Raising growth potential through structural reforms

the main opportunity for raising growth potential is to improve productivity. However, if necessary reforms are not undertaken, the rate of potential growth could actually fall, significantly. the reforms discussed below would help to raise potential growth - perhaps even yielding greater gains than would have resulted from ambitious reform through higher productivity and human and physical capital deepening. They would also increase employment and reduce informality - in most cases without increasing inequality - and thus improve the welfare of all Mexicans.

The OECD’s Going for Growth report serves as a tool for identifying and prioritising structural reforms that can help make long-term gains in GDP per capita. These reform priorities are subject to the prerequisites of macroeconomic and fiscal sustainability. Such report includes the following five key priorities for boosting Mexico’s long-term growth:

  • • Raise educational achievement - Weaknesses in educational enrolment and quality limit productivity gains and exacerbate inequality. Stronger standards have been implemented, but student and teacher evaluation systems need to be developed further (see Chapter 6).
  • • Reduce job protection on formal contracts - Institutional rigidities in the labour market hurt productivity growth and aggravate informality, also harming equity. A major reform in this area to reduce the cost of hiring and firing regular workers, ease shorter-term contracts and considerably

simplify labour court procedures was recently approved by Congress (see Chapter 5).

  • Remove barriers to entry and competition - In general, the costly registration procedures that prevail at the sub-national and federal levels, as well as a lack of contestability in key network services - notably the telecommunications (see Chapter 9), electricity, oil and gas sectors (see Chapter 12) - limit productivity growth. Legal restraints on private investment in the national oil company (PEMEX) -a major potential source of capital - limit the company’s production. At the same time, that company’s efficiency and governance need to be improved.
  • Eliminate restrictions on foreign direct investment - Barriers to foreign direct investment in services (including network services) and infrastructure are among the most restrictive in the OECD area, harming trade, investment and technological upgrading. Foreign investment restrictions in transport, media, fixed-line telecom and financial services need to be relaxed (see Chapter 8).
  • Improve the rule of law - Sound legal institutions are important for any type of structural policy to be effective. Weaknesses in the legal system hurt the efficacy of contracts and the security of property rights, reducing firm size and investment. Legal reforms to improve efficiency and fairness of court proceedings have not yet been implemented in many states.

All of the above structural reform priorities were highlighted in the 13 decisions President Pena Nieto announced in his inaugural Message to the Nation and the recent Pact for Mexico. To establish the priority in which reforms are to be sequenced (see Box 1.1), both their long and short-term effects need to be considered. Education reforms can offer the greatest potential long-term benefits in terms of productivity, but those gains clearly can take years to be fully realised as a new generation of young people need to be educated (Barnes et al., 2011). Recent OECD work suggests that product market reforms - notably, removing barriers to entry in network industries and restrictions on foreign investment - are the reforms most likely to pay off in the short term. Labour market reforms are often thought to have negative short-term side effects; however, recent OECD evidence suggests that this is not necessarily the case, and that if designed well, the effects can be positive even in the short run (OECD, 2012a). Improvements in the rule of law and the contractual environment are likely to take time to be fully effective since they involve fundamental changes in the operation of the court system, though these can in turn help to re-enforce product and labour market reforms.

Weaknesses in the legal system hurt the efficacy of contracts and the security of property rights, reducing economies of scale and limiting investment and efficiency. Major reforms have been initiated to improve the accountability and professionalism of the judicial sector, including through the implementation of oral trials; however, these have yet to be implemented for criminal cases in about one-third of the states, and only experimentally in a few states for civil cases. Legal reforms such as revision of the amparo system of injunctions are also needed at the federal level to strengthen competition; in some network sectors, these injunctions are used to obstruct regulators’ actions. Specialised economic courts now being established through recent competition law should help to restrict the application of amparos and streamline other competition decisions. While the 13 Presidential decisions and the 95 commitments of the Pact are key steps to push these reforms forward, major efforts will be required, along with strong, continued political commitment of stakeholders.

Reforms to product markets and related institutions that could boost investment and the speed of convergence are discussed in depth in this chapter. Dedicated chapters will deal in more depth with education and labour market reform, which are no less important. Similarly, reforms to tax and spending policies would help to leverage domestic savings and capital inflows to boost investment - notably in infrastructure - and make higher growth rates more sustainable and balanced across various regions and over time (see Chapter 4).

Box 1.1. Making reform happen

The business of actually carrying out reform is complex and involves a wide range of political economy considerations, both country-specific and general. A recent OECD analysis has examined the political economy of 20 specific case studies of reform in 10 Member countries and assessed the conditions that can make actual reform possible (OECD, 2009 and 2010). Such review, which builds on earlier OECD work, suggests a number of basic principles that have proven successful:

Governments need to have an electoral mandate for reform. Reform “by stealth” has severe limits; major reforms for which governments have not previously sought public approval tend to succeed only when they generate visible benefits very rapidly, which major structural reforms generally do not. While crises can create opportunities for reform surprises, sustainability is essential for real impact.

Effective communication by governments is important. Major reforms are usually accompanied by coordinated efforts to persuade voters and stakeholders that reform is needed, with special emphasis placed on the costs of not reforming. Where the costs of the status quo are opportunity costs, they tend to be politically “invisible”, making the challenge to ”sell” these reforms all the greater.

Policy design should be underpinned by solid research and analysis. An objective evidence-based proposal for reform with a sound technical analysis serves both to improve the quality of policy and to increase the chances that the reform will be adopted. research presented by an authoritative, non-partisan institution that commands trust across the political spectrum may have a final impact.

Structural reforms that ultimately prove successful often take considerable time to implement. the more successful reforms in the case studies generally took over two years to adopt, and that does not include the preparation work: in many reform episodes, problems and proposals are debated and studied for years before the authorities actually set to work framing specific reforms.

Cohesion of the government is important. if the government undertaking a reform initiative is not united around the policy, it will send out mixed messages, and opponents will exploit its divisions; defeat is usually the result. the case studies suggest that cohesion matters more than such factors as the strength or unity of opposition parties, or the government’s parliamentary strength.

Government leadership is essential. Reform progress may be facilitated by frequent discussions involving the government and the social partners (i.e. unions and private groups). However, firmness on the part of the government also seems to be a critical element of success. A co-operative approach is unlikely to succeed unless the government is in a position to reward cooperation by the social partners, or can make a credible threat to proceed unilaterally if a concerted approach fails.

The previous condition of the policy intended to be reformed matters. The most successful reforms of firmly established policies often have been preceded by the “erosion” of the status quo through smaller piecemeal reforms or unsuccessful reform attempts. Where the existing arrangements are well institutionalised and popular, and there appears to be no danger of imminent breakdown, gaining acceptance of reform is far more difficult to propose, explain, "sell” and implement.

Successful reform requires persistence. Another significant conclusion is that previously blocked, reversed or very limited reforms need not be seen as failures: they may play a role in illustrating the unsustainability of the status quo and setting the stage for a more successful attempt later on.

The OECD case studies confirm the conclusions of earlier analytical work with respect to the facilitating effect of crises and sound public finances. Finally, the studies cast some doubt on the often repeated claim that voters tend to punish reforming governments: the likelihood of subsequent reelection was about the same for those involved in the more and less successful reform episodes.

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