Identifying Service Market Reform Priorities in Italy

IMF Working Papers, February 21, 2020

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Italy’s labor productivity in market services has declined since 2000 and underperforms manufacturing and peer European countries, especially in strongly regulated sectors.
A model of monopolistic competition is used to identify which service sectors would benefit more from removing entry and/or exit barriers.
Using Italian firm-level data, the paper finds sectoral heterogeneity in reform gains:
- Sectors with high markups, such as professional services, would primarily benefit from removing entry barriers.
- Sectors with a large mass of unproductive firms, such as retail, would instead benefit from removing exit barriers.
Policy recommendations to improve efficiency are outlined in relation to the sectoral priorities identified in the data.

Analytical framework: a model of monopolistic competition calibrated to sectoral, firm-level Italian data.
Empirical input: Italian firm-level data used to identify markups and distribution of firm productivity across service sectors.
Focus: mapping sectors to reform type (entry liberalization versus easing exit) based on observed markups and mass of unproductive firms.

Labor productivity trends:
- Decline in market services labor productivity since 2000.
- Underperformance relative to manufacturing and peer European countries, concentrated in strongly regulated sectors.
Sectoral reform priorities:
- High-markup sectors (example: professional services): greater gains from removing entry barriers.
- Sectors with many low-productivity firms (example: retail): greater gains from removing exit barriers.
Efficiency drivers:
- Entry liberalization can discipline markups and increase competitive pressure in sectors with entrenched pricing power.
- Facilitating exit reallocates resources away from unproductive firms and raises aggregate productivity where a large mass of unproductive firms exists.

For high-markup sectors (e.g., professional services):
- Prioritize removal of entry barriers to increase competition and reduce markups.
For sectors with many unproductive firms (e.g., retail):
- Prioritize easing exit barriers to allow reallocation of resources toward more productive firms.
Tailor reform sequencing to sectoral characteristics revealed by firm-level data, balancing entry liberalization and exit facilitation according to where the dominant inefficiency (excess markups vs. mass of unproductive firms) lies.

Identifying Service Market Reform Priorities in Italy — Nazim Belhocine and Daniel Garcia-Macia, February 21, 2020