## 1. Number of reforms shocks (26 advanced economies, 1970-2013)

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### I. Introduction and motivation
- Global current account imbalances declined from their pre-2008-financial-crisis peak level of 6 percent of global GDP to about at 3 percent of global GDP, but remain sizable and for over a third of them deemed “undesirable” by the IMF.
- Persistence and rotation of imbalances toward advanced economies (examples: Germany, Japan, Korea, Netherlands running surpluses; Australia, Canada, the United Kingdom, United States running deficits; Southern European economies shifted from deficit to surplus alongside large output losses).
- Market regulation (labor and product market regulations) is a structural force of interest; its effects on current accounts are marginally studied empirically.
- This paper builds on a new “narrative” database of major reforms in: employment protection legislation (EPL) for regular workers and product market regulation (PMR) for non-manufacturing industries across 26 advanced economies over the past four decades.

### III. Reform data (coverage and construction)
- Coverage:
  - 26 countries: Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Slovak Republic, Spain, Sweden, Switzerland, United Kingdom and United States.
- Sample period:
  - Reforms identified from 1970; empirical sample reported 1970-2013 for counts and analyses.
- Identification method:
  - Collected legislative/regulatory actions reported in OECD Economic Surveys and additional country-specific sources; over 1000 actions initially identified.
  - A policy action qualifies as a major reform (value 1) or counter-reform (value -1) if one of three criteria is met: (1) strong normative language in OECD Survey; (2) repeated mentions across editions; (3) very large change in OECD indicator (5th percentile of distribution). Otherwise, extensive country-source search is done.
  - Reform variable takes value 0 in non-reform years, 1 in reform years, -1 in counter-reform years.
- Focus:
  - Product market reforms in seven non-manufacturing industries: telecoms, electricity, gas, post, rail, air passenger transport, and road freight.
- Stylized facts:
  - Number of major EPL reforms for regular workers: about 35 in sample.
  - Majority of reforms implemented in the 1990s and 2000s; rail transport exceptions including the 1980s.
  - EU countries undertook more actions on average than non-EU countries.
  - Product market reforms more frequently implemented during higher economic growth (real GDP growth above country historical average); EPL implementation less dependent on prevailing economic conditions.
  - Figure evidence suggests EPL reforms associated on average with an increase in current account; PMR reforms associated with decrease.

### II. Theoretical evidence (concise synthesis)
- Two broad model classes:
  1. Standard DSGE with implicit EPL/PMR via markups:
     - EPL/PMR deregulation → lower wage/price markups → ambiguous short-term effects on consumption and investment; calibrated models typically show current account strengthens after EPL deregulation and weakens after price-markup decline.
     - Effects largely transitory; real effective exchange rate depreciates short term after EPL deregulation and appreciates after price-markup declines.
  2. DSGE with explicit layoff and entry costs, labor frictions, endogenous producer entry:
     - EPL liberalization (cutting layoff costs) → immediate job destruction > slow job creation → short-term lower employment, consumption, output → current account strengthens.
     - PMR liberalization (cutting entry costs) → short-run investment surge (new firms enter and build capital) → current account weakens.
     - Business cycle role: effects more positive (or less negative) in bad times — EPL strengthening current account more in recessions; PMR weakening effect muted in recessions due to lower expected returns to entry and tighter borrowing constraints.
- Overall theoretical predictions:
  - EPL deregulation tends to strengthen the current account.
  - PMR deregulation tends to weaken the current account.
  - Effects are typically transitory.

### IV. Empirical methodology
- Estimation approach:
  - Local projection method (Jordà, 2005) to estimate dynamic responses (impulse-response functions) of current account, saving, and investment (all as shares of GDP) to reform shocks.
- Baseline specification highlights:
  - Dependent variable: change in y (current account, saving, or investment) from t-1 to t+k.
  - Key regressor: R (reform shock) with country fixed effects αc and control vector X including three lags of reform shocks and three lags of dependent variable.
  - IRFs plotted for k = 0,1,..3 and beyond; confidence bands reported at 90 percent and 60 percent.
  - Standard errors: robust, clustered at country level.
- Endogeneity and robustness:
  - Controls for expected economic growth at time of reform, other macro drivers, reforms in other areas.
  - Instrumental Variable (IV) approach using political-economy instruments employed in robustness checks.

### V. Results — baseline estimates and magnitude
- Baseline dynamic responses (three-year horizon; confidence intervals reported):
  - Major historical episodes of EPL deregulation improved the current account balance by about 0.5 percentage point of GDP after two years.
  - Major cuts in non-manufacturing PMR weakened the current account balance by about 0.7 percentage point of GDP after two years.
  - Effects are statistically and economically significant in the short term.
- Temporal profile:
  - Effects start declining after a few years and become statistically insignificant seven years after reforms.
  - Seven-year medium-term effects reported: EPL reform 0.49 percent of GDP with a t-statistic of 0.9; PMR reform -0.38 percent of GDP with a t-statistic of 1.2.
  - Comparison: magnitudes broadly similar to effect of a 1 percentage point of GDP improvement in the fiscal balance found in literature.
- Saving and investment channels (three-year horizon):
  - EPL deregulation (after 3 years): associated with an increase in aggregate saving of about 0.3 percentage point of GDP and a decline in investment of about 0.2 percentage point of GDP (effects not statistically different from zero).
  - PMR cuts (after two years): associated with an increase in investment of about 1 percentage point of GDP and an increase in saving of about 0.4 percentage point of GDP (investment increase statistically significant).
  - Additivity property: responses of current account equal saving minus investment responses (OLS specification identical across variables).
- Exports/imports decomposition:
  - EPL reforms: significant increase in both exports and imports, effect on exports larger than on imports.
  - PMR reforms: effects on exports/imports smaller and less precisely estimated, effect on imports larger than on exports.

### V. Robustness and sensitivity checks
- Controls and specifications tested with similar results:
  - Inclusion of year fixed effects and country-specific time trends.
  - Expanded controls: lagged changes in domestic demand, foreign demand, real exchange rates, terms of trade, short-term interest rates (current and lagged), general government primary budget balance, Chinn-Ito index of capital controls, EPL and PMR reforms in major trading partners.
  - Controls for other simultaneous reforms: labor tax wedge, unemployment benefits replacement rate, EPL for temporary contracts.
    - Additional finding: a one percentage point reduction in the tax wedge associated with a statistically significant and persistent deterioration in the current account balance.
    - Reforms in unemployment benefits and EPL for temporary contracts not statistically significant.
  - Controlling for GDP growth expectations (expected values in t-1 of future real GDP growth from IMF WEO) — results remain similar.
  - Focusing only on liberalizing reforms (omitting counter-reforms) — results robust.
  - Sectoral PMR analysis: individual-sector PMR reforms generally associated with declines in the current account; larger absolute effects in postal services, telecom, electricity, rail transport (statistical significance lower due to simultaneous sectoral reforms).
- Instrumental Variable (IV) estimation:
  - Instruments: political-economy variables from World Bank Database of Political Institutions—Parties (ideology coded 3/2/1 for left/center/right), System (discrete for parliamentary/assembly-elected/presidential coded 2/1/0), Fragmentation (continuous 0–1), Democ (Polity IV normalized 0–1).
  - Two-stage least squares with up to two lags of instruments.
  - Kleibergen-Paap and Hansen statistics used to assess identification and instrument validity.
  - IV results similar to and not statistically different from OLS — suggesting endogeneity not a serious concern.

### V. Role of business cycle conditions (non-linear effects)
- Method:
  - Smooth transition local projections using output gap as state variable z (normalized zero mean, unit variance) and weighting function F(z) with γ = 1.5 (economy spends about 20 percent of time in recessionary regime defined as F(z)>0.8).
- Main non-linear findings:
  - In recessions (bad times), reforms have a sizable positive and statistically significant impact on the current account balance.
  - In booms (good times), reforms have a negative and statistically significant impact on the current account balance.
  - Differences across regimes statistically significant for PMR reforms.
- Transmission channels by regime:
  - Saving: reforms—especially EPL—tend to raise saving more in bad times (precautionary motives and larger decline in consumption).
  - Investment: reforms have larger positive effects on investment during expansions; PMR investment surge muted in recessions.
- Robustness:
  - Results hold when replacing smooth transition with a simple dummy indicator for bad times (GDP growth below sample average).

### VI. Conclusion (key takeaways and research gaps)
- Empirical evidence from a narrative reform database across 26 advanced economies over four decades:
  - Product market deregulation is associated with deterioration in the current account.
  - Labor market deregulation is associated with improvement in the current account.
  - Effects are statistically and economically significant in the short term and tend to decline over the medium term (transitory).
  - Results broadly consistent with DSGE models featuring endogenous entry and labor frictions.
- Open questions and suggested future research:
  - Broader set of market regulations (financial markets, pension, healthcare, international trade and FDI) and their aggregate effects on saving, investment, and current accounts warrant systematic investigation.
  - Cross-country heterogeneity in impacts due to structural characteristics needs further exploration.
  - Micro-econometric analysis at household (saving) and firm (investment) levels recommended to elucidate mechanisms.

*Source: wpiea2021054-print-pdf - 1. Number of reforms shocks (26 advanced economies, 1970-2013) — PDF chapter/section.*

### 1. Number of reforms shocks (26 advanced economies, 1970-2013) _____________________ 12

### 1. Number of reforms shocks (26 advanced economies, 1970-2013)

### Figures (numbered items)
- 1. Number of reforms shocks (26 advanced economies, 1970-2013) _____________________ 12
- 2. Evolution of the Current Account around Labor and Product Market Reforms (% of GDP) _ 12
- 3. Effect of Reforms on the Current Account (% of GDP) _____________________________ 15
- 4. Effect of Reforms on Saving and Investment (% of GDP) ___________________________ 17
- 5. Effect of Reforms on the Current Account (% of GDP) – the role of the business _________ 19
- 6. Effect of Reforms on Saving (% of GDP) – the role of the business cycle _______________ 19
- 7. Effect of Reforms on Investment (% of GDP) – the role of the business cycle ___________ 20
- 8. Effect of Reforms on the Current Account (% of GDP) – the role of the business cycle, robustness check _____________________________________________________________ 20

### Appendix figures (A-prefixed)
- A1. Effect of Reforms on the Current Account (% of GDP) – controlling for year fixed effects  25
- A2. Effect of Reforms on the Current Account (% of GDP) – controlling for country-specific time trends __________________________________________________________________ 26
- A3. Effect of Reforms on the Current Account (% of GDP) – controlling for other current account determinats ___________________________________________________________ 26
- A4. Effect of Reforms on the Current Account (% of GDP) – controlling for other reforms ___ 27
- A5. Effect of Other Labor Market Reforms on the Current account (% of GDP) ____________ 28
- A6. Effect of Reforms on the Current Account (% of GDP) – controlling for growth expectations ___________________________________________________________________________ 29
- A7. Effect of Reforms on the Current Account (% of GDP) – liberalizing reforms only ______ 29
- A8. Effect of Different PMR Reforms on the Current Account (% of GDP) _______________ 30
- A9. Effect of Reforms on the Current Account (% of GDP) – Instrumental Variables  _______ 31

### Tables
- TABLES
  - 1. Reform shocks by period (%) _________________________________________________ 13
  - 2. Reform shocks by geographical region (%)  ______________________________________ 13

*Source: wpiea2021054-print-pdf - 1. Number of reforms shocks (26 advanced economies, 1970-2013) — PDF chapter/section.*

### 3. Reform shocks over the business cycle (%)  ______________________________________ 13

### 3. Reform shocks over the business cycle (%)  ______________________________________ 13

### I. Introduction and motivation
- Global current account imbalances declined from their pre-2008-financial-crisis peak level of 6 percent of global GDP to about at 3 percent of global GDP, but remain sizable and for over a third of them deemed “undesirable” by the IMF.
- Persistence and rotation of imbalances toward advanced economies (examples: Germany, Japan, Korea, Netherlands running surpluses; Australia, Canada, the United Kingdom, United States running deficits; Southern European economies shifted from deficit to surplus alongside large output losses).
- Market regulation (labor and product market regulations) is a structural force of interest; its effects on current accounts are marginally studied empirically.
- This paper builds on a new “narrative” database of major reforms in: employment protection legislation (EPL) for regular workers and product market regulation (PMR) for non-manufacturing industries across 26 advanced economies over the past four decades.

### III. Reform data (coverage and construction)
- Coverage: 26 countries (Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Slovak Republic, Spain, Sweden, Switzerland, United Kingdom and United States).
- Sample period: reforms identified from 1970; empirical sample reported 1970-2013 for counts and analyses.
- Identification method:
  - Collected legislative/regulatory actions reported in OECD Economic Surveys and additional country-specific sources; over 1000 actions initially identified.
  - A policy action qualifies as a major reform (value 1) or counter-reform (value -1) if one of three criteria is met: (1) strong normative language in OECD Survey; (2) repeated mentions across editions; (3) very large change in OECD indicator (5th percentile of distribution). Otherwise, extensive country-source search is done.
  - Reform variable takes value 0 in non-reform years, 1 in reform years, -1 in counter-reform years.
- Focus on product market reforms in seven non-manufacturing industries: telecoms, electricity, gas, post, rail, air passenger transport, and road freight.
- Stylized facts:
  - Number of major EPL reforms for regular workers: about 35 in sample.
  - Majority of reforms implemented in the 1990s and 2000s; rail transport exceptions including the 1980s.
  - EU countries undertook more actions on average than non-EU countries.
  - Product market reforms more frequently implemented during higher economic growth (real GDP growth above country historical average); EPL implementation less dependent on prevailing economic conditions.
  - Figure evidence (Figure 2) suggests EPL reforms associated on average with an increase in current account; PMR reforms associated with decrease.

### II. Theoretical evidence (concise synthesis)
- Two broad model classes:
  1. Standard DSGE with implicit EPL/PMR via markups:
     - EPL/PMR deregulation → lower wage/price markups → ambiguous short-term effects on consumption and investment; calibrated models typically show current account strengthens after EPL deregulation and weakens after price-markup decline.
     - Effects largely transitory; real effective exchange rate depreciates short term after EPL deregulation and appreciates after price-markup declines.
  2. DSGE with explicit layoff and entry costs, labor frictions, endogenous producer entry (Cacciatore & Fiori; Cacciatore et al.):
     - EPL liberalization (cutting layoff costs) → immediate job destruction > slow job creation → short-term lower employment, consumption, output → current account strengthens.
     - PMR liberalization (cutting entry costs) → short-run investment surge (new firms enter and build capital) → current account weakens.
     - Business cycle role: effects more positive (or less negative) in bad times — EPL strengthening current account more in recessions; PMR weakening effect muted in recessions due to lower expected returns to entry and tighter borrowing constraints.
- Overall theoretical predictions summarized:
  - EPL deregulation tends to strengthen the current account.
  - PMR deregulation tends to weaken the current account.
  - Effects are typically transitory.

### IV. Empirical methodology
- Local projection method (Jordà, 2005) used to estimate dynamic responses (impulse-response functions) of current account, saving, and investment (all as shares of GDP) to reform shocks.
- Baseline specification (paraphrased from equation (1)):
  - Dependent variable: change in y (current account, saving, or investment) from t-1 to t+k.
  - Key regressor: R (reform shock) with country fixed effects αc and control vector X including three lags of reform shocks and three lags of dependent variable.
  - IRFs plotted for k = 0,1,..3 and beyond; confidence bands reported at 90 percent and 60 percent (noting the text refers to 90 (60) percent).
  - Standard errors: robust, clustered at country level.
- Endogeneity concerns addressed in robustness: control for expected economic growth at time of reform, other macro drivers, reforms in other areas, and an Instrumental Variable (IV) approach using political-economy instruments.

### V. Results — baseline estimates and magnitude
- Baseline dynamic responses over a three-year horizon (with 90 percent and 68 percent confidence intervals):
  - Major historical episodes of EPL deregulation improved the current account balance by about 0.5 percentage point of GDP after two years.
  - Major cuts in non-manufacturing PMR weakened the current account balance by about 0.7 percentage point of GDP after two years.
  - These effects are statistically and economically significant in the short term.
  - Temporal profile: effects start declining after a few years and become statistically insignificant seven years after reforms.
    - Seven-year medium-term effects reported: EPL reform 0.49 percent of GDP with a t-statistic of 0.9; PMR reform -0.38 percent of GDP with a t-statistic of 1.2.
  - Comparison: magnitudes broadly similar to effect of a 1 percentage point of GDP improvement in the fiscal balance found in literature.
- Saving and investment channels (Figure 4; three-year horizon):
  - EPL deregulation (after 3 years): associated with an increase in aggregate saving of about 0.3 percentage point of GDP and a decline in investment of about 0.2 percentage point of GDP (effects not statistically different from zero).
  - PMR cuts (after two years): associated with an increase in investment of about 1 percentage point of GDP and an increase in saving of about 0.4 percentage point of GDP (investment increase statistically significant).
  - Additivity property: responses of current account equal saving minus investment responses (OLS specification identical across variables).
- Exports/imports decomposition (Annex reference):
  - EPL reforms: significant increase in both exports and imports, effect on exports larger than on imports.
  - PMR reforms: effects on exports/imports smaller and less precisely estimated, effect on imports larger than on exports in that decomposition.

### V. Robustness and sensitivity checks
- Controls and specifications tested (results similar to baseline; not statistically different):
  - Inclusion of year fixed effects and country-specific time trends.
  - Expanded controls: lagged changes in domestic demand, foreign demand, real exchange rates, terms of trade, short-term interest rates (current and lagged), general government primary budget balance, Chinn-Ito index of capital controls, EPL and PMR reforms in major trading partners.
  - Controls for other simultaneous reforms: labor tax wedge, unemployment benefits replacement rate, EPL for temporary contracts.
    - Additional finding: a one percentage point reduction in the tax wedge associated with a statistically significant and persistent deterioration in the current account balance.
    - Reforms in unemployment benefits and EPL for temporary contracts not statistically significant.
  - Controlling for GDP growth expectations (expected values in t-1 of future real GDP growth from IMF WEO) — results remain similar.
  - Focusing only on liberalizing reforms (omitting counter-reforms) — results robust.
  - Sectoral PMR analysis: individual-sector PMR reforms (telecoms, postal, electricity, gas, air, rail, road) generally associated with declines in the current account; larger absolute effects in postal services, telecom, electricity, rail transport (statistical significance lower due to simultaneous sectoral reforms).
  - Instrumental Variable (IV) estimation:
    - Instruments: political-economy variables from World Bank Database of Political Institutions—Parties (ideology coded 3/2/1 for left/center/right), System (discrete for parliamentary/assembly-elected/presidential coded 2/1/0), Fragmentation (continuous 0–1), Democ (Polity IV normalized 0–1).
    - Two-stage least squares with up to two lags of instruments.
    - Kleibergen-Paap and Hansen statistics used to assess identification and instrument validity.
    - IV results similar to and not statistically different from OLS — suggesting endogeneity not a serious concern.

### V. Role of business cycle conditions (non-linear effects)
- Method: smooth transition local projections (Auerbach and Gorodnichenko approach) using output gap as state variable z (normalized zero mean, unit variance) and weighting function F(z) with γ = 1.5 (economy spends about 20 percent of time in recessionary regime defined as F(z)>0.8).
- Main non-linear findings (Figures 5–8):
  - In recessions (bad times), reforms have a sizable positive and statistically significant impact on the current account balance.
  - In booms (good times), reforms have a negative and statistically significant impact on the current account balance.
  - Differences across regimes statistically significant for PMR reforms.
  - Transmission channels by regime:
    - Saving: reforms—especially EPL—tend to raise saving more in bad times (precautionary motives and larger decline in consumption).
    - Investment: reforms have larger positive effects on investment during expansions; PMR investment surge muted in recessions.
  - Robustness: results hold when replacing smooth transition with a simple dummy indicator for bad times (GDP growth below sample average).

### VI. Conclusion (key takeaways and research gaps)
- Empirical evidence from a narrative reform database across 26 advanced economies over four decades:
  - Product market deregulation is associated with deterioration in the current account.
  - Labor market deregulation is associated with improvement in the current account.
  - Effects are statistically and economically significant in the short term and tend to decline over the medium term (transitory).
  - Results broadly consistent with DSGE models featuring endogenous entry and labor frictions.
- Open questions and suggested future research:
  - Broader set of market regulations (financial markets, pension, healthcare, international trade and FDI) and their aggregate effects on saving, investment, and current accounts warrant systematic investigation.
  - Cross-country heterogeneity in impacts due to structural characteristics needs further exploration.
  - Micro-econometric analysis at household (saving) and firm (investment) levels recommended to elucidate mechanisms.

*Source: IMF Working Paper content unit "3. Reform shocks over the business cycle (%)" (from the provided PDF content).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021054-print-pdf.pdf_