Tag: Labor Market

Gaming the System: Side Effects of Earnings-Dependent Benefits

Posted on January 30, 2017 | Policy Brief

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Today policy makers in developing and middle-income countries face tremendous challenges in combating various forms of tax evasion. Increasingly it is proposed to tie social security benefits to the reported income and in this way increase tax compliance incentives. We use administrative data from Latvia to study generous childcare benefits, which depend on the reported wages in the pre-childbirth period. Our analysis reveals pronounced wage growth shortly before the childbirth, which we rationalize by the legalization of previously undeclared wages. Obtained results show that the wage growth is temporary and lasts only until the end of the period, which is taken into account when calculating parental benefits.

Today policy makers around the world are increasingly preoccupied with reducing various forms of tax evasion. To provide tax compliance incentives it is often proposed to tie social security benefits to declared wages. For example, Kumler et al. (2013) show that a reform tying future pension benefits to the payroll tax in Mexico increased tax payments after the reform. Similarly, Cruces and Bergolo (2013) and Bergolo and Cruces (2014) demonstrate that a reform tying health care insurance of children to the reported earnings of parents increased “legal” labor supply in Uruguay.

On the other hand, Kreiner et al. (2016) document inter-temporal wage shifting in Denmark to enjoy significantly lower marginal tax rates. In light of the results by Kreiner et al. (2016), it is possible that employees and employers collude to increase the wage during the period, which is taken into account when calculating social security benefits. If the wage increase is temporary then the result of tying social security benefits to wages might be a net loss to the government finances. Hence, the question of whether tying social security benefits to reported wages is a solution to the problem of payroll tax evasion is still open.

We demonstrate that tying social security benefits to the declared wages can backfire to the extent that it can lead to the excessive payments of social security benefits, while doing almost nothing to reduce payroll tax evasion, in this way producing net fiscal loss to government finances. More specifically, we show that if the contribution period that determines the size of the benefit is relatively short and social security benefits are generous, then by colluding, employees and employers can temporally increase the legal wage to extract generous benefits afterwards. This result can have implications for the design of social benefit systems in many countries, where relatively short contribution periods ensure generous long-lived benefits afterwards.

Institutional background and methodology

We illustrate this phenomenon by studying the childcare benefit in Latvia, which in 2005-2008 depended on parents’ declared wage in the pre-childbirth period. This system, introduced in 2005, replaced a universal (very modest in size) childcare benefit. The new rules foresaw that one of the parents could receive a benefit that was equivalent to the parent’s previous net wage until the child became one year old. The average wage that determined the size of the benefit was calculated over the 12-months period that ended three months before the childbirth (hereinafter – benefit qualification period) and therefore included 5 months of pregnancy. Initially the benefit was not compatible with employment but as of March 2007 it became possible to simultaneously work full-time and receive the benefit.

Presumably, the 2005 reform created incentives to report higher earnings before the childbirth, because of the generosity of the new benefit and because the benefit qualification period included pregnancy, i.e., the period when the mother knows if/when she will be eligible for the benefit. To uncover the effects of the incentives to report more income, we use administrative data on declared monthly wages and use three sources of identifying variation in a difference in differences setup.

First, we compare wage growth during pregnancy with wage growth of women who did not become pregnant. The identifying assumption is that, in the absence of pregnancy, the wages of women who became pregnant would follow the same trend as the wages of other women. Under this assumption, any difference in the wage growth can be interpreted as a legalization of previously undeclared wages. However, this assumption may not hold because pregnancy is not randomly assigned across women: women can anticipate a wage increase (e.g. anticipate a promotion) and adjust the decision to have a child. Therefore, we use a second source of identifying variation by comparing wage growth during pregnancy for women employed in the private sector with wage growth for women employed in the public sector, where tax evasion is presumably absent. Assuming that promotion anticipation effects in the private and the public sector are identical, this difference in wage growth can be interpreted as the growth of wages resulting from wage legalization.

Our previous assumption might be violated if promotions in the public sector can be easier to predict (which means that anticipation effects in the private and the public sectors are not necessarily identical). To address this challenge, we use a third source of identifying variation coming from the 2005 reform, which tied the childcare benefit to the previous earnings. Since this reform increased incentives to disclose higher earnings during pregnancy, the difference in wage growth in the private sector versus public sector should not be observed before the reform.

Estimations are based on a matched employee – employer administrative dataset, which covers monthly-declared earnings of all employed workers in Latvia from 1996 to 2010.

Results

There are three main findings. First, wage growth during the first five months of the pregnancy in the private sector is always higher than that in the public sector. If we use this observation to obtain an estimate of the wage growth due to the legalization of previously undeclared wages, we find, depending on the regression specification, that it varies between 5 and 7 percent.

Second, this effect is mainly driven by the time period after the reform of 2005 (see Figure 1). Thus, if we use the time period before the reform of 2005 only to difference out permanent differences in the anticipation effects between public and private sector, our preferred regression specifications provide us with an estimate that varies from 5 to 6 percent.

Figure 1. Difference-in-difference-in-difference estimate by year, %

Note: difference in difference in differences estimate for a given year is calculated by first comparing wages of pregnant women with those of not pregnant before and during first five months of the pregnancy. Then this estimate is compared between public and private sectors. Everything is compared with respect to one year before the reform announcement – 2003.

The final finding shows that the sharp jump in the wage growth in private sector versus the public sector starts to appear exactly in the first month of the pregnancy (see Figure 2). It is important to note that we do not see any differential wage growth between the public and the private sector before the date of conception, indicating that potential anticipation effects are limited.

Figure 2. Difference-in-difference-in-difference-in-differences estimate by pregnancy month, %

Note: difference in difference in difference in differences estimate for a given month is calculated by first comparing wages of pregnant women with those of not pregnant in a given month with respect to one month before the date of conception. Then this estimate is compared between public and private sectors and finally previously calculated difference is contrasted before and after the reform tying parental benefits to reported wages.

Due to the fact that many women do not return to the same employer after childbirth, it is problematic to make inferences about the wage a woman receives once she returns to the labor market. To overcome this challenge we use the same social security data for men for the time period covering January 2007 until August 2010.

As explained previously, starting in March 2007 the childcare benefit became compatible with full time employment. The outcome of this reform was that many men started to receive the benefit, while continuing to work. This allows us to perform the previous analysis for the sample of men.

Results presented in the Figure 3 show that similarly as in the sample of women we see a sharp increase in the wage during the qualification period. Additionally, we see a slowdown in the wage growth once the qualification period ends. It is important to mention that displayed coefficients describe the difference between public and private sector in the change in wages between men whose partners became pregnant and those who did not with respect to the reference period (here one month before the conception date). We also record a sharp growth in wages in the public sector in the months following the childbirth. On the contrary, wages in the private sector stay the same, hence the large difference in the months following the childbirth.

Figure 3. Difference-in-difference-in-differences estimate for men by month of partner’s pregnancy, %

Note: difference in difference in differences estimate for a given month is calculated by first comparing wages of men whose partner became pregnant with those men whose partner did not become pregnant with respect to one month before the date of conception. Then this estimate is compared between public and private sectors

Conclusion

Drawing on the example of the childcare benefit in Latvia, we show that declared wages sharply increase during the period that is taken into account when calculating social security benefits. This wage growth is temporary and does not continue once the benefit qualification period is over. We interpret this phenomenon as the legalization of previously undeclared wages: this temporary legalization of earnings is possible, because the benefit qualification period is relatively short (12 months), and includes 5 months of pregnancy, which makes the average wage during the qualification period relatively easy to affect. Such setting creates bad incentives – an employee and an employer can collude to increase the average wage that determines the size of the benefit.

Additionally, our research casts doubts on policies tying parental benefits to declared earnings with an aim to reduce opportunity costs of high earners and increase their fertility. Researchers analyzing such policies should be very cautious when interpreting their results because the effect that they capture might not come from high earning women, but rather from women who manage to increase their income during pregnancy. Absent monthly data, it might be challenging to disentangle the two.

Many countries implement earnings-dependent benefits. Our results show that even very well designed social security benefits can and will be abused if people are given wrong incentives. Thus to achieve the best outcomes policy makers when deciding whether to tie social security benefits to declared earnings should take into account side effects described in this brief.

References

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Socio-Economic Policy in Poland: A Year of Major Changes in Benefits, Taxes, and Pensions

Posted on January 23, 2017 | Policy Brief

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2016 was the first full calendar year of the new Polish government elected to power in October 2015. The year marked a number of major changes legislated in the area of socio-economic policy some of which have already been implemented and others that will take effect in 2017. In this policy brief, we analyse the distributional consequences of changes in the direct tax and benefit system, and discuss the long-term implications of these policies in combination with the policy to reduce the statutory retirement age.

The Law and Justice party (Prawo i Sprawiedliwość, PiS) won an absolute majority of seats in both houses of the Polish Parliament in the parliamentary elections of October 2015. Earlier that year, Andrzej Duda of PiS was elected President of the Polish Republic. In both cases, the electoral victories came on the wave of pledges of significant financial support to families with children and to low-income households, especially pensioners. The new president pledged to cut back the pension age to the levels prior to the 2012 reform, which introduced a gradual increase from 60 and 65 to 67 for both women and men, and to nearly triple the income tax allowance. Following Duda’s victory in May 2015, PiS reiterated these pledges in the parliamentary election campaign and added the promise to increase the total level of financial support for families with children by over 140% through a nearly universal benefit called “Family 500+” and to hike the minimum wage by over 8%.

Despite a rather tight budget situation, the government went ahead with the “Family 500+” and successfully rolled it out in April 2016 (Myck et al., 2016a). The new instrument directs support of 500 PLN per child per month (110 EUR) to all second and subsequent children in the family in the age group between 0 and 17. Benefits for the first child in the family in this age group are granted conditional on overcoming an income threshold of 800 PLN (180 EUR) per person per month. Since April 2016, over 2.7 million families have received the benefit and 60% of them received the means tested support (if they have more than one child this is paid out in combination with the universal benefit).

The second key electoral pledge – to increase the tax allowance from 700 to 1,850 EUR at an estimated cost of 4.8 billion EUR – has so far been postponed (CenEA, 2015a). Increases in the allowance became a major policy issue in October 2015 when the Constitutional Tribunal ruled that maintaining its level below minimum subsistence, as it was at the time, was unconstitutional. To satisfy the Tribunal’s ruling, the allowance would have to increase to ca. 1,500 EUR at a cost of nearly 15 billion PLN (3.4 billion EUR, and about 0.8% of GDP, CenEA 2015b). Instead of a simple increase in the allowance, the government decided to implement a digressive tax allowance for 2017. This raised the value to the required minimum subsistence level for the lowest income tax payers, but since it is rapidly withdrawn as taxable income rises, the allowance will be unchanged to a large majority of taxpayers and will cost the public purse only 0.2 billion EUR (CenEA, 2016). This policy will be more than paid for by the fiscal drag given the decision to freeze all other parameters of the tax system, which will cost the taxpayers 0.5 billion EUR (Myck et al., 2016b).

The policies that directly affect household budgets will in total amount to about 5.5 billion EUR in 2017 (1.3% of GDP and 6.2% of the planned central budget expenditures) and will include also an increase in the minimum pension to benefit about 1.5 million pensioners. The cost of the “Family 500+” reform makes up the large majority of this value (5.4 billion EUR). Households from the lower income decile groups will benefit the most from this reform package, with their monthly disposable income increasing on average by 15.1% (ca. 60 EUR). High-income households from the top income decile will see their income grow on average by only 0.5% (see Figure 1). Overall, nearly all of the gains will go to families with children, with single parents gaining on average about 95 EUR and married couples with children about 84 EUR per month. Other types of families will, on average, see negligible changes in their household disposable incomes (see Figure 2). Thus, the implemented package clearly has a very progressive nature and redistributes significant resources to families with children.

Figure 1. Distributional consequences of changes in direct tax and benefit measures implemented between 2016-2017

Source: calculations using CenEA’s microsimulation model SIMPL based on PHBS 2014 data.

The pension age and public finances in the years to come

The most recent major reform, legislated at the end of 2016 and which will come into effect in October 2017, represents an implementation of yet another costly electoral pledge. This policy has overturned gradual increases in the statutory retirement age, initiated by the previous government in 2012. Despite the very rapid ageing of the Polish population, the new government decided to return to the pre-2012 retirement ages of 60 and 65 for women and men, respectively. This comes at a time when, according to EUROSTAT (Eurostat, 2014), the old-age dependency ratio in Poland, i.e. the proportion of the 65+ population to the working-age population, will grow from the current 24% to 27% in 2020 and to 40% in 2040. With the defined contribution pension system, the shorter working lives resulting from this change will be reflected in significantly reduced benefits (Figure 2). For example, pension benefits of men retiring in 2020 will on average be 13.5% lower than the pre-reform value. For women that retire in 2040, the pension benefits will on average fall by 15.2%, which corresponds to a 43% lower benefit than the pre-reform value, and with consequences of the reform becoming more severe over time. The reform will also be very costly to the government budget. In 2017, it is expected to cost 1.3 billion EUR and its full effect will kick in after 2021, when the cost of the reform will exceed 3.9 billion EUR per year (Figure 2).

Figure 2. Reducing the statutory retirement age and its implications on pension benefits and public finances

Source: Based on data from Council of Ministers (2016).

Conclusion

Since coming to power in October 2015, the PiS government has implemented a majority of its costly electoral pledges. Direct changes in taxes and benefits will cost 5.5 billion EUR in 2017 and benefit primarily those in the lower end of the income distribution and in particular families with children. The reduced statutory retirement age will add an extra 1.3 billion EUR in 2017 and as much as 3.9 billion EUR four years later. The very generous “Family 500+” programme has significantly reduced child poverty and may have important positive long-term effects in terms of health and education for today’s beneficiaries. However, its fertility implications are still uncertain and the programme is expected to reduce the employment rate among mothers. While the government maintains that its financing is secured, it is becoming clear that maintaining the policy will not be possible without higher taxes.

The government came to power claiming that the implementation of this programme will be based on reducing tax fraud and that only a small fraction will be financed from tax increases. While it seemed likely at the time when these declarations were made, the expected major shift in the reduction of tax fraud has yet not materialised. The government have withdrawn from the pledge of reducing the VAT and from assisting those with mortgages denominated in Swiss Francs, while its income tax allowance reform was nearly thirty times less expensive compared to that announced in its electoral programme.

With a very tight budget for 2017 based on relatively optimistic assumptions, the key factors determining further realisations of the generous programme will be the rate of economic growth and related dynamics on the labour market. Developments of the labour market will also be essential for the longer-term economic success of the implemented reform package. This relates both to the future level of participation of women and to the success of extend working lives of people who will soon reach the new reduced retirement age.

References

  • CenEA (2015a) Konsekwencje prezydenckiej propozycji podwyższenia kwoty wolnej od podatku (Consequences of the presidential proposal to raise the incoem tax allowance), CenEA press release, 3 December 2015.
  • CenEA (2015b) Co z kwotą wolną od podatku po wyroku Trybunału Konstytucyjnego? (what will happen to the income tax allowance after the decision of the Constitutional Tribunal?), CenEA press release, 13 November 2015.
  • CenEA (2016) Zmiany w kwocie wolnej od podatku za 800 mln rocznie (Changes in the income tax allowance at the cost of 800m per year), CenEA press release, 29 November 2016.
  • EUROSTAT (2014) Eurostat – Population projections EUROPOP2013, access 21 December 2016.
  • Myck, M., Kundera, M., Najsztub, M., Oczkowska, M. (2016a) 25 miliardów złotych dla rodzin z dziećmi: projekt Rodzina 500+ i możliwości modyfikacji systemu wsparcia. (25bn for families with children: plans for the Family 500+ reform and other options to modify the system of support.), CenEA Commentaries, 18 January 2016.
  • Myck, M., Kundera, M., Najsztub, M., Oczkowska, M., 2016b, Zamrożony PIT i utrzymane wyższe stawki VAT – jak brak zmian w podatkach wpłynie na budżety gospodarstw domowych? (Frozen PIT and higher VAT – how lack of changes in taxees will affect househod budgets?), CenEA Commentaries, 05 October 2016.
  • Council of Ministers (2016) Position of the Council of Ministers on the presidential bill proposal, Warsaw, 25 July 2016.

The Economic Track Record of Pious Populists – Evidence from Turkey

Posted on November 21, 2016 | Policy Brief

FREE Network Policy Brief | A Case Study of Economic Development in Turkey under AKP

In this policy brief, I summarize recent research on the economic track record of the Justice and Development Party (AKP) in Turkey. The central finding is that Turkey under AKP grew no faster in terms of GDP per capita when compared with a counterpart constructed using the Synthetic Control Method (SCM). Expanding the outcome set to health and education reveals large positive differences in both infant and maternal mortality as well as university enrollment, consistent with stated AKP policies to improve access to health and education sectors for the relatively poorer segments of the population. Yet, even though these improvements benefited women to a large extent, there are no commensurate gains in female labor force participation, and female unemployment has increased under AKP’s watch. Of further concern is the degree to which the SCM method applied to institutional measures fail to find any meaningful early improvements along this dimension, and more often than not reveals adverse institutional trajectories.

The Turkish political economy represents something of a puzzle. After a traumatic financial crisis in 2001, a series of political and economic reforms brought higher economic growth and a promise of EU membership. An authoritarian political elite, spearheaded by a military with a troubled past of controversial coups ousting democratically-elected governments, looked set to give way to a new cadre of political and economic elites who, despite a recent past as radical Islamists, seemed to favor free markets as well as democratic reform.

News media, as well as several international organizations, heaped praise on the Turkish government. In some cases, these represented optimistic interpretations of events, whereas in some cases they inadvertently served to spread a misleading picture of the strength of the Turkish economy. A recent World Bank report described Turkey’s economic success as “a source of inspiration for a number of developing countries, particularly, but not only, in the Muslim world” (World Bank, 2014).

Today, the state of Turkey’s political economy is represented very differently. Several international rankings of political institutions (Meyersson, 2016b) and human rights show Turkey spiraling ever lower, following years of stifling freedom of speech, recurring political witch hunts, and escalating internal violence. Lower GDP growth rates, falling debt ratings and exchange rates are evidence less of a rising new economic giant than a stagnating middle income country under increasingly illiberal rule. A recent IMF staff report (IMF, 2016) noted how Turkey remains “vulnerable to external shocks” and a labor market “marred by rapidly increasing labor costs, stagnant productivity, and a low employment rate, especially among women.”

What has been the AKP’s track record on economic growth in Turkey? While some has described it as an economic success (as noted above), others have pointed out that Turkey’s economic development has not been much more than middling (Rodrik, 2015).

Evaluating the economic track record of the AKP faces numerous challenges. The rise to power of the AKP government came in the wake of one of the worst financial crises in modern history and following a number of substantial economic and political reforms. Finding a candidate for the counterfactual, a Turkey without AKP rule, is challenging and looking solely at time series of Turkish development omits significant trends that likely shape its trajectory.

The focus of my new paper (Meyersson, 2016a) is thus to examine the economic and institutional effects of the AKP in a comparative case study framework. Using the Synthetic Control Method (SCM), developed by Abadie et al. (2010, 2015), I estimate the impact of the AKP on Turkey’s GDP per capita by comparing it to a weighted average of control units, similar in pre-intervention period observables. The construction of such a “synthetic control” avoids the difficulty of selecting a single (or a few) comparable country, and instead allows for a data-driven approach to find the best candidate as a combination of many other countries. This avoids ambiguity about how comparison units should be chosen, especially when done on the basis of subjective measures of affinity between treated and untreated units. The method further complements more qualitative research with a research design that specifically incorporates pre-treatment dynamics, which due to the financial crisis preceding the election of AKP to power, is essential. Similar to a difference-in-differences strategy, SCM compares differences in treated and untreated units before and after the event of interest. But in contrast to such a strategy design, SCM allocates different weights to different untreated units based on a set of covariates.

Figure 1. Results for Turkey’s GDP per capita

fig1Note: Upper graph shows Turkey’s GDP per capita compared to a synthetic counterpart. The middle graph shows the difference between the former and the latter (black line) as well as placebo differences for untreated units (gray lines). The lowest graph plots the weights assigned to countries that constitute the synthetic control for Turkey. See Meyersson (2016a) for details.

As shown in Figure 1, I find that GDP per capita under the AKP in Turkey has not grown faster than its synthetic control. A “synthetic Turkey” (upper graph in Figure 1), which went through similar pre-2003 dynamics in its GDP per capita, also experienced an economic rebound very similar to that of Turkey.

This is robust to a range of specifications that in different ways account for the pre-AKP GDP dynamics. Restricting the set of control units to Muslim countries only, reveals Turkey to have actually grown significantly slower than the weighted combination of the Muslim counterparts. Moreover, a comparison of severe financial crises using SCM shows Turkey’s post-crisis trajectory in GDP per capita to be no faster than its synthetic control. The focus on post-crisis recoveries allows estimation of the composite effect, including both the financial crisis of 2001 as well as the election of AKP and, under the assumption that post-crisis – and pre-AKP – reforms were indeed growth enhancing, provides an upper bound for the effect of the AKP.

These results, however, hide some of the more transformative aspects of how the Turkish economy has changed during the AKP’s reign. Focusing on education outcomes, I instead find large positive effects on university enrollment for both men and women. These improvements are mirrored for key health variables such as maternal and infant mortality, and are likely responses to large-scale policy changes implemented by the AKP that are discussed in Meyersson (2016a). The policy changes include the extensive Health Transformation Program (HTP) implemented by the AKP government (Atun et al 2013), as well as mushrooming of provincial universities from 2006 and onward (Çelik and Gür, 2013).

As such, to the extent that the AKP has engaged in populism from a macroeconomic perspective, it has nonetheless also experienced a significant degree of social mobility, especially among the poorer segments of society. An exaggerated focus on economic output risks obfuscating the structural changes in key factor endowments that could very well prove beneficial in the long run. Still, the improved access to these areas has not been followed by improved outcomes in the labor markets, especially for women. The period under AKP has seen significant reductions in both female labor force participation as well as higher female unemployment. This raises concerns over to what extent the Turkish government has been able to put a valuable talent reserve to productive use, as well as allowing women meaningful labor market returns to education.

Figure 2. Results for Turkey’s gross enrollment in tertiary education

fig2Note: Upper graph shows Turkey’s gross enrollment in tertiary education compared to a synthetic counterpart. The middle graph shows the difference between the former and the latter (black line) as well as placebo differences for untreated units (gray lines). The lowest graph plots the weights assigned to countries that constitute the synthetic control for Turkey. See Meyersson (2016a) for details.

An evaluation of the AKP’s institutional effect using multiple institutional indicators, measuring various aspects ranging from institutionalized authority, liberal democracy, and human rights results in a failure to find any durable early positive effects during AKP’s tenure. In the longer run, for all outcomes the overall effect seems to have been clearly negative. Finally, the significant reduction in military rents, whether measured in terms of expenditure or personnel, is illustrative of the degree to which the military’s political power diminished relatively early on, and posits concerns over lower economic rents as another source of friction between the civil and military loci of power in the country.

Overall, the results point to Turkey undergoing a transformative period during the AKP, socioeconomically as well as politically. Even though the initial years of higher GDP per capita growth under the AKP, in absolute terms, dwindle significantly in comparison to a synthetic counterpart, increased access to health and education provide reasons for political support of a government that has extended a socioeconomic franchise to a larger segment.

References

  • Abadie, Alberto, Alexis Diamond, and Jens Hainmueller, “Synthetic Control Methods for Comparative Case Studies: Estimating the Effects of California’s Tobacco Control Program,” Journal of the American Statistical Association, 105 (2010), 493-505.
  • Abadie, Alberto, Alexis Diamond, and Jens Hainmueller, “Comparative Politics and the Synthetic Control Method,” American Journal of Political Science, 2015, 59 (2), 495-510.
  • Atun, Rifat, Sabahattin Aydin, Sarbani Chakraborty, Safir Sümer, Meltem Aran, Ipek Gürol, Serpil Nazlıoğlu, Şenay Özğülcü, Ülger Aydoğan, Banu Ayar, Uğur Dilmen, Recep Akdağ, “Universal health coverage in Turkey: enhancement of equity,” The Lancet, Vol 382 July 6, 2013.
  • Çelik, Zafer and Bekir Gür, “Turkey’s Education Policy During the AKP Party Era (2002-2013),” Insight Turkey, Vol. 15, No. 4, 2013, pp. 151-176
  • International Monetary Fund, “Staff Report for the 2016 Article IV Consultation: Turkey,” IMF Country Report No. 16/104
  • Meyersson, Erik, 2016a, “’Pious Populists at the Gate’ – A Case Study of Economic Development in Turkey under AKP”, working paper.
  • Meyersson, Erik, 2016b, “On the Timing of Turkey’s Authoritarian Turn”, Free Policy Brief, http://freepolicybriefs.org/2016/04/04/timing-turkeys-authoritarian-turn/
  • Rodrik, Dani, 2015, “Turkish Economic Myths”, http://rodrik.typepad.com/dani_rodriks_weblog/2015/04/turkish-economic-myths.html
  • “The World Bank, Turkey’s Transitions: Integration, Inclusion, Institutions.” Country Economic Memorandum (2014, December).

Traces of Transition: Unfinished Business 25 Years Down the Road?

Posted on June 13, 2016 | Policy Brief

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This year marks the 25-year anniversary of the breakup of the Soviet Union and the beginning of a transition period, which for some countries remains far from completed. While several Central and Eastern European countries (CEEC) made substantial progress early on and have managed to maintain that momentum until today, the countries in the Commonwealth of Independent States (CIS) remain far from the ideal of a market economy, and also lag behind on most indicators of political, judicial and social progress. This policy brief reports on a discussion on the unfinished business of transition held during a full day conference at the Stockholm School of Economics on May 27, 2016. The event was organized jointly by the Stockholm Institute of Transition Economics (SITE) and the Swedish Ministry for Foreign Affairs, and was the sixth installment of SITE Development Day – a yearly development policy conference.

A region at a crossroads?

25 years have passed since the countries of the former Soviet Union embarked on a historic transition from communism to market economy and democracy. While all transition countries went through a turbulent initial period of high inflation and large output declines, the depth and length of these recessions varied widely across the region and have resulted in income differences that remain until today. Some explanations behind these varied results include initial conditions, external factors and geographic location, but also the speed and extent to which reforms were implemented early on were critical to outcomes. Countries that took on a rapid and bold reform process were rewarded with a faster recovery and income convergence, whereas countries that postponed reforms ended up with a much longer and deeper initial recession and have seen very little income convergence with Western Europe.

The prospect of EU membership is another factor that proved to be a powerful catalyst for reform and upgrading of institutional frameworks. The 10 countries that joined the EU are today, on average, performing better than the non-EU transition countries in basically any indicator of development including GDP per capita, life expectancy, political rights and civil liberties. Even if some of the non-EU countries initially had the political will to reform and started off on an ambitious transition path, the momentum was eventually lost. In Russia, the increasing oil prices of the 2000s brought enormous government revenues that enabled the country to grow without implementing further market reforms, and have effectively led to a situation of no political competition. Ukraine, on the other hand, has changed government 17 times in the past 25 years, and even if the parliament appears to be functioning, very few of the passed laws and suggested reforms have actually been implemented.

Evidently, economic transition takes time and was harder than many initially expected. In some areas of reform, such as liberalization of prices, trade and the exchange rate, progress could be achieved relatively fast. However, in other crucial areas of reform and institution building progress has been slower and more diverse. Private sector development is perhaps the area where the transition countries differ the most. Large-scale privatization remains to be completed in many countries in the CIS. In Belarus, even small-scale privatization has been slow. For the transition countries that were early with large-scale privatization, the current challenges of private sector development are different: As production moves closer to the world technology frontier, competition intensifies and innovation and human capital development become key to survival. These transformational pressures require strong institutions, and a business environment that rewards education and risk taking. It becomes even more important that financial sectors are functioning, that the education system delivers, property rights are protected, regulations are predictable and moderated, and that corruption and crime are under control. While the scale of these challenges differ widely across the region, the need for institutional reforms that reduce inefficiencies and increase returns on private investments and savings, are shared by many.

To increase economic growth and to converge towards Western Europe, the key challenges are to both increase productivity and factor input into production. This involves raising the employment rate, achieving higher labor productivity, and increasing the capital stock per capita. The region’s changing demography, due to lower fertility rates and rebounding life expectancy rates, will increase already high pressures on pension systems, healthcare spending and social assistance. Moreover, the capital stock per capita in a typical transition country is only about a third of that in Western Europe, with particularly wide gaps in terms of investment in infrastructure.

Unlocking human potential: gender in the region

Regardless of how well a country does on average, it also matters how these achievements are distributed among the population. A relatively underexplored aspect of transition is to which extent it has affected men and women differentially. Given the socialist system’s provision of universal access to education and healthcare, and great emphasis on labor market participation for both women and men, these countries rank fairly well in gender inequality indices compared to countries at similar levels of GDP outside the region when the transition process started. Nonetheless, these societies were and have remained predominantly patriarchal. During the last 25 years, most of these countries have only seen a small reduction in the gender wage gap, some even an increase. Several countries have seen increased gender segregation on the labor market, and have implemented “protective” laws that in reality are discriminatory as they for example prohibit women from working in certain occupations, or indirectly lock out mothers from the labor market.

Furthermore, many of the obstacles experienced by small and medium-sized enterprises (SMEs) are more severe for women than for men. Female entrepreneurs in the Eastern Partnership (EaP) countries have less access to external financing, business training and affordable and qualified business support than their male counterparts. While the free trade agreements, DCFTAs, between the EU and Ukraine, Georgia, and Moldova, respectively, have the potential to bring long-term benefits especially for women, these will only be realized if the DCFTAs are fully implemented and gender inequalities are simultaneously addressed. Women constitute a large percentage of the employees in the areas that are the most likely to benefit from the DCFTAs, but stand the risk of being held back by societal attitudes and gender stereotypes. In order to better evaluate and study how these issues develop, gendered-segregated data need to be made available to academics, professionals and the general public.

Conclusion

Looking back 25 years, given the stakes involved, things could have gotten much worse. Even so, for the CIS countries progress has been uneven and disappointing and many of the countries are still struggling with the same challenges they faced in the 1990’s: weak institutions, slow productivity growth, corruption and state capture. Meanwhile, the current migration situation in Europe has revealed that even the institutional development towards democracy, free press and judicial independence in several of the CEEC countries cannot be taken for granted. The transition process is thus far from complete, and the lessons from the economics of transition literature are still highly relevant.

Participants at the conference

  • Irina Alkhovka, Gender Perspectives.
  • Bas Bakker, IMF.
  • Torbjörn Becker, SITE.
  • Erik Berglöf, Institute of Global Affairs, LSE.
  • Kateryna Bornukova, Belarusian Research and Outreach Center.
  • Anne Boschini, Stockholm University.
  • Irina Denisova, New Economic School.
  • Stefan Gullgren, Ministry for Foreign Affairs.
  • Elsa Håstad, Sida.
  • Eric Livny, International School of Economics.
  • Michal Myck, Centre for Economic Analysis.
  • Tymofiy Mylovanov, Kyiv School of Economics.
  • Olena Nizalova, University of Kent.
  • Heinz Sjögren, Swedish Chamber of Commerce for Russia and CIS.
  • Andrea Spear, Independent consultant.
  • Oscar Stenström, Ministry for Foreign Affairs.
  • Natalya Volchkova, Centre for Economic and Financial Research.

 

Did Russian Migration to Russia Affect the Labor Market?

Posted on January 25, 2016 | Policy Brief

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As a result of the collapse of the Soviet Union, five million Russian and Russian-speaking people repatriated to Russia during 1990-2002. I use this natural experiment to study the effect of a large migration wave on the employment and wages of the local population. Taking into account the non-random choice of location by migrants within Russia, I find a negative effect of the inflows of immigrants on the local population’s employment but not on wages. The initial negative effects on employment are particularly large for local men, but they disappear after about ten years from the peak of the migration wave.

The effect of migration on the labor market of the host country is a long-standing question within economic literature and in public debate. In many cases, researchers try to estimate this effect using the data on large and unanticipated migration movements. The most famous study of this kind is probably Card (1990). Another case is the Russian migration to Russia resulting from the collapse of the Soviet Union. According to the 2002 Russian Census, 5.2 million of the people living in Russia in 2002 resided outside the country in 1989. That is, 3.6 percent of the 2002 population immigrated to Russia after 1989. Almost all of them (94.4 percent) immigrated from the former Soviet republics, most notably Kazakhstan, Ukraine and Uzbekistan.

The existing literature on migration flows in the former Soviet Union (fSU) since its collapse has emphasized the socio-political factors of migration. Locher (2002) finds that ethnic sorting was a major determinant of migration among the fSU countries, with the countries’ stage of transition and wealth level playing a minor role. Yerofeeva (1999) shows that ethnic repatriation was one of the main reasons behind migration from northern and eastern Kazakhstan.

In Lazareva (2015), I study two sides of the labor market effects of the immigration from fSU countries to Russia. The first side is the process of assimilation of migrants in the Russian labor market. The second side is the effect that inflows of immigrants had on the labor market position of the local population in Russia. Data used for estimation span a long period of time, which allows for tracing dynamic long-term effects of the influx of immigrants. This is the first comprehensive study of the labor market effects of one of the largest migration waves in Europe in recent history.

Method

In order to estimate the effects of the inflow of immigrants on the employment and wages of the local population, I exploit variation in the share of immigrants across Russian regions. According to the Census in 2002, migrants were quite dispersed over Russia’s vast territory; their share in population varied from 0.42% in the Tyva region to 8.5% in the Kaliningrad region. A relatively large share of migrants is observed along the border to fSU countries as well as in the oil-rich regions of Western Siberia.

A major problem when using regional variation to estimate labor market effects is that the migrants’ choice of region may be affected by the condition of that region’s labor market. Naturally, migrants tend to choose locations with higher wages and more employment opportunities. If this is the case, the estimates of the labor market effects will be biased.

However, the immigrants’ choice of location was not completely unconstrained due to the costs of migration related to the distance and access to information. Given these constraints, there is a relative crowding of immigrants in the regions of Russia that are closer to the border with fSU countries. Hence, I use the variation in the share of migrants across regions, which depend on the geographical distance from the source countries. In other words, I obtain the estimates from the comparison of regions that are similar in all their characteristics except for the distance to the border with fSU.

Data and Results

I use panel data on households from the Russian Longitudinal Monitoring Survey for the period 1995-2009. In the 2009 survey, the respondents were asked since what year they live in the Russian Federation. I define as immigrants, people at the age of 18 and above who moved to Russia after 1989. Note that the RLMS sample, which consists of people residing in the same dwelling units in each round, is unlikely to include illegal migrants or temporary (seasonal) labor migrants. Rather these are mainly people who settled in Russia permanently at some point during the 1990s and 2000s.

In the RLMS sample, 3.6 percent of the respondents moved to Russia after 1989. This is consistent with the national-level statistical data on immigration flows. A majority of the immigrants arrived to Russia in the early and mid-1990s. Immigration peaked in 1994 when almost 1.2 million people moved to Russia. After that, immigration steeply declined; during the 2000s, the registered level of immigration was at about 200,000 people per year.

A majority of the immigrants (71.7%) in the RLMS sample are of Russian ethnicity, and there is a slightly higher share of males. Importantly, migrants are not significantly different from the locals in terms of their education levels. The statistics on marital status show that a higher share of migrants compared to locals have families and children. Apparently, family migration was a large part of this migration wave.

Using the methodology described above, I obtain an insignificant effect of the share of immigrants on the wages of the local population over the period of 1995-2009. The effect of immigrant share on the unemployment of the local population is also insignificant. In contrast, estimates for the labor force participation (LFP) show a significant negative effect of immigration on the LFP of the local population. The size of the effect is non-negligible: a one-percentage point increase in the share of immigrants in a region reduces the probability for a local person to be in the labor force by 0.6 percentage points. Thus, over the whole period of 1995-2009, Russian immigration is estimated to have had some displacement effect, but only in terms of the labor force participation of the local population.

Since the inflow of immigrants was mostly concentrated in the first half of 1990s, I estimate my model for three sub-periods: 1995-2000, 2001-2004, and 2005-2009. The results for the wages remain insignificant in all sub-periods. Immigration is shown to increase the unemployment among locals in the first half of 2000s, but this effect dissipated in the second half of 2000s. The effect of immigration on the labor force participation is negative and highly significant for the late 1990s, still negative and significant but smaller in magnitude in the early 2000s, and disappears in the late 2000s. This analysis suggests that the immigration wave had a quite significant displacement effect for the local population in terms of unemployment and labor force participation, but not in terms of wages. This effect slowly declined and had disappeared by the second half of 2000s. My results also suggest that the negative labor market effects were more significant for men than for women.

Conclusion

The results of this study have implications for the debate on the effect of immigration on local labor markets, in particular on wages and employment opportunities for the native population. The majority of existing studies find only minor negative effects of migration on the labor market position of locals. My results suggest that immigrants who are close substitutes to the local labor force, due to the common language and similar education, have more significant effects on the labor market outcomes of the local population.

The finding that displacement effects in Russia dissipated quite slowly may be related to the very low migration rates of the local population in Russia throughout the transition. In order to reduce negative labor market effects of large influxes of immigrants, policy measures are needed that improve labor mobility across regions. These may include moving or housing subsidies, retraining programs and policies ensuring equal access to jobs and public services for internal migrants across the regions of Russia.

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References

  • Card, David, 1990, The Impact of the Mariel Boatlift on the Miami Labor Market, Industrial and Labor Relations Review, Vol. 43, No. 2, pp. 245-257.
  • Lazareva O. Russian Migrants to Russia: Assimilation and Local Labor Market Effects //IZA Journal of Migration. 2015. No. 4:20
  • Locher, Lilo, 2002, “Migration in the Soviet Successor States,” Applied Economics Quarterly, 48 (1), 2002, 67-84
  • Yerofeyeva, Irina, 1999, “Regional aspects of Slavic migration from Kazakhstan on the basis of examples from North Kazakhstan and East Kazakhstan provinces”. In: Vyatkin, Anatoly, Kosmarskaya, Natalya, Panarin, Sergei (Eds.), V Dvizhenii Dobrovoljnom i Vynuzhdennom [In Motion—Voluntary and Forced]. Natalis, Moscow, pp. 154–179

Skill Structure of Demand for Migrants in Russia: Evidence from Administrative Data

Posted on May 5, 2014 | Policy Brief

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Authors: Simon Commander (IE Business School, EBRD and Altura Partners) and Irina Denisova (CEFIR, NES).

Using Russian Ministry of Labor administrative data for all legal migrant applications in 2010 and matching the migrant to the sponsoring firm, we find that there is some – albeit limited – evidence of firms using migrants to address high skill shortages. However, the overwhelming majority of migrants are skilled or unskilled workers rather than qualified professionals; a reflection of the low underlying rates of innovation and associated demand for high skill jobs.

Migration policy continues to be a priority in Russian economic policy. This is driven both by a demand for labor – given the unfavorable demographic trends of the last decades – and the easily available supply from the CIS countries. It is still not clear, however, what is the skills structure of the demand for migrants. Relatively new administrative data on demanded permissions to employ migrants sheds however some light on the issue.

In particular, we use the 2010 nationwide dataset ‘Job positions filled by migrants’ published by the Russia Federal Employment Service. The dataset gives detailed information on the applications for permits for migrants, including the 4-digit occupation, firm ID and the offered wage. The Federal Employment Service’s role is to approve or reject an application. In almost all cases documented in this dataset, approval was granted. Moreover, in 99% of the cases, the duration of the permitted contract was one year.

The data allow us to study the skill composition of demand for migrants from the legal sector, with the sizeable illegal labor migration staying beyond the scope of the study. The total number of applications for all of Russia in 2010 was just over 890,000, of which nearly 250,000 or 28% originated from firms in Moscow. The analysis below uses the permission data for the 21 most developed Russian regions (a full version of the paper is available as Commander and Denisova, 2012).

A breakdown of the number of requests in 2010 by skill type using the one-digit ISCO-88 classification (Managers, High-level professionals, Mid-level professionals, Service worker, Skilled agricultural workers, Craft and trades workers, Plant and machine operators, Unskilled workers) shows that over 70% of the requests were for skilled and unskilled workers. At the same time, about 17% of the total migration requests were for higher-level professionals (7%) and managers (10%). Among managers, nearly nine out of ten requests were for production or department managers with no more than 12% of managerial migration requests being for top-level executives. Among the category of high-level professionals, architects and engineers accounted for over two-fifths of requests.

Is the situation any different in the main urban labor markets? In Moscow a lower proportion – around two thirds of the migrant applications – were for skilled and unskilled workers. The starkest difference was that professionals working in IT accounted for a minute share of total high-level skill applications in Russia, but nearly 9% in Moscow. Thus, while there are some differences in the migration profile between Moscow and the rest of the country, the broad picture that emerges is one where migration policy and practice seem to be responding mainly to the apparent bottlenecks at the lower-skill end of the labor market.

Legal requests for migrants are massively dominated by requests concerning low-skill groups; and illegal migrants, as shown by anecdotal evidence, are mainly low skilled. At the same time, there is a sizeable demand for qualified migrants, managers and professionals. There are two potential motives to issuing a request for a qualified migrant: to economize on the costs of labor by substituting a local laborer with a migrant; or to fill in the gap of the scarce qualification/skills hardly available domestically. The two motives could be distinguished by looking at the wage offers associated with the posted positions and comparing them with wages paid in comparable occupations in the same region. The aim of the exercise is to see – particularly within the categories of higher-skilled applicants – whether they command any wage premium that might reflect their scarcity value.

Figures 1-2 plot the reported (relative) wage offers for two migrant skill categories: Department Managers (ISCO code=122) and Computing Professionals (ISCO code=213). The figures depict distributions of relative (to the region average) wage in logs, thus implying that the points around 0 are the wage offers at the level of regional average, above 0 means positive wage premium, and below 0 means negative wage premiums (economizing on the costs). Each figure also gives the mean search wage from the EBRD survey of recruiting agencies in 2010 (relative to the regional average).

Figure 1. Relative Wage Distribution, Production and Operation Department Managers (ISCO-88 Code: 122)
Denisova1
Source: Authors’ calculations based on Rostrud 2010

It is clear from Figure 1 that the wage offers for migrants do not identify any clear positive selection effect, in that migrants’ wages mostly fall below the survey search mean comparators. In the majority of cases, the offered wages also fall below the regional average wage thus implying that the motive is to substitute for cheaper labor.

The demand for migrants with skills of IT professionals is more complicated: there are those who offer wages below regional average, but there is also a large group of those ready to pay a wage premium to attract migrants (with log wage above zero). The search through recruiting agencies (the survey wage) would still require offering higher wages.

Figure 2. Relative Wage Distribution, IT Professionals (ISCO-88 Code: 213)
Denisova2
Source: Authors’ calculations based on Rostrud 2010

For further analysis, the migration dataset was mapped to the ORBIS (a dataset assembled by Bureau van Dijk) firm observations using the unique national tax identification code (so called INN). The ORBIS data includes information on firms’ balance sheets and simple performance data such as output per employee.

When looking only at demand from firms that lie in the top 10-20% of the productivity distribution (productivity is calculated as output per worker in the narrowly defined industry), the picture looks somewhat different: wage offers tend to lie above the average (Figure 3). It is likely that the most productive firms tend to offer wages higher than both regional average for the occupation and the survey-based search wages. This implies that the scarcity of skills on the domestic labor market is one of the more important motives behind the demand for migrants from high-productivity firms.

 
Figure 3. Relative Wage Distribution, Production and Operation Department Managers (ISCO-88 Code: 122), 10% Most Productive Firms
Denisova3
Source: Authors’ calculations based on Rostrud 2010 and Orbis-Roslana

To control for other firm characteristics, we run regressions relating the relative wage of a migrant to a set of firm and region characteristics, including measures of size and ownership, a measure of recent growth in the region, as well as the level and change in foreign direct investment in a given region since 2007. We also control for the tightness of the local labor market, using a measure of search wages raised in the EBRD survey compared to average wages in a region. The estimates are run with and without region, industry and occupation controls. The results show that relatively high wages tend to be associated with large and/or foreign-owned firms. Growth in a region or the level of FDI per capita are not systematically associated with the relative wage once controls enter the regression, suggesting that the relative wage is largely determined by firm-level features. The measure of labor market tightness enters positively but is insignificant whencontrolling for industry, region and occupation.

Overall, the data from the Russian Ministry of Labor that documents all applications for migrants to Russia in 2010 and allows matching the migrant to the sponsoring firm, show that there is very limited evidence of firms using migrants to fill high-skill jobs. In fact, the overwhelming majority of migrants, skilled or unskilled workers, were mostly originating from other states of the CIS. Furthermore, most were hired at relatively low wages in comparison to the occupation/region averages or the wages reported in the EBRD survey of recruiting firms. At the same time, there is a sizeable portion of demand for skilled migrants, which are offered wage premiums. The demand originates mostly from highly productive firms. Migration policy should acknowledge these different motives behind the demand for migrants.

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References

  • Simon Commander and Irina Denisova “Are Skills a Constraint on Firms? New Evidence from Russia”, IZA Discussion Paper No. 7041, November 2012

The relationship between education and labor market opportunities: the case of Ukraine

Posted on March 10, 2014 | Policy Brief

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Author: Hanna Vakhitova, KSE and Tom Coupe, KSE

This brief is based on a research project that analyses the extent to which the educational system in Ukraine contributes to better local employment opportunities, hence diminishing the outflows. According to the results, additional year of education increases the chance of finding a job by 2-3%. However, the effect of education on wages is small, especially when compared to other transition countries (1-5% wage premium for a year of education). In addition, while in 8 out of 10 countries education has zero or positive impact on the probability of starting a business, this impact is negative and significant in Ukraine. *)

Transportation Infrastructure and Labor Market Integration: the Moscow Oblast Case

Posted on February 11, 2013 | Policy Brief

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The model of city organization proposed by von Thünen in the beginning of the XIXth century, and then formalized by Alonso followed by Muth and Mills (see Ner (1986)), is one of the most “successful” models in economics in terms of practical applications.  The model explains why the gradient of population density and land rents decline from the city center towards the periphery. In fact, almost all modern cities fit this pattern, i.e. the model invented two centuries ago is capable of describing today’s spatial structure of cities. Even though von Thünen’s original idea of a city center as a single “marketplace” is no longer realistic, a multitude of factors beyond this make central locations nevertheless attractive. If firms are located near each other, they can take advantage of a common labor pool, easier access to consumers and suppliers, shared infrastructure, and knowledge spillovers, to name but a few advantages. Access to the center brings tangible economic benefits to both labor and capital and these benefits exceed possible losses due to increased competition, and so the von Thünen mechanism still works today, albeit through different channels.

In cities, there are generally two types of spatial organizations possible with respect to household income. If the advantages of amenities in a city center are not very strong, rich people tend to choose to locate in suburbs in order to consume higher quality housing. Such patterns are typical in US cities. If the advantages of a center are strong, the rich choose to live in the center. (Brueckner et al. (1999)) Due to historical circumstances, such patterns are typical of European or Russian cities. In these cases we observe a declining gradient of income; the further we move from the center, the further residents’ average income falls.

There are two forces at work shaping this declining gradient of wage. First, poor people sort themselves into suburban locations. Second, residents of the suburbs who want to take advantage of the labor market in the center face a barrier involving commuting costs. Many of them forgo high-wage opportunities that require tedious everyday commuting and therefore remain poor as a consequence.

An apparent policy solution to reduce income inequality would be to reduce transportation costs.  The higher transportation costs are, the steeper the gradient of income. Fast and convenient transportation promotes the integration of local labor markets, gives the residents of the suburbs more, and often better, job opportunities, and works toward equalization of income across the agglomeration. Moreover, as transportation costs decline, the geographic area of agglomeration grows, which opens new opportunities for real estate development as well as new possibilities for rural residents to commute and participate in large labor market.

We conducted a study at CEFIR (Mikhailova et al. (2012)) comparing the spatial patterns of average wages in the Moscow agglomeration with several agglomerations in Western Europe. We considered municipal-level data for Moscow Oblast and for 25 agglomerations in Sweden, Germany, and Netherlands. In the sample of municipalities that are served by suburban train system, we estimated how average wages in a given municipality respond to different lengths of travel times to the city center.

Figure 1 shows the estimated wage-travel time relationship for Moscow Oblast and Figure 2 for the selected European cities.

Figure 1. Average Wage and Travel Time to the City Center, Moscow

 Mkihailova1

Figure 2. Average Wage and Travel Time to the City Center, Europe.
Mkihailova1b

The residents of the Moscow agglomeration are at a clear disadvantage according to the data shown above. Residents of Moscow Oblast, even those who live in relative proximity to the city, loose drastically in terms of average wage. Doubling the travel time (say, from 20 min to 40 min, which is the range most commuters fit into) results in a 25% drop in the average wage for residents in Moscow Oblast compared to only a 5% drop in Europe. The wage in a municipality, from which it would take 90 minutes to travel to the city center, is almost half of the average wage inside Moscow’s Ring Road whereas in Europe 90 minutes translates into a 10% loss of in average wages.

A 90 minutes travel time could be considered as a realistic limit to the size of an agglomeration. This is roughly the maximum distance over which a typical working commuter would be willing to travel each day in each direction. A 90 minute commute in Europe represents approximately a 100 kilometer distance. In Moscow Oblast, however, it is only 63 km. So, Moscow Oblast loses in the effective “reach” of suburban transportation: people who live further than roughly 60 km from the center cannot practically commute.

Even for the same commuting time, the difference in wages between center and suburban municipality is much smaller in Europe (see Figures 1 and 2). This means that a commute for the same time length (in terms of railroad transport) presents a larger barrier for the residents of Moscow Oblast. This is obviously an over simplification of the situation since taking into account only commuting times as the measure of costs we ignore many other critical factors such as price (relative to income), the convenience of schedule and travel comfort, alternative modes of transportation, etc.  Suburban trains in Moscow Oblast run infrequently, they are overcrowded, and alternative transportation modes (car or bus) face considerable delays due to road congestion. All of these additional factors serve to reduce the labor market opportunities of the Moscow Oblast residents and make wage inequality even deeper.

Figure 3 presents wage-distance gradients for the Moscow agglomeration under different scenarios using a hypothetical “European” gradient to show what could be the case if changes were made to reduce barriers to transportation bringing the Moscow agglomeration in line with European standards. The graphs end at a distance that corresponds to a typical 90-minute commuting time under various scenarios ranging from the status quo to the best case, where Moscow Oblast replicates European standards. The red curve represents the upper bound estimate of the possible effect of investments to improve the transportation infrastructure to bring Moscow regional transportation network in line with the quality of a typical European agglomeration. The residents of Moscow region could gain up to 24% more in terms of current average wages if this were to take place. The purple curve, however, presents a more modest scenario assuming that the structure of Moscow regional transportation network remains the same, but the travel time were to be cut by 20%. Even in this case, the gains to Moscow Oblast residents are about 3% of wages which is very significant economically for an area populated by 5.5 million people.

Figure 3. Wage Distance Gradient

 Mkihailova2

Note: BLUE – Estimated actual wage gradient for Moscow Oblast; Red – European wage gradient applied to Moscow Oblast data, simulation; Purple – a Moscow Oblast gradient given 20% cut in the travel time, simulation.

Further, it is important to note that to take advantage of labor market integration residents do not necessarily all have to commute to work to the center. The mere possibility of commuting creates arbitrage opportunities in the labor market and puts upward pressure on wages. As a result, it is important for economic policy to constantly improve transportation infrastructure even if the private benefits of increased usage are modest.

In the end, our analysis did not touch on the other benefits from transportation infrastructure. Apart from labor market integration, improvements in transportation infrastructure promote real estate development (Baum-Snow (2007), Garcia-López(2012)) and expand the market for goods and services. We leave these questions for further research.

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References

  • Baum-Snow, Nathaniel (2007) “Did Highways Cause Suburbanization?” The Quarterly Journal of Economics 122(2): 775-805
  • Brueckner, Jan K., Jacques-François Thisse, and Yves Zenou (1999) “Why is central Paris rich and downtown Detroit poor?: An amenity-based theory.” European Economic Review 43.1: 91-107.
  • Garcia-López, Miquel-Àngel (2012) “Urban spatial structure, suburbanization and transportation in Barcelona”, Journal of Urban Economics, Volume 72, Issues 2–3, September–November, Pages 176-190
  • Mikhailova, T, V. Rudakov and N. Zhuravlyova (2012) “Economic effects from the Moscow Oblast suburban railroad infrastructure development” («Экономические эффекты от развития инфраструктуры пригородного железнодорожного сообщения в Московской области»), project report, CEFIR.
  • Ner, J. B. (1986). The structure of urban equilibria: A unified treatment of the Muth-Mills model. Handbook of regional and urban economics: Urban economics, 2, 821.