Going for growth

Getting the strategies right
Chief Economist, OECD

Disappointment about persistent economic underperformance is now widespread in several major OECD countries, particularly in the EU and Japan. At the same time though, governments accept that restoring growth is key to preserving standards of living, particularly at this time of rapidly ageing societies. Achieving this will be hard.

The story is becoming a familiar one. Economic catch-up, which was widely believed to be automatic, started to stall during the 1980s and degenerated into relative decline during the 1990s. Today GDP per capita in France, Germany or Italy is 30% below US levels. The trouble is, without action, this gap between leaders and laggards will increase over the foreseeable future. To put it in a nutshell, several countries are faced with a major growth challenge.

For Europeans, in particular, a wider gap hardly furthers the Lisbon Agenda’s ambitious target of “overtaking” the US. Setting the bar high is worthy, but the approach has its drawbacks, not least because it tends to cloud the bleak reality of much of Europe’s policy performance. In other words, before overtaking the US, the first objective should be to stop the relative decline. This will be hard to do in a context of ageing populations. There are encouraging signs. The UK, for instance, has done a better job than its European neighbours in closing at least a small portion of the gap with the US, but the bulk of the catching up still lies ahead.

Convergence will not come by itself, and clearly we economists must work harder to explain the need for reform. Benchmarking can help us. Through naming and shaming and, at times, praising, our message may finally get through. That is why we have launched a new series on “Economic Policy Reforms”, starting with the first study, Going for Growth.

At the end of the day, being unable to keep up with competitors is nothing other than losing capacity, not just in economic terms, but in terms of learning from others, their successes and their mistakes. Regaining this capacity to learn implies first an ability to position oneself on an international scale and to evaluate the gaps that need to be bridged.

Assessing the extent to which one is lagging behind is, of course, unpleasant to some, especially if that gap is widening. The natural temptation is to belittle the significance of the comparison. In the end, aren’t we all unique and truly incomparable! Surely our own choices and way of life are worth so much more than a vulgar GDP per capita statistic.

This reticence in the face of potentially misleading comparisons can be greatly exaggerated, but it is not without legitimacy. Nevertheless, recent methodological progress can help us.

The OECD has developed a diversified set of structural indicators in the areas of labour and product markets, which do a reasonably good job at explaining economic performance. And they show that in many cases, bad policies as opposed to legitimate societal choices can explain weak GDP performance. Ignoring these rigorous comparisons would be a mistake.

In any case, benchmarking is not just the business of governments, but of society as a whole, since there is no successful reform without the public’s support. And in many countries there is a need to win over public opinion, to show that reform does not have to be about winners and losers.

So, what do these OECD indicators look like? First, we examine performance indicators such as GDP per capita and its main components: labour utilisation and labour productivity. These components are in turn subdivided. For instance, labour utilisation is broken down into overall rates of employment and number of hours worked per employee. Overall rates of employment are themselves split into employment rates by age group, and so on.

Alongside these performance indicators, there are policy indicators, dealing with labour and product markets. We evaluate the stringency of employment protection legislation, for instance, and the relative cost of unskilled labour.

Take the example of the UK. Its overall rate of labour utilisation is high, and its very good labour market performance is matched by very good policy indicators, too. The UK’s success is not accidental. Its main challenge lies, of course, in the field of productivity. Over the past five years the UK performed better than its European counterparts but no better than the US. Yet, product market regulation indicators are generally excellent, unlike on the continent.

The sources of the productivity problem are to be found elsewhere, according to our assessment. One of them is the efficiency of the education system. In particular, the share of youngsters with only lower secondary education is very large and vocational training is not meeting the requirements of a modern workplace. Reforms are underway in these areas, but more should be done in terms of quality or coverage.

As for mainland Europe, there has been noticeable progress in the opening of product markets, markedly under Brussels influence between 1998 and 2003. This should show up in the next few years in terms of productivity increases.

As far as European labour markets are concerned, it is not obvious that the conditions are being met to stem the ongoing relative decline in terms of GDP per capita. There are glimmers of hope with the very recent reforms in Germany (unemployment insurance, working time) or Italy (employment protection legislation).

Overall, though, major European countries still lag behind in terms of GDP per capita, in large part because of a low rate of labour utilisation, and, more specifically, because labour force participation of ageing people is weak. People over 55 are basically absent from the labour markets, while they are still very active in Asia, North America and English-speaking countries, and in Nordic countries, too.

Is this a reflection of different cultural choices, with retiring early a reflection of a better way of life? Or does the gap stem from misguided policies that are hampering labour supply?

Our analysis suggests the latter is more responsible. We have computed “implicit tax on continued activity” indicators. This tax represents the income forgone by a person who would like to continue working despite the possibility of taking advantage of generous early retirement schemes. Where the implicit tax is high, the participation rate of ageing workers is generally well below OECD average.

Through rigorous econometric analysis, we have simulated what would happen in a state of the world where social and pension systems are neutral with respect to labour supply all across the OECD. And we find that in the absence of biased public policies, French people may wish to work as long as their American counterparts. In other words, policy, not preferences, has a lot to answer for. That means there is hope for reform.

This is not a superficial benchmarking exercise based solely on rankings, but it goes further to diagnose policies and their influence on performance. The OECD plans to publish this comprehensive benchmarking every two years. That will give a little time for economic reforms to develop and for indicators to evolve. The next benchmarking exercise will be delivered in early 2007.

Before that, we will publish a special issue, at the beginning of 2006, assessing progress achieved in the area of economic reforms over 2005. It will focus on the contribution of financial markets to long-term growth and short-term economic resilience. We will also look closely at the role of innovation policies.

Together with analysis of labour and product markets, taxation, pension systems and, to some extent, education, this will help build a complete picture of the economic policy landscape in OECD countries. Hopefully, the series will help the public to see reforms in a constructive, positive way, and serve as a catalyst for change designed to improve economic performance. That is, after all, what the OECD reform agenda is really about.

Reference

OECD (2005), Economic Policy Reforms: Going for Growth. 

©OECD Observer No 249, May 2005




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