Giuseppe Nicoletti OECD Economics Department Policies, labour utilisation and growth: the OECD experience TÜSİAD-KOÇ UNİVERSITY ECONOMIC RESEARCH FORUM Growth Strategies in Global Economy Istanbul, 7 April 2005

Outline Stylised growth patterns The proximate determinants of growth –Productivity –Labour utilisation Convergence and the role of policies Policies to enhance labour utilisation –The mistakes not to make –The policies that (may) work

Stylised growth patterns There are wide differences in income levels and growth rates across OECD countries Virtually all countries still have a gap vis à vis the United States In many countries the gap has been rising recently, after decades of convergence Turkey has been lagging behind both in levels and in growth rates The major deceleration of Turkish growth over the past decade further deepened the gap

Explaining the GDP p.c. gaps A simple accounting decomposition Sources of gaps differ across the OECD: –Low productivity is key in some countries (e.g. Japan) –Low labour utilisation is key in other countries (e.g. Euro) –A few countries, among which Turkey, are lagging behind in both areas However, no long-run employment-productivity trade off exists Moreover, experience of several OECD countries (notably the US) suggests that no trade off exists in short/medium term either

Productivity patterns Some countries are filling the productivity gap with the US, but most aren’t Only a few countries (among which the US!) experienced a productivity acceleration over the past decade –Notably, large continental EU countries and Japan failed to do so Despite its large gap, Turkey’s productivity growth stagnated and even decelerated sharply on average over the past decade But Turkey’s productivity growth has accelerated again recently

What has driven productivity? Using a simple accounting decomposition of long-run productivity  Capital quality has been crucial in explaining cross- country differences in productivity growth Rapid ICT take up coincided with a productivity acceleration Using a different decomposition based on firm- level data  Within-firm productivity improvements and firm turnover are key Firm turnover was especially important in innovative industries

Labour utilisation patterns Depend on differences in hours worked, labour force participation and unemployment rate (demography not a factor yet, but will be crucial over the next two decades) Over the past decade, most countries increased labour force participation and reduced unemployment (but reduced hours) But differences remain very large –While no major gaps in employment rates of prime age males –Wide gaps in employment rates of old workers, young workers, women –Major gaps also in employment rates of unskilled workers Turkey went wrong way in both participation and unemployment, even though demographics is favourable

Cross-country convergence and the role of policies Should we expect convergence in GDP p.c. levels or growth rates? –The long-run evidence –The « consensus » view (conditional convergence) The catch-up process needs to be fuelled by policies that create a good environment for growth –The policy channels –How do policies affect growth trajectories?

Policies to enhance labour utilisation Encourage labour force participation of all categories of workers (gender, age, skills) Eliminate incentives to remain unemployed Avoid institutional rigidities that generate wage-productivity gaps Allow firm entry and growth to optimal size Facilitate reallocating workers from ailing to successful firms in the process of “creative destruction” Facilitate reallocating workers from declining to growing industries in the process of structural adjustment Some desirable features

Policies to enhance labour utilisation Malthusianism (lump-of-labour fallacy) –Participation and employment move together –Lack of actuarial neutrality and interaction with transfer schemes encourage early retirement –This lowers participation but does not generate jobs; moreover, worsens fiscal imbalances and the costs of the demographic transition Discourage participation of low-skilled and second-earners –High marginal taxation of labour –Policies that impede temporary or part-time employment –Policies that increase long-term unemployment (“discouraged worker” effects) –Policies that encourage home production of services (see below) The mistakes not to make (1)

Policies to enhance labour utilisation High minimum cost of labour that curbs jobs for low-productivity workers (and encourage informal economy) –Combination of (de facto or statutory) minimum wages and high tax wedges –Administrative extension of collective agreements –Bargaining systems leading to wage compression Lower incentives for job search –Combination of high unemployment benefit generosity and duration –Curbs search incentives, increases long-term unemployment and insulates insiders from outside pressures, raising their bargaining power Protect jobs instead of promoting employment –High and unpredictable firing costs curb employment opportunities; increase unemployment duration and insiders’ bargaining power –Particularly detrimental in bargaining systems that fail to internalise costs for outsiders –Also encourage informal economy Shelter firms from competition and/or make firm creation costly –Low entry and rents curb activity levels (and encourage informal economy) –Inefficiencies spread out in the economy and curb job creation –Growth in service sector jobs is inhibited –Market alternatives to home production are made unattractive, lowering participation The mistakes not to make (2)

Policies to enhance labour utilisation Eliminate incentives for early retirement –Make retirement schemes actuarially fair –Phase out alternative early retirement routes (ad hoc benefits, lax disability schemes)  Implicit tax on continuing work is between 40 and 80% in most EU countries  Removing tax could increase participation of older workers by between 20 and 40 percentage points in these countries –Raise effective retirement age with longevity gains Encourage participation of low-skilled and second-earners –“Make work pay” policies and family support policies (e.g. child care) –But should be carefully designed and take into account indirect effects through budget  Removing disincentives for second-earners could increase participation of women by between 5 and 20%, depending on initial distortions The policies that work (1)

Policies to enhance labour utilisation Lower minimum cost of labour –Reduce tax wedge (effects of targeted measures, such as payroll tax rebates, not clear) –Avoid administrative extension of collective contracts –Encourage bargaining systems that account for interest of outsiders and are flexible enough to reflect differences in productivity across sectors, skills and regions  Reducing the tax wedge by 10 % points could increase the employment rate by 2.5 % points on average Promote job search/matching –Reduce duration of benefits, strengthen willingness to work requirements and condition on participation in “activation” measures (though effect of blanket ALMPs not clear) –Make employment service more efficient  Lowering income replacement rates by 10 % points could increase the employment rate by 1.3 on average Reduce costs of employment protection –Ease excessive protection and make firing charges more certain and transparent –Exploit “flexicurity” trade off (Danish model)  Bringing employment protection to best practice could raise the employment rate by 1.5 percentage points Enhance competitive pressures –Eliminate barriers to international trade and investment –Make firm creation easier by reducing administrative burdens –Deregulate competitive service markets and ensure competitive access to networks  In restrictive countries, bringing regulation to best practice could increase the employment rate by 4-5 percentage points The policies that work (2)

GDP p.c. levels and growth rates Who is catching up?

Proximate and policy determinants of GDP p.c. GDP per capita Labour productivity (output per hour worked) Labour utilisation (hours worked per capita) GDP per capita Labour productivity (output per hour worked) Labour utilisation (hours worked per capita) Capital deepening (capital per hour worked) Multi-factor productivity Quality of capital (vintage and asset composition ) Quality of labour (skill mix ) Pure technical progress GDP per capita Labour productivity (output per hour worked) Labour utilisation (hours worked per capita) Hours worked per worker Capital deepening (capital per hour worked) Multi-factor productivity Structural unemployment rate Labour force participation Quality of capital (vintage and asset composition ) Quality of labour (skill mix ) Pure technical progress Employment rate GDP per capita Labour productivity (output per hour worked) Labour utilisation (hours worked per capita) Hours worked per worker Capital deepening (capital per hour worked) Multi-factor productivity Structural unemployment rate Labour force participation Labour market policiesProduct market policies Other policies Quality of capital (vintage and asset composition ) Quality of labour (skill mix ) Pure technical progress Employment rate

The sources of GDP p.c. gaps

Observed and “structural” productivity The productivity advantage of large EU countries partly reflects low labour utilisation Observed and “structural” labour productivity as a percentage of the level in the US, 2002

Productivity growth and acceleration

Productivity acceleration and ICT investment

GDP growth, ICT and the quality of capital

Sources of change in labour utilisation

Growth trajectories and convergence time GDP per capita (in logs) Start reform Impact of reform exhausted low long-run GDP p.c. high long-run GDP p.c. time GDP per capita (in logs) GDP p.c. path of the leader 1 st reform block 2 nd reform block 3 rd reform block Catch-up sustained by reforms

Growth trajectories and convergence Convergence within OECD (logs GDP per capita) USA and BRICs Leader Source: Maddison (2003), data 1990 US$ PPPs

Participation and employment rates (2000) Correlation coefficient = 0.9

Female participation and tax on second earner

Participation of workers and implicit tax on continuing work

Employment protection and employment rates (1998)

Product market regulation and employment rates (1998)

Productivity growth decomposition

Regulation in the OECD, Point estimates

Regulation in the OECD, 2003 Confidence intervals

Employment protection and product market regulation (2003)

Regulation and the service employment share (2003)

Tax wedges and minimum wages

Regulation and employment

Employment protection and employment