Structural Reforms Give Biggest Help To Lagging Countries

IMF Blog, September 22, 2017

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Labor and product market reforms benefit all countries but deliver especially large productivity gains to countries that are less efficient at the time reforms are introduced.
Based on data for advanced economies from 1980 to 2014, the less efficient a country is when it introduces reforms, the bigger the efficiency gains it reaps relative to more productive countries.

Workers in less productive countries can, on average, produce higher output per hour over three years—an estimated labor productivity gain of 2½ percentage points—after governments remove excessive job protection for workers with regular contracts.
High‑efficiency countries experience smaller average gains over the same period, and those gains are statistically closer to zero.
Product market reforms (for example, slashing red tape to make it easier to set up businesses) yield similar patterns: all countries gain, but low‑productivity countries gain much more on average than high‑efficiency countries.

Better matching of resources:
- More flexible rules on hiring, firing, firm entry, and firm exit allow more efficient firms to attract capital and high‑quality workers while failing firms close.
- The closure of unprofitable companies creates space for new firms and helps unleash innovation, enabling larger reallocations of resources in economies that were less flexible to begin with.
Leapfrogging:
- State‑of‑the‑art reforms in regulations, technology, and digital infrastructure allow lagging countries to close the gap to the frontier by adopting best practices and innovations developed elsewhere.
- Less productive countries are further from the frontier, so adopting these innovations can yield a bigger boost because they can skip intermediate steps.

Structural reforms—retooling the regulations and structures that govern a country’s economy—remain politically and socially difficult because adjustment creates winners and losers, but they are an effective route for countries with lower per capita incomes to catch up with richer countries rather than persistently lagging behind.
The study provides fresh arguments in favor of pursuing labor and product market reforms despite their associated costs, especially in economies starting from lower productivity levels.

Angana Banerji, Christian Ebeke — September 22, 2017