[Type text]

Bailouts: the Lesser of Two Evils?

Silvia Calò1

International Relations, Central Bank of Ireland, New Wapping Street, North Wall Quay, Dublin 1, Ireland

Abstract

This paper investigates the relation between bailouts and regulation. Regulation, by limiting the room for government intervention in the market, can affect the likelihood and size of a bailout. While a higher level of regulation is associated with a lower likelihood of a direct acquisition, such countries resort to a higher use of State aid. The findings suggest the more transparent nature of direct acquisitions, makes them the lesser of two evils. In this light, policy-makers should monitor State Aid and bailouts together, with the aim of making the former more transparent.

Keywords: Bailouts; Regulation; State aid JEL: E6; H12; H81

The author acknowledges funding from the Irish Research Council GREP programme and the Trinity College Dublin Economics Department. The author is also grateful to the participants to the 10th Max Weber Conference and the European University Institute and SAEe2016 for the useful comments. I thank H. Hermansson for the useful political-economy insights, mistakes are all mine. The views expressed in this paper are purely those of the author and do not necessarily represent the views of the Central Bank of Ireland or the ESCB.1 E-mail address: Silvia.Calo@centralbank.ie

Introduction

One of the issues raised by the recent financial crisis is whether a decreasing level of regulation has ultimately resulted in an urgent need for governments to bail out firms in distress, partially causing the rapid accumulation of public debt witnessed in some European countries, and diverting scarce resources towards these rescue plans. This increase in debt resulted in a decrease in the fiscal space available to governments at a time when it was most needed. The literature has so far focused its efforts on the analysis of the effects of regulation in the banking and the financial sectors (Caprio and Honohan, 1999; Lyons, 2009), but the impact of lower levels of overall regulation in the economy and its effects beyond the financial industry have not yet been investigated.A better understanding of what determines the choice of bailing out a firm, regardless of its sector, and of why governments resort to a certain type of bailout rather than to another, can help policymakers reduce this type of expenditure, and make it more transparent and widely accepted by the citizens. This could ultimately result in both a gain of fiscal space for the government, and an increase in the legitimacy of the decisions to bail out firms.This paper investigates empirically the relation between product market regulation and the frequency and size of bailouts, distinguishing between types of ad-hoc measures used to rescue firms in turmoil.Regulation can affect the frequency and size of bailouts through two channels. Traditionally, if a country has a very competitive market, the ability of the government to intervene directly in the economy could be lower than in a highly regulated one. According to this hypothesis, more regulated economies will experience a higher rate of discretionary government intervention, both through direct acquisition and financing of firms, and through a higher level of aid granted by the State, compared to the less regulated and more competitive economies.On the other hand, a higher level of regulation could shield firms from competition, resulting in a lower need for government intervention. Thanks to the distinction between different types of measures undertaken by governments, this paper introduces and tests a third scenario, where the level of regulation could influence not only the frequency and size of bailouts, but also the instrument chosen by the government to help firms in distress: depending on the level of regulation in the economy, the government will tend to help firms resorting to more transparent instruments at its disposal, the lower the level of regulation in the product market.In addressing this question I define bailouts as a set of ad-hoc measures taken by governments, aimed at financially helping firms in turmoil. Bailouts are captured though a set of macroeconomic variables, differentiating between the type of bailout, whether it is the direct acquisition of a firm – the most “traditional” definition of bailout – or whether it takes place through the granting of State aid. This extends the classical definition of bailouts to every instrument available to policy-makers to respond to extreme events, and it helps linking these responses to the overall policy stance in normal times and the existing policy environment, as described by the overall level of regulation in the economy. To capture the direct acquisition of a stake in the firm by the government I use the stock-flow adjustment of government debt and its components. Stock-flow adjustments are defined as the difference between the change in the stock of debt in a period and the government deficit for that same time window. Since stock-flow adjustments are not included in the deficit, they have been made the object of several studies on creative accounting and fiscal transparency (von Hagen and Wolff, 2006; Weber, 2012), but their role has not been investigated outside this particular field. To capture the least transparent type of bailouts, I use State aid granted to firms as an exception to the Treaty on the Functioning of the European Union and monitored by the European Commission. State aid includes off-budget measures, as well as foregone revenue, and in-budget expenditure, a different type of government intervention, compared to stock-flow adjustments, not necessarily reflected in government debt statistics. Relying on these aggregates emancipates the analysis of bailouts from

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anecdotal evidence and offers the advantage of relying on data closely monitored by the European Commission and measured homogeneously across countries. To capture the level of regulation in the economy I use the product market regulation indicators, produced by the OECD.A higher level of regulation is, in this analysis, associated with the lower likelihood of a bailout and a lower expenditure in bailouts. Countries with a lower level of product market regulation experience higher stock-flow adjustments and a higher level of net acquisition of financial assets. In contrast, the level of State aid granted by countries is higher in more regulated economies. Results are valid for a sub-set of indicators, especially those capturing the overall level of regulation in the country rather than a specific type of procedure.These findings highlight the importance of regulation and the role of government in the economy in determining the types of measures implemented in times of crisis. In light of this finding it would also be recommended that although State aid and stock-flow adjustments are closely monitored, this monitoring effort should not be carried on separately, and instead the two measures should be assessed together. In a policy perspective, given the role of State aid in bailouts, it might be advisable to put more stress in communicating the overall spending in State aid. State aid and acquisitions are both instruments available to policy-makers for the same aim, and such they should be monitored and assessed.The rest of the paper is organized as follows: Section 2 briefly discusses the literature; data sources are described in Section 3, while the methodology and results are reported in Section 4; Section 5 concludes.

2. Fiscal Position and Regulation

Government debt is not only the result of the accumulation of deficits over the years, it sometimes surges because of the direct intervention of the government in the economy. Governments often intervene in market financing, both sustaining privately-held firms, and through their direct interest in state-owned corporations.Bailouts and State aid are ad-hoc measures capturing this discretional spending. The frequency of the adoption and the size of such measures can be influenced by a stricter or wider level of regulation in the economy.First of all, regulation in the product market affects how much firms invest in lobbying. The literature on politically connected firms and lobbying, in fact, found a significant relation between these two variables. In Bernhagen and Mitchell (2009), tighter regulation creates an incentive for firms to invest in rent-seeking behaviour. Also, large firms have more resources and benefit from scale economies when investing in direct lobbying. In this context, regulation would be positively correlated with ad-hoc measures, since the investment in lobbying would result in more support granted to large firms. Moreover, politically-connected firms would be over-represented among the beneficiaries of such measures, since, according to Faccio (2006), these firms tend to be bigger than average.Over-representation of politically-connected firms among the recipients of ad-hoc measures goes beyond the size effect; in fact, according to Faccio et al. (2006), such firms are more likely be bailed out, ceteris paribus, than non-connected firms, and they are in a worse financial position at the time of bailout. Also, previously privatized firms have a higher probability of being bailed out. While the authors make a very important contribution in finding the type of firms that benefit the most from government intervention, the paper is based on anecdotal evidence; in addition, it uses a broad definition of bailout, not distinguishing between different measures, meaning that the results cannot be easily extended outside their sample.The analysis in this paper builds on their results but introduces a differentiation between the types of measures taken by governments. Faccio et al. (2006), in fact, derive their information about corporate bailouts from a keyword search in news articles. The keywords they use include the words “aid” and “rescue”; thanks to this inclusion, the authors capture not only government acquisitions of financial assets, but also include State aid and other extraordinary measures that do not necessarily imply an acquisition. The use of stock-flow adjustments and State aid in this paper allows to distinguish between two forms of government intervention

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that are very different in nature from both an economic and a political point of view. It also allows comparing the size of the bailouts in total and differentiating between instruments.One of the main macroeconomic sources of information on bailouts, stock-flow adjustments have been studied mainly in the fiscal rule literature as a means to avoid the stringency of the rule itself (e.g. Milesi-Ferretti, 2004).Empirical studies have investigated this effect on the level of debt, following the imposition of the stability and growth pact, as in von Hagen and Wolff (2006), where stock-flow adjustments are the Trojan horse used to avoid the limits imposed by the fiscal rule. Weber (2012) links the magnitude of stock-flow adjustments to the level of fiscal transparency of a country. Easterly (1999) takes a different approach, making reference to “illusionary fiscal adjustments”, where reductions in the debt burden are caused merely by creative accounting operations, pushing some expenditure items off-budget.A useful source of information on stock-flow adjustments is the annual report published by Eurostat in its effort to monitor this variable. It describes some of the relevant facts and illustrates the trends that guide the stock-flow adjustments figures. For a few years Eurostat, together with the main stock-flow adjustments subcomponents, provided details about the firms receiving capital injections, including disclosing the names of the firms. The information included in the reports confirms that stock-flow adjustments do capture bailouts. Banks, airlines and real estate companies are the industries mentioned most frequently. This should not come as a surprise, as these sectors are often considered by governments to be strategically important.This evidence can be reconciled with an effective monitoring by Eurostat, by looking at components of stock-flow adjustments. Since stock-flow adjustments register the revenue from privatizations – and the corresponding expenditure in the case of a bailout – results in the von Hagen and Wolff (2006) analysis could be capturing the intervention of the government in the economy, rather than creative accounting. The imposition of the 3% deficit threshold decreases the cost of off-deficit policies, relatively to those included in the deficit. For instance, it is now less costly to bail out a firm or to grant State aid, rather than incurring the increase in expenditure in automatic stabilizers caused by a restructuring. A fiscal rule that focuses only on the flow component of government expenditure and leaves out the stock can cause the perverse effect of increasing the debt level. According to Lyons (2009), the special attention granted to bank bailouts is due to the particular nature of this industry. In fact, a bank failure would increase the risk of contagion within the banking system. Moreover, it would also expose other industries to a higher risk of turmoil, in case the access to credit and refinancing were affected. State aid, on the other hand, is often used to help firms in other sectors, since the risks described before do not exist or are significantly smaller, and losses and failures are accepted as a normal outcome in a competitive market.To stress the peculiarity of the banking sector, regulation in this case can increase the risk of a systemic crisis according to Beck et al. (2006), although concentration appears to be a stabilizing force. The ambiguous effects of regulation in the banking sector are described, among others, in Caprio and Honohan (1999). Banks do appear quite often among the beneficiaries of equity injections, according to the reports on stock-flow adjustments, although the cases mentioned are not limited to the banking sector but include firms in utilities and transport. Iwanicz-Drozdowska (2016), looks at the role of State aid in the banking sector, finding which of the bank’s characteristics are associated with different rescue measures. In the extensive literature on liberalization, just a few studies have focused on the macroeconomic effects of changes in product market regulation, as reported in Schiantarelli (2005). Some interesting results come from Alesina et al. (2005), where the overall level of investment in liberalized sectors is related to the level of regulation. More often, studies on the effects of economic liberalization have been carried on in the context of political liberalization (see, for instance, Giavazzi and Tabellini, 2005). Currently, there are no studies that try to investigate the link between liberalization and the fiscal position of a country, an exception being Duval (2008). In his paper, however, causation goes in the other direction, with the macroeconomic policy of the country causing structural reforms, including reduced product market regulation.

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In the context of this study, I investigate the effects of the degree of product market regulation on bailout expenditure of different countries, to address the question of whether a highly regulated economy will create the conditions for more frequent and larger bailouts, and greater requirement for State aid, or whether it will reduce the usage of such instruments because the high level of regulation protects the profitability of the incumbents. The main hypothesis tested is that regulation affects the likelihood of a bailout. While protecting the incumbents, high levels of regulation could lower the need for a direct intervention of the government in the rescue of a firm, as captured by the net acquisition of financial assets. On the other hand, big and politically connected firms would have the incentive and the capacity to lobby for ad-hoc measures, as in Faccio et al. (2006).This paper introduces a third scenario, where large and politically connected firms might be less likely to be bailed out, if the bailout also implies a change in the management. State aid, from this point of view, is more compatible with the status quo than a direct takeover. State aid, in fact, is meant to be an instrument to relieve a firm facing special circumstances, while a bailout would imply a discontinuity with the previous management. I address this difference by comparing the relation between product market regulation and these different types of ad-hoc measures used by governments to bail out firms.

3. The Data

To capture the extent of bailouts this paper uses three different aggregates as a dependent variable: Stock-flow Adjustments, Net Acquisition of Financial Assets (net assets acquisitions, from now on) and State aid. The degree of regulation in the economy is captured by the OECD Product Market Regulation indicators (PMR). The time period covered is from 1998 to 2013, and the sample includes 21 European countries.2

3.1. Data on RegulationThe data on regulation come from the OECD Product Market Regulation (PMR), indicators. These indicators were calculated for OECD countries for the first time in 1998 and new values are released every five years. They provide a measure of the degree of regulation in the economy, ranging from 0 to 6, and increasing with the degree of regulation.The indicators are structured on three different levels. The high-level indicator offers the widest definition of regulation while the three medium-level indicators distinguish between State Controls, Barriers to Trade and Investment, and Barriers to Entrepreneurship. Every medium-level indicator is divided into sub-domains. Sub-domains are then built as a weighted average of the corresponding low-level indicators. Because of their stratified nature, the PMR indicators allow to distinguish between the effects of the overall level of regulation, as expressed by the higher level indicators, and between specific policies, summarized in the 18 low-level indicators. While the level of regulation as captured by the indicators decreased on average over time, the between-country variance stayed quite high and it does not seem to matter less over time (see Figure 1 for the behaviour of the summary and high-level indicators over time).

2 Namely: Austria, Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Luxembourg, Netherlands, Norway, Poland, Portugal, Slovakia, Spain, Sweden, United Kingdom.

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01

23

45

1998 2003 2008

Product market regulation State control

Barriers to entrepreneurship Barriers to trade and investment

Figure 1: OECD Product Market Regulation summary and high-level indicators value over time

The Product Market Regulation indicators then offer a good description of the level of regulation within country and provide a good measure of the cross-country heterogeneity in the level of regulation as well (Schiantarelli, 2005).

3.2. Fiscal DataThe use of stock-flow adjustments, its components, and State aid allows distinguishing between different definitions of bailouts.To adopt a rather comprehensive definition of bailout, looking at cases where governments buy a firm or grant a special loan, stock-flow adjustments are the dependent variable of reference. Stock-flow adjustments are defined as the difference between the change in government debt and the accumulated deficit over a period.Stock-flow adjustments cover a set of measures that directly accrue into government debt. They consist of four main instruments: Net Acquisition of Financial Assets, which includes the proceeds from liberalization and the money spent in bailouts, while it also registers government loans to banks granted as actions undertaken in the context of the present crisis; Incurrences in Liabilities not in Government Debt, consisting of pending payments and receipt; Valuation Effects and Other Changes in Government Debt; finally a residual term, capturing statistical discrepancies. Focusing on net asset acquisitions narrows the definition of bailouts, since it excludes a number of measures (such as other changes in government debt), included in stock-flow adjustments but not in net asset acquisitions.3

Finally, the adoption of State aid as the dependent variable constitutes the broadest definition of bailout, and the most different from the common understanding of the word. The European Commission categorises its instruments in Equity Participation, Grant, Guarantee, Soft Loan, Tax Deferral, Tax Exemption, and a residual category Other.

3 1An example of this comes from the Eurostat report on stock-flow adjustment of 2009, where a measure implemented by the British government in 2008 in response to the crisis is mentioned without giving any other additional detail about it in the report of 2010.

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As mentioned before, in this analysis I define bailouts not only as the money granted by the government to firms through loans or equity injections, I extend the definition to include State aid. State aid, in fact, allows governments to select a specific firm or sector and help it, just like the direct acquisition of a firm in distress.State aid could be thought of as complementary to stock-flow adjustments – and to the acquisition of financial assets – since, during times of economic distress, the government is allowed to grant State aid under the European scheme and will also have to take over firms. On the other hand, the two measures could be seen as substitutes, since governments could either choose to grant State aid or bailout the firm. This hypothesis cannot be tested, since net asset acquisitions and State aid cannot be summed together to give a broader measure of bailouts. In fact, they have some components in common: for equity participations and soft loans, there is a perfect overlap. These common expenditure voices cannot be removed, since we do not have data disaggregated at the necessary level. The lack of such insights imposes a constraint on the understanding of policy-makers’ choices and on the effective communication of such policies to the public.Yet, it is still possible to look at the sign of the correlation between State aid and bailouts, defined in their narrowest sense as the net acquisition of financial assets by the government. Whether State aid and net assets acquisitions move together, depends on the country: Austria, Belgium, Czech Republic, Germany, Spain, Finland, the Netherlands, Portugal, Slovakia and the United Kingdom register an inverse relationship between the two measures; while the rest of the sample shows a positive correlation (see Table 1).

Table 1: Correlations between State Aid and Net Acquisition of Financial Assets

Country Assets Acq. Total Assets Acq. Total Assets Acq. TotalAustria France Poland

Total -0.40 0.09 -0.25Industry and Services -0.43 -0.34 0.23 0.99 -0.35 0.98

Belgium Greece PortugalTotal -0.20 0.59 -0.73Industry and Services -0.22 0.92 0.65 0.96 -0.58 0.81

Czech Republic Hungary SwedenTotal -0.76 0.25 0.58Industry and Services -0.76 0.99 0.59 0.47 0.89 0.10

Germany Ireland SlovakiaTotal -0.54 0.94 -0.86Industry and Services -0.56 0.99 0.92 0.73 -0.87 0.89

Denmark Italy United KingdomTotal 0.33 0.68 -0.49Industry and Services 0.46 0.88 0.83 0.99 -0.26 0.85

Spain LuxembourgTotal -0.35 0.02Industry and Services -0.40 0.98 0.44 0.97

Finland NetherlandsTotal -0.89 -0.39Industry and Services 0.79 0.60 0.40 -0.55Note: The table contains the correlations between Total State aid excluding railways (Total), State aid to industry and service (Industry and Service), and Government Net Acquisition of Financial Assets (Assets Acq.).

In terms of their size, net asset acquisitions add up to a higher share of GDP than State aid. State aid amounts to an average of 0.54% of GDP over the period, while the average net acquisition of financial assets is 1.5% of GDP. By restricting the sample to the periods and countries for which observations for both variables are available, the average State aid amounts to 0.57% of GDP, while net asset acquisitions amount to 1% of GDP. While these numbers could seem negligible when expressed as a percentage of GDP, it is worth remembering that the threshold for the deficit in the Growth and Stability Pact is set at 3% of GDP, so the average level of State aid amounts to 16.7% of the threshold.

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4. Empirical Analysis

4.1. Estimating the Probability of a BailoutI first address the question of how much the degree of regulation in the economy affects the probability of having a change in debt bigger than the deficit, i.e. of having a positive stock-flow adjustment. This exercise has the advantage of being consistent with the previous literature regarding the impact of macroeconomic policies on the level of regulation (Duval, 2008); even if it cannot provide information about causality, it provides an answer for an important policy question and its results are easy to interpret.Also, focusing on the sign of the sum of stock-flow adjustments during the period, rather than on their dimension, frees the analysis from a bias derived from the pricing of firms in turmoil. The price paid by governments when bailing out a company is rarely – if ever – the market price of the firm, and it is usually higher. Looking at the value of stock-flow adjustments over the period matches the frequency of the indicator and smooths any cyclical behaviour of the dependent variable, while also lessening the impact of measurement errors.The dependent variable is then a dummy equal to one if the total stock-flow adjustment in a country during the time frame between two indicators is positive and zero, otherwise4 as illustrated below:

sf an={1 ,∧if ∑t =0

n

Stock-Flow Ad jt>0

0 ,∧if ∑t=0

n

Stock-Flow Ad jt<0

(1)

An additional rationale for approaching the question using a binary variable comes from the results in Huang and Levich (1999) and Pagano and Volpin (2001). According to the authors, governments do not always sell at market prices either, but they tend to offer shares at a significantly higher discount than any other initial public offerings. This implies that the values registered in stock-flow adjustments could be higher than the market value when positive and lower when negative. Focusing on the sign gets rid of this bias. Hence I proceed by estimating the following model

Prk , s

( sf an=1 )=¿ 1

1+e−(β 0+ β1 REGU Lk, t+ β2 REGU Lk, t

2 +γ Z t ,k)¿ (2)¿

¿

Where REGUL takes the form of one of the OECD Product Market Regulation indicators and Z is a set of control variables. The model is tested with and without the squared value of the indicator, REGUL 2 and a set of control variables, Zt,k. Adding a squared term in the analysis allows bailouts to be non-linear in the degree of protection that incumbents are granted. In fact, when incumbents are shielded from competition, they do not need to be taken over by the government through a bailout, since the firm could be earning profits (Blanchard and Giavazzi, 2003). As the level of regulation decreases, incumbents might suffer from the higher level of competition in the industry and require government intervention in the form of a bailout, or other special measures. This might result in a non-linear relation between the level of regulation and the net acquisition of financial assets from the government.The controls in Zt,k include the unemployment rate and the level of debt, since a poor economic outlook could make governments keener to bail out firms. The coefficients are often insignificant and in several cases it is not possible to include more independent variables in the regression because of the limited dimension of the sample. For these reasons, the tables with the results have been omitted.

4 The choice of a threshold equal to zero is justified by having taken for each country the average value of the stock-flow adjustment over a five-year period, hence reducing the measurement error, and by the fact that even small changes of this variable have an important effect in terms of fiscal space available.

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Results from this naive regression are reported in Tables 2 and 3. For the sake of brevity I report the coefficients only when significant.

Table 2: Probability of a positive Stock-flow Adjustment - High and Medium-Level Indicators

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)PMR -3.9* -13.5*

(-1.73) (-1.83)PMR2 2.4

(1.56)BTE -3.0** -8.6*

(-2.28) (-1.77)BTE2 1.4

(1.29)POW -1.3*

(-1.70)BTI -1.7*

(-1.85)IBO -12.2***

(-2.58)IBO2 1.3*

(1.66)RAO -1.3**

(-2.41)XBR -1.3*

(-1.85)OBR -1.0*

(-1.69)Constant 7.4* 16.5** 6.1** 11.1** 5.1* 1.6** 19.9*** 2.6*** 1.7** 1.0**

(1.81) (2.00) (2.40) (2.16) (1.87) (2.43) (3.41) (2.64) (2.36) (2.32)N 59 59 59 59 59 59 59 59 59 59t statistics in parentheses* p<0.10, ** p<0.05, *** p<0.01NOTE: The dependent variable is a binary variable that assumes value 1 if the sum of stock-flow adjustments during the previous period was positive and zero otherwise. The independent variables correspond to PMR: Product market regulation, BTE: Barriers to entrepreneurship, POW: Public ownership, BTI: Barriers to trade and investment, IBO: Involvement in business operation, RAO: Regulatory and administrative opacity, XBR: Explicit barriers, OBR: Other barriers.

In spite of these limitations, the results yielded by this simple model are quite interesting and offer important insights for policy. Significant coefficients are always negative. A higher level of regulation in the economy is associated with a lower probability of registering a positive stock-flow adjustment.

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Table 3: Probability of a positive Stock-flow Adjustment – Low-level Indicators

(1) (2) (3) (4) (5) (6) (7) (8) (9)DCB -0.9**

(-2.01)PCT -1.5*

(-1.80)LPS -0.5**

(-2.01)CSR -1.9**

(-2.35)ABC -1.1**

(-1.99)LBR -1.8*

(-1.81)BEN -0.9*

(-1.65)FDI -0.9**

(-1.99)RBR -1.0*

(-1.69)Constant 3.6** 3.1* 2.0** 1.8** 3.0** 3.4** 3.0* 2.0** 1.0**

(2.24) (1.80) (2.34) (2.52) (2.31) (2.00) (1.86) (2.41) (2.32)N 59 59 59 59 59 59 59 59 59

t statistics in parentheses* p<0.10, ** p<0.05, *** p<0.01Note: The dependent variable is a binary variable that assumes value 1 if the sum of stock-flow adjustments during the previous period was positive and zero otherwise. The independent variables correspond to DCB: Direct control over business enterprise, PCT: Price controls, LPS: Licences and permits system, CSR: Communication and simplification of rules and procedures, ABC: Administrative burdens for corporation, LBR: Legal barriers, BEN: Barriers to entry in network sectors, FDI: Barriers to FDI, RBR: Regulatory barriers.

It follows that more regulated economies are associated with a lower probability of the government buying out firms in distress. This result, read in isolation, points in the direction of product market regulation shielding firms from competition and guaranteeing higher margins and lower distress over time and it would imply that by increasing product market regulation, policymakers would be able to decrease the future cost of a bailout, and increase the fiscal space. On the other hand, these results do not extend beyond the direct acquisition of firms and the other instruments included in the stock-flow adjustment of government debt. It is hence possible that more regulated economies resort to instruments that do not add to the stock of government debt, but still affect the fiscal balance, like State aid.Another reason for extending the analysis to all the instruments available to governments, and hence including State aid into the analysis, lies in the evidence that higher-level indicators tend to be more significant than their components. It is then the overall policy stance in the country that matters, rather than the single measures applied in the product market regulation. The overall level of regulation in the economy seems to influence the probability of a bailout more than the single policies. Sub-domain indicators are not necessarily significant when their components are significant. Since the overall level of regulation seems to be more important when it comes to the probability of a bailout, it is reasonable to think that the mechanism at work does not directly affect the profitability of firms, or we would have seen indicators capturing price controls also to be significant on their own. For this reason , the logit analysis has to be integrated with a further linear analysis that also exploits the information in the different definitions of bailout introduced by this paper.

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4.2. The Size of Bailout and the Role of State aidThe logit analysis yields some interesting results and gets rid of the bias in prices, but it does not fully exploit the information available in the dataset. Moreover, since State aid cannot assume a negative value and it is always different from zero, it is not possible to apply the logit analysis to it. The best way to overcome this, and other limitations described earlier, is to use a linear analysis of the impact of regulation on the three different types of bailouts measured. A linear model has the advantage of yielding clear results, thus exploiting the peculiarity of the macroeconomic measurement of bailouts introduced in this paper. The following equation has been estimated:

Bailout i ,T=α+ β1 REGU Li , T+β2 REGU Li ,T2 +γ Z i ,T+ν i+ϵ i ,T (3)

where Bailout is either the average value over the period of stock-flow adjustments, of net asset acquisitions, or of State aid for country i. Like for the logit approach, REGULi,T identifies the OECD indicator, and Zi,t is a vector of control variables, the level of government debt and the unemployment rate over the period.Again, the use of the average value for the period as a dependent variable is justified because it smooths the cyclical behaviour of the dependent variable and it also lessens the impact of measurement errors. In this case as well we also run our analysis excluding the squared term and the controls. When added to the analysis, the squared value of the indicator is rarely significant, and never across specifications: the cost of bailouts seems then to be linear in the degree of regulation, with relatively more competitive economies facing the same cost of liberalization, in terms of higher expenditure in bailouts, as the most regulated economies.For sake of clarity, comparability, and brevity, we map the coefficients for the three different specifications together in Figure 2. As before, we report only coefficients that are statistically significant for every specification of Equation 3.5

High- and medium-level indicators are once again significantly different from zero and negatively correlated to a bailout under both definitions using Stock-flow adjustments and its component as a dependent variable. When the definition of a bailout is extended to State aid, the coefficients are consistently positive. The overall R2 (not reported in the figure), is always quite low and product market regulation indicators are usually more powerful when explaining stock-flow adjustments than net asset acquisitions. These results suggests that the common understanding of a bailout – i.e. what is captured by the net acquisition of financial assets or by the stock-flow adjustment of government debt –, is too narrow a measure and governments do intervene in the economy using other policy instruments in addition to those included in net asset acquisitions (Weber, 2012). Moreover, in contrast to what happened in the logit model, the coefficients for the sub-domains are often significantly different from zero.

5 The full set of results is available upon request

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Figure 2: Comparing bailout definitions and their relation to product market regulation - Mapping

Coefficients from Equations 3

NOTE: The table reports the coefficients and confidence intervals at 95% for the regressions in Equation 3. The marker indicates the estimate for the coefficient, while the length of the line represents the confidence interval.

Comparing then the results for stock-flow adjustments and net asset acquisitions to the results obtained for State aid, State aid seems to be the instrument used in combination with a higher level of regulation to help struggling firms, while direct bailouts that result in a stock-flow adjustment are more frequent when the level of regulation is lower. A higher level of regulation, while protecting mark-ups, can also induce a higher stream of aid from the government to firms.When regulation is low, on the other hand, firms are not granted annual aid, but the government resorts to those instruments included in stock-flow adjustments. From this perspective, it would be interesting, if more data become available, to investigate the behaviour of the common measures included in both State aid and stock-flow adjustments. In fact, once stripped of the common components, we might be able to see a sharper difference in the behaviour of these variables and to determine which components drive the results.The regularity of the results – where Stock-flow adjustments are associated with less regulated economies, while State aid takes place in countries where the role of government in the economy is much wider –, can be explained by the different nature of the instruments and how through their different effect on government accounts, they affect policymakers’ incentive to resort to one or the other instrument. All of the components of State aid in fact affect the fiscal accounts but do not necessarily constitute hidden expenditure. Tax deferral and tax exemptions do affect the deficit, permanently or temporarily, through foregone revenue. Guarantees expose the fiscal balance to the risk a contingent liability necessarily implies. Because of the non-explicit nature of lower revenue and contingent liabilities, State aid not only shares some of the opacity characterising stock-flow adjustments, but it can be even more difficult to identify and divulge. The use of State aid is in fact easier to conceal, since governments are aware that the use of particular instruments will not be reflected in the deficit or debt.While a direct acquisition is eventually reported in the debt figures, the damage to the government balance caused by the loss of revenue goes unreported and unnoticed to a higher extent. Grants and tax exemptions constitute 95% of total aid to industry and services granted in the last three years. It is important to notice that not all the instruments of State aid fall outside the definition of government debt. Some components, such as

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Product market regulat ion

Barriers to ent repreneurship

I nvolvement in business operat ion

Regulat ory and administ rat ive opacit y

Administ rat ive burdens on start ups

Price cont rols

Communicat ion and simplif icat ion of rulesand procedures

Administ rat ive burdens for corporat ion

Barriers to ent ry in network sectors

-3 -2 -1 0 1 2 3

St ock-f low Adjustment State aid

Net Acq. of Financial Assets

tax exemptions and tax deferrals, although not included in the deficit as discussed before do contribute to it since they are forgone revenue. Grants enter the deficit,6 while equity participation and soft loans are part of the off-budget measures included in the stock-flow adjustment. As for guarantees – as long as they are not called –, they are off-balance since they are classified as contingent liabilities; such liabilities would be included in the budget like any other, in case they eventually manifest themselves.From a policy perspective, an important difference between stock-flow adjustments, net asset acquisitions, and State aid, is how easy it is for the citizens of a country to observe these measures and understand the extent of government resources that goes into them. While the level of government debt and deficit are made the object of frequent communications and are often reported in the news, the overall level of State aid granted to firms is rarely known by the general public. Foregone revenue, in particular, is one of the opaquest instruments the government has at its disposal, since while it contributes to a higher deficit by lowering government revenue, a measure of the deficit not including State aid is not made widely public.

5. Conclusions

This paper has investigated, for a panel of 21 European OECD economies over a 15-year period, the effect of the level of product market regulation on the likelihood of a bailout. We used broader and stricter definitions of bailouts, ranging from the whole stock-flow adjustment, to the net acquisition of financial assets, or the granting of State aid.The results show that stricter regulation in the product market is associated with a lower probability of registering a bailout, as captured by off-budget government expenditure. When restricting the definition of bailouts to the net acquisition of financial assets by the government, we still find that higher product market regulation is associated with governments’ lower use of bailouts. The opposite result holds for State aid: in fact, it increases with the level of regulation. More competitive economies are then more likely to rescue firms directly than granting them State aid.We explain our results in two scenarios. While regulation can shield firms from competition and grant them higher mark-ups, it also creates an incentive for the firms affected by this regulation to lobby with the government for State aid. The high cost imposed by regulation, in fact, makes it rational for the firm to invest in direct lobbying with the government. In this case, higher regulation results in both a lower need for bailouts and in a higher level of State aid granted to firms.In a competitive market, on the other hand, we can see a bailout as a drastic measure undertaken by the government to rescue a firm, preferable to State aid. In this second scenario a bailout would require a change in the status quo, including management. This would not be feasible in a less competitive market where big and politically connected firms do not accept such change with favour, and prefer to be financed through State aid.These findings have important policy implications, as they point out that the decision to bail out firms is not independent of the decision to grant State aid, and the two should hence be monitored together. Moreover, a stronger effort in making the State aid process more transparent and better known to the public, especially in terms of disseminating information about the actual cost to the government, would be recommended.

6 The ESA95 manual leaves some discretionality on this point. For instance an investment grant in kind to a public corporation, although falling into the D.92 category as investment grants, would leave the deficit unchanged.

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