Estimation of service sector mark-ups determined by structural reform indicators

This paper presents new estimates for service sector mark-ups in the EU. We extend a widely used mark-up estimation methodology by allowing mark-ups in service sectors to depend on strictness of product market regulation as measured by the OECD's sectoral Product Market Regulation index. The idea here is that less strict regulation of product markets fosters competition and hence reduces firms' mark-ups. Our empirical analysis broadly confirms this. Our findings indicate that mark-ups in most EU countries and most sectors have shown a declining trend over the past 15 years, due to competition-friendly product market reforms. Further, we find that in each of the sectors analysed in this paper, mark-up reduction is driven by one particular sub-group of product market regulations: in the communication sector regulations related to a more competitive market structure show a significant effect; in the energy public ownership appears to matter most; professional services mark-ups are most affected by entry regulations and in the retail sector mark-ups are most affected by registration and licensing regulations. We also find that product market regulations do not fully explain the mark-ups but that there is a significant country-specific component that can potentially be explained by other factors such as competition or labour market policies. We discuss potential extensions of this paper in order to explore the role of these additional factors. The estimates from this paper are used in DG ECFIN's QUEST model to analyse the macro-economic effects of product market reforms.