Proceedings from the ECFIN Workshop "The budgetary implications of structural reforms" - Brussels, 2 December 2005

would be a further proof for the existence of a type of indirect budgetary reform effects that have
been neglected so far.

For these purposes, two models are tested. The first one extends the specification of reform
processes of Abiad and Mody (2005) and includes a number of detailed fiscal variables. The
second one is a simple model relating consumer and business confidence towards both reforms
and the fiscal stance while controlling for the general economic environment.

Starting point is the specification developed by Abiad and Mody (2005) and applied by Helbling
et al. (2004), Annett (2005) and Heinemann (2005). This model allows for the series of reforms to
be driven by a steady convergence of regulation to some “optimum” level of regulation REG*i,t .
In this notation, larger levels of REG are associated with less restrictive regulatory regimes.

(2)     ΔREGi,t=μ(REGi^*,t-REGi,t-1)+εi,t

If the status quo bias is relevant the values of μ should be below 1. This parameter of institutional
stickiness is assumed to depend on the strictness of current regulation:

(3) μ=k REGi,t-1

Thus, this specification allows for learning: Deregulative reforms can be helpful to limit
uncertainty about the outcomes of deregulation. In this case, reforms can be self-enforcing.

Furthermore, this basic adjustment process is driven by further determinants including some
element of international interaction where the distance to the regulatory situation of the
benchmark group (REGBM) has an impact on the country’s deregulation path.56 The inclusion of
this element is particularly relevant in the European context, where cross-border learning is
regarded as an important element of EU policy cooperation - long before the “Open Method of
Coordination” has become explicit. This setting results in the following testable specification:

(4)

^ΔREGi,t ⁼α1REGi,t-1 ⁺α2REGi²,t-1 ⁺ α3(REG i^B,t^M-1 ^-REGi,t-1)⁺∑k^K=1^βkxk,i,t⁺εi,t

⁵⁶ It is left open which specific cross-border interdependencies may drive the interaction, possible explanations range from mobility of regulatory
sensitive factors over direct regulatory externalities up to phenomena of yardstick competition where voters judge governments by comparison to
policies in third countries (see Brueckner, 2003, for an overview of strategic interactions among governments).

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