Product and service market efficiency
When markets for goods and services function efficiently, each factor of production is allocated to its most productive use. That means businesses produce the goods and services most desired by customers and sell them for the lowest possible price. The efficiency of product markets can be reduced by lack of competition and distortionary fiscal policies and regulations. For the most part, aspects related to these topics are already captured in the current GCI. In the updated GCI, we plan to also include the effects of bankruptcy law on competition and market efficiency.
Industries where competition is more intense are more efficient and produce more innovation, thus improving productivity.57 Competition-enhancing policies enable the market to select the best firms, thereby creating incentives for firms to reduce costs and for new, more efficient firms to enter the market.58 The presence of dominant players in a market—for example, in oligopolies and monopolies—drives up prices but also, importantly, can decrease the level of innovation. Effective antitrust policies should avoid the creation of such dominant positions while preserving economies of scale and incentives for innovation, especially in resource-intensive and high-tech sectors.
In most cases,59 opening a market to foreign competition forces the least-productive companies to exit the market and rewards the most productive;60 removing domestic barriers to entry into and exit from markets can increase productivity through the “creative destruction” of less-productive firms.61 When firms can easily enter and exit markets, resources can be reallocated to emerging sectors and capital reinvested in new technologies with higher productivity.
The legal and regulatory environment can directly impact the entry and exit of firms. An efficient framework for settling bankruptcy is necessary to ensure that investors can close a failing entrepreneurial experience and move on to new challenges. Barriers to entry include licensing (especially of professional or public services), public monopolies, and administered prices.62 There is evidence that reforms to market regulation policies in Organisation for Economic Co-operation and Development (OECD) countries intended to promote competition tend to also boost productivity.63 These specific factors are not fully captured in the current GCI, but they will be reflected in the updated competitiveness index.
Beyond lack of competition and restrictive regulations, fiscal policies can also reduce the efficiency of product markets by distorting investment choices and artificially favoring sectors based on political selection.64 Although there can be arguments for such interventions, in many cases they have negative effects on a country’s overall productivity—for example, by subsidizing traditional but declining industries at the expense of new and more vibrant sectors.
It is well established that taxation in general affects productivity by reducing investment, because it effectively increases the cost of investment capital.65 Specific tax structures can exacerbate the effect: for example, Fatica (2013) finds that the structure of tax incentives for capital investment in advanced economies has led to a significantly higher share of investment in machinery and equipment and a significantly lower share in ICTs.