ cient allocation of resources. Although this is certainly correct, I think the world is a little more complicated, so we have to make this very simple static theory compatible with real life. There are five obstacles that should be addressed in future research. Obstacle one is related to static efficiency. In a frictionless world, regulation that imposes barriers to competition re‐ duces efficiency and welfare. But in case of market frictions, regulation can make sense. Therefore, we need economic models that cover channels through which regulation can make sense. One channel through which regulation can have positive effects is reducing transaction costs. How‐ ever, the economic models that we have seen today do not include any po‐ tential positive effects of regulation. Obstacle two is related to dynamic efficiency. It could be the case that temporary profits based on incomplete competition may be necessary to make large investments in research and development profitable. It is not clear whether this is important in the services sector. We need theoretical models and empirical research that shed more light on this. Although simple and abstract models are very useful for communica‐ tion within the scientific community, it is dangerous to use models that ap‐ pear too simple in the communication with the general public. Many noneconomists think that economic models are neglecting important aspects of reality and are therefore not convincing for them. More effort of economists is necessary to explain economic reasoning to non-economists. Obstacle three is about distribution. Of course, reasonable structural re‐ forms have positive aggregate effects. However, that does not necessarily mean that income is higher for everybody. In most cases, there will be losers and there will be winners of reforms and this is always difficult when it comes to the implementation of reforms. You have to think about the losers, that is what is behind the Brexit discussion and also behind the discussion about free trade agreements. So even if a particular reform has VI 269 positive aggregate effects, it is difficult to convince people who lose – or think they lose – from the reforms. Obstacle four is that we still do not know enough about the economic effects of regulation. We need more evidence-based policy advice and more data to work with. The empirical evaluation of economic policy with modern methods that allow identifying causal effects needs to become standard. Finally, not only professional economists should be able to understand basic economic reasoning but also non-economists. However, the degree of economic education in Germany is too low. It would probably be easier to explain the positive effects of structural reforms on the allocation and on the distribution if the level of economic education in the population was higher. VI Conclusions (Oliver Holtemöller) 270

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

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