Economic growth in the European Union has been low for more than a decade now. While some of the poor performance can be explained by the crisis, the sustained low growth is to a very large extent the consequence of sluggish productivity performance. Productivity is above all an indicator of a society’s long-term welfare and measures how effective we are at using our scarce resources in the economy. Therefore, it is critically important – and any reform effort should focus on boosting growth through higher productivity growth.
The recent Services Package – a set of proposals to support Europe’s services sector – is a case in point. It has long been established that rates of productivity growth in Europe’s services sector trails the rates in the United States and other comparable economies. As the economy increasingly gets dependent on services, the risk for Europe is that the natural economic transformation will weigh down our productivity growth.
Obviously, any services reform aiming at delivering growth should start from the policy barriers that hold back growth and a greater degree of economic dynamism. Few, however, do. The type of restrictive policy measures in the EU vary across different services sectors – and, hence, what is the right policy priority for one country may not be right for the other. Yet, when looking at some services policy developments in Europe more closely, some patterns do become clear. Those should now be the focus of policy reform.
Barriers to Entry – and Barriers to Operation
Generally, domestic regulatory policy barriers in services can be broken down into those that affect entry of firms into a market and other policy barriers that have an impact on the operations of firm activity. The two policies are connected, of course, and have a distinctive impact on productivity.
Barriers to entry restrict foreign and domestic service providers from bringing competition to the market. If entry barriers are high, domestic incumbents will be sheltered from competition and less incentivized to perform better. Eventually, this leads to higher prices for European consumers and businesses using services. Barriers to operations, on the other hand, are barriers that firms encounter after entry has taken place.
Previous studies have shown that in order to generate growth, the EU’s rate of new firms entering the markets does not substantially differ from the United States (i.e. Bertelsman et al, 2003). What differs is what happens next: firms in the EU are less likely to expand quickly and have greater difficulties pushing out less-productive firms from the market (OECD, 2016). Hence, barriers to operations are essential in the EU or what could be called barriers to firm growth.
This is important. To generate growth in Europe, there needs to be much more work on the regulatory burden – the regulations that prevent the well-known Schumpeterian dynamic of ‘creative destruction’. Indeed, in the EU a great deal of potential productivity growth would come from services reform in the post-entry phase. A recent study by Van der Marel et al (2016), using data from millions of European firms, shows that in order to raise productivity growth in services markets it is the removal of conduct barriers that really matters. This does not mean, however, that reforms on operational restrictions can be successfully pursued without reforming entry barriers. As a matter of fact, work still needs to be done to ease market-entry for firms, particularly in professional services; an area that the Services Package tries to tackle.
This can be seen in Figure 1 below. The left-hand panel splits up the two types of regulatory barriers into entry barriers on the vertical axis and barriers to firm growth, i.e. operational barriers, on the horizontal axis. Services sectors placed in the upper-left corner of this figure show a relatively high share of entry barriers in their markets compared to their operational barriers. It means that entry barriers in these services are currently greater than their operational barriers. Conversely, sectors positioned in the lower-right corner of the figure still have a relatively high share of operational barriers in their markets, inhibiting firm growth compared to their level of entry barriers.
The figure shows that many professional services such as engineering, legal, accounting and architectural services still have high entry barriers in place. Many domestic and foreign firms are therefore still prevented from reinforcing competition in their sectors, and these restrictions ultimately reduce consumer choice and the positive effects of a true single European services market. Other services such as transportation services and utilities have relatively lower barriers to entry, but comparatively higher conduct barriers.
Source: OECD; van der Marel et al. (2016). Productivity figures are TFP based on Ackerberg et al. (2015)
These categories of services regulation have a knock-on effect on productivity in the EU. Detailed studies such as Arnold et al. (2011) and Van der Marel et al. (2016) have shown how they depress productivity in EU countries. This can also be seen in the right-hand panel of Figure 1 in which the average productivity of each sector is shown in order of importance. It shows that postal, telecoms, retail and airline services all have positive growth effects. These are exactly the sectors which already have experienced lower entry barriers for firms. However, their growth is still below their potential and their productivity levels are still modest. Reducing these sectors’ post-entry barriers of firm growth and expansion will therefore increase the potential to create further productivity growth.
There is a different story for professional services – and rail and road services. These sectors have seen negative productivity growth in recent years, underlying the fact that competitive forces – increasing the level of productivity – remain untapped. This is most likely due to the high entry barriers in these sectors. The results of these productivity figures are robust to alternative productivity measures. There are several ways in which productivity can be computed – and they could provide different results. Yet, using another commonly used methodology of calculating productivity provides the same sectoral ranking as can be seen in the left-hand panel of Figure 2.
Figure 2: Productivity in services and barriers to entry vs barriers to firm growth (2013-2014)
Source: OECD; van der Marel et al. (2016). Productivity figures are TFP based on Olley and Pakes (1996)
In addition, the right-hand panel of Figure 2 points out which countries, across all services sectors, have relatively high entry barriers or conduct barriers. In a similar manner, countries which are more placed towards the vertical axis have relatively high entry barriers, whilst countries which are more located towards the horizontal axis have a relatively large share of regulatory policies inhibiting firm growth. Austria, Poland and Italy, for instance, still have services barriers in place which prohibits firms from entering, whilst other countries such as Finland, Romania and France have relatively high restrictions on firm expansion.
 The firm-level TFP measure are weighted by firm-size in the aggregation process across each services sector.
 Country-specific studies using firm-level data show this knock-on effect outside the EU as well such as Arnold et al. (2015). Studies using industry-level data showing this effect for OECD economies are Barone and Cingano (2011) and Bourlès et al. (2013).
 The only exception is retail services which still has relatively high entry barriers. However, this sector’s measurement of productivity is difficult to measure and therefore needs to be taken with some margin of error.