Market Reforms at Work in Italy, Spain, Portugal and Greece, EUROPEAN ECONOMY n.5, 2014, Economic and Financial Affairs

EXECUTIVE SUMMARY As part of the response to the crisis, a significant number of market reforms were introduced to boost economic activity and competitiveness. The intense reform effort appears to be showing early signs of effectiveness in some of Europe’s most vulnerable countries. Insufficient reform efforts in the years before the crisis has hampered the ability of many countries to adjust and made their current need for reforms all the more urgent. Vulnerable countries such as Italy, Spain, Portugal and Greece were more exposed because existing rigidities in product markets added to the difficulties their economies encountered when hit by the financial crisis. Structural reforms improve an economy’s flexibility and increase the efficiency of how and where productive factors are used. However, for reforms to deliver their full impact, the channels through which their effects are transmitted throughout the economy need to work properly. Well-functioning transmission mechanisms require that firms can enter and grow unimpeded and that inefficient ones can restructure or exit without hurdles; that prices and mark-ups are flexible enough to properly act as signalling devices; and that reallocation of resources takes place towards the most productive uses and activities. If the chain of transmission is hampered, the expected impact of a reform will not materialise. This report focuses on estimating the potential impact of a selection of market reforms and provides first signs that suggests a positive response in the four countries. Cut off dates for various parts of the study vary depending on the availability of data but in some cases information has been taken into account as recently as April 2014. Indicators measuring the overall regulatory environment show that Greece and Portugal are among the largest reformers: between 2008 and 2013, the two countries led the reform effort according to the OECD Product Market Regulation indicator. Italy and Spain, that started from a more favourable regulatory situation, also improved their regulatory environment over the same period. For the four countries though, the distance with other Member States with the most flexible regulatory framework in product markets is still significant. A look at traditionally protected sectors in detail reveals that although Italy, Spain, Portugal and Greece have done much to reform their professional services sectors, there is ample room for further reductions when compared to countries such as the UK or Finland. The four economies are adjusting at different rhythms. The large reallocation of resources observed before the crisis towards low-productivity non-tradable activities has come to a halt in Spain, Portugal and very recently in Italy. This is good news for the correction of external imbalances. In the years leading up to the crisis, the amount of labour resources absorbed by non-tradable activities increased by over 5 percentage points in Greece and Spain: from 38 % to 44 % in Greece, and from 47 % to 52 % in Spain (between 2000 and 2007). Although market reforms typically take several years to bear fruit, encouraging signs are already visible in Europe’s most vulnerable economies as shown by short-term monitoring indicators. In Spain, efforts to reduce the cost and complexity of registering new companies seem to have yielded results, as the entry rate for micro firms (firms with less than nine employees) in the retail sector rose significantly, from 9.4 % to 11.7 % between 2010 and 2013. Service sector liberalisation may have helped to attract many new foreign companies, particularly to the country’s scientific and professional services sectors, despite a recession. The length of insolvency proceedings has also been substantially reduced from an average of more than 2.5 years to just one year -for simplified procedures- helping banks to curtail the deterioration of their loan portfolios and helping entrepreneurs to move on. In Portugal, a pilot programme to replace authorisations and licensing procedures for the accommodation and the food and beverage sectors has contributed towards a 1 600 jump in the number of new firm registrations over the years 2011-2012 compared to 2009-2010. Public sector health authorities have slashed the amount of time they take to pay bills from 196 days in 2012 to 126 days in 2013. Reform of Portugal’s public procurement practices has also spread the use of public tenders, which should help get tax payers better value for money by fostering competition among bidders. Italy has made progress in many indicators of business environment regulation and is starting to see some tangible benefits, although the momentum for reforms seems to have slowed. Improvements in preinsolvency procedures, which allow companies to stay in business by providing creditor protection at an earlier stage, have been well received. Between their introduction in September 2012 and June 2013, almost 3 900 applications were submitted, far more than the 1 100 applications filed under the old scheme during the whole 2012. Measures to reduce late payments by public administrations remain very high but have improved slightly average payment duration from 190 days in 2012 to 180 days in 2013. Greece has made significant efforts to improve its business environment and continues to do so but monitoring the implementation and actual take-up of reforms is difficult due to a lack of data. The introduction of an electronic registry to simplify the creation of new businesses and the introduction of a new form of limited liability corporation that has no capital requirement may have helped Greece rise 110 places to 36th out of 189 in the World Bank’s Doing Business Report, the biggest improvement of any country between July 2012 and June 2013. There is also evidence to suggest that Greece’s efforts to liberalise its heavily protected professions have made some headway. In addition to reporting on these early signs of adjustment, the report presents a more in-depth empirical investigation of the effects of a number of reforms, selected on the basis of significance and data availability. Although the full effect of the reforms may not yet be visible, this analysis shows that the potential gains are significant. Gains estimated generally focus on microeconomic variables such as business dynamics and productivity. For a few reforms the impact on macro variables such as FDI and overall GDP is also estimated. Data from the four countries confirms the large benefits of the EU’s Services Directive and the power of business environment reforms. Reforms implemented by mid-2013 are estimated to boost labour productivity in the sectors affected by the Directive by around 4.3 % in Portugal, 5.7 % in Spain, 7 % in Italy and almost 9 % in Greece. Given that the directive covers an average of 40 % of GDP in the four countries, the full economy-wide effects should be considerable. The measures taken since 2011 to lower the administrative costs of starting a business and to make it easier for companies to export are estimated to stimulate the creation of new firms and increased entry rates by 1 percentage point in Spain, 0.7 percentage points in Portugal and 0.5 percentage points in Italy. This reform could bring over 20 000 new firms in Italy and Spain. The efficiency of justice is a fundamental consideration when making investment decisions or launching new business operations. Efforts to decrease the average length of trials and the backlog of court cases therefore bring significant positive economic effects. A 10 % reduction in trial lengths has the potential to increase the entry rate of firms by almost 1 percentage point. Over the period 2010-2012 only Portugal and Spain decreased trial lengths (by 10.7 %and 8.1 %, respectively). Estimates for Italy, Spain and Portugal (no data was available for Greece) show that the liberalisation of protected professions has benefits for economic efficiency. In Spain, for example, reforms to professional services could trigger a restructuring of the sector leading to an estimated increase in the legal sector’s efficiency by 2 percentage points, which will translate into a substantial gain in labour productivity. Gains are even larger for Italy. The study also suggests that reforms to ensure that public authorities pay their bills within a reasonable time frame can have a real impact on the survival of many companies. Reforms introduced in Portugal to reduce late payments are estimated to have averted the exit of 4900 companies from the market between 2010 and 2013. Reforms encouraging the digital economy appear to be paying off too. The auctioning of mobile telephony frequency spectrums has contributed to a 27.4 % fall in the cost of mobile phone usage in Portugal and a 26.9 % fall in the cost in Italy. Altogether, the combined effect of measures covering radio spectrum allocation as well as improvements in e-skills, e-commerce and fixed broadband are estimated to have a long term impact on GDP amounting to 1.5 % in Italy, 1 % in Portugal, 0.9 % in Spain and 0.6 % in Greece. Boosting economic activity and competitiveness through targeted market reforms is a central part of the EU’s response to the crisis and it is encouraging that market reforms underway in four of Europe’s most vulnerable economies are showing early signs of success. The full gains of reforms adopted by the four countries are estimated to be significant though there is plenty of scope to do more.