Productivity Growth and Job Creation in Eastern Europe and the Former Soviet Union

Productivity Growth and Job Creation in Eastern Europe and the Former Soviet Union Pradeep Mitra Chief Economist Europe and Central Asia Region Expanded version of a presentation made at the plenary session of a conference on “Modernization of Economy and the State” organized by the State University Higher School of Economics, with the participation of the World Bank and IMF, in Moscow, April 4-6, 2006 Views expressed are mine and do not necessarily reflect those of the World Bank.

The Presentation • The Evolution of Poverty • GDP Growth and its Components • Growth of Labor Productivity and its Correlates • Job Creation and its Correlates • The Business Environment facing Firms • Conclusions

Distribution of Population by Poverty Status Growth and (mostly) no increase in inequality have moved 40 million people out of poverty in Eastern Europe and the Former Soviet Union during 1998-2003 • Where roughly 20 percent (or 1 in 5) were poor, today 12 percent (1 in 8) are poor • Poverty has fallen almost everywhere • Much of this poverty reduction has occurred in the populous middle-income countries in the Region (Kazakhstan, the Russian Federation, and Ukraine) Source: Staff estimates based on World Bank (2005a)

As in the 1990s, working adults and children form the bulk of the poor in the region and benefited from growth. Much of the impact of growth on poverty reduction has been transmitted through the labor market. EU8 Countries Czech Rep, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Slovenia SEE Countries Albania, Bosnia, Bulgaria, Croatia, Macedonia, Romania, Serbia and Montenegro Middle Income CIS Belarus, Kazakhstan, Russia, Ukraine Low Income CIS Armenia, Azerbaijan, Georgia, Kyrgyzstan, Moldova, Tajikistan, Uzbekistan Note: EU-8 $4.30 a day at 2000 PPP as a poverty line; others $2.15 a day at 2000 PPP Source: World Bank (2005a)

Growth of public transfers due to improved public finances, combined with high coverage, has also helped to reduce poverty • Real social spending increased very strongly in SEE and middle income CIS, but most resources goes to pensions • Some targeted social assistance programs made contribution to poverty reduction: Romania, Bulgaria, Belarus Source: World Bank (2005a)

But all is not well • Nearly 130 million people – almost a third of the population – live on an income of between $2.15 and $4.30 a day and, while not absolutely poor, are vulnerable to downturns in economic activity • While consumption inequality declined in the CIS as a whole between 1998 and 2003, inequality increased in Tajikistan (the poorest country in Central Asia) as well as in Georgia (the poorest country in the South Caucasus) and, among the European countries, in Poland and Romania. • Non-income poverty shows mixed trends • in health (no decisive progress in life expectancy, low health care utilization in low income CIS, AIDS/HIV/TB epidemics) • in education (falling quality in regional mathematics performance, rich/poor and rural/urban disparities) • in infrastructure (reduced affordability for electricity, heating, water and sewerage, disparities in water quality between rich and poor)

Structure of the Argument Poverty Reduction Slide 6 Public transfers (pensions, social assistance) Slides 4-5 GDP Growth Slides 9-15 Growth in Labor Productivity Employment Growth Slide 23 Labor market institutions (employment protection legislation, system of wage bargaining, unemployment benefits) 16-18 19-22 Slides Slides Firm Entry and Exit Firm Entry Slides 24-34 Business Environment (regulations, institutions/property rights, taxation, competition) Slide 36 Slides 35-36 Conclusions

Growth in GDP per capita from 1998 to 2003, the most rapid for CIS countries recovering from a deep transitional recession, owes more to growth in labor productivity (GDP/EMPL) than improved employment rates (EMPL/Working POP) or favorable demography (Working POP/POP) Growth in GDP/POP) = (Growth in GDP/EMPL) +(Growth in EMPL/Working POP) + (Growth in Working POP/POP) Average annual growth in GDP per capita and its components, 1998-2003 Working age population covers the age range 15-64 Source: ILO LABORSTA database, World Development Indicators

Growth in labor productivity was reflected in real wage growth across all consumption quintiles . . . . Source: World Bank (2005a)

. . . . but employment growth was weak except in selectedCIS countries. Source: World Bank (2005a)

Indeed the employment rate continued to fall in many countries after 1998. Slack labor markets are manifest in either open unemployment, falling labor force participation or low-productivity employment. While the employment rate is generally higher in CIS countries, (compared to the EU-8 countries where it falls short of the Lisbon target of 70%) many jobs in the CIS are in low-productivity occupations partly because . . . . Employment Rates: Early Transition, 1998 and 2003 Note: The earliest years (blue bars) for each country are as follows: 1990:Azerbaijan, Belarus, Bulgaria and Estonia 1992: Hungary, Russia 1993: Armenia, Czech Republic, Kazakhstan, Poland and Slovenia 1994: Albania, Lithuania, Romania and Slovak Republic. 1995: Moldova and Ukraine. Source: ILO LABORSTA database, World Development Indicators Note: The employment rate in Moldova between 1998 and 2003 shows a decline based on LFS but an increase based on household survey data (previous slide) on account of a likely more restrictive definition of informal sector employment in the LFS.

. . . . de-industrialization in low income CIS has been accompanied by a large labor transfer into low-productivity agriculture in the absence of adequate social safety nets. Not so in Central Europe, where over-industrialization has been corrected through a reduction in agricultural and industrial employment, with jobs moving to market services, but with high open unemployment and/or low labor force participation in some countries. Kyrgyz Republic Czech Republic Source: World Bank (2005b)

These sectoral shifts reflected in declining share of skilled labor- and capital-intensive exports in low income CIS and move towards natural resource exports. In EU-8, by contrast, increased share of skilled labor- and capital-intensive exports, while in SEE an increased share of unskilled labor-intensive exports. Source: Computations based on UN COM Trade Statistics adapted from World Bank (2005c)

The change in aggregate labor productivity is decomposed into (i) within-firm, (ii) between-firm, and (iii) cross components1/, and the contribution of (iv) entrant and (v) exiting firms Sources of Productivity Growth in Transition, Emerging, and OECD Countries Labor Productivity decomposition shares – Manufacturing Five-Year Differencing, Real Gross Output For Hungary and Romania the decomposition refers to a three-year differencing which, given significant learning and selection by new entrants, underestimates the contribution of entry to productivity growth. 1/ The cross term reflects gains in productivity from expanding employment shares in high productivity-growth firms or shrinking employment shares in low productivity-growth firms Source: Staff estimates based on Bartelsman, Haltiwanger and Scarpetta (2004)

Firm entry and exit are more important in transition countries, contributing between 20 to 45 percent of productivity growth, as against between 3 and 35 percent in developed and other developing countries.

Job destruction generally surged first but it was the response of job creation which varied across countries – catching up rapidly with job destruction in leading reformers but staying lower than job destruction for prolonged periods in lagging reformers

Job creation1/ and job destruction2/ rates increased dramatically in transition countries, reflecting increasingly dynamic labor markets, to levels equaling or exceeding those in developed countries and lagging slightly below those in developing countries 1/ Employment gains during a year divided by average employment during the year. 2/ Employment losses during a year divided by average employment during the year.

Firm entry contributed strongly (25% to 50%) to job creation. But the contribution declined over time . . . except in Russia and Ukraine – both late reformers – where the role of firm entry in job creation increased in the second half of the 1990s. In contrast to the behavior of entrant firms, existing firms resorted on average to “defensive restructuring”, i.e. improved productivity by downsizing and shedding redundant labor.

Labor market regulations – on the books – are rigid in the transition countries but enforcement varies across the region • Notwithstanding significant reforms, employment protection legislation (EPL) in the transition countries is, on average, among the strictest in the world with, however, considerable variation in legislation and enforcement across subgroups of countries • Even with weak enforcement, stringent EPL can have deleterious effects on job creation and destruction and likely on productivity growth • However, factors outside the labor market – the business environment – rather than labor market institutions such as EPL and systems of wage determinants are more important for labor market outcomes, as evidenced by high unemployment to vacancy ratios and, except in the EU-8, firms not reporting labor regulations as among the most important obstacles to business Source: World Bank (2005b) drawing on calculations from Doing Business database (2005)

The business environment has been improving steadily in the transition countries, but is generally still more difficult than in the cohesion countries of Western Europe, with labor regulations a notable exception The business environment was assessed on a scale from 1 (no obstacle) to 4 (major obstacle) Cohesion countries include Greece, Ireland, Portugal and Spain Source: EBRD-World Bank Business Environment and Enterprise Performance Surveys 1999, 2002, 2005

Unbundling by ownership category reveals that business environment in 2005 more difficult for de novo than privatized and state firms in areas such as regulation and taxation and institutions protecting property rights, as well as taxation . . . . The business environment was assessed on a scale from 1 (no obstacle) to 4 (major obstacle) Source: EBRD-World Bank Business Environment and Enterprise Performance Survey, 2005

. . . . particularly with respect to customs and trade regulations and business licensing and permits, within the overall area of regulatory constraints . . . . Source: EBRD-World Bank Business Environment and Enterprise Performance Survey, 2005

. . . . as well as with respect to judiciary and corruption within the overall area of institutions. Hence business environment is more difficult for de novo firms which are critical for productivity growth and job creation. Source: EBRD-World Bank Business Environment and Enterprise Performance Survey, 2005

Moving from entrant firms to potential exiters, while the fraction of firms with arrears has been falling and those receiving subsidies is virtually unchanged, (although note that the fraction of subsidized firms in SEE and CIS is lower than in the cohesion countries) . . . . Source: EBRD-World Bank Business Environment and Enterprise Performance Surveys, 2002, 2005

. . . . subsidies from all levels of government to a higher fraction of state and privatized firms compared to de novo firms in 2005 retard the exit of the former . . . .(true in cohesion countries too) Source: EBRD-World Bank Business Environment and Enterprise Performance Survey, 2005

. . . . and arrears owed by a higher fraction of state and privatized firms compared to de novo firms in 2005 on utility payments and taxes as well as to employees and suppliers also retard the exit of the former. The business environment was assessed on a scale from 1 (no obstacle) to 4 (major obstacle) Source: EBRD-World Bank Business Environment and Enterprise Performance Survey, 2005

Unsurprisingly, various measures of administrative corruption are related to perceptions of the business environment and show improvement pari passu, e.g. bribes as a proportion of sales (bribe tax) show more rapid decline between 2002 and 2005 in subregions where the bribe tax was higher . . . . Source: Staff calculations based on World Bank (2006)

. . . . but progress is more mixed when administrative corruption is unbundled into its components, although the deterioration shown for courts and public procurement between 2002 and 2005 is not statistically significant. Source: Staff calculations based on World Bank (2006)

FDI Stock per Capita and Share of Skilled Labor and Capital-Intensive Exports, 2003 • Business environment difficulties partly reflected in FDI stock per capita at end-2003, ranging from $11 in Tajikistan to $3771 in the Czech Republic, a ratio of over 300:1 • EU-8, some SEE: high FDI instrumental in integration in global “producer-driven” networks (e.g. automotives, IT), leading to skilled-labor and capital-intensive exports and better jobs • CIS, some SEE: low FDI and limited integration in “buyer driven” networks (e.g. apparel, furniture), unskilled labor-intensive or natural resource exports and lower quality jobs Source: Staff calculations based on World Bank (2005c)

Conclusions • Continued poverty reduction among working families will depend on growth in both labor productivity and job creation, together with a targeted program of public income transfers. • Labor market slack in transition countries is manifested in high unemployment, low participation or low-productivity jobs which, if not addressed, could limit the impact of future growth on poverty reduction. • Entry of new firms and exit of obsolete firms are important for the growth of labor productivity. • Entry of new firms is important for job creation as well as productivity growth in the transition countries. Whereas new firms have expanded employment, existing firms have, on average, improved productivity by downsizing and shedding labor (“defensive restructuring”). • While the business environment and many (though not all) measures of administration corruption have been improving, the latter at the level of the region as a whole, the business environment continues to be more challenging in the transition countries (esp. SEE and CIS) than in the cohesion countries of the EU, and particularly so for those firms which are important in productivity growth and job creation, viz, new private firms compared to state and privatized firms.

Conclusions (cont.) • The business environment also retards the exit of state-owned and privatized firms relative to new private firms through tolerance of arrears and subsidies from all levels of government, also impeding productivity growth. • Difficulties in the business environment in part limit the FDI that would integrate CIS and parts of SEE into the global economy, expand the share of skilled labor- and capital-intensive exports and create better jobs. • Looking ahead, continued improvements in the business environment, but particularly a level playing field for de novo firms, as well as exit mechanisms for obsolete firms, will be critical for productivity growth and job creation and call for reform of competition policy, the regulatory regime and institutions which protect property rights. • While labor market institutions are not the primary cause of low labor market performance, job creation can be helped by reform of employment protection legislation, firm-level wage determination, and reform of social assistance schemes to encourage labor turnover.

References • EBRD-World Bank Business Environment and Enterprise Performance Surveys 1999, 2002, 2005 • E. Bartelsman, J. Haltiwanger and S. Scarpetta (2004), Microeconomic Evidence of Creative Destruction in Industrial and Developing Countries, World Bank Policy Research Working Paper No. 3464 • World Bank (2005a), Growth, Poverty, and Inequality: Eastern Europe and the Former Soviet Union • World Bank (2005b), Enhancing Job Opportunities: Eastern Europe and the Former Soviet Union • World Bank (2005c), From Disintegration to Reintegration: Eastern Europe and the Former Soviet Union in International Trade. • World Bank (2006), Anticorruption in Transition 3, forthcoming

Productivity Growth and Job Creation in Eastern Europe and the Former Soviet Union