Author: Admin
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
- Bockerman, Petri and Pekka Ilmakunnas. 2006. “Do job disamenities raise wages or ruin job satisfaction?” International Journal of Manpower 27 (3):290–302.
- 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
- Gorodnichenko, Yuriy, Klara Sabirianova Peter, and Dmitriy Stolyarov. 2010. “Inequality and Volatility Moderation in Russia: Evidence from Micro-Level Panel Data on Consumption and Income.” Review of Economic Dynamics 13 (1):209–237
- Guerriero, Marta. 2012. “The Labour Share of Income around the World. Evidence from a Panel Dataset.” URL http://www.sed.manchester.ac.uk/idpm/research/publications/wp/depp/documents/deppwp32.pdf. Working Paper
- Hamermesh, DS. 1999. “Changing inequality in markets for workplace amenities.”Quarterly Journal of Economics 114 (4):1085–1123.
- Hensler, Deborah R., M. Susan Marquis, Allan Abrahamse, Sandra H. Berry, Patricia A. Ebener,Elizabeth Lewis, Edgar Lind, Robert J. MacCoun, Willard G. Manning, Jeannette Rogowski, and Mary E. Vaiana. 1991. “Compensation for Accidental Injuries in the UnitedStates.” RAND Corporation Report Series R3999, Santa Monica, CA: RAND Corporation. URL http://www.rand.org/pubs/reports/R3999
- Keogh, J. P., I. Nuwayhid, J. L. Gordon, and P. W. Gucer. 2000. “The impact of occupational injury on injured worker and family: outcomes of upper extremity cumulative trauma disorders in Maryland workers.” American journal of industrial medicine 38 (5):498–506. Research Support, U.S. Gov’t, P.H.S
- Lokshin, Michael and Martin Ravallion. 2005. “Rich and powerful?: Subjective power and welfare in Russia.” Journal of Economic Behavior & Organization 56 (2):141–172.
- Marquis, M. S. and W. G. Manning. 1999. “Lifetime costs and compensation for injuries.” Inquiry: a journal of medical careorganization, provision and financing 36 (3):244–254. Research Support, Non-U.S. Gov’t.
- 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).
- Ostry, Jonathan David and Andrew Berg. 2011. “Inequality and Unsustainable Growth: Two Sides of the Same Coin?” IMF Staff Discussion Notes 11/08, International Monetary Fund.
- Rosen, Sherwin. 1986. “The Theory of Equalizing Differences.” In Handbook of Labor Economics, edited by O. Ashenfelter, R. Layard, P.R.G. Layard, and D.E. Card, v.2, chap. 12. North-Holland, 641–692.
- Senik, Claudia. 2009. “Direct evidence on income comparisons and their welfare effects.”Journal of Economic Behavior&Organization 72 (1):408–424.
- Wilkinson, R. and K. Pickett. 2010.The Spirit Level:Why Equality is Better for Everyone. Penguin Books Limited.
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
Effects of International Taxation on Firm Valuation: Evidence from Japan’s 2009 Tax Reform
This brief highlights the results of a study of Japan’s 2009 adoption of a territorial tax regime exempting corporations’ foreign earnings from domestic taxation. We examine stock market reactions to events leading to the adoption of a dividend exemption system. We use an event study methodology leveraging firm characteristics and accounting for confounding effects from recent financial market developments. We find that relative to other Japanese multinationals, firms facing lower effective tax rates on their foreign operations benefit disproportionately from the reform. Surprisingly, firms with less foreign exposure and fewer opportunities for tax avoidance experience relatively larger abnormal returns overall. We attribute these gains to a combination of enhanced opportunities for international expansion among smaller domestic firms, direct tax savings on undistributed foreign earnings, and general cultural biases against tax planning.
As firms’ operations have expanded their global reach, corporate taxation has become inextricably tied to the taxation of multinational firms’ (MNCs’) foreign earnings. Correspondingly, international tax issues including tax avoidance, tax competition, and multinational competitiveness have dominated discussions on corporate tax reform. Much of the debate focuses on the choice over worldwide (residence-based) versus territorial (source-based) taxation. This brief summarizes a study by Bradley, Dauchy, and Hasegawa (2014) in which we aim to capture the full range of possible effects of Japan’s 2009 adoption of a 95 percent foreign dividend exemption system on firm after-tax profitability by examining stock market reactions around key events leading to the reform. More specifically, our study looks into abnormal stock returns (ARs) defined as extra-normal firms’ returns below or beyond what the market would have predicted, absent the event. ARs surrounding key event dates leading to the reform are used to quantify current and future tax savings on repatriated earnings as well as benefits flowing from firms’ enhanced ability to compete in foreign markets.
Japan’s 2009 Tax Reform
From 2003 to 2009, 10 OECD countries switched from worldwide to territorial tax regimes; the latest and most consequential among these being Japan and the United Kingdom. Motivated by a desire to encourage domestic reinvestment of accumulated foreign earnings, and to enhance Japanese firm competitiveness in foreign markets through reduced tax and compliance costs, the Japanese dividend exemption system arose from a short succession of tax policy discussions. Given the tightly structured nature of Japan’s annual tax reform process, the most informative and authoritative events in the sequence that we consider, are thus the initial May 9, 2008 announcement. The Ministry of Economy, Trade, and Industry (METI) was then instructed to analyze the consequences of adopting a territorial tax regime. This announcement was followed by two subsequent Cabinet meetings, in which details of the proposed reform were refined and ultimately endorsed on June 27, 2008 and January 23, 2009, respectively.
Our data and identification strategy
For our analysis, we use data from Datastream, which consist of daily stock market returns for the largest quartile (by market capitalization) of publicly listed Japanese, U.S., and German firms. These data are combined with annual financial statement information from Orbis on each publicly listed Parent Corporation and all of their foreign subsidiaries. Adapting the standard market model event study methodology, returns on U.S. and German market portfolios are incorporated in our determination of abnormal Japanese stock returns. This is to control for potential confounding events associated with the global financial crisis. Conversely, we also study possible spillover effects of the reform in the U.S. and German markets. The idea is to identify whether the Japanese reform may have affected the prospects for adoption of a territorial tax regime in the U.S.—which now accounts for around 80 percent of GDP among the remaining OECD worldwide regimes – or how this may have affected U.S. and German firm competitiveness, the latter being subject to a dividend exemption system very similar to Japan’s under Germany’s long-standing territorial tax system. Significant differences in investor reactions across the Japanese, U.S., and German markets around our event dates are hence informative about the different channels by which the Japanese reform was perceived to impact firm after-tax profitability.
Figure 1. Cumulative Abnormal Returns on May 9, 2008, by Firm Nationality and Multinational Status.
Notes: This figure plots cumulative abnormal returns (CARs) within a 5 trading-day window centered around the May 9, 2008 event, defined as the sum of daily ARs. ARs are the mean cross-sectional prediction errors derived from estimation of the standard market model including market portfolio returns drawn from the Japanese, U.S., and German exchanges over the last 250 trading days ending 20 days before the first event. Tests of statistical significance (in red) follow Kolari and Pynnönen’s (2010) “adjusted BMP” methodology.
Moreover, we leverage the location of foreign subsidiaries and financial statement characteristics of both parents and subsidiaries to estimate in a single step the contribution to ARs from particular firm attributes. Among these, we emphasize simple distinctions between domestic and multinational firms, or the ownership of at least a single subsidiary in a tax haven, as a proxy for tax planning sophistication. A direct measure of tax savings on the repatriation of accumulated foreign earnings is calculated as the difference between the average effective tax rate on domestic and foreign operations. Further interactions of this potential tax savings rate with measures of intangible intensity are intended to distinguish prospects for future tax savings on intangibles-facilitated income reallocation.
Unexpected Winners
A striking point that emerge from Figure 1 is that Japanese market reactions generally appear larger in magnitude among domestic firms than MNCs. Statistically-significant 1-2 percent cumulated abnormal returns (CARs) observed among the former group appear to validate one of the Japanese reform’s objectives of facilitating expansion of smaller firms into overseas markets (Toder, 2014).
It is also noteworthy that the positive effect on Japanese firms is unmet by comparable reactions in either German or U.S. markets, such that the observed effect in Japan is more credibly attributable to the METI announcement — itself evidently either ignored or perceived as unimportant for U.S. and German firm profitability.
Table 1. Cumulated Event Date AAR Effects by Nationality and MNC Status
Notes: Significance levels are designated as *** (1 percent), ** (5 percent), and * (10 percent). Cumulated marginal effects measure ARs averaged over each three-day event window (AARs) and summed across Cabinet meeting dates.
These results appear to be reinforced after accounting for key firm characteristics, albeit in a nuanced way. Over the course of the full sequence of three Cabinet meeting dates, Japanese MNCs experienced significantly worse cumulated average abnormal returns (AARs) than their domestic counterparts, equal to a difference of 3.8 percent of market capitalization through the end of the January 23, 2009 event window (see Table 1).
As Predicted, Firms with Larger Tax Savings Potential Are Net Winners
Underlying these differences by multinational status, the rate of anticipated tax savings resulting from the reform is nevertheless associated with substantial positive effects on Japanese MNC valuations, with the largest such contributions arising around the last Cabinet meeting date. Over the course of all three events, a 10-percentage point increase in the tax savings rate was associated with AARs of 0.31 percent (top panel of Table 2). Applied to the set of Japanese firms in our sample with an observed average tax savings rate of 21.5 percent, this implies aggregate savings just slightly in excess of predicted tax savings on the repatriation of ¥17 trillion in undistributed earnings held by foreign subsidiaries of Japanese firms in fiscal 2006 according to the best available estimates prior to reform (METI, 2008).
Table 2. Cumulated Event Date AAR Effects among MNCs, by Nationality
Notes: See notes for Table 1.
More sophisticated or tax aggressive firms with subsidiaries located in tax havens performed relatively worse than other Japanese MNCs, while firms in industries characterized by heavier reliance on intangibles likewise saw no additional gains in relation to potential tax savings on future shifted earnings.
Conclusion
Our study reveals that the Japanese adoption of a territorial regime was, at least initially, perceived as being disproportionately valuable for firms that might previously have been deterred from expanding overseas due to international tax compliance issues and lack of competitiveness under the previous worldwide regime, consistent with one of the motives for the reform. More tax savvy Japanese MNCs may have benefited disproportionately less, in part, because the previous regime was not limiting their ability to borrow from their affiliates, or simply because of a lack of interest in tax planning, as is widely reported among tax practitioners.
Our study confirms the importance of the most direct source of gains from adoption of a territorial tax regime – namely, the tax savings on immediate repatriations. At the same time, it highlights the perceived benefits among aspiring entrants into foreign markets of reductions in tax compliance costs and enhanced competitiveness in foreign markets.
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References
- Bradley, Dauchy, and Hasegawa. CEFIR/NES WP Series, No. 201, September 2014. http://www.cefir.ru/index.php?l=eng&id=35
- Kolari, J. and S. Pynnönen (2010), “Event Study Testing with Cross-sectional Correlation of Abnormal Returns,” Review of Financial Studies, Vol. 23, No. 11, pp. 3996–4025.
- Ministry of Economy, Trade and Industry of Japan (2008), “Repatriations of Foreign Profits by Japanese Enterprises: Toward the introduction of a dividend exemption regime (In Japanese: Wagakuni Kigyo no Kaigairieki no Kanryu nitsuite).” http://www.rieti.go.jp/en/columns/a01_0387.html#note2.
- Toder, Eric (2014), “Review of the Conference on What the United States Can Learn from the Experience of Countries with Territorial Tax Systems,” Urban Institute, Washington D.C., June 18. http://www.urban.org/publications/413159.html
Meeting Qualification Mismatch with Vocational Training
While in an ideal world the qualification preferences of job seekers and employers would coincide, in reality this is often not the case. Besides informational asymmetries (job seekers not knowing which qualifications are demanded by employers) the reason is that employers may be in need of qualifications that are not considered attractive by the job seekers. In the country of Georgia, we want to address this problem through a “recommendation system” which will suggest vocational training to job seekers. There are two main problems to be tackled in this project: (1) How can we decide what would be the most useful qualification for a given job seeker, and (2) how can we incentivize the job seekers to follow our recommendations? This policy brief discusses our approach to this problem.
Introduction
Qualification mismatches are common in many labor markets around the world (see for example, Ghignoni and Verashchagina (2014) for Europe, McGuinness and Sloane (2011) for the UK, and Béduwé and Giret (2011) for France). It is well known that qualification mismatch is a relevant problem also in the country of Georgia, as was shown in various studies (see ISET (2012) and The World Bank (2013)).
The ISET Policy Institute (ISET-PI) was commissioned by the World Bank to assist the Social Service Agency (SSA) of Georgia, an agency of the Ministry of Labor, Health, and Social Affairs, in developing a system which will recommend vocational training to job seekers with the aim to reduce the qualification mismatch in Georgia.
Job Seekers’ Preferences Matter
Vocational training addresses the needs of two different groups. It is demanded by job seekers, who want to improve their human capital in a way that matches their preferences and, in the optimal case, maximizes their chances to get back into employment. At the same time, vocational training also addresses the needs of employers, whose businesses may face shortages in qualified personnel.
It is not enough to only include employers in the analysis if one wants to effectively fight the qualification mismatch. If one does not consider job seeker’s preferences, it may happen that people prefer to not participate in the vocational training system at all. Even if one can effectively incentivize job seekers to attend training programs, as is the case in Germany for example, where the refusal to participate in training is sanctioned by a reduction of unemployment benefits (cf. Neubäumer (2012)), it is likely that involuntary training will be less effective. Therefore, it is problematic that most studies which analyze the demand for qualifications in the job market, for example for the European Union (Lettmayr and Nehls (2012)), New Zealand (Earle (2008)), and Australia (Shah (2010)), exclusively focus on employers and neglect the preferences of the people who are to be trained. In Georgia, we will do it differently.
Why Would Job Seekers Follow Our Recommendations?
The objective of the recommendation system we develop is to maximize the impact the training has on the employment chances of the job seeker. Arguably, this is also the primary goal for most job seekers, as they often state that they want to receive training in an “employable” profession. Therefore, if the purpose of the recommendation system is communicated properly, and if it is transparent and trustworthy, the job seekers may want to voluntarily follow its advice.
Recommendation System vs. Matching Algorithm
One can think of two different ways of advising job seekers in their training choices: recommendation systems and matching algorithms.
Recommendation systems make suggestions to job seekers separately. These kinds of systems are ubiquitous on the Internet. For example, Amazon.com proposes books to its customers based on their purchasing history. In a similar way, a recommendation system for vocational training would suggest vocational training programs to job seekers based on relevant data about their characteristics and the job market situation. Yet its major shortcoming is that a recommendation system will not take into account what other job seekers do and what recommendations were given to them.
For that reason, in a recommendation system, it can happen that the number of people recommended to choose a certain program is larger than that program’s capacity (because the advice comes as a ranking, this does not cause the system to be useless, as the job seeker may then choose the program which is highest in the ranking and which has free places).
Likewise, if many job seekers follow the advice of the recommendation system, oversupply and undersupply of certain qualifications in the job market is not ruled out. This is again due to the fact that recommendations are made separately. If there is a huge demand for, say, plumbers, and many people receive the advice to receive training in plumbing, this may subsequently cause an oversupply of plumbers.
In contrast, a matching algorithm aims at an overall optimum for the whole group of job seekers. Genuine matching algorithms do not make separate recommendations, but propose a globally optimal assignment. In Western countries they are used, for example, to match interns to hospitals, students to universities, and kidneys to dialysis patients. Matching theory is one of the most successfully applied subfields of game theory, acknowledged through the award of the Economics Nobel Prize of 2012 to matching theorist Alvin E. Roth. The standard survey of matching theory is Roth and Sotomayor (1990).
In a matching algorithm, the abovementioned problems of a recommendation system would not occur (up to statistical uncertainty), because the matching algorithm would take into account how the suggestions made by the system affect the demand for a program. It would aim to keep the number of people, likely to choose a program, to remain below its capacity.
While a matching algorithm is more ambitious, it also has disadvantages compared to a simple recommendation system. First of all, the data requirements are higher, as the capacities of programs have to be taken into account. More importantly, in a matching algorithm the recommendations will be generated in a way that is not transparent to the job seeker (though it is possible to give some general explanations). This may reduce acceptance and willingness to participate. The recommendation system, on the other hand, can work in a relatively transparent way. Finally, a recommendation system can be adjusted and changed on an ongoing basis by Social Service Agency personnel without the help of external experts. Given its complexity, this is hardly possible with a matching algorithm.
Therefore, it was decided that the simpler option of a recommendation system is to be pursued. Later, the system may be upgraded to a full-blown matching algorithm.
The Technical Aspects of How Recommendations are made
Consider the situation of a job seeker looking for vocational training. Through the envisioned system, they will receive a recommendation of which qualification to pick in the vocational training system of the SSA.
The pieces of information used for making this recommendation are personal characteristics of the job seeker (like age, gender, preferences, skills, and other information obtained through the website worknet.ge which is operated by the SSA) and the current and future economic situation in different sectors. To this end, we will use value added tax data that can be decomposed into 45 sectors and updated on a monthly basis. For forecasts, we will draw on the Business Confidence Index of ISET, which allows decomposition into 5 sectors.
Given the information about the job seeker and the economic environment in different sectors, we will answer the question: “How many months do we expect the job seeker to be unemployed in the year after the training if the training was in qualification X?” Here, X can be whatever is offered in the vocational training system at the location of the job seeker, for example welder, mechanic, accountant, or IT expert. Alternatively, we could answer the question: “What is the salary we expect the job seeker to have in the year after the training if the training was in qualification X?”
The recommendation made to the job seeker will be: “Choose the training in field X if somebody with your personal characteristics, given the economic situation and outlook, has the lowest expected number of unemployed months (or the highest salary) in X in the year after training in X was received.” This recommendation is likely to be accepted by the job seeker if also the job seeker wants to maximize their employment chances (or maximize salary).
The forecast can be made using econometric regression analysis. Let i be a job seeker and xi be the number of months unemployed in the year after training was received. Then we have for each qualification one estimation equation
where alpha is the intercept and the betas are the coefficients for different personal and economic characteristics. When the alpha and beta coefficients are known, then one can enter the specific data for a job seeker and forecast how long it would take him to find a job if training would be received in a particular field.
For estimating the coefficients, no recommendations will be made for some time (like 3 months) after the system is launched and only information will be collected. The SSA or a specialized survey agency will call the job seekers every month after they received training and ask whether they found employment. Job seekers who received training through the SSA will be obliged to answer this question truthfully. Information about the characteristics of the job seeker is known through their participation in the worknet.ge system, which is a requirement for anybody who wants to receive vocational training through the SSA.
When the recommendation phase starts, further data will be collected. Errors in the estimation of the coefficients will be corrected “automatically” through the feedback (in terms of job market performance of the trainees) that the system gets on an ongoing basis. To increase this effect, the database used for the estimation of the coefficients will be “rolling”, i.e. people who recently received training will be added while those who received training a longer time ago (e.g. one year or more) will be removed from the database.
Conclusion
In Georgia, ISET will design and implement a recommendation system for vocational training, addressing the qualification mismatch in the labor market. As in many other areas, Georgia is willing to go for innovative policy solutions making use of advanced economic methods, very much in line with the country’s reputation as one of the top reformers in the world.
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References
- Béduwé, Catherine and Giret, Jean-Francois (2011): “Mismatch of vocational graduates: What penalty on French labour market?”, Journal of Vocational Behavior 78, pp. 68-79
- Earle, David (2008): “Advanced trade, technical and professional qualifications: Matching supply to demand”, New Zealand Government Ministry of Education, Auckland.
- Ghignoni, Emanuela and Verashchagina, Alina (2014): “Educational qualifications mismatch in Europe. Is it demand or supply driven?”, Journal of Comparative Economics, in press
- ISET (2012): “National Competitiveness Report for Georgia”, Tbilisi.
- Lettmayr, Christian F. and Nehls, Hermann (2012): “Skills supply and demand in Europe: Methodological framework”, CEDEFOP Working Paper No. 25
- McGuinnes, Seamus and Sloane, Peter J. (2011): “Labour market mismatch among UK graduates: An analysis using REFLEX data”, Economics of Education Review 30, pp. 139-145
- Neubäumer, Renate (2012): “Bringing the unemployed back to work in Germany: training programs or wage subsidies?”, International Journal of Manpower 33, pp. 159 – 177
- Roth, Alvin E. and Sotomayor, Marilda (1990): “Two-Sided Matching: A Study in Game-Theoretic Modeling and Analysis”, Econometric Society
- Shah, Chandra (2010): “Demand for qualifications and the future labour market in Australia 2010 to 2025”, Center for the Economics of Education and Training Working Paper, Monash University
- The World Bank (2013): “Georgia: Skills Mismatch and Unemployment Labor Market Challenges”, World Bank Report No. 72824-GE
How Transport Links Help Market Integration: the Case of Moscow Office Rental Market
This brief is based on a research project on the Moscow office real estate (Ignatenko & Mikhailova, 2014). We study the market for office space rentals in Moscow. Our main interest regards spatial competition: when an object is rented, does the rental rate respond to the behavior of competing objects in a geographical vicinity? What is the geographical extent of the market, and how do urban transportation links help integrate local markets and extend the geographical scope of competition? We find that urban transportation “shortens” the effective distances and intensifies competition between geographically differentiated objects. The effects are modest but statistically significant.
We analyze a unique dataset on office space rental deals in Moscow in 2001-2010. The dataset was collected by an analyst team at Cushman & Wakefield Russia and includes all the deals on office spaces that were publicly advertised, with detailed and verified information on the object characteristics, rental prices, and the contract dates. We also have information on the object’s location – precise geographical coordinates – and thus we are able to study this market at a very detailed level of geographical aggregation.
Moscow Office Rental Market in 2001-2010, an Overview
The market for office space in Moscow went through a stage of rapid growth through 1990s and 2000s. Economic development drove the demand for all types of offices at all price ranges. The demand was met by a conversion of residential and industrial spaces into offices, as well as by new construction. In our sample, the top year in terms of the number of transactions was 2005, with a slight decline in the years after, and a somewhat sharper drop in 2009 after the global financial crisis. The composition of different types of offices and their characteristics have changed toward slightly higher quality through that decade: the share of transactions with class A and B+ offices was steadily rising (see Figure 1).
Figure 1. Number of Office Rental Transactions by Year and Class of Office
Source: Authors’ own calculations.
Up until the third quarter of 2008, the rental rates were constantly increasing. Average office rental prices in Moscow grew more than two-fold during 2001-2008, but fell almost to the initial level after the global financial crisis and the subsequent crush of the market. Figure 2 illustrates the quarterly index of simple average office rental rates and the corresponding hedonic price index. A hedonic index is constructed using a regression of the objects’ prices onto the observed characteristics of the objects and a set of time period indicators. Thus, the regression decomposes the overall price into the contributions of object quality and time period. The estimated time effects give the hedonic index, cleaning the time series of prices from all of the effects of changes in quality. Interestingly enough, the value of the hedonic index at the beginning of 2010 was exactly at the same level as in 2001. Thus, although the average price level was higher in 2010, all the price gains can be attributed to an increase of the average object’s quality.
Figure 2. Average Price and Hedonic Price Index of Moscow Office Rentals, 2001-2010
Source: Authors’ own calculations.
In Moscow we observe a typical behavior of the real estate market during booms and busts. While prices rise, tenants switch to lower quality objects to fit the budget, and the hedonic index rises faster than the average price. When prices fall, tenants support the higher end of market, looking for high-quality bargains, and the hedonic index falls faster than the average price. Overall, Moscow real estate market fits the basic stylized facts.
A hedonic analysis reveals the value of the object’s characteristics in the eyes of the consumer. The presence of transport infrastructure creates direct benefits. Consumers value an accessible transport infrastructure: offices lose 9% of rental price for each 10 minutes of walking distance to the nearest subway station. It is easy to calculate the surplus from a new subway line: it would increase the value of the land and real estate objects in the area of service. Because land and real estate are supplied inelastically, the bulk of this benefit goes to the owner. Consumers (in our case, tenants) receive the benefit of shorter commuting time, but in exchange for higher rental prices.
In addition to these direct benefits, transport links also tend to promote market integration by making objects that are near and objects that are far away, more substitutable in the eyes of the consumer. Transport links lower the degree of product differentiation in the geographical dimension. And, as with any kind of product differentiation, this should limit seller’s market power and reduce prices. The benefits of increased competition (if any) go directly to consumers. We analyze competition between the offices for rent in the context of geographical distance to determine whether transport links indeed make competition stronger.
Spatial Competition and Transport Infrastructure
We use the dataset to study price competition between real estate objects. Real estate objects are best thought of as differentiated goods. Each object possesses a set of characteristics and a fixed location, i.e. objects are differentiated by consumer characteristics and by geography. Each object is essentially unique, but the owners’ market power is limited by competition. Competition between objects is stronger if objects are closer in consumer characteristics and in location, so that potential tenants view them as closer substitutes. An owner of an object reacts to the behavior of their competitors, i.e. sets the price reacting to the prices set by similar objects in the neighborhood. We study how the strength of price reaction depends on geographical distance between objects by estimating the slope of the reaction function of the owners in a price competition game.
Our estimates show that price reactions of competition from the neighboring objects are very modest. Hypothetically, if two offices of similar size in the same location are for rent, and one of them cuts a price by 10%, the other responds on average by cutting price by only 1.7%. Even at a zero geographical distance between competing objects, there is substantial market power, presumably because of strong differentiation in the other product characteristics. The response is weaker if competing objects are located further away from each other, and at 1.8 kilometers is statistically indistinguishable from zero, i.e. such objects practically do not compete.
When we consider competition inside a more narrowly defined class of offices (grouping A and B+ offices vs B- and C offices), the results change slightly. We find that offices compete mainly within their own class. The reaction to the prices of another class is not different from zero, even in the immediate geographical vicinity. For the offices within the same class the geographical range of competition extends from 1.8 km to 2.1 km, and the reaction to neighbor’s prices is slightly stronger, with an elasticity of 0.2.
As a next step, we include transport links into our measure of distance. Consider offices that are located on the same subway line, i.e. where a passenger can travel between locations without changing the line. Price response to such competing objects is not much stronger: about 22% of the shock, but it stays above zero at longer distances. Price responses become indistinguishable from zero only at a distance of about 4.7 km. Figure 3 compares the two estimated price response functions: for all offices and for offices of the same class and on the same subway line.
Figure 3. Price Response as a Function of Geographical Distance when Objects are Connected by a Direct Subway Line
Source: Authors’ own calculations.
To summarize, our findings confirm the old stylized fact: the real estate market is very “local”. It is local not only in a geographical sense, but also in a product space sense: objects compete only with similar objects and mainly in the immediate geographical neighborhood. Direct transportation links (subway) promote market integration: it “shortens” the effective distance and makes the geographical boundaries of a market much wider. In the case of office real estate, the effect on the price level is very modest. The price reaction is weak even in the immediate vicinity, and it decays quickly with the distance. Yet our research underscores that the effects of transportation links on market integration and competition are real and measureable, and should be considered in cost-benefit analysis of transportation projects.
References
Ignatenko, Anna and Tatiana Mikhailova “Spatial Competition and Transport Infrastructure: The Case of Moscow Office Rental Market”, mimeo, 2014
Decentralization Reform in Ukraine
The current Ukrainian political system, which is a highly centralized “winner-take-all” system, is one of the main causes of the recent mass street protests. A decentralization reform is needed to make the system more stable by providing people with more impact on policy making, and increasing accountability of the government. A decentralization reform would reduce paternalistic expectations and provide people with more opportunities to take responsibility for public policy design in their region. In addition, it would improve the quality of national politics by introducing more competition and allowing successful regional politics to spread to the national level. However, as all reforms, decentralization bears some risks. This policy brief discusses the benefits and risks of such reform, suggests some ways of mitigation of the risks, and the procedure for reform development.
“In decentralized systems, problems can be solved early and when they are small. And when there are terrible failures in economic management—a bankrupt county, a state ill-prepared for its pension obligations—these do not necessarily bring the national economy to its knees.” / Nassim Taleb
In their path-breaking article Roger Myerson and Tymofiy Mylovanov argue that the underlying reason for the Ukrainian street protests in 2004 and 2014 is a fundamental flaw in the country’s Constitution, namely, the design of its government system. Currently, it is basically a “winner-take-all” system, where a winner of the national elections gains almost a dictator’s power, and then tries to prolong his stay in office with all means.
Such a system – where almost all the power is concentrated in the hands of the central government, and where local authorities, even the elected ones, have very little room for their own decisions – resembles an inverted pyramid and is therefore unstable. A natural way to stabilize the system is to put the pyramid on its foundation – i.e. to provide people with more impact on (and responsibility for!) both local and central government policy.
However, the Ukrainian government has announced a decentralization reform, and has already adopted a Decentralization Concept, which defines the main goals and milestones of the reform. According to the Concept, the legislative base for the decentralization should be developed by the end of 2014. However, it is clear that these plans are unrealistic. This, since on top of Constitutional changes, the reform implies changes to the administrative structure of the country, a redistribution of responsibilities between different levels of local government, and changes to the Tax Code, the Budget Code, and to several other documents. Such a scope of reforms is hardly attainable within the planned timeframe.
So far, the President’s office has developed changes to the Constitution, and the Cabinet of Ministers has drafted changes to the Budget Code. However, both documents miss the main point of the reform – empowering of people (rather than simply delegating some responsibilities from central to local governments). Instead, the drafted law on changes to the Constitution empowers the President, and the drafted changes to the Budget Code are an attempt of the central government to get rid of its “headaches” (e.g. ecological or social housing programs) while at the same time consolidating “electorally valuable” spheres, such as education and healthcare. This Draft Law proposes transferring some revenue sources from central to local levels, and at the same time to extract a part of the revenues that currently belong to local budgets to the central budget. A more detailed analysis of the proposed changes is provided in this article.
To my mind, the main impediment to the decentralization reform is a lack of a systemic approach. The Decentralization Concept does not provide a clear reform path, and changes to the legislation proposed so far look like pieces of a puzzle that do not fit together.
I suggest that the decentralization reform should be developed together with the administrative reform and proceed according to the following algorithm:
- Define functions of the state and distribute them between different levels of government according to a subsidiarity principle; i.e. a function should be transferred to the lowest government level capable of implementing it.
- Estimate the volume of funds needed to implement these functions.
- Assign sufficient revenue sources to local governments.
- If a community is too small to generate a sufficient revenue flow, merge several communities and repeat steps 3-4, keeping the distance between the center of such a united community and its most remote settlement below a defined limit.
- Establish feedback mechanisms through which people in a community could control the authorities and impact their decision-making. These mechanisms are not only elections, but also, more importantly, permanent between-elections activities, such as public hearings/discussions of drafts of local government decisions.
- Use a few communities as pilots and thus find out potential strengths and weaknesses of the proposed reform and make necessary corrections.
The outcome of this algorithm should be a logically connected package of legislative changes rather than a bunch of separate documents.
The development of this reform should be as transparent as possible, and accompanied by wide information and education campaigns about the opportunities that decentralization will provide, and the ways to use these opportunities. These information campaigns are necessary because many Ukrainians now think that decentralization (or federalization) is pushed by the Russian president in order to split Ukraine into parts.
As with all reforms, the decentralization has its potential benefits and risks, which should be accounted for. Fortunately, there exists both a wide academic literature and international experience on this issue.
The economic literature, both theoretical and empirical, does not unambiguously show that “decentralization is good”. Rather, a success of decentralization depends on a number of other factors, such as the presence of democracy (Inman, 2008) and a sufficient accountability of the government (both local and central).
In itself, decentralization does not lead to higher economic growth (e.g. the review of Feld et al, 2013). However, when accompanied by other growth-enhancing reforms, decentralization can positively impact a country’s economic development (Bardhan 2002).
Both the literature and experience of other countries suggest the following major risks of decentralization:
- Decentralization may increase corruption at the local level. If a local official is not accountable to a higher-level government, she may try to extract some rent from her position. This risk can be reduced by a high transparency of the government and working mechanisms of control of citizens over officials.
Indeed, Lessmann and Markwardt (2009) show that decentralization lowers corruption in countries with high levels of freedom of the press, and is harmful for countries where monitoring of the government is not efficient. Besides, Fan, Lin and Treisman (2009) find that “giving local governments a larger stake in locally generated income can reduce their bribe extraction”, i.e. for decentralization to lower corruption, the institutional setup should encourage local officials to create a favorable business environment in their regions.
- Decentralization may intensify secessionist movements. To lower this risk, the largest volume of responsibilities should be transferred to the lowest (community) level. It is rather easy for separatists to buy support of oblast-level officials and get control over an entire oblast. It would be much harder for them to buy every community head in an oblast. Moreover, getting control over an oblast, even rayon by rayon, let alone by community, is practically infeasible.
- Decentralization enhances initial inequality between regions – so the central government has to step in by providing subsidies/subventions to less developed regions (Cai and Treisman, 2005).
At the same time, the “bonuses” of decentralization are worth taking the risks:
- Reduction of tensions between the regions. In the Ukrainian situation, this implies removing grounds for mutual accusations that “one region feeds other regions” or “one region rules the entire country”. If a party that wins a majority in the national elections does not have extensive power over the daily life of people, they can more easily accept the fact this is not the party they voted for.
- Improvement of the national politics by increasing competition between local officials, and between local and central officials. As we know, competition typically increases the quality of a product. Political competition is no exception. As Myerson (2006) notes, “by creating more opportunities for politicians to build reputation as responsible democratic leaders, a federal [decentralized] system can effectively offer an insurance policy against general failure of democracy”. Thus, democracy and decentralization strengthen each other.
- More efficient government. On average, policy decisions will be made closer to their final beneficiaries and hence, will be more fitted to the needs of a certain community. At the same time, all levels of government will work more efficiently.
Decentralization does not imply a weakening of the central government. Rather, it frees its institutions from an unnecessary workload allowing them to concentrate on more strategic tasks, such as:
- protecting people’s rights by establishing a working judicial and security (police and army) systems;
- forming a strategic vision and general directions of the country’s development;
- protecting the country’s interests on the international level.
To make sure that decentralization does not result in feudalization, local officials should be controlled not only by local citizens but also by the central government (law enforcement); strong country-wide political parties would also help to hold the country together.
Conclusions
A decentralization of the Ukrainian political system is currently in the very focus of political, public and research debate.
However, this reform is not likely to be an easy one. The prerequisites for successful decentralization include functioning democratic mechanisms – fair elections, a free press and a strong civil society – resulting in government accountability. Also, for the decentralization reform to succeed, it needs to be coherently bundled with a range of political and administrative reforms (such as the development of a functioning judicial system, deregulation, reduction of rent-seeking opportunities etc.), and development and implementation of such a package is challenging and time-consuming.
At the same time, a wisely designed decentralization process will be highly beneficial for Ukraine, both politically and economically. It will strengthen democracy (by increasing people’s participation) and improve the quality of national politics by introducing more competition into the political system. It is also likely to significantly contribute to economic growth and prosperity, and these benefits make the decentralization reform in Ukraine a challenge worth undertaking despite of all the costs and risks.
References
- Bardhan, Pranab (2002). “Decentralization of Governance and Development,” Journal of Economic Perspectives, American Economic Association, vol. 16(4), pp. 185-205
- Brancati, Dawn (2006). Decentralization: Fueling the Fire or Dampening the Flames of Ethnic Conflict and Secessionism? International Organization. Vol.60, issue 03, pp. 651-685
- Cai, Hongbin and Daniel Treisman (2005). Does competition for capital discipline governments? Decentralization, globalization and public policy. The American Economic Review, Vol. 95, No. 3, Jun.2005
- Cai, Hongbin and Daniel Treisman (2009). Political decentralization and policy experimentation. Quarterly Journal of Political Science. Vol 4. Issue 1.
- Deiwiks, Christa, Cederman, Lars-Erik und Kristian S. Gleditsch (2012). Inequality and Conflict in Federations. Journal of Peace Research. March 2012 vol. 49 no. 2, pp. 289-304
- Enikolopov, Ruben and Ekaterina Zhuravskaya (2007). Decentralization and political institutions. Journal of Public Economics, No. 91, pp. 2261–2290
- Fan, C. Simon, Lin, Chen and Daniel Treisman (2009). Political decentralization and corruption: Evidence from around the world. Journal of Public Economics. Vol.: 93 (2009)
Issue: 1-2, pp: 14-34 - Inman, Robert P. (2008). Federalism’s Values and the Value of Federalism. NBER Working Paper 13735. http://www.nber.org/papers/w13735
- Lars P. Feld, Baskaran, Thushyanthan and Jan Schnellenbach (2013). Fiscal Federalism, Decentralization and Economic Growth: A Meta-Analysis. Public Finance Review 41 (4), 421-445
- Lessmann, Christian and Gunther Markwardt (2009). One Size Fits All? Decentralization, Corruption, and the Monitoring of Bureaucrats, CESIFO Working Paper No. 2662, Cat. 2: Public Choice.
- Myerson, Roger B. (2006). Federalism and Incentives for Success of Democracy. Quarterly Journal of Political Science, 2006, 1: 3–23
- Treisman, Daniel (2006). Fiscal decentralization, governance, and economic performance: a reconsideration. Economics and Politics, July 2006, 18, 2, pp. 219-35.
Gender and Development: the Role of Female Leadership
This policy brief reports on a discussion of the role of female leadership in development held during a full day conference at the Stockholm School of Economics on June 16, 2014. The event was organized jointly by the Stockholm Institute of Transition Economics (SITE) and the Swedish Ministry for Foreign Affairs, and was the fourth installment of Development Day – a yearly development policy conference. It is well known that women fall behind men on many markers of welfare and life opportunities, both in developed and developing countries. For most indicators, though, such as education and labor force participation, both the absolute and relative position of women tend to improve with economic development. However, in some areas the beneficiary effect of raising incomes is less clear. Access to leadership positions and decision-making roles are examples of such areas. To discuss this question, the conference brought together a distinguished and experienced group of policy oriented scholars and practitioners from government agencies, international organizations, civil society and the business community.