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Identifying underperforming GDP components and
policy areas:
Methodological approach and application for Estonia
Natalie Lubenets
DG Economic and Financial Affairs (ECFIN)
European Commission
31 October 2007
Tallinn
Structure
1. Introduction: structural reform process in
Europe
2. Multi-step methodological approach to
identifying growth-enhancing policies
3. Origin of per capita GDP gap
4. The source of growth in EU15 and EU10
5. Effect and channels of transmission of
structural reforms
6. Mechanical application for Estonia
Evaluation of structural reforms
 Micro-economic reforms and their microeconomic effects
 Impact of specific product market reforms on
specific product markets
 Impact of labour market reforms on labour
market
 Micro-economic reforms and their macroeconomic effects
 Models
 Political economy issues
3
A multi-step methodological approach
Step 1: Identifying the components of GDP where countries
are underperforming (in terms of level and growth) relative to a
given benchmark through GDP accounting.
Step 2: Identifying the conceptual links between policy
interventions, a list of indicators and the underperforming GDP
components.
Step 3: Using performance and policy indicators to identify the
most problematic policy areas/issues, which are likely to be
responsible for the income gaps/weak growth components.
Step 4: Supplementing the method with country-specific
expertise before drawing policy insights.
4
Step 1: growth and GDP accounting
5
Productivity and employment:
GDP per capita in Belgium, Ireland and E15 compared to US in 1975, 1985,
1995, and 2005
1,2
EU15
Ireland
Belgium
Hourly productivity of labour
1995
1
2005
2005
1985
1995
0,8
1995
2005
1975
1985
80% of the US GDP per capita
1975
1985
70% of the US GDP per capita
0,6
60% of the US GDP per capita
1975
50% of the US GDP per capita
0,4
0,2
Source : Sapir (2007):
Groningen Growth and Development
Center, Total Economy Database
0
0
0,2
0,4
0,6
0,8
1
1,2
Hours worked per capita
6
GDP and growth components and their
endogeneity/exogeneity
Standard disaggregation
DG ECFIN refined
disaggregation
Native
population
Working age population
Net migration
Working age population share in
total population
Labour market Participation
Unemployment rate
Average hours worked per
person
Capital deepening (capital per
hour worked)
•Total factor productivity
Degree of exogeneity or
endogeneity
Exogenous
Partially endogenous
Exogenous
Youth Participation
Largely endogenous
Male prime-age participation
Partially endogenous
Female prime-age participation
Partially endogenous
Older-worker participation
Largely endogenous
Unemployment rate
Partially endogenous
Average hours worked per
worker
Partially endogenous
Labour quality
Largely endogenous
Capital deepening
(capital per low-skilled labour
hour worked)
Total factor productivity
Partially endogenous
Endogenous
7
Caveats of the growth accounting
1. GDP accounting is




Descriptive, and not causal;
Affected by business cycle/demand side;
Affected by measurement problems;
Screwed towards labour inputs
2. Approach using macro- indicators, while
many structural developments of micro
nature and interrelated
3. Need to distinguish factors mainly outside
government control from those potentially
influenced by policies
8
GDP decomposition
1
Y
Y
H  L 
 
  K


 A  QL  
   H  SWP  PART  (1  ur ) 
POP H  L POP 
H

L

 
Y total GDP
H the annual hours worked per person employed
L total employment, which the product of POP, PART and (1-ur)
α the share of labour in total value added, which is set equal to
65% in all countries
POP total population
SWP the working age population share (15-64) in total population
PART total labour force participation rate
ur the overall unemployment rate
QL Indicator of labour quality
K The stock of capital
TFP Total factor productivity as a residual
9
Computing the indicator of labour
quality
To capture this change in average quality of labour, we
compute the average relative productivity of a person
employed compared with those with low educational
attainment:
Q
t

1
EL t  EM
t
 E H t . S

WS

ES t .


WL
Low, Medium, High  

.

2002 
2002
Where Es and Ws are respectively employment and hourly
wage (without overtime) for each educational attainment
(ISCED-3).
10
EU performance vis-à-vis EU5
Percentage gap with respect to
EU-5 1) GDP per capita
Effect of labour
resource utilisation
(Hours worked per capita)
Effect of labour
productivity
(GDP per hour worked)
Change in gap
2000 - 2005
Luxembourg
Ireland
Denmark
Netherlands
Austria
Belgium
United Kingdom
Sweden
Finland
Germany
France
EU-15
Euro area
Italy
EU-25
Spain
Cyprus
Greece
Slovenia
Czech Republic
Portugal
Malta
Hungary
Estonia
EU-10
Slovak Republic
Lithuania
Poland
Latvia
-80 -60 -40 -20
0
20
40
60
80 100
-80 -60
-40
-20
0
20
40
60
80
100
-80 -60 -40 -20
1) Average of the best 5 performing EU countries (Luxembourg, Ireland, Denmark, Netherlands and Austria)
0
20
40
60
80 100
-10
-5
0
5
10
15
20
11
Labour utilisation vis-à-vis the EU5
Change in labour
utilisation gap
2000 - 2005
Average hours worked
per person employed
share of
non-unemployment
Participation
rate
Share of
working age population
Gap in labour
resource utilisation
Luxembourg
Ireland
Denmark
Netherlands
Austria
Belgium
United Kingdom
Sweden
Finland
Germany
France
EU-15
Euro area
Italy
EU-25
Spain
Cyprus
Greece
Slovenia
Czech Republic
Portugal
Malta
Hungary
Estonia
EU-10
Slovak Republic
Lithuania
Poland
Latvia
-40
-20
0
20
40
60
-40
-20
0
20
40
60
-40
-20
0
20
40
60
-40
-20
0
20
40
60
-40
-20
0
20
40
60
-10
0
20
10
12
Hourly productivity vis-à-vis the EU5
Labour
productivity
Gap
Capital
Intensity
Total
Factor
Productivity
Relative
Labour
Quality
Change in labour
productivity gap
2000 - 2005
Luxembourg
Ireland
Denmark
Netherlands
Austria
Belgium
United Kingdom
Sweden
Finland
Germany
France
EU-15
Euro area
Italy
EU-25
Spain
Cyprus
Greece
Slovenia
Czech Republic
Portugal
Malta
Hungary
Estonia
EU-10
Slovak Republic
Lithuania
Poland
13
Latvia
-80
-60
-40
-20
0
20
40
60
-80
-60
-40
-20
0
20
40
60
-80
-60
-40
-20
0
20
40
60
-80
-60
-40
-20
0
20
40
60
-10
-5
0
5
10
Growth accounting
1


K

Y  A( L  H  QL ) K 1  A( L  H  QL ) ( L  H  QL ) 1 K 1  A( L  H  QL )
 L  H  QL 
gY  g A  (1   )( g K  g L  g H  gQL )  gQL  g H  g L
gY  g A  (1   )( g K  g L  g H  gQL )  gQL  g H  g POP M  g m 
mt 1
ur
 g SW P  g PART  gur  t 1
1  mt 1
1  urt 1
g denotes a rate of growth
POP-M Native population
m net migration rate (net migration flow over total
population)
14
Growth failures at country level (2)
Countries with low labour input growth in 20002005 (0.8% or less): have generally experienced a
sharp decline of their working time, which was combined
with either a fall in youth participation or a rise in
unemployment.
Countries with low labour productivity growth in
2000-2005 (1.4% or less) recorded both weak TFP
growth and capital accumulation contribution (except for
SI). In a few countries, TFP growth was even negative.
Symmetrically, countries with high labour
productivity growth experienced both buoyant growth in
TFP and strong capital deepening contribution.
16
Overview of the over/underperformance of the
GDP component X in LEVEL
Under normal
distribution
EU15
Average+one stdev. E(X)+ (X)
E(X)+0.4 (X)
EU15 Weighed average E(X)
E(X)- 0.4 (X)
E(X) - (X)
++ =2 16%
+
0
0
-
=1
19%

=0
=-1
31%
19%
- - =-2 16%
17
Growth failures at country level (3)





Moderately growing EU economies
BE, DE, FR, NL, DK, AT, UK and SI
Mediterranean countries
CY, ES, MT, IT, PT and LU
Fast-growing EU economies
EL, IE, FI, SE plus BE and RO
Dynamic EU10 member states
CZ, HU, SK, and PL
Fast catching-up Baltics
EE, LV and LT
18
Step 2: conceptual links between
policy interventions, indicators, and
GDP components
19
The effect and the channels of
transmission of structural reforms
 Challenge: no conventional links
 Solutions: literature “state of the art”
 Still missing:
 Complementarities between reforms
 Community vs national reforms
(“spillovers”)
20
Classification: 18 policy areas
Labour market
Innovation and knowledge
Macroeconomy
Product market
Active labour market policies (training, jobsearch assistance, well-designed and
targeted programmes
Openness to trade and
investment
R&D, innovation policies
and ICT
Long-term sustainability of
public finances and
welfare policies
Making work-pay: incentive to work
through the interplay of tax and
benefit system
Barriers to entrepreneurship
and business
environment
Education and life long
learning
Stability oriented
macroeconomic
policies
Reforming labour taxation to stimulate
labour demand
Competition-friendly policy
framework
Relaxing job protection while combating
labour market
segmentation/dualisation
Efficient financial markets
and access to finance
Working time organisation
Specific labour supply measures for women
Specific labour supply measures for olderworkers
Improving wage bargaining and wagesetting policies
Immigration and integration policies
Labour mobility (geographical and sectoral)
22
Structure of policy notes
 Definition and scope of the policy area
 Impact on growth components (theoretical
mechanism and transmission channels);
direct and indirect
 Evidence and estimated elasticities in
recent literature
 Possible spillovers and complementarities
with other policy areas
 Non-exhaustive list of relevant indicators
23
Example for older workers (1)
Policy
area
GDP
Specific
labour
supply
measures
for olderworkers)
Older-worker
participation
Policy and performance indicators
components
Policy indicators
Implicit tax on continued work (Net change in pension
wealth if retiring at 65 instead of 62 -2004 (-)
Coverage of early retirement 2004 (-)
Life-long learning: Participation of the population aged 5564 in education and training 2000-2006 (+)
Performance indicators
Average exit age from the labour force 2001-2005 (+)
Employment rate of older workers aged 55 to 64 - Women
(%) 1992-2006 (+)
24
Employment rate of older workers aged 55 to 64 - Men
(%) 1992-2006 (+)
Step 3: analysis of policy indicators
25
Example for older workers (2):
indicators -- levels
Implicit tax
on continued
work
Coverage of
Life-long
Average exit Average exit Employment Employment Aggregate
Number of
early
learning:
age from the age from the rate of older rate of older score on level individual
retirement those aged 55- labour force- labour force- workers aged workers aged
indicators
64 in
Women
total
55 to 64- Men
55 to 64with negative
education and
Women
performance
training
Aggregation
weights
1
1
1
BE
-1
-2
0
1
1
1
-1
1
-2
1
0
-2
0
1
-2
0
-1
2
-1
0
1
1
0
0
0
-1
0
-1
-1
-1
BG
CZ
DK
DE
EE
IE
GR
ES
FR
IT
CY
1
1
1
1
0
-1
0
0
0
1
2
1
1
-2
-1
2
-2
-1
1
2
0
0
2
1
1
-2
-2
2
-2
-1
-1
2
0
2
0
-1
-1
0
-2
0
-1
-1
0
1
0
1
1
0
1
-1
-1
1
26
4
3
2
1
1
1
0
3
1
3
5
1
Step 4: country-specific assessment
27
Mechanical application for Estonia:
per capita GDP gap
Gap with EU15 in level in 2005
Growth decomposition 2000-2005
GDP per capita
GDP per capita
Labour Productivity
Labour Productivity
Labour Resource Utilisation
Labour Resource Utilisation
Capital Deepening
Capital Deepening
Total Factor Productivity
Total Factor Productivity
Labour Quality (Education)
Labour Quality (Education)
Share of Working age Population
Share of Working age Population
55-64 Participation
55-64 Participation
Unemployment Rate
Unemployment Rate
Average Hours Worked
Average Hours Worked
Native Population
Native Population
Net Migration
Net Migration
Youth Participation
Youth Participation
25-54 Male Participation
25-54 Male Participation
25-54 Female Participation
25-54 Female Participation
-60
-40
-20
0
20
40
-2
0
2
4
6
8
10
28
Mechanical application for Estonia:
combining growth and levels
GDP components
Labour utilisation
Share of working age population
Native population
Net migration
Unemployment rate
Average hours worked
Youth participation
25-54 male participation
25-54 female participation
55-64 participation
Labour productivity
Capital deepening
Total factor productivity
Labour quality (educational attainment)
GDP per capita
Level
2
2
-2
2
0
2
-2
-2
2
2
-2
-2
-2
0
-2
Growth
2
2
-2
-2
2
2
-2
0
0
1
2
2
2
1
2
29
Policy areas -- Aggregate scores for EE
Labour market
Active labour market policies
Making work-pay: incentive to work through the interplay of tax and
benefit system
Reforming labour taxation to stimulate labour demand
Relaxing job protection while combating labour market
segmentation/dualisation
Working time organisation
Specific labour supply measures for women
Specific labour supply measures for older-workers)
Improving wage bargaining and wage-setting policies
Immigration and integration policies
Labour mobility (geographical and sectoral)
Product and capital market regulations
Openness to trade and investment
Barriers to entrepreneurship and business environment
Competition-friendly policy framework
Efficient financial markets and access to finance
Innovation and knowledge
R&D, innovation policies and ICT
Education and life long learning
Macroeconomy
Long-term sustainability of public finances and welfare policies
Stability oriented macroeconomic policies
Level
Change
-1
2
1
0
1
1
0
1
0
1
-1
0
1
2
1
0
1
0
1
-2
1
1
1
1
1
0
-1
0
-1
0
0
-1
1
0
1
0
30
Example: labour supply of older
workers
Specific labour supply measures for older-workers
Implicit tax on continued work
Coverage of early retirement
Life-long learning: Participation of the population aged 55-64 in education and training
Average exit age from the labour force- Women
Average exit age from the labour force- total
Employment rate of older workers aged 55 to 64- Men
Employment rate of older workers aged 55 to 64- Women
Aggregate score on level
Number of individual indicators with negative performance
Level
Growth
-1
1
0
2
1
1
1
1
2
1
0
31
Example: making work pay
Making work-pay: incentive to work through the interplay of tax and benefit system
Unemployment benefit duration, months (Danish study-median of the min-max range)
Average unemployment benefit duration (years) (OECD)
Job availability requirement index (Danish study)
Unemployment trap (low wage-earner): Marginal effective tax rate for an unemployed person (67% AW, single person)
Unemployment trap (average wage-earner): Marginal effective tax rate for an unemployed person (100% AW, single person)
Inactivity trap (low wage-earner): Marginal effective tax rate when moving from social assistance to work (67% AW, single person)
Inactivity trap (average wage-earner): Marginal effective tax rate when moving from social assistance to work (100% AW, single person)
Net Replacement Rates for unemployed persons (67% AW, single person)
Net Initial Replacement Rates for unemployed persons (100% AW, single person)
Average unemployment benefit replacement rate (%) (OECD)
Unemployment rate - Pre-primary, primary and lower secondary education - levels 0-2 (ISCED 1997) (%)
Employment rate - Pre-primary, primary and lower secondary education - levels 0-2 (ISCED 1997) (LFS) (%)
Long-term unemployment rate
Aggregate score on level
Number of individual indicators with negative performance
Level
Growth
1
2
2
0
1
1
2
0
1
0
0
0
-1
0
-1
-2
0
1
2
2
1
2
1
1
32
Example: competition-friendly policy
framework
Competition-friendly policy framework
LEVEL
GROWTH
Average Mark up - Total industry based on Euklems data (DG ECFIN) (-)
-2
er011) (-)
2
Comparative price levels - comparative price levels of final consumption by private households including indirect taxes (EU-25=100) (STRIND
0
-2
Market share of the largest generator in the electricity market - as a percentage of the total generation (STRIND er031) (-)
Market share of the incumbent in fixed telecommunications - local calls (including calls to the Internet) - as a percentage of the total market (STRIND er0321) (-)
Market share of the incumbent in fixed telecommunications - long distance calls - as a percentage of the total market (STRIND er322) (-)
Market share of the incumbent in fixed telecommunications - international calls - as a percentage of the total market (STRIND er323) (-)
0
-1
Market share of the leading operator in mobile telecommunication - as a percentage of the total market (STRIND er033) (-)
-2
Price of telecommunications - local calls - Price level and evolution in the telecommunications market (in Euro per 10 min call) (STRIND2er02a1) (-)
1
2 er02a2) (-)
Price of telecommunications - national calls - Price level and evolution in the telecommunications market (in Euro per 10 min call) (STRIND
-2
-2 er02a3) (-)
Price of telecommunications - calls to USA - Price level and evolution in the telecommunications market (in Euro per 10 min call) (STRIND
-1
2
Electricity prices - industrial users - Price level and evolution in the electricity market (in Euro per kWh) (STRIND er02b1) (-)
-2
2
Electricity prices - households - Price level and evolution in the electricity market (in Euro per kWh) (STRIND er02b2) (-)
2
2
Gas prices - industrial users - Price level and evolution in the gas market (in Euro per Gigajoule) (STRIND er02c1) (-)
0
2
Gas prices - households - Price level and evolution in the gas market (in Euro per Gigajoule) (STRIND er02c2) (-)
-2
1
Total State aid - as a percentage of GDP (STRIND er051) (-)
2
-1
Sectoral and ad hoc State aid - as a percentage of total state aid (STRIND er051 er052) (-)
Public procurement - Value of public procurement which is openly advertised, as a percentage of GDP (STRIND er040) (+)
The competition law and policy indicator - Indicator scale of 0-6 with 6 designating an overall framework least conducive to competition.(OECD: Høj et al., 2007) (-)
Barriers to competition - Legal barriers (OECD) (-)
Barriers to competition - antitrust exemptions (OECD) (-)
State control - Involvement in business operation (OECD) (-)
Regulation impact - average impact of regulation in non-manufacturing sectors (post and telecom ; energy, finance, transport, distribution, business services) on other industries (OE
-1
1
Aggregate score on level
6
4
Number of individual indicators with negative performance
33
Example: education and lifelong
learning
Education and life long learning
LEVEL
PISA 2003 average score
Spending on Human Resources - Total public expenditure on education as a percentage of GDP
0
Life-long learning - females - Percentage of the female population aged 25-64 participating in education and training over the four weeks prior
0 to the survey
Life-long learning - males - Percentage of the male population aged 25-64 participating in education and training over the four weeks prior-1
to the survey
LLL 25-34
-1
LLL 35-44
-1
LLL 45-54
LLL 55-64
LLL - by working status: employed
-1
LLL - by working status: unemployed
LLL - by working status: inactive
LLL - Low educational attainment
LLL - Medium educational attainment
-1
LLL - High educational attainment
-1
Total graduates (ISCED 5-6) per 1000 of population aged 20-29
0
Youth education attainment level - females - Percentage of the female population aged 20 to 24 having completed at least upper secondary2 education
Youth education attainment level - males - Percentage of the male population aged 20 to 24 having completed at least upper secondary education
0
Early school-leavers - females - Percentage of the female population aged 18-24 with at most lower secondary education and not in further1education or training
Early school-leavers - males - Percentage of the male population aged 18-24 with at most lower secondary education and not in further education
0
or training
Aggregate score on level
0
Number of individual indicators with negative performance
6
GROWTH
0
1
-2
-1
1
0
0
-2
-2
-2
-1
5
34
Questions for discussion



Is there a policy challenge for
Estonia?
What will be the source of labour
supply in the future?
Is the Estonia’s policy framework
adequate? What are the
weaknesses? What are the
strenghts?
35