Washington, DC

March 2009

Going for Growth 2009

Klaus Schmidt-HebbelChief Economist and Head

OECD Economics Department

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Outline

A. Going for Growth: analysis and policy recommendations for boosting long-term growth

B. Which long-term growth policies help to boost the recovery from the financial crisis?

C. New empirical results concerning long-run growth in this edition

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The Going for Growth process

• Systematic policy and performance benchmarking using indicators

• Identifies five priorities per country

• Follow-up and review

To promote long-run economic growth

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4

GDP per capita as a welfare measure

• GDP per capita is not a perfect measure of well-being …

• … but it is the least imperfect proxy of welfare that is available.

• It is closely correlated with other objective performance measures but not with alternative measures of human development or subjective measures of happiness.

5

Decompose GDP per capita

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 policies Product market policies Other policies

Quality of capital

(vintage and asset

composition )

Quality of labour

(skill mix )

Pure technical progress

Employment rate

GDP per capita gaps with the US (2007)

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Convergence had improved before the crisis (vs. US)

7

Convergence pattern is robust to the choice of the numéraire

8

Benchmarking uses about 50 mostly OECD policy indicators

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• Policy indicators affecting mainly productivity– Product market regulation database, 1998, 2003 and

2008– Producer support estimates in agriculture– FDI restrictiveness index– Educational attainment and achievement– Health and infrastructure expenditure

• Policy indicators mainly affecting labour markets– Tax wedges– Implicit tax rates on continued work– Minimum wages and labour costs– Unemployment benefit replacement rates– Employment protection legislation– Disability/sickness beneficiaries

Policy measures have been tied to outcomes in panel studies

• Empirical work based on OECD studies– Sources of Growth in OECD Countries (OECD,

2003)• Estimates of short-run and long-run effects of

policies on GDP/capita growth in Bassanini and Scarpetta (2001):

• V is a vector of institutional variables• Dynamic panel estimates using pooled mean

group (PMG) methods

Policy measures have been tied to outcomes in panel studies

• Empirical work based on OECD studies– Reassessment of OECD Jobs Strategy (OECD, 2006)

• Estimates of labour market policies effect on unemploy-ment and employment (Duval and Bassanini, 2006):

• X is are a vector of labour market policies (EPL etc.), plus interactions. Unempl. eqn. looks at interactions.

• System GMM estimators used for the dynamic panel.

• Many other (primarily OECD) studies.

Benchmarking methodology• Three steps:

– Identify performance weaknesses associated with subcomponents of GDP/capita

– Identify policy weaknesses based on policy indicators and analysis establishing links between policy and performance

– Select most important policy weaknesses as priorities for reform

Sample country: New Zealand 2009

Priority policy areas shift over time

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Five priorities for each member country and the European Union

Policy recommendations for the US, Japan and the EU (2009)

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Outline

A. Going for Growth: analysis and policy recommendations for boosting long-term growth

B. Which long-term growth policies help to boost the recovery from the financial crisis?

C. New empirical results concerning long-run growth in this edition

15

Financial crisis, reflected in the OECD’s financial conditions index …

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… affecting real activity

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Industrial production

Implication of the financial crisis for structural reforms

• The crisis reflects a failure of regulatory and supervisory policies to deal with risks inherent to the financial sector

• Yet it does not cast doubt on the importance of reforms to improve labour and product market performance recommended in Going for Growth

• Experience shows that structural reforms are often carried out at a time of economic crisis

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Policy action at a time of crisis

• Focus on policies that stimulate demand in the short run and strengthen long term growth

• OECD analysis shows that the key win-win policies are:1. Enhance infrastructure investment

2. Cut taxes on lower income groups

3. Raise human capital through labour training

4. Reform product market regulation

(#s 1-3 part of fiscal policy plans, reviewed next)

Special chapters of GfG on these four areas

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Desirable Features of Fiscal Stimulus Plans

• Timely, temporary, targeted

• Size determined by:o Economic conjunctureo Initial fiscal balance and debt levelso Size of automatic stabilizers

• Targeting: short-term (stabilization); long-term (growth); job creation; green component

• Accompanied with credible commitment to medium-term fiscal sustainability

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Size of Fiscal Stimulus Plans

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Size of Fiscal Stimulus Plans

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Composition of Fiscal Stimulus Plans

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Fiscal Multipliers

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Medium/Long-Term Short-Term (1 year) Literature Literature IMF OECD* Total Spending Increases

Consumption -0.02 [-0.06,-0.8] 1 [-0.3, 1.3] [0.3, 0.7] Investment 0.6 [ 0.03, 1] 1.1 [1, 1.3] [0.5, 1.8] [0.7, 0.9] Transfers -0.1 [-0.4, 0] 0.7 [0.2, 0.5] Total Tax Cuts Direct Taxes 0.7 [0.02,1.5] 0.4 [0.1, 0.6] [0.3, 0.6] [0.1, 0.3] Indirect Taxes 0.1 [ -0.9,0.8] 0.3 [ 0, 0.5] [0.1, 0.2]

Note: Literature review regarding medium/long-term is based on panel and cross-country analysis. Literature review regarding short-term effect is based on VAR studies and Macro models.* Ranges for the OECD depend on country differences in import intensity

A. Going for Growth: analysis and policy recommendations for boosting long-term growth

B. Which long-term growth policies help to boost the recovery from the financial crisis?

C. New empirical results concerning long-run growth in this edition

25

Long-Term Policies: Outline

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1. Infrastructure investment, growth and public policy

Special chapter

Infrastructure investment has been falling: crisis offers opportunity to reverse it

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Empirical work on the impact of infrastructure

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• Hard to measure infrastructure systematically in the national accounts, use physical measures

• Estimates of long-run and short-run effects– MRW framework adapted to infrastructure:

• Infrastructure taken as separate input

– Shows some countries and periods had negative effects (relative to other types of investment)

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• Since the impact of infrastructure– Varies over time and by industry

• Overprovision of infrastructure is a real risk• A good regulatory environment is critical

– Requires careful cost-benefit analysis of projects

• Hard to implement quickly, but can move forward with maintenance expenditure and good, off-the-shelf investment projects

• Public investment has the highest short-term (0.7 to 0.9) and long-term (up to 1.0) multiplier effects on GDP levels

Infrastructure investment has to be done carefully

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Having a good regulatory framework is critical to ensure efficiency

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One key component: Independence of the regulator in the OECD

Reference period: 2007/08

2. Taxation and economic growth

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Special chapter

Tax composition

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Share of tax revenues (2005)

The effects of tax composition on growth

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• Empirical work looks at tax effect on growth– Aggregate level:

– Industry level:

– – Firm level:

• Effects on investment through user cost also examined

Which taxes should be cut?

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• It depends on the current tax structure in each country

• Taxes matter for long-term growth: – Corporate taxes are the most harmful, followed by …– … labour income taxes, and then …– … taxes on goods and services with …– … taxes on immovable property the least harmful

• In the short-run, the best strategy at present is to cut taxes on labour income for low-income workers, as this will boost aggregate demand and raise labour utilisation in the long term

There is much room to reduce labour income taxes for lower income workers

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Tax burden at 67% of average worker earnings

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3. Population structure, employment and productivity

Special chapter

Education and population structure vary considerably across the OECD

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Education and population structure explain part of the income gap

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Income gap relative to the United States (%)

Strengthen education and training

• Education and training is very important for high productivity levels in the long run

• Increased activation through mandatory training programmes for the unemployed can facilitate transition to new employment in the short term

• A temporary increase in public spending in this area can help boost aggregate demand

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Moderate long-term trade-off between labour utilisation and productivity

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Employment and productivity changes when matching US employment rates in each

group (2004)

Elasticities estimated over 1997-2004

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4. Reform of product market regulation

Special chapter

Reforms of product market regulation (PMR) have been substantial

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Restrictiveness of product market regulation (0-6)

Scope of public enterprise

(0.33)

Gov’t involvement in network sectors

(0.33)

Direct control over business

enterprises(0.33)

Scope of public enterprise

(0.33)

Gov’t involvement in network sectors

(0.33)

Direct control over business

enterprises(0.33)

Licenses and permits system

(0.50)

Communication and

simplification of rules and procedures

(0.50)

Licenses and permits system

(0.50)

Communication and

simplification of rules and procedures

(0.50)

Admin. burdens for corporations

(0.33)

Admin. burdens for sole

proprietor firms(0.33)

Sector-specific administrative

burdens(0.33)

Admin. burdens for corporations

(0.33)

Admin. burdens for sole

proprietor firms(0.33)

Sector-specific administrative

burdens(0.33)

Legal barriers(0.25)

Antitrust exemptions

(0.25)

Barriers in network sectors

(0.25)

Barriers in services (0.25)

Legal barriers(0.25)

Antitrust exemptions

(0.25)

Barriers in network sectors

(0.25)

Barriers in services (0.25)

Barriers to FDI(0.33)

Tariffs(0.33)

Discriminatory procedures

(0.33)

Barriers to FDI(0.33)

Tariffs(0.33)

Discriminatory procedures

(0.33)

Regulatory barriers

(1.0)

Regulatory barriers

(1.0)

Product market regulationProduct market regulation

Price controls(0.50)

Use of command

and control regulation

(0.50)

Price controls(0.50)

Use of command

and control regulation

(0.50)

State control(0.33)

State control(0.33)

Other barriers(0.50)

Other barriers(0.50)

Explicit barriers to trade and investment

(0.50)

Explicit barriers to trade and investment

(0.50)

Barriers to competition

(0.33)

Barriers to competition

(0.33)

Regulatory and administrative

opacity(0.33)

Regulatory and administrative

opacity(0.33)

Involvement in business operations

(0.50)

Involvement in business operations

(0.50)

Public ownership

(0.50)

Public ownership

(0.50)

Barriers to trade and investment (0.33)

Barriers to trade and investment (0.33)

Barriers to entrepreneurship(0.33)

Barriers to entrepreneurship(0.33)

Administrative burdens on

start-ups(0.33)

Administrative burdens on

start-ups(0.33)

Updated indicator of PMR based on detailed policy settings (2008)

Reform product market regulation, strengthen competition

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• Stronger competition in product markets increases productivity in the long term by ensuring better use of resources and spurring entrepreneurship

• New firms and new products may also help to raise demand in the short term

• Many OECD studies show strong link with pace of convergence

Firm entry barriers can be reduced

45

Barriers to entrepreneurship, 2008 (increasing stringency, 0-6)

Need for reform in range of areas, depending on area

46

Distance from best practice, 2008 (increasing stringency, 0-6)

Going for Growth 2009

Klaus Schmidt-HebbelChief Economist and Head

OECD Economics Department