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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