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Regulation, Institutions and Aggregate Investment: New Evidence from OECD Countries

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Abstract

This paper investigate the relationship linking investment (capital stock) and structural policies. Using a panel of 32 OECD countries from 1985 to 2013, we show that more stringent product and labour market regulations are associated with less investment (lower capital stock). The paper also sheds light on the existence of non-linear effects of employment protection legislation (EPL) on the capital stock. Several alternative testing methods show that the negative influence of EPL is considerably stronger at higher levels. Finally, and importantly, the paper uncovers important policy interactions between product and labour market policies. Higher levels of product market regulations (covering state control, barriers to entrepreneurship and barriers to trade and investment) tend to amplify the negative relationships between EPL and the capital stock and ETCR and the capital stock. Equally important is the finding that the rule of law and the quality of (legal) institutions alters the overall impact of regulations on capital deepening: better institutions reduce the negative effect of more stringent product and labour market regulations on the capital stock, possibly through the reduction of uncertainty as regards the protection of property rights. This result also implies that the benefit from product and labour market reforms may be smaller in countries with weaker institutions.

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Notes

  1. A strict definition of business investment is aggregate investment excluding housing investment and public investment. This type of investment can be called private business investment. Business investment according to OECD terminology excludes housing investment but includes public investment.

  2. Pelgrin et al. (2002) use real investment rather than the capital stock as the dependent variable in equation (8). They argue that in the steady state, investment can be written as a constant share of the capital stock if one assumes a constant growth rate of the capital stock: I = (δ + g)K where δ is the depreciation rate and g is output growth in the steady-state. In practice, the capital stock can be replaced by investment if the historical investment to capital stock ratio is a stationary process. This is, however, not always the case in practice.

  3. More stringent EPL can increase the capital-to-labour ratio by raising the cost of labour. In the absence of financial and labour market frictions, firms can decide to substitute capital for labour. But in the case of market frictions and wage bargaining, higher EPL decreases the capital-to-labour ratio (Cingano et al. 2015).

  4. Westmore (2013) use the PMR indicator by filling in the gaps between the observations in 1998, 2003, 2008 and 2013 via linear interpolation.

  5. The ETCR indicator captures regulation in seven sectors: electricity and gas (energy), post, rail, air passenger transport, and road freight (transport) and telecoms. For more details, see http://www.oecd.org/regreform/reform/44754663.pdf

  6. The labour tax wedge is the statutory tax wedge including social contributions and income taxes for the average wage for a couple with 2 children. Spending on active labour market policies (ALMPs) is defined as spending per unemployed as a share of GDP per capita. The EPL indicator measures regulations for regular contracts. Unemployment gross benefit replacement rate measures the average combined effect of initial replacement rate and benefit duration.

  7. The aggregate PMR indicator is the arithmetic average of the three sub-indicators. State control reflects public ownership and government involvement in business operations via price controls and command and control regulations. Barriers to entrepreneurship capture the administrative burden on start-ups, the regulatory protection of incumbent firms and the complexity of regulatory procedures. Finally, barriers to trade and investment relate to explicit and implicit barriers to trade and investment. See Koske et al. (2015) for more details.

  8. Table 3 reports descriptive statistics for the common sample for all variables. Results are very similar for common samples obtained for less policy variables.

  9. Results for the baseline model are not reported here but are available upon request. All regressions include country and year fixed effects.

  10. Threshold results for private credit are not reported: the results are very sensitive to changes in modelling parameters.

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Acknowledgements

Many thanks go to Alain de Serres, Peter Gal, Catherine L. Mann, participants at the Second International Conference of the Society of Economic Measurement held in Paris on 22-24 July 2015 and the 4th ISCEF conference in Paris on 14-16 April 2016, and an anonymous referee for useful comments and suggestions. Many thanks go to Arnaud Cerbelaud for able research assistance. The views expressed in this document represent those of the author and do not engage the OECD or its member countries in one way or the other.

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  1. OECD, Economics Department, Paris, France

    Balázs Égert

  2. Economix at the University of Paris X Nanterre, Nanterre, France

    Balázs Égert

  3. CESifo, Munich, Germany

    Balázs Égert

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Égert, B. Regulation, Institutions and Aggregate Investment: New Evidence from OECD Countries. Open Econ Rev 29, 415–449 (2018). https://doi.org/10.1007/s11079-017-9449-9

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