The neighbourhood effect of reforms after crises

Simeon Djankov, Dorina Georgieva, Hibret Maemir 03 July 2020

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Neighbouring countries’ experiences with structural reform influence domestic reforms though their effect on policymakers’ beliefs (see, for example, Buera et al. 2011). Such reforms are especially important in the aftermath of economic crises, as job retention and creation take centre stage (Baldwin 2020).

In a VoxEU ebook paper (Djankov et al. 2020), we study the determinants of regulatory reform, using a dataset on business regulatory reforms from the World Bank’s Doing Business project. The data are based on consistent methodology spanning sixteen years, 2004 to 2019, and cover 190 economies with 3,800 reforms.

We uncover two facts. First, previous economic crises spurred regulatory and administrative reform in registering property, trading across borders, protecting investors, and resolving bankruptcy. Second, neighbours incite their neighbours to implement positive reforms.

Fact no. 1: Crises spur regulatory reform in registering property, trading across borders, protecting investors and resolving bankruptcy

The incidence of structural reforms during the 2004 to 2019 period peaks in 2009, when the previous global financial crisis had gathered speed. That year, a total of 298 reforms were recorded, or about 1.5 reforms per country.

This finding is consistent with a body of literature that suggests governments resort to regulatory reform in difficult times when their fiscal balances deteriorate (Agnello et al. 2015). Ranciere and Tornell (2015) in particular show that trade reforms tend to follow periods of severe economic crises.

We test this hypothesis by correlating the incidence of regulatory reform with a lagged-economic-crisis variable, controlling for other country effects. We find that the relationship between reforms and the lagged-fiscal-crisis variable is positive and often statistically significant.

When we further distinguish by type of reform, economic crises beget statistically significant reforms in protecting investors, resolving bankruptcy, registering property, and trading across borders.

Fact no. 2: Countries reform when their neighbours have reformed too

We construct several measures to test the neighbourhood reform effect hypothesis (Figure 1). The first measure (‘contiguous neighbours’) shows that reforms by all contiguous neighbours in the previous year increases the likelihood of domestic reform by roughly 10 percentage points.

The second measure (‘distance’), using the inverse distance-weighted average of reforms in other countries, provides further evidence that geographical proximity facilitates the transmission of reforms across countries.

To capture the effect of countries learning about the benefits of regulatory reform from trading partners or the same currency union, we compute trade-share-weighted reforms in other countries. We find that a country is more likely to implement reforms when other countries in the same regional trade agreement implemented reforms in the previous year.

Figure 1 Neighbours incite neighbours to implement positive reforms

Notes: The dependent variable for each regression is an indicator that takes the value ‘1’ if a country implements two or more reforms in a given year. Each regression controls for country and year fixed effects, as well as for the region-specific time trends.

We also test whether reform reversals – reforms that make the business environment more difficult – in neighbouring economies have the same influence on domestic policy. The findings suggest that reform reversals by neighbouring countries do not increase the likelihood of reversals at home (Figure 2).

Figure 2 Reform reversals by neighbouring countries do not increase the likelihood of reversals at home

Notes: The dependent variable for each regression is an indicator that takes the value ‘1’ if a country implemented one or more negative reforms in a given year. Standard errors are clustered at the country level. Each regression controls for country and year fixed effects, as well as for the region-specific time trends.

Conclusions

Countries that implement reforms invite their neighbours to do the same. Economic crises spur regulatory reform. In the post-COVID-19 period, politicians can learn from each other in their efforts to revive the economy.

References

Agnello, Luca, Vitor Castro, João Tovar Jalles and Ricardo M Sousa (2015), “What determines the likelihood of structural reforms?”, European Journal of Political Economy 37(C): 129–45.

Baldwin, Richard (2020), “Covid, hysteresis, and the future of work”, VoxEU.org, 29 May.

Buera, Francisco J, Alexander Monge‐Naranjo and Giorgio E Primiceri (2011), “Learning the wealth of nations”, Econometrica 79(1): 1–45.

Djankov, Simeon, Dorina Georgieva and Hibret Maemir (2020), “Regulatory reforms after COVID-19”, in Simeon Djankov and Ugo Panizza (eds.), Covid-19 in Developing Economies, VoxEU eBook.

Ranciere, Romain, and Aaron Tornell (2015), “Why do reforms occur in crises times?”, working paper, Economics Department, University of California at Los Angeles, August.

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Topics:  Global crisis Global economy

Tags:  economic reform, neighbourhood effect, financial crises, financial reform

Policy Director, Financial Markets Group, London School of Economics

Economist, World Bank

Economist, World Bank

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