Author: Admin
On Leniency, Damages and Deterrence
Authors: Catarina Marvão and Giancarlo Spagnolo, SITE.
On November 26th of 2014, an EU Directive on antitrust damage actions was signed into law. The Directive is to praise as it does a lot to facilitate private antitrust actions in the EU. However, the Directive also tries to address a possible conflict between public and private antitrust law enforcement due to the central role played by Leniency Programs in cartel detection and prosecution. This conflict has long been at focus of legal debate. Private damage actions may reduce the attractiveness of Leniency Programs for cartel participants if their cooperation with the competition authority increases the chance that the cartel’s victims will bring a successful suit. The Directive strikes a compromise between public and private enforcement by preventing the use of leniency statements in subsequent actions for damages and limiting the liability of the immunity recipient to its direct and indirect purchasers. A new paper by Buccirossi, Marvão and Spagnolo (2014) shows that damage actions will actually improve the effectiveness of such programs, through a legal regime in which the civil liability of the immunity recipient is minimized and full access to all evidence collected by the competition authority, including leniency statements, is granted to claimants, a legal regime already implemented in Hungary since 2011.
The Political Economy of the Latvian State Since 1991: Some Reflections on the Role of External Anchors
This brief discusses the role of external anchors or goals such as WTO accession, NATO and EU accession in Latvia’s development strategy since 1991. On the one hand the external goals ‘depoliticised’ many potentially contentious areas of Latvian life. On the other hand, some developments would not have happened or would not have happened as fast without the constraints imposed by the external goals. For example liberalisation of the citizenship laws was prompted by NATO accession and the balance was tipped when the rejection of Latvia from fast-track EU accession talks in December 1997 led Latvia to abandon its quota or ‘windows’ naturalisation system. Most recently, Eurozone accession was an externally defined exit strategy from the austerity episode induced by the economic and financial crisis. Today there are no big external goals left to guide policy making. Home grown problems such as inequality require home grown solutions. But even now an external dependency persists. For example a long needed reform of the financing model of higher education has had to wait for a World Bank report published in September 2014 for action to be taken.
On January 1st, 2015 Latvia assumed the Presidency of the European Union. This milestone represents a certain level of maturity of the Latvian state and offers an opportunity for reflection on some aspects of how politics and political economy have evolved in Latvia between 1991 and today.
After Latvia regained independence in 1991, it faced (at least) two political economy challenges: one was to disentangle the economy from the Soviet system in which it had been deeply integrated, and the second, perhaps more difficult challenge, was to create an independent nation state. At a formal level, the solution to the latter challenge appeared straightforward – assume continuity of the Latvian state. Effectively this meant reinstating the pre-war constitution, which was indeed done for the most part. Symbolically this continuity was signalled by, for example, calling the first post-Soviet parliamentary elections held in June 1993 the elections for the 5th Saeima (parliament). The elections for the 4th Saeima had taken place more than 60 years earlier in October 1931.
At a practical level the challenges were more complex – Latvia had had no practical experience of statehood for nearly fifty years and mistakes were made. For example, Latvia initially diplomatically recognised Taiwan rather than the Peoples Republic of China.
There was a presumption that newly independent Latvia should become a market economy but little consensus on how this should be achieved. This is in contrast to Estonia where a group of ‘young market economy Turks’ were able to implement a kind of zero option i.e. zero tariffs, fast privatisation, etc. In Latvia there were strong protectionist sentiments and the initial privatisation was a muddled process.
Advice and advisers were abundant in post-independence Latvia. In the early 1990s, Latvia was awash with international advisers: the IMF and the World Bank were both present, the Germans were advising on a constitution for the Bank of Latvia, the British were active in public administration reform, the Danish advised on research and higher education and so on. Advice was often conflicting with different advisers promoting their own visions of structures as models that Latvia should adopt e.g. on legal and education systems. Today, we see something akin to this in the Eastern Partnership countries such as Moldova and Ukraine.
There was a general sense of the desirability of a ‘return to Europe’ but no plan or strategy. Nevertheless, even without a conscious plan a strategy emerged – namely a strategy of external anchors.
The external goals or anchors that emerged included the following:
- World Trade Organisation, 1998
- NATO, 29 March 2004
- European Union, 1 May 2004
- Eurozone, 1 January 2014
The most important effect of the external anchors was that they ‘depoliticised’ many potentially contentious areas of Latvian life. This has been particularly important given the fragmentation that has historically dominated Latvian politics. Thus, in the interwar period, no less than 32 different political parties were represented in the Saeima. In the early post-Soviet parliaments, similar tendencies were observed with newly created parties being the winners in terms of the number of seats in the first four elections. The election of 2006 was the first in which the previously largest party returned as the largest party. Between the first post-Soviet election in 1993 and the 2014 election, there have been no less than 17 governments which mostly have been uneasy coalitions of 3 or 4 partners with divergent views and interests. In this context the benefit of external anchors is self-evident.
The external anchors each contributed in different ways: WTO accession contributed to modify the protectionist sentiments that were rife in the early years of independence. Rather curiously, Estonia, which adopted a radical free trade policy right from the first days of independence, had more difficulties in achieving their WTO membership than ‘protectionist’ Latvia. Estonia was obliged to implement additional economic regulations in order to conform to the rules of the WTO and the EU (to which it was committed to join as its WTO application proceeded), and as a consequence, Estonian WTO accession was delayed to 1999. The WTO accession process also gave Latvia’s fledgling Foreign Ministry invaluable experience of multi-lateral negotiation.
Apart from the obvious security benefit, NATO membership was conditional on the creation of the Latvian anti-corruption Bureau (KNAB) and on the liberalisation of citizenship legislation, the latter because NATO was concerned about the prospect of a member state with a large number of non-citizen residents.
EU accession represents the biggest and most significant anchor. The requirement of candidate countries to accept the EU acquis communautaire took huge swathes of economic and social legislation out of the political arena. While the economic criteria for accession presented few difficulties of principle for Latvia – most people were in favour of a market economy – the requirement of respect for and protection of minorities presented problems for many Latvian politicians and liberalisation of the citizenship law was resisted until after 1997 when the rejection of Latvia from fast-track EU accession talks in December 1997 prompted a rethinking of Latvia’s intransigent position on the quota or ‘windows system’.
It is hard to over-estimate the impact of EU accession on Latvia. What would Latvia be like today if it were not a member state of the EU? There are sufficient tendencies even now in Latvia to suggest we would observe something like a tax-haven, off-shore economy, probably with weak democratic institutions. EU accession has saved the Latvian people from something like such a fate.
Even later in Latvia’s largely self-inflicted financial and economic crisis of 2008-10 it was the ‘Holy Grail’ of accession to the Eurozone that politically anchored Latvia’s famous austerity programme.
What of today? The ‘big’ external anchors are used up, and Latvia today:
- Is the fourth poorest country in the EU with GDP per capita in 2013 at 67% of the EU average (only Croatia, Romania and Bulgaria are poorer);
- Is a particularly unequal society – Latvia has some of the worst poverty and inequality indicators in the EU;
- Has a shadow economy at 23.8% of GDP (data on 2013; Putniņš and Sauka (2014)); and
- Has an internationally uncompetitive higher education system.
These and other problematic aspects of Latvian life and society are home grown and it is hard to imagine external anchors that can improve poverty or inequality, that can reduce the size of the shadow economy, or which can improve the quality of the Latvian higher education system.
Nevertheless, Latvian policy makers seem to be addicted to the external anchor concept and often find difficult to progress without it. The recent experience of reform of the financing of higher education illustrates. Latvia has historically had a funding mechanism for universities and other higher education institutions based entirely on student numbers. The lack of a link between funding and quality has resulted in a Latvian higher education system that is strong on enrolment but low on quality e.g. as measured by peer-reviewed publications. At some level this has been understood and there has been much talk of reform. Although various reports and evaluations have been published, there has been little progress on concrete reform until the Ministry of Education commissioned the World Bank in December 2013 to produce a report on funding models for Latvia. The final report was delivered in September 2014 and action has now been taken to adopt the World Bank recommended three-pillar model where the funding criteria will now include performance and innovation.
Of course, the new model will not solve all the problems of Latvian higher education – far from it – but it illustrates the pervasive nature of policy makers seeming dependency on external anchors.
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References
- Putniņš, Tālis & Arnis Sauka (2014). “Shadow Economy Index for the Baltic Countries. 2009-2013,” The Centre for Sustainable Business at SSE Riga, May 2014.
Crisis and Trust
Authors: Maxim Ananyev and Sergei Guriev, CEFIR
Our research uses the 2008-2009-crisis experience in Russia to identify the relationship between income and trust. In 2009, Russian GDP fell an 8-percent drop in 2009. The impact of the crisis was very uneven among Russian regions because of their differences in industrial structure inherited from the Soviet times. We find that the regions that specialize in producing capital goods, as well as those depending on oil and gas, had a more substantial income decline during the crisis. The variation in the industrial structure allows creating an instrument for the change in income. After instrumenting average regional income, we find that the effect of income on generalized social trust (the share of respondents saying that most people can be trusted) is statistically and economically significant. Controlling for conventional determinants of trust, we show that a 10 percent decrease in income is associated with 5-percentage point decrease in trust. Given that the average level of trust in Russia is 25%, this magnitude is substantial. We also find that the post-crisis economic recovery did not restore the pre-crisis trust level. Trust recovered only in those regions where the 2009 decline in trust was small. In the regions with the large decline in trust during the crisis, trust in 2014 was still 10 percentage points below its pre-crisis level. This has straightforward policy implications: governments should pursue generous countercyclical policies especially in the areas that are the most vulnerable to macroeconomic shocks.
The Role of Belarusian Private Sector
The development of a private sector and the expansion of its role in the economy is one of the key goals repeatedly announced by the Belarusian authorities. The reforms carried out in Belarus in 2006-2014 moved the country from 106th to 57th position in the World Bank Doing Business ranking. The official statement is that reforms boosted the rapid development of business initiatives and its impact on economic development. Unfortunately, there is no clear confirmation of this statement. The absence of a transparent and clear methodology in Belarusian statistics on how to evaluate the role of the private sector makes it difficult to evaluate the exact input of the Belarusian business in the economy and compare its role to other countries.
In the last 5 years, the Belarusian authorities have repeatedly highlighted the need to develop the private sector, perceiving it as the main source for sustainable economic growth and competitiveness of Belarus in the future.
However, it may be difficult to assess the real role of the private sector in the Belarusian economy. First, existing data do not allow a clear identification of the boundaries between the private and state-owned sectors in Belarus. Furthermore, there are certain methodological differences in identifying and evaluating the private sector between Belarusian official statistics, the World Bank approach and alternative methodologies. These methodological variations combined with data limitations result in significantly different estimates of the role of the private sector for the Belarusian economy. The problem concerns both the evaluation of the role of small and medium enterprises (SMEs) and the private sector in general.
Small and Medium Enterprises
One good example of the abovementioned data issue is the statistics for SMEs sector. Unlike the EU, Belarus does not include individual entrepreneurs to the micro organizations in the SME sector. This results in highly different estimates for the number of SMEs per 1000 inhabitants (Figure 1). If we follow the methodology of the National Statistical Committee of the Republic of Belarus (Belstat), the number is 9.7 firms per 1000 people. However, switching to the EU methodology (IFC report, 2013) raises the number significantly up to 35.9. Moreover, the inclusion of unregistered self-employed individuals involved in the shadow economy (which according to estimations of the authorities amount to at least 100,000 inhabitants) increases the number to 46.5 firms per 1000 people, which is above the level of many European countries.
Figure 1. SME density
Source: own estimations from Belstat data, Eurostat.
Private Sector
As for the private sector in general, the problem here is that the official statistics counts enterprises with mixed form of ownership and state presence to the private sector. This makes it difficult, if at all possible, to obtain the exact input of the private sector to the economy and see the dynamics of its change.
More specifically, there are three potential ways to assess the contribution of the private sector. Unfortunately none of them provides reliable estimates of the role of business. The first method is to use official data. The main problem here is that the private sector according to official statistics includes enterprises with state presence as well as large private companies that are under state control and not totally independent. Thus, the contribution of the private sector calculated based on these figures is likely overestimated.
The second method is to look at enterprises that do not report to the Belarusian ministries, following the methodology of the World Bank used in their evaluation of Belarus machinery industry (Cuaresma et al., 2012). Here, non-ministry reporting enterprises work as a proxy for a private firm, as in this case it doesn’t have to report directly to Belarusian ministries and is independent from the state.
The problem is that the majority of large private enterprises, even though there is no state share in them, are not in this list. In Belarus these enterprises often form a part of state concerns on the one hand and are independent on the other. The example here is JSC “Milavitsa”, one of the largest lingerie producers in EE, which is a part of the Bellegprom concern. Therefore, this methodology likely underestimates the role of the private sector.
The third way is to try to exclude state presence from the official data of the private sector. According to official statistics, the private sector includes several groups of enterprises, such as individual entrepreneurs, legal entities with/without state/foreign presence, etc. However, the absence of a clear distinction between these sub-groups allows for only rough estimates, through the extraction of the state presence.
As a result, all obtained numbers are qualitatively different from each other and there is no clear answer if any of them reflects the real picture.
For example, the contribution of the private sector in total employment according to the three different methods (Figure 2) provides the following results. Officially, in 2013 around 53% of the active labor force worked in the private sector. However, the exclusion of state presence in private property changes the results significantly and the share of the active labor force involved in the private sector drops to a level of 31%, while the non-ministry reporting enterprises employ around 18% of the active labor force.
Figure 2. Private sector in employment (%)
Source: own estimations from Belstat data.
The input of the private sector in the total production volume (Figure 3) is also very diverse depending on the method of evaluation. Official data show that the private sector is responsible for 80% of total production volume. However, the exclusion of state presence decreases the value to a level of just 26%, which is similar to the result demonstrated by the non-ministry reporting enterprises (25%).
Figure 3. Private sector in total production volume (%)
Source: own estimations from Belstat data.
At the same time, the absence of a clear definition of the private sector does not allow for obtaining reliable information about its effectiveness. If we take the rate of return on assets (ROA), again, there is a significant gap in the results of the different methods of estimation (Figure 4). ROA of the private sector according to official statistics is significantly lower than similar indicators based on the data obtained by the other two methods (in 2013: 1.17 vs. 2.4 and 1.3 respectively). Thus, the lower the “measured” state presence, the higher is the productivity of the private sector, especially in comparison with the effectiveness of the state sector (0.25).
Figure 4. Return on Assets (BYR/BYR)
Source: own estimations from Belstat data.
Conclusion
The above discussion has illustrated that diffuseness of data and the definition of the private sector is likely to create troubles for understanding the importance of the private sector in Belarus. This, in turn, may undermine the effectiveness of economic and political measures targeted towards this sector.
The implementation of a clear, unified and transparent methodology of how to estimate the role of business and what exactly can be treated as a private sector in statistics would allow for a better understanding of the obstacles and barriers that the private sector is dealing with, as well as to help developing effective measures of business support. Until then, the official statistics should not stick to just one definition of the private sector. Instead, it can use all three abovementioned gradations, as a better reflection of the realities of Belarusian business.
References
- Cuaresmo, J., Oberhofer, H., Vincelette, G. (2012).‘Firm Growth and Productivity in Belarus: New Empirical Evidence in the Machine Building Industry’, World Bank, Policy Research Working Paper No. 6005.
- ‘Business Environment in Belarus 2013.Survey of Commercial Enterprises and Individual Entrepreneurs’, IFC, Report.
Green Transition: Adapting Markets and Policies
This policy brief summarizes the discussion at the 8th annual SITE Energy Day conference, devoted to market adaptations and policies necessary to address the green transition. Recent energy trends with ever more green energy-mixes will have consequences for the functioning of related markets as well as implications for appropriate policy responses. New financial solutions, technological developments, international cooperation, and national policy initiatives in both developing and developed countries are examples of adaptations to this transition process. To discuss these issues, the conference brought together a group of distinguished experts from the energy industry, policy community and academia.
In December 2014, world leaders have gathered in Peru (Lima) for the 20th annual meeting of the United Nations Framework Convention on Climate Change. This convention has as an objective to “stabilize greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system” (see UNFCCC’s webpage). Even though the agreement to reduce emissions to a sustainable level may take years to be negotiated, at least 195 countries have ratified the UFCCC convention. The willingness to reduce environmentally harmful emissions has led to many countries changing their energy profile to include more green energy, a process that is often referred to as “green transition”.
It may be worth mentioning that the label “green transition” consists of two conceptual components. “Green” refers to the ability to generate environmentally friendly energy, which has become a key challenge for our society. Indeed, a majority of people now recognize the pressing need to cut pollution in the face of climate change and environmental degradation. The wording “transition” acknowledges that a shift toward a greener energy mix seems unavoidable, but this shift may not occur immediately or uniformly around the globe. The required time for change is long and the shift itself may not be smooth. To put it differently, the green transition has had and will continue to have wide-ranging consequences for businesses, governments, and the international community.
As a result, there is a need to carefully address the potential implications for the existing energy and related markets and market players, and for government policies, as well as new markets and new policies triggered by the green transition. These topics were the focus of the 8th SITE Energy Day, a half-day conference held at the Stockholm School of Economics on December 2, 2014.
Green Transition and the Energy Markets
The first panel focused on how energy markets have responded to green transition and how they may react in the future. Speakers from electricity companies, regulatory bodies and think tanks discussed how the green transition may affect the use of traditional financial instruments by energy companies; the choice of economically viable technology for producing green energy; and the way markets could be integrated to increase the efficiency of green energy.
As green transition almost always introduces more intermittent production, it is likely that market uncertainty will increase. This is one of the reasons why traditional financial instruments may not be fully adequate. The first speaker Laurent Cheval, Head of Nordic and Fuel Origination in the business division Asset Optimization & Trading at Vattenfall discussed this issue extensively. Energy companies face substantial financial risks since both prices and quantities may be highly volatile. To mitigate these risks, market participants may use an array of financial products. In mature energy markets, the products are fairly standardized. However, more complex and tailor-made financial products are required to face the ongoing changes in the sector. For example, the increased share of renewable energy combined with more interconnected markets create specific market risks. To hedge against risks associated with weather changes, future fuel costs, interest rates and so on, more and more energy providers trade customized derivatives “over-the-counter” (OTC) rather than through a centrally-cleared exchange. Another example is the development of decentralized power production and the rise of the “Prosumer” who simultaneously produces and consumes power. So far, the relevant regulation is underdeveloped and there is an additional demand for innovative financial solutions. Large energy companies such as Vattenfall are for instance offering a range of financial hedging solutions combined with actual physical handling and delivery of energy products.
Green transition should in the long run lead to a domination of environment friendly energy. However it is important that only economically viable technologies subsist. It is therefore necessary to assess the cost of producing green energy. Lars Andersson, Head of Wind Power Unit at the Swedish Energy Agency, reported on an extensive study done by the Agency on this issue. Over the last five years, the production cost of wind power has fallen consistently and capacity usage has increased. This dramatic change in the wind power industry likely implies that the existing subsidies for building wind power plants gradually will be phased out. It is unclear how the industry will react to these cuts in subsidies. Furthermore, according to Andersson, wind production faces at least two challenges. Without developing the capabilities for energy storage, electricity markets will face more energy imbalances as the share of wind power increases. Additionally, the support from the local communities is needed to ensure an expansion of wind power. Addressing these issues requires the development of new regulation and defining a common goal which may promote cooperation between stakeholders.
Ultimately the green transition will end when and if the green energies are largely adopted around the globe. One way to accelerate this green transition may be to coordinate action and development of governmental policies. Martin Ådahl, Chefsekonom at Centerpartiet, and Daniel Engström, Programchef Miljö och Klimat at Fores, presented the current state of the international climate policy and discussed the benefits of linking carbon emission rights markets. Because of conflicting interests, the likelihood of reaching an agreement within the current United Nations climate negotiations is rather small.
However, Ådahl and Engström suggested that the focus should instead be on reaching agreements between big polluter countries that contribute the lion’s share of global emissions. Indeed, regional emission trading schemes already exist in the EU, the US and China, the three regions which together account for over 50 percent of global emissions. One potential shortcoming of this suggestion is that it may not be enough to stabilize greenhouse gas concentrations in the atmosphere. Thereby, Ådahl and Engström discussed the possibility to link current cap-and-trade markets, as a first step toward an international system with a more formal global agreement. Linking cap-and-trade markets has many benefits, especially in the form of efficiency gains. However, emission caps vary across countries and regions because of different political goals or priorities. When markets are linked, difference in abatement costs (or allowance prices) would lead to a flow of allowances and emissions from countries/regions with low abatement cost to countries with higher ones. Thereby prices would be equalized, benefiting entities with cheaper allowances. To avoid opportunistic behavior, countries would first have to agree ex ante on an exchange rate between different countries’ emission rights. Second, a clear regulatory framework is required. Both Ådahl and Engström emphasized the need of an international organization devoted to climate economics. Such an institutional body could not only regulate the links between cap-and-trade markets, but also provide concrete solutions and technical models to improve on the market design.
Environmental Policies: International Experience
The second panel focused on how governments may promote green transition. Anna Pegels, Senior Researcher at the German Development Institute (DIE), reviewed green policy initiatives in developing countries. Pegels argued based on evidence from e.g. India and South Africa that it is possible to combine substantial growth with green energy. This is good news since emerging countries are among the highest polluters. However, to change a country’s energy profile, governments need to intervene and develop new industrial policies.
Governments can set long-term goals, which are supported by short- and mid-term targets. However, given the large profits that are at stake, officials may likely be subject to the risk of capture and corruption. To limit such risks, Pegel emphasized the need to introduce competition in the energy sector as a whole. Subsidized feed-in tariffs for renewable energy for example should be only a first step, to reach a certain scale of production. But the technology is mature enough that producers should be able to bear some additional risk in their current activity. This should increase the scope for competition. Finally, it is essential that governments continuously engage in policy revision cycles and learn from other countries’ experiences.
Benjamin Sovacool, Professor of Business and Social Sciences at Aarhus University and Director of the Danish Centre for Energy Technologies, talked about the process of low carbon transition in the Nordic region. In spite of large investments into renewable energy, fossil fuels still dominate the consumption in the Nordic countries and considerable measures need to be taken in the decades ahead to make the transition to a greener energy mix. Sovacool highlighted four areas which could help reduce the carbon footprint of the Nordic countries: renewable energy, increased energy efficiency of buildings, transportation, and carbon capture and storage (CCS). In order to be successful, the green transition has to bring about a systemic change engaging actors across the economy, particularly including end-users. There should also be a focus on additional technological progress. Finally, Sovacool noted that a rapid emission reduction such as the one planned in the Nordic countries is unlikely to be followed on a global scale in the near future due to a lack of political feasibility.
Conclusion
The green transition is expected to have a profound impact on the functioning and structure of energy markets as well as the policies that facilitates this transition.
There is an ongoing process of decentralization in the energy sector, with the rise of “prosumer” market places that alter market dynamics. Moreover, market uncertainty is increasing due to more intermittent production (due to renewables) and a stronger interconnectedness between energy markets. It is likely that energy imbalances will be a major concern and that more and more energy trade will take place on real time markets (as opposed to e.g. on the day-ahead market). As markets’ linking becomes stronger, the interdependence between markets in terms of energy type and geographical location will be intensified. The need for coordination and international cooperation will be even more pressing. The uncertainty regarding the development of international cooperation, but also regarding national policy changes, may however disrupt energy markets. Measures such as withdrawing existing subsidies must be handled in a gradual and strategic manner so as not to discourage investment. A key issue for governments is to have a credible green policy in the long-term. Such credibility will also depend on the level of involvement of different actors in the green transition, including the necessity to have a multilevel engagement of the end-users.
References
- Energimyndigheten, (2014), Produktionskostnads-bedömning för Vindkraft i Sverige, ER 2014:16
- Pegels, A. (Ed.). (2014), Green industrial policy in emerging countries, Vol. 34, Routledge
- Rutqvist, J., Engström, A.and Ådahl, M., A Bretton Woods for the Climate. Fores, 2010
- SITE 8th Energy Day, http://www.hhs.se/en/about-us/calendar/site-external-events/2014/site-energy-day/
- UNFCCC, (n.d). First steps to a safer future: Introducing The United Nations Framework Convention on Climate Change, http://unfccc.int/essential_background/convention/items/6036.php [8 December 2014]
Growing Inequalities in Workplace Amenities
Inequality is considered to be a serious detrimental factor for societies’ development. It has been shown to undermine the health of the population, cause civil unrest, and slow down countries’ economic growth. Nizalova’s (2014) paper shows that the focus on the purely monetary component in the studies of inequality is too narrow. In Ukraine, which has had almost no change in income/wage inequality since 1994, the inequality in other workplace dimensions has soared. Nizalova finds that workers in establishments paying higher hourly wages have enjoyed (i) relatively greater reductions in the total workplace injury burden, (ii) greater retention of various benefits/amenities, and (iii) relatively larger increases in wage payment security (de-creased wage arrears). These findings document a high degree of an unequal shift away from work-centered provision of social services, not counter-balanced by the government, and highlight the importance of timely policy intervention as a possible cause of societal disturbances.
Inequality in income, health, and political rights has been on the agenda of many governments and international organisations. It has been shown to lead to tensions in society that can grow into civil unrest, and is named one of the top global risks in the World Economic Forum Global Risk Report, 2013. Country-level comparisons by epidemiologists have documented that more unequal countries have (i) higher rates of mental illness, drug use, and homicide, (ii) a larger incarceration rate, (iii) a larger share of obese population, (iv) higher school drop-out rates, lower socio-economic mobility, lower child wellbeing, and (v) a lower level of trust (Wilkinson and Pickett, 2010). At the macro level, inequality has also been shown to impede sustainable growth (Ostry and Berg, 2011).
Yet, in Ukraine, in spite of a number of continuing severe problems with population health, labor markets, infrustructure, etc., inequality has not been high on the agenda, except for occasional concerns raised by some international organisations and researchers. In our view, there are at least three reasons for this.
First of all, most of the attention in inequality discussions is paid to income inequality. However, in Ukraine after a significant increase in this indicator by the mid-nineties, there has been hardly any dynamics, with the exception of extreme increases in incomes/wealth of a few oligarchs.
Second, and this relates to inequality in any dimension, when people in power are predominantely concerned with self-enrichment, and citizens are not showing their dissatisfaction, or the government has “effective” means of dealing with this dissatisfaction (imprisonment, physical elimination, etc.), as has been the case in Ukraine for many years, those at the lower end of the income distribution have the least chances to attract attention.
Finally, we believe that the reason international organisations have not given much attention to Ukrainian inequality must be related to the fact that the situation in many areas of life has been so dire, i.e. the level of “well-offness” is so low throughout the distribution that the overall level was considered more important than the distribution.
A recent paper by Olena Nizalova (2014) examines the importance of the non-monetary dimensions of work in studies regarding inequality in total returns to work. Nizalova’s paper exploits a unique data set collected by the International Labour Office in Ukraine to study whether there has been a significant change in the non-monetary components of inequality. If this is the case, it can explain the growing tensions in society where the changes in income/wage inequality have been limited.
Non-monetary aspects of inequality
A few academic studies have explored the issue of income/wage inequality in Ukraine and Russia (Ganguli and Terrell, 2006; Galbraith, Krytynskaia, and Wang, 2004; Gorodnichenko, Peter, and Stolyarov, 2010; Lokshin and Ravallion, 2005), and found that, if anything, the change in inequality after 1995 has been quite modest. These results are in line with the dynamics of wage inequality in Ukraine presented in Figure 1, which pictures the ratio of wages in 2nd, 3rd, and 4th quartiles of the wage distribution against those in the 1st quartile.
Figure 1. Log Differences in Hourly Wages Relative to the Lowest Paying Quartile
Source: The authors own calculations based on Ukrainian Labour Flexibility Survey for the period 1994-2004.
However, the measures used in the earlier studies may not reflect the true inequality levels in the society. Indeed, they are omitting the contribution of the non-monetary dimension of work to the overall inequality.
The study of non-monetary working conditions is important for several reasons. First, work is central to people’s lives not only because a major share of household income in most countries comes from labor earnings (Guerriero, 2012), but also because individuals spend a considerable part of their time at work. Thus, earnings inequality can inappropriately reflect the true level of the total inequality in the labor market.
Second, the importance of this direction of research is further highlighted by the development of the ILO “Decent work agenda”. One of its aims is to promote both inclusion and productivity by ensuring that women and men enjoy working conditions, which satisfy several criteria. These criteria include that working conditions are safe, allow adequate free time and rest, take into account family and social values, provide for reasonable compensation in case of lost or reduced income, and permit access to adequate healthcare.
Lastly, inequality in working conditions, and in particular workplace injuries, may directly translate into income and wealth inequality, and, indirectly, affect inequality in future generations.
Ukraine: Inequality in Non-Monetary Work Dimensions Matters
The analysis in Nizalova (2014) shows that establishments that pay higher wages, tend to provide safer and, in general, better working conditions than establishments that pay lower wages. In addition, the latter are much more likely to experience difficulties with the payment of wages and have a higher percentage of workers with severe (more than 3 months) wage arrears. This suggests that the wage inequality may be further exacerbated by the inequality in non-monetary work dimensions.
A further distributive analysis demonstrates that the inequality in non-moneraty work dimensions has been changing noticeably over time. In particular, Figure 2 shows that the burden of workplace injuries, measured as total work days lost due to injuries per 100 Full Time Equivalent (FTE) employees, over time has shifted from being concentrated in the top part of the wage distribution to the lowest part (the way to interpret Figure 2 and all subsequent figures is as follows: the diagonal line in all figures corresponds to the equal distribution of the mentioned workplace characteristic across the wage distribution. The further the actual distribution curve (in red) is from the diagonal, the more unequal it is, with the curve below the diagonal indicating a concentration of the characteristic among higher paying enterprises and the curve above the line – concentration of the characteristic in the lower end of the wage distribution).
Figure 2: Concentration Curves – Total Injury Burden by Year
Source: The authors own calculations based on Ukrainian Labour Flexibility Survey for the period 1994-2004.
Moreover, the distribution of employer-provided benefits has also changed from being almost equally spread across the wage distribution to being more concentrated in the upper part (Figure 3).
Figure 3: Concentration Curves – Amenity Scores by Year
Source: The authors own calculations based on Ukrainian Labour Flexibility Survey for the period 1994-2004.
Notice that this result is not driven by any one particular amenity – it is observed across the whole range of indicators (for example, see Figures 4-6).
Figure 4: Distribution of Transportation Subsidy Provision by Year
Source: The authors own calculations based on Ukrainian Labour Flexibility Survey for the period 1994-2004.
Figure 5: Distribution of Kindergarden Subsidy Provision by Year
Source: The authors own calculations based on Ukrainian Labour Flexibility Survey for the period 1994-2004.
Figure 6: Distribution of Health Service Provision by Year
Source: The authors own calculations based on Ukrainian Labour Flexibility Survey for the period 1994-2004.
Similarly, wage arrears’ (non-payments) concentration has changed from being almost equally distributed across all wage levels to being more concentrated among lower paying establishments (Figure 7).
Figure 7: Distribution of Wage Arrears by Year
Source: The authors own calculations based on Ukrainian Labour Flexibility Survey for the period 1994-2004.
Further, the analysis of distributional shifts in the establishment characteristics over the corresponding period shows significant changes only with respect to firm size, export status, and some sectoral shifts.
Overall, the findings of the paper document an emergence of sizeable inequality in the workplace characteristics in the Ukrainian labor market: workers in poorly paying establishments are facing disproportionately larger risks of on-the-job injury, worse provision of amenities, as well as less security in timely payments of earning.
Conclusion
Although further research on causes of growth in multidimensional inequality in returns to work is required, this study provides two important lessons for the research community and policy makers.
First of all, it highlights the importance of a multi-dimensional approach to labor market returns, since a focus on monetary compensations only may significantly underestimate the true inequality in a society.
Secondly, it draws attention to the need of developing adequate governmental policies to address the inequality of workplace-centered provisions of social services during the transition to market economy. By prioritizing measures to facilitate provision of affordable housing, health care, kindergartens, as well as training opportunities, the government could mitigate increasing inequalities. This would allow the government to avoid significant tensions and conflicts in society, which is an important pre-requisite for ongoing sustainable development.
References
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- Clark, Andrew E. and Claudia Senik. 2010. “Who Compares to Whom? The Anatomy of Income Comparisons in Europe.”Economic Journal 120 (544):573–594.
- Galbraith, James K., Ludmila Krytynskaia, and Qifei Wang. 2004. “The Experience of Rising Inequality in Russia and China during the Transition.” European Journal of Comparative Economics 1 (1):87–106
- Ganguli, Ina and Katherine Terrell. 2006. “Institutions, markets and men’s and women’s wage inequality: Evidence from Ukraine.” Journal of Comparative Economics 34 (2):200–227
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- Hamermesh, DS. 1999. “Changing inequality in markets for workplace amenities.”Quarterly Journal of Economics 114 (4):1085–1123.
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- Lokshin, Michael and Martin Ravallion. 2005. “Rich and powerful?: Subjective power and welfare in Russia.” Journal of Economic Behavior & Organization 56 (2):141–172.
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- Nizalova, Olena Y., 2014. “Inequality in Total Returns to Work in Ukraine: Taking a Closer Look at Workplace (Dis)amenities,” IZA Discussion Papers 8322, Institute for the Study of Labor (IZA).
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- Senik, Claudia. 2009. “Direct evidence on income comparisons and their welfare effects.”Journal of Economic Behavior&Organization 72 (1):408–424.
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Does Immigration Help Diffuse Knowledge? Evidence from Russian Scientists
Author: Ina Ganguli, SITE.
Immigration is a hotly contested policy issue in many countries. Often, the debate centers on whether immigration is ‘good’ or ‘bad’ for the receiving country. A growing literature in economics focuses on understanding whether immigrants can be beneficial for a receiving economy by helping spread knowledge and increasing innovative activities. In this policy brief, I discuss new evidence showing that immigrants can be an important channel for diffusing knowledge across national borders. Drawing upon the influx of Russian scientists to the United States after the end of the Soviet Union, I present compelling evidence that immigrants contributed to cross-border knowledge flows, which are the basis for innovation and ultimately economic growth.
Stimulating Growth in Belarus: Selecting the Right Priorities
Belarus is suffering from a substantial decline in economic growth potential. Both the government and academic researchers are discussing a number of options for stimulating the growth rate and enhancing its stability. The government tends to focus on equipment investments as the priority for growth stimulation. However, academic researchers have revealed huge unused potential for growth in institutional environment in Belarus. In this brief, we deal with the issue of selecting the right priorities in growth stimulation policies.
Nowadays emerging markets as a whole, and especially countries of Central and Eastern Europe (CEE) and the CIS region suffer from the problem of declining growth potential (IMF, 2013). Belarus is not an exception from this trend. However, the situation in Belarus is distinct from the regional patterns since the majority of factors behind the declining growth potential in Belarus differ from those in other CEE and CIS countries. While the IMF (2013) emphasizes constraints for capital accumulation as the core challenge for the CEE region, the major problem in Belaurs is the lack of productivity growth. Capital accumulation has in fact been huge and ineffective in Belarus in recent years (Kruk and Bornukova, 2014). Hence, a key issue for Belarus for restoring output growth, and enhancing its sustainability, is total factor productivity. Some degree of consensus about this priority exists both in the academic sphere and among economic policy makers. However, further questions about the sources of productivity growth generate ambiguous solutions, which result in different growth strategies.
Embodied Technical Progress versus Neutral Productivity Growth
Two years ago, the Belarusian government initiated a so-called modernization campaign. The idea of this campaign was to accomplish rapid re-equipment of large Belarusian firms, which was expected to increase their productivity. The government considers this channel to be self-sufficient, hence staking on it almost exclusively.
At the same time, a number of both academic (World Bank, 2012; Cuaresma et al., 2012; Kruk and Bornukova, 2014) and economic policy studies (IMF, 2012) emphasize the necessity of institutional changes for productivity growth. Gains in productivity herewith are expected due to improved incentives by firms and more efficient allocation and usage of factor inputs by firms.
From an academic perspective, the first approach may be interpreted as one based on technical progress embodied in capital (embodied technical progress, ETC). In other words, equipment investments are to provide productivity growth per se (De Long and Summers, 1991; Greenwood et al., 1997; Hernstein and Krusell, 1996). More recent studies provide evidence on the importance of this mechanism for a modern transition agenda (Skare and Sinkovic, 2013).
The second approach deals with so-called neutral productivity growth (NPG), i.e. productivity gains independent of the quantity of either capital or labor inputs. NPG can be divided into a number of channels: neutral technical change, technical efficiency (characterized by the distance between the actual position of the firms and the production frontier), scale economies, and allocative efficiency (Coelli et al., 2005).
Impact of NPG and ETC on Productivity: Complementary or Substitutive?
As a rule, growth models do not assume any trade-off between NPG and ETC. For instance, a firm that succeeds to implement a new technology (independent on capital of labor inputs) will generate higher productivity. This will attract additional inputs – capital and labor – given higher factor returns due to productivity gains. New capital (equipment), in turn, may generate additional gains in productivity. Hence, productivity growth may stem from both tracks complementing each other. In this sense, the issue of decomposing actual sources of productivity growth – capital or technology itself – becomes largely meaningless.
The idea of the Belarusian modernization – that ETC comes first and other things do not matter – substantially changes this growth pattern. Rapid technical re-equipment makes the lack of financial sources for investments roughly inevitable, as national savings can hardly be enough for a surge in investments. The government in Belarus partially solves this problem through centralized reallocation of financial resources. However, this reallocation negatively impacts allocative efficiency (Kruk, Haiduk, 2013). Further, it is likely to have a similar adverse effect on technical efficiency and scale economies. Hence, in Belarus the trade-off between ETC and NPG arises: artificially pushing ETC suppresses NPG.
Criterions for Assessing Effectiveness of NPG and ETC
A misbalance between the ETC and NPG resulting from an artificial ETC stimulation raises serious concerns about the desirability of this policy. However, the ‘modernization ideology’ uses a counter-argument: productivity gains from ETC may be sufficiently large to allow sacrificing potential gains from NPG growth.
From this perspective, we can compare both channels through the following criterions:
- How large is the productivity effect from both channels
In order to get a quantitative assessment, we employ the model by Greenwood et al. (1997) that dissect NPG and ETC for a balanced growth path (the equilibrium trajectory when capital and output grow with the same rates). We apply our estimates of the Belarusian growth parameters to the model. For assessing ETC growth rate, we employ an approach by Hernstein and Krusell (1996). The latter produces an assessment of an average ETC productivity growth in 2005-2012 from -1.55 up 6.40% (depending on the measures of correspondent prices). The mean of the corridor seems to be rather close to the one Hernstein and Krusell (1996) estimate for developed countries (3-4%). Hence, in the current exercise we use a value of 3.5% for the Belarusian ETC. In this manner, we get the estimates of output growth-rate returns on growth rate of NPG (1.69) and ETC (0.41). This means that a change in the growth rate of NPG by 1 percentage point results in 1.69 percentage point increase of output growth rate, while the latter will increase by only 0.41 in case of 1 percentage point increase of ETC. However, the range in which NPG and ETC may vary due to government policies is highly important as well.
- How large is the sensitivity of NPG and ETC to government stimulation?
Economic modelling assumes that, once an economy is on a balanced growth path (the stock of capital grows by the same growth rate as output), the ETC growth rate is exogenously determined by global technology gains. In this case, an attempt to push ETC by excessive capital accumulation will only generate a savings-investment misbalance. Hence, this kind of stimulus policy makes sense only if the economy has not yet entered the balanced growth trajectory. Whether this is the case for Belarus is still an open question, although findings in Kruk and Bornukova (2014) signal that this path has already been achieved.
Existing options for stimulating NPG seem to be much more numerous. First, technical efficiency and scale economies may progress substantially due to a changing environment, with more intense competition and tighter budget constraints. Such environment will force firms to increase their flexibility and adaptability, which will finally result in more technical efficiency and more proper scaling. Second, Belarus has accumulated great growth potential in the sphere of allocative efficiency. Due to long periods of inefficient capital accumulation, its proper reallocation can provide up to 10% growth of output (Kruk and Bornukova, 2014).
- What are the costs of growth stimulation?
In the case of NPG, there are actually no direct costs. Enhancing more flexibility and adaptability for firms, along with establishing tough budget constraints does not require new financial injections. These goals may be achieved through legislative activity, implementing new practices and standards into business activities.
As for ETC, a number of undesirable outcomes may be interpreted as costs. First, while stimulating productivity growth due to technology background, artificial ETC stimulation may further dampen allocative efficiency in Belarus. Second, an attempt to boost it requires sources for additional investments, which typically exceed available savings. Hence, the country is likely to face a deficit of savings-investments balance. The latter is to determine current account deficit, the necessity of external borrowings, and vulnerability of financial market.
Conclusion
In the last two years, Belarus has spent considerable effort towards modernization and re-equipment of large industrial enterprises. However, the most important outcome from the Belarusian experience – artificial stimulation of ETC – is likely not worth the effort as it might hinder allocative efficiency. Because of such practices, Belarus has faced an unfavorable trade-off between ETC and NPG.
However, this trade-off should not be treated as a predetermined one. It is possible and desirable to avoid it. In the long term, the growth should stem from both tracks – NPG and ETC. However, in a shorter perspective, more returns in terms of welfare may be obtained through a more efficient allocation of resources, improvements in the institutional environment, and more flexibility and adaptability by firms.
References
- Cuaresmo, J., Oberhofer, H., Vincelette, G. (2012). ‘Firm Growth and Productivity in Belarus: New Empirical Evidence from the Machine Building Industry’, World Bank, Policy Research Working Paper No. 6005.
- De Long, J., Summers, L. (1992). ‘Equipment Investment and Economic Growth’, Quarterly Journal of Economics, 106, 2, pp. 445-502.
- Greenwood, J., Hercowitz, Z., Krusell, P.(1997). ‘Long-Run Implications of Investment-Specific Technological Change.’ American Economic Review, 87, 3, pp. 342–362.
- Hornstein,A., Krusell, P. (1996). ‘Can Technology Improvements Cause Productivity Slowdowns?” In NBER Macroeconomics Annual 1996, eds. Julio J.Rotemberg and Ben S. Bernanke. Cambridge, MA: MIT Press.
- IMF (2013). ‘Central, Eastern and Southeastern Europe: Faster, Higher, Stronger – Raising the Growth Potential of CESEE’, Regional Economic Issues, October 2013.
- IMF (2012). ‘Republic of Belarus: Selected Issues’, IMF Country Report No.12/114.
- Kruk, D., Bornukova, K. (2014). ‘Belarusian Economic Growth Decomposition’, Belarusian Economic Research and Outreach Center, Working Paper No.24
- Skare, M., Sinkovic, D. (2013). ‘The Role of Equipment Investments in Economic Growth: Cointegration Analysis’, International Journal of Economic Policy in Emerging Economies, 6, 1, 2013.
- World Bank (2012). ‘Belarus Country Economic Memorandum: Economic Transformation for Growth’, Country Economic Memorandum, Report No. 66614.
Culture, Cold War, and Trade
This study evaluates how the impact of cultural differences on trade evolves over time, especially after the Cold War. We show that the negative influence of cultural differences on trade has increased over time. More specifically, it is more prominent in the post-Cold War era than during the Cold War. For instance, two countries with distinct religious majorities have 35% lower bilateral trade flows in the post-Cold War period compared to countries sharing the same majority religion. This negative effect was less than half during the Cold War (16%). In addition, we provide an explanation for the differential impact of cultural differences over time. By mapping out the transition of the effects of cultural and ideological dissimilarities, we show that cold-war ideological blocs might be a reason for the suppression of cultural differences during the Cold War. Therefore, long-term cultural determinants of trade gain more significance by the end of the Cold War and replace ideological differences as a major impediment to international trade.
Equity and Efficiency in the Latvian Tax-Benefit System
There is a trade-off between two major objectives of a tax-benefit system: equity and efficiency. The tax-benefit systems that redistribute a lot of income tend to generate disincentives to work. The tax-benefit systems that create good incentives to work and earn, are less effective in mitigating poverty, social exclusion and deprivation. In this brief we argue that, when contrasted to other EU countries, the Latvian tax-benefit system is less effective in achieving either of the objectives.
Equity-Efficiency Trade-Off
There is a fundamental trade-off between the two principal objectives of a tax-benefit system – income redistribution and efficiency. On the one hand, income redistribution is desirable as it helps to mitigate socially undesirable market outcomes such as poverty and deprivation. On the other hand, more income redistribution is often associated with higher distortions to labour supply and work effort.
There is no universal prescription as to how much a government should redistribute. The answer to this question depends, among other factors, on the relative value that society (government) assigns to the welfare of different population groups, and on the individuals’ labour supply elasticity.
However, a given degree of income redistribution can be achieved at a different cost of efficiency. In this brief, we analyse the degree of income redistribution generated by the tax-benefit system and work incentives in Latvia in the context of other EU countries. In our analysis, we use the European microsimulation tax-benefit model EUROMOD (Sutherland and Figari, 2013) version G2.0, EU-SILC data, and the analysis framework developed by Jara and Tumino (2013).
Income Redistribution in the EU
EU countries differ substantially in terms of inequality of original income and in terms of the degree of redistribution generated by the tax-benefit system (see Figure 1, data on 2007 and 2013). The Gini coefficient of equivalised household original income (which consists of income from employment and self-employment, property income, private pensions, private transfers and other relatively minor components) ranges from around 0.4 (Cyprus, Netherlands) to almost 0.55 (Romania in 2007, Ireland in 2013).
Inequality of original income in Latvia in 2007 was at the EU average level (Gini coefficient of 0.47), but the degree of income redistribution generated by direct taxes, benefits and pensions was the lowest in the EU. As a result, the inequality of disposable income in Latvia in 2007 was the highest in the EU (Gini coefficient of 0.37). Part of the answer as to why the degree of income redistribution in Latvia is so low is a relatively small contribution of pensions to redistribution – it is almost half of that observed in the EU on average, despite the fact that the share of public pension recipients in the total Latvian population in 2007 was above the EU average. Another important factor was the very minor role of means-tested benefits: in the EU on average, means-tested benefits generate a reduction in Gini coefficient by about 0.02, while in Latvia the corresponding figure is just one tenth of this.
Figure 1. Gini coefficients of original equivalised household income and degree of redistribution generated by tax-benefit systems in the EU in 2007 and 2013
Source: EUROMOD statistics, authors’ calculations.
In the course of the crisis and the following recovery, the degree of redistribution in Latvia increased (see lower panel of Figure 1). An important factor behind the increase was growing number of pension recipients and an increase in the average size of pensions (both in absolute terms and relative to employment income). The increase in the number of pension recipients was not a result of changes in eligibility criteria, but was due to population ageing and the fact that more people applied for other types of pensions. The growth in the average size of pension was due to generous indexation of pensions in 2008 and compositional changes, as pensions of new pensioners until 2012 were larger than the average pension. Another reason for a growing degree of redistribution was an increase in the size and the number of recipients of means-tested benefits (mainly Guaranteed Minimum Income (GMI) benefit). This was a result of reforms in the provision of the means-tested benefits and of falling incomes from employment, which made more people eligible for the social assistance programmes. Nevertheless, despite the increase in recent years, the degree of income redistribution in Latvia remains one of the lowest in the EU.
Work Incentives
The existence of a trade-off between income redistribution and better work incentives suggests that tax-benefit systems that ensure less income redistribution are likely to generate better work incentives. Jara and Tumino (2013) have demonstrated the existence of this trade-off in the EU countries in 2007-2010 by identifying a negative and statistically significant correlation between Gini coefficients and Marginal Effective Tax Rates (METR). The METR is a measure that is commonly used to quantify work incentives at the intensive margin. It shows what proportion of a small increase in earnings (which results from e.g. an increase in the supplied hours of work) is lost as a result of extra tax payments or foregone benefits that the person is no longer eligible for after the increase in earnings. The negative correlation identified in Jara and Tumino (2013) suggests that countries with less income redistribution (i.e., higher Gini coefficients) tend to have better work incentives (lower METRs).
In Latvia, the mean METR in 2013 was 32.2%, only slightly below the EU average (34.5%), and much higher than the average in Estonia (22.8%) and Lithuania (27.4%), despite a lower degree of income redistribution (EUROMOD statistics). Another feature of the Latvian tax-benefit system is that it is characterised by especially high METRs for poor individuals. Thus, in 2013, 94% of individuals who faced METRs in excess of 50% belonged to the two bottom deciles of distribution of equivalised disposable income. This is different from many other European countries, where distribution of high METRs is either more even across deciles or rising towards the top end of income distribution (Jara and Tumino (2013), data for 2007).
The main reason for high METRs faced by the poorest population groups in Latvia is the design of means-tested benefits (GMI and housing benefits), which generates 100% METRs for the recipients of these benefits. Namely, for each additional euro earned, the amount of benefit is reduced by one euro, which leaves the net income unchanged. This adversely affects employment incentives for the poorest individuals and increases the poverty risk.
Figure 2 illustrates mean METRs by deciles of equivalised disposable income in Latvia and shows the contribution of taxes, benefits and social insurance contributions (SICs) to the mean METRs. It clearly demonstrates that high METRs in the bottom deciles result mainly from the contribution of benefits, which disappears in the fourth decile. The contribution of SICs is slightly smaller in the bottom decile, which is due to the fact that the proportion of employed individuals is smaller in the bottom decile. For the same reason, and also because of basic tax allowances, the contribution of direct taxes is smaller in the bottom deciles, but then the contribution of taxes levels off, reflecting the Latvian flat tax rate.
Figure 2. The contribution of direct taxes, benefits and social insurance contributions (SIC) to METRs in Latvia by deciles of equivalised disposable income in 2013
Source: authors’ calculations using EUROMOD-LV
In their study on the incentive structure created by the tax and benefit system in Latvia, the World Bank (2013) pointed out the problem of bad work incentives generated by Latvian means-tested benefits. Our results, which are based on a population-representative database of incomes, also identify means-tested benefits as the major contributor to high METRs in the lowest deciles of the income distribution. Another concern expressed by the World Bank (2013) was that the problem of informal employment (either in the form of undeclared wages or work without a contract) can be exacerbated by high participation tax rates and METRs.
Conclusion
The Latvian tax-benefit system is characterized both by a relatively low degree of income redistribution and relatively weak work incentives, as measured by METRs. Recipients of means-tested benefits (GMI and housing benefits) are faced with 100% METRs, as benefits are withdrawn at the same rate as household income rises. This creates disincentives to increase labour supply for low-paid/low-skilled individuals, and hence creates a risk of poverty traps. Evidence from the literature suggests that the labour supply of low paid workers is particularly sensitive to the incentives generated by the tax-benefit system, hence reforms that would bring down METRs in the bottom deciles could yield positive results in terms of employment of low paid/low skilled workers.
A potential reform is to introduce either a gradual phasing out of the means-tested benefits, or to exclude a certain amount of employment income from the income test for the means-tested benefits. Such reforms would be targeted at the bottom end of the income distribution, help combat poverty, improve the incentive structure of the Latvian tax-benefit system, and positively affect the labour supply of low-skilled/low-paid workers.
References
- EUROMOD statistics on Distribution and Decomposition of Disposable Income, accessed at http://www.iser.essex.ac.uk/euromod/statistics/ using EUROMOD version no. G2.0, retrieved on October 14, 2014
- Jara, H. Xavier & Alberto Tumino (2013). “Tax-benefit systems, income distribution and work incentives in the European Union,” International Journal of Microsimulation, Interational Microsimulation Association, vol. 1(6), pages 27-62.
- Sutherland, Holly & Francesco Figari (2013). “EUROMOD: the European Union tax-benefit microsimulation model,” International Journal of Microsimulation, Interational Microsimulation Association, vol. 1(6), pages 4-26.
- World Bank (2013). “Latvia: “Who is Unemployed, Inactive or Needy? Assessing Post-Crisis Policy Options”. Analysis of the Incentive Structure Created by the Tax and Benefit System. Financial Incentives of the Tax and Benefit System in Latvia,” European Social Fund Activity “Complex support measures” No. 1DP//1.4.1.1.1./09/IPIA/NVA/001