Profit dynamics and product market regulations in the OECD
Growth Analysis has had an assignment to build up knowledge about the impact of regulation on business. This paper examines how swiftly profits that are greater or less than the norm are restored and what the determinants are. In particular, we examine how product market regulations influence profit persistence, which provide us with information about how competitive countries are.
Profits that persist above or below the norm for prolonged periods of time indicate a systematic misallocation of resources and dead-weight losses in the economy. They also indicate a lack of competition. In a competitive environment, monopoly rents will not persist and will be eroded by the entry of new firms and by entrepreneurs who imitate the incumbent firm. At the same time, profits are a vital force for economic development, and the mere observation of abnormal profits does not imply persistent misallocation of resources. Conventional partial equilibrium analysis teaches us that profits greater than the competitive return on capital are associated with welfare losses. However, from a dynamic perspective, profits offer incentives for entrepreneurs and thus enhance welfare.
We are interested in understanding how swiftly profits that are greater or less than the norm are restored and what the determinants are. In particular, we are interested in examining how product market regulations influence profit persistence.
We use a measure of the persistence of abnormal profits, which provides us with information about how competitive countries are. The report covers 33 OECD countries and close to 20 000 firms (164 000 firm-year observations). As measure of regulations we use OECD product market regulation (PMR) measures. The PMR includes three subcomponents: state control, barriers to entrepreneurship and barriers to trade and investment. We find that PMR, state control and barriers to entrepreneurship have negative impacts on competition, which lead to more persistent profits. Barriers to trade and investments have no significant effects.
The main findings are that Greece, Spain, the Czech Republic and Italy have the least competitive economies (i.e., most persistent profits) in the OECD, whereas Germany, Norway, Japan and Sweden are among the most competitive economies (i.e., least persistent profits). The findings have implications for regulatory economics and suggest that economies could improve their competitiveness through regulatory reform. Finally, we suggest areas for further research.