Regulation, Institutions and Aggregate Investment: New Evidence from OECD Countries

This paper investigate the relationship linking investment (capital stock) and structural policies. Using a panel of 32 OECD countries from 1985 to 2013, we show that more stringent product and labour market regulations are associated with less investment (lower capital stock). The paper also sheds light on the existence of non-linear effects of employment protection legislation (EPL) on the capital stock. Several alternative testing methods show that the negative influence of EPL is considerably stronger at higher levels. Finally, and importantly, the paper uncovers important policy interactions between product and labour market policies. Higher levels of product market regulations (covering state control, barriers to entrepreneurship and barriers to trade and investment) tend to amplify the negative relationships between EPL and the capital stock and ETCR and the capital stock. Equally important is the finding that the rule of law and the quality of (legal) institutions alters the overall impact of regulations on capital deepening: better institutions reduce the negative effect of more stringent product and labour market regulations on the capital stock, possibly through the reduction of uncertainty as regards the protection of property rights. This result also implies that the benefit from product and labour market reforms may be smaller in countries with weaker institutions.