Removing local barriers to entry can be a cost-efficient way to boost aggregate productivity growth in developing countries
During the 2000s, Peru implemented a comprehensive competition policy framework at the national level, and one of the most liberal trade regimes in the world. The average tariff rates have been reduced to only 1.9 percent by 2013, and only a few products are subject to nontariff trade barriers. The presence of state-owned companies has been minimised and key sectors such as telecommunications and energy have been deregulated. Most economic policies such as tax policies, tariffs, monetary policies, and public utilities regulations are applied nationwide with very few, or no, region-, sector-, and industry-specific policies. Peru also introduced a best-practice national, legal and institutional framework to implement an effective competition policy following the creation of Indecopi, an independent competition authority. Despite these economic liberalisation reforms, firms’ productivity growth has been disappointing and has lagged the performance of peer countries (World Bank 2017).
Notably, despite far-reaching deregulations at the national level, barriers to market entry and competition in Peru have emerged at the local level. The legal framework gives local governments the authority and discretion to regulate local market entry since―similar to many other developing countries―Peru decentralised the regulation and enforcement of issuing operating licenses, permits, defining local technical standards, and conducting inspections. As a result, each of Peru’s more than 1,800 municipalities issues its own specific code of business regulations, the Texto Unico de Procedimientos Administrativos (TUPA). In principle, procedures in the TUPAs should be consistent with national legislation, but in practice this has been the exception rather than the rule. Several municipalities outright refused to issue operating licenses to new firms. Before 2013, the municipality of Chilca, for example, refused to receive the applications of selected firms for the construction permit of a new building without providing a reason. The decentralised system effectively allowed local public officials to limit market access to protect local incumbents.
To challenge local regulations affecting businesses, Peru underwent a major reform of its competition authority’s mandate in 2013. The reform introduced for the first time a legal mechanism that allowed for an effective elimination of local, sector-specific regulatory entry barriers. It allowed Indecopi to perform ex-officio investigations, publicly declare a local regulation as illegal, and introduced a fast-track sanctioning procedure by Indecopi, including against individual public officials. This mechanism, along with fines that increased by 400 percent, forced the effective removal of local regulatory barriers that were declared as illegal or irrational either by means of sanctioning procedures or by a preemptive action of local governments to avoid the costly sanctions on individual local public officials. As a result, the number of rulings against entry barriers in municipalities increased dramatically after 2013. The change in the legal mandate of Indecopi in the 2013 law unfolded a quasi-experiment to identify the impact of more intensive competition on firm productivity since the decisions by the competition authority to remove barriers to entry were independent from local market conditions and sector or firm characteristics of individual municipalities.
Notably, existing evidence on the link between competition and productivity have been relatively scant, except for reforms related to trade liberalisation, due to the lack of adequate data (e.g. see Syverson 2011). At the macroeconomic level, small low-frequency cross-country sample sizes relative to the seemingly open-ended list of growth correlates make it almost impossible to obtain robust results or address the problem of endogeneity. At the microeconomic level, the empirical relation between competition and productivity is also difficult to identify beyond case studies focusing on a specific, homogenous good for which detailed information on prices and market structure characteristics are available. Either researchers lack appropriate disaggregated measures of competition, or a valid control group of firms not affected by competition reforms. The Peruvian experience thus provides a generalisable impact evaluation using firm-level evidence within the controlled institutional environment of a single country, based on rich subnational geographical variation and a wider range of economic activities and firms affected by the competition reform.
Eliminating barriers to entry causes firm productivity growth
The reform generated a new, rich dataset that captures eliminated regulatory barriers to entry across economic sectors in 1,800 municipalities in Peru. The data is matched with firm census panel data from 2007-17 to estimate the impact of eliminating entry barriers on changes in productivity and markups for firms operating in affected sectors and municipalities.
The elimination of barriers to entry caused a strong increase in subsequent firm productivity growth which we regard as evidence of the positive impact of enhanced competition on market efficiencies. Firms operating in municipalities and sectors that eliminated barriers to entry experienced a significant increase in productivity growth, but not in markups, relative to comparable, same-sector firms not located in reform-municipalities (Figure 1). Given that revenue productivity can rise because of increases in physical productivity or increases in firm-specific prices due to higher local product quality―which raises markups and offsets their decline from lower local rents in reform municipalities-sectors―the results suggest that physical productivity improved.
A range of evidence supports a causal interpretation of this finding. First, the results are robust to different strategies to identify the control group. Second, treated and control firms followed parallel productivity trends in pre-reform years, and municipalities’ pre-reform average firm productivity levels, encapsulating the effect of other municipal productivity determinants, do not predict the elimination of local entry barriers. Third, as expected, the reform impact is strongest when illegal licenses procedures were eliminated, as these allowed local public officials to withhold the issuance of local operating licenses, directly restricting the entry of competitors to local incumbents.
Figure 1: The 2013 legal reform reducing local entry barriers spurred productivity growth
Notes: The figure reflects the estimated reform impact in each year relative to 2012, showing that firms operating in municipalities and sectors that eliminated barriers to entry experienced a significant increase in productivity growth relative to comparable, same-sector firms not located in reform-municipalities. The underlying estimation controls for firm as well as province-year and sector-year fixed effects. 95% confidence intervals; *,**,*** significance at 10, 5, 1 percent level. Source: Schiffbauer, Sampi, and Coronado (2022).
Strengthening the mandate of state institutions enforcing competition is critical
This column shows that new legislation in Peru in 2013, which strengthened the mandate of the national competition authority over business regulations controlled by local governments, led to large-scale eliminations of subnational entry barriers to local markets which boosted firm productivity growth. These results support the hypothesis that more intense competition can drive countries’ productivity growth, as it is thought to encourage firms to innovate, adopt cost-reducing production techniques, or embark on organisational changes (e.g. Aghion et al. 2001). They further highlight the critical role of subnational barriers to market entry in attenuating competition and reducing firm productivity in developing countries. Subnational entry barriers can thus undermine the productivity and growth impact of seemingly best practice national policies. The findings further suggest that strengthening the mandate of state institutions enforcing competition is critical to raise productivity.
The results can help explain the sluggish productivity performances of some developing countries that have liberalised trade and business regulations, installed macroeconomic stability, and put in place best-practice competition policy frameworks at the national level. They also suggest that decentralisation policies need to be carefully designed. While some degree of fiscal decentralisation, for example, can help improve the effectiveness of local capital spending, the decentralisation of business regulation appears to amplify the risk of state capture.
Aghion, P, C Harris, P Howitt, and J Vickers (2001), "Competition, Imitation and Growth with Step-by-Step Innovation," The Review of Economic Studies, 68:3, 467–92.
Schiffbauer, M, J Sampi, and J Coronado (2022), “Competition and Productivity: Evidence from Peruvian Municipalities”, The Review of Economics and Statistics, forthcoming.
Syverson, C (2011), “What Determines Productivity?”, Journal of Economic Literature, 49:2: 326-365.