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THE STANDARD OF LIVING IN LATVIA: CAN WE / SHOULD WE TRY TO CATCH ESTONIA?
Līva Zorgenfreija06.03.2017
Latvijas Universitāte
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OUTLINE1. How to compare countries?
– indicators characterizing living standards and wellbeing– is Latvia indeed always behind Estonia?
2. Where could the differences be coming from?– availability of natural resources– geographical position– openness of the economy
3. GDP per capita – how large is the gap and what is required to close it?– capital– labour– total factor productivity
4. Possible directions of reforms
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"COMPARISON IS THE THIEF OF JOY"Theodore Roosevelt
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HOW TO CHARACTERIZE LIVING STANDARDS AND WELLBEING?
• GDP?• GDP per capita?• Life length?• Healthy life?• Free life choices and opportunities?
• Singapore shares 3rd and 4th position in the world according to the GDP/capita, however standing 22nd in the Happiness index
with a Gini index of income inequality exceeding 0.4 (higher than in any OECD country);
• Norway is slightly lower in the income ranking; however, it holds the 4th position in the Happiness index and Gini is ~ 0.25
(one of the lowest)
Source:http://worldhappiness.report/wp-content/uploads/sites/2/2016/03/HR-V1_web.pdf;https://www.cia.gov/library/publications/the-world-factbook/rankorder/2172rank.html, PIXABAY
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INCOME LEVEL IN LATVIA SLOWLY CONVERGES TO THAT OF ESTONIA, AND HAS REACHED 84% OF THE ESTONIAN LEVEL
GDP per capita PPP, constant 2011 international USD
Source: IMF
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
20112012
20132014
20150.0
5000.0
10000.0
15000.0
20000.0
25000.0
30000.0
Estonia Latvia
73% of the EE level
84% of the EE level
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ESTONIA PERFORMS BETTER IN MOST INDICES; HOWEVER, NOT ALL OF THESE REFLECT QUALITY OF LIFE OR LIFE SATISFACTION
Index Institution EE LV LT
Index of Economic Freedom Heritage Foundation 77.2 70.4 75.2(max = 100%; > 70 = mostly free; 2016; 178) 9 36 13
Global competitiveness index WEF 4.78 4.45 4.60(1-7, 2016/2017, 138) 30 49 35
Ease of Doing Business World Bank 81.05 80.61 78.84(DTF %points, max = 100, 2017, 190) 12 14 21
Human Development index UNO 0.861 0.819 0.839( 0-1, 2015, 188) 30 46 37
Better Life index OECD 5.85 4.71(11 topics weighted equally, 1-10, 2016, 38) 22 30 -
World Happiness index United Nations Sustainable Development
Solutions Network
5.517 5.56 5.813(1-10, best score = 7.526, 2016 update for
2013-2015, 157) 72 68 60
Social Progress Index The Social Progress Imperative
82.62 76.19 76.94
(0-100, 2016, 133) 23 36 34
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Denmark ranks the highest (7.526 no 10); Dystopia – imaginary country that would have all the lowest estimations in each area; its Happiness = 2.33; other countries are compared to Dystopia
Source: World Happiness Report
ESTONIANS AND LATVIANS SEEM TO BE NEARLY EQUALLY SATISFIED WITH THEIR LIVES
Denmark (1.)
Lithuania (60.)
Latvia (68.)
Estonia (72.)
0 1 2 3 4 5 6 7 8GDP/capita Social support Healthy life expectancy Freedom of choices
Generosity Corruption perception Dystopia (2.33) + residual
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WHERE COULD THE DIFFERENCES STEM FROM?
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DID THE COUNTRIES HAVE AN EQUAL STARTING POSITION AFTER REGAINING INDEPENDENCE?
Estonia Latvia
Main natural resources
Neighbours and the relationship with them
Source: PIXABAY; Latvenergo, Hannu - Own work, Public Domain, https://commons.wikimedia.org/w/index.php?curid=3105544
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RESOURCES: ENERGY DEPENDENCE IS LOWER IN EE BECAUSE OF AVAILABILITY OF OIL SHALE
Source : Eurostat; Enefit, Pixabay
20002001
20022003
20042005
20062007
20082009
20102011
20122013
20142015
01020304050607080
Estonia Latvia
Share of imported energy in total energy consumption, %
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OPENNESS OF ECONOMY: OPENNESS OF LATVIAN ECONOMY IS LOWER THAN THAT OF THE ESTONIAN, WITH A TENDENCY TO DECREASE LATELY
Source : Eurostat
Openness of economy, % of GDP
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
20112012
20132014
20152016
40%60%80%
100%120%140%160%180%
Euro area Estonia Latvia
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OPENNESS: MAIN TRADING PARTNERS OF EE SINCE EARLY 90-TIES: SCANDINAVIAN COUNTRIES; LV: RU, DE AND UK IN THE 90-TIES, NOW – BALTICS, RU
Breakdown of Latvian exports by country, % Breakdown of Estonian exports by country, %
0%10%20%30%40%50%60%70%80%90%
100%
Sweden Finalnd Latvia Others
19931995
19971999
20012003
20052007
20092011
20132015
0%10%20%30%40%50%60%70%80%90%
100%
Lithuania Estonia Russia Germany Poland UK
Source: CSB, Statistics Estonia
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OPENNESS: TRADE WITH WESTERN PARTNER COUNTRIES IN 90-TIES AND EARLY 2000-NDS: EE – MACHINERY AND EQUIPMENT, LV – MAINLY WOOD AND METALS: A VERY LOW POTENTIAL OF TRANSFER OF TECHNOLOGIES IN LV
1993 1996 1999 2002 2005
Estonia
Finland metals (23.0%)machinery
(30.0%)machinery
(35.8%)machinery
(43.9%)machinery
(54.4%)
Swedentextiles (22.2%);
wood (21.2%)
machinery (25.5%); wood
(24.5%)machinery
(46.2%)machinery
(30.8%)machinery
(36.2%)
Latvia
Germany textiles (20.9%) wood (29.9%) wood (37.2%) metals (30.8%) wood (23.2%)
The UK wood (59.2%) wood (92.0%) wood (90.2%) wood (80.2%) wood (71.6%)
Source: CSB, Statistics Estonia
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OPENNESS: THE KEY DIFERENCE - THE SHARE OF MACHINERY AND EQUIPMENT IN TOTAL EXPORTS
Latvian exports by commodity group, % Estonian exports by commodity group, %
0%10%20%30%40%50%60%70%80%90%
100%Other
Machinery&transport eq.
Other manufac-tured g
Chemicals and re-lated prod.
Mineral fuels etc
Raw materials
Food, drinks
Source: Eurostat
19992001
20032005
20072009
20112013
20150%
10%20%30%40%50%60%70%80%90%
100%
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THESE DIFFERENCES CREATED DIFFERENT STARTING POSITIONS
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6%
25%
7%22%3%6%
20%
Agriculture Industrial production Construction Trade, transp., restaurants IT Financial serv.Real estate Professional serv. Public sector Art, other
THE STRUCTURE OF THE ECONOMY IS SIMILAR; HOWEVER, CERTAIN DIFFERENCES CAN BE NOTED
1995 2007
9%
26%
5%23%4%
6%
18%
3%
20%
11%
23%5%
10%
13%
20163%
21%
6%22%
4%
10%
16%
4%
14%
10%
26%
5%
12%
16%
3%
17%5%
25%
6%
13%
16%
LV
EE
?
?
Source: Eurostat
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ECONOMIC STRUCTURE: NOTABLE DIFFERENCES IN VALUE ADDED IN MANUFACTURING. PRODUCTS OF LOW R&D INTENSITY ACCOUNT FOR HALF OF MANUFACTURING IN LATVIALatvia, Value added in manufacturing, 2014 Estonia, Value added in manufacturing, 2015
Source: Eurostat
Wood& products17%
Food, alcohol13%
Textiles, wearing apparel
6%Coke and petrol
3%Metals& products
13%
Furniture&jewellery &repair
12%
Construction mat.&rubber
8%
Chemicals2%
Machinery &equipm.
4%
Electrical eq.5%
Transportation eq.6%
Pharmaceuticals0%
Computers, electronic prod-
ucts5%
Other5%
Wood& products22%
Food, alcohol19%
Textiles, wearing apparel
5%Metals& products
13%
Furniture&jewellery &repair
9%
Construction mat.&rubber
10%
Chemicals3%
Machinery &equipm.
3%
Electrical eq.3%
Transportation eq.3%
Pharmaceuticals3%
Computers, electronic products3%
Other4%
Technological intensity '14 LV EE LT EA
low 54.7% 40.3% 43.6% 21.7%medium-low 28.2% 36.2% 33.0% 30.0%medium-high 11.3% 17.1% 15.8% 38.2%high 5.7% 6.4% 4.2% 10.1%
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ECONOMIC STRUCTURE: HOWEVER, THE TECHNOLOGICAL INTENSITY IN LATVIAN MANFACTURING IS CURRENTLY MUCH BETTER THAN IN THE 90IES
Latvia, Value added in manufacturing by technological intensity, %
20002001
20022003
20042005
20062007
20082009
20102011
20122013
20140%
10%20%30%40%50%60%70%80%90%
100%
Low Medium-lowMedium-high High
Estonia, Value added in manufacturing by technological intensity, %
20002002
20042006
20082010
20122014
0%10%20%30%40%50%60%70%80%90%
100%
Source: Eurostat, calculations by the BoL
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GDP GAP – HOW FAST SHOULD LATVIA GROW TO CATCH UP WITH ESTONIA?
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IN ORDER TO REACH ESTONIA'S LEVEL OF GDP PER CAPITA IN 5 YEARS, LATVIAN REAL GDP HAS TO GROW AT THE SPEED OF >6% Y-O-Y
GDP per capita PPP, constant 2011 international USD
Source: IMF data and forecasts (WEO 2016. Oct), calculations by Latvijas Banka
19951998
20012004
20072010
20132016
20190.0
5000.0
10000.0
15000.0
20000.0
25000.0
30000.0
35000.0
EE LV, IMF forecastLV, to catch-up
20102011
20122013
20142015
20162017
20182019
20202021
-4.0
-2.0
0.0
2.0
4.0
6.0
Estonia Latvia outcome and IMF fcst Growth to catch EE
BoL fcst
Real GDP growth for Latvia: IMF and BoL forecasts and the growth required to reach the living standart of Estonia in 5 years
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THE PER CAPITA INCOME OF LATVIANS IS 16% LOWER THAN THAT OF ESTONIANSThe difference in per capita income between Latvia and Estonia (%), breakdown by factors
02468
1012141618
Capital Total factor productivityLabour
Source: calculations by Latvijas Banka
Y=AKαL(1-α)
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CAPITAL
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INVESTMENT AS A SHARE OF GDP AS WELL AS FDI IN LV HISTORICALLY AND CURRENTLY LOWER THAN IN EE
Share of investment in GDP, % Amount of FDI as a share of GDP at the end of the period
20002002
20042006
20082010
20122014
2016Q30
20
40
60
80
100
120
Estonia Latvia
Source: Eurostat
19951997
19992001
20032005
20072009
20112013
2015 10
15
20
25
30
35
40
-5
-
5
10
15
20
25
Difference (right axis) EstoniaLatvia
Y=C+I+G+NX
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THIS IS NOT A RESULT OF REGULATORY RESTRICTIONS, WHICH ARE NEGLIGIBLE IN THE BALTICS. THE DIFFERENCE IS MORE LIKELY TO BE DUE TO PROBLEMS IN THE BUSINESS ENVIRONMENT
1997 2003 2006 2010 2011 2012 2013 2014 20150.000
0.020
0.040
0.060
0.080
0.100
0.120
0.140
Estonia Latvia OECD
Source: OECD
FDI Regulatory Restrictiveness Index, 0 (open) – 1 (closed)
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LATVIA LAGS BEHIND IN BUSINESS ENVIRONMENT AND ECONOMIC FREEDOM
Source: http://www.doingbusiness.org/, http://www.heritage.org/index/visualize* - imprved, increasing the coverage of credit bureaus
World bank Doing business (Distance to frontier)
Property rights
Freedom from corruption
Fiscal freedom
Government spending
Business feredom
Labour freedom*
Monetary freedom
Freedom of trade
Investment freedom
Financial freedom
0
50
100
2000 EST 2000 LAT2016 EST 2016 LAT
Heritage Foundation indices of economic freedom, based on normative indicators
Starting business
Dealing with contruction permits
Access to electricity
Registering property
Access to credit*
Protection of minority investors
Paying taxes
Trading across borders
Enforcing contracts
Resolving insolvency
0
50
100
EST 2006 EST 2017 LAT 2006 LAT 2017
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THE SHARE OF SHADOW ECONOMY IN ESTONIA IS MUCH LOWER THAN IN LATVIA
SSE Riga index of shadow economy (for the private sector), % of GDP
Source: T. J. Putniņš & A. Sauka, Shadow economy index for the Baltic countries 2009 – 2015 (2016); PIXABAY
2009 2010 2011 2012 2013 2014 20150
5
10
15
20
25
30
35
40Latvia Estonia
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THE SHADOW ECONOMY SHRUNK IN 2015
• Shadow economy contracted due to a decline in the proportion of unreported business income and “envelope” wages;
• The key components of shadow economy: underreporting of business income or tax avoidance (44%), envelope wages (35%) and unreported employees (21%).
Source: Putniņš & Sauka, Shadow Economy Index for the Baltic countries 2009 – 2015 (2016)
Level of shadow economy by component 2013 2014 2015
Underreporting of business income (% of actual profit) 19.9 21.7 19.9
Envelope wages (% of total wages) 25.2 20.3 17.9
Unreported employees (% of total number of employees) 10.3 9.6 9.6
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LATVIANS ARE HIGHLY DISSATISFIED WITH THE TAX POLICIES AND THE GOVERNMENT, RESULTING IN A HIGH LEVEL OF SHADOW ECONOMY…
Satisfaction with the tax policy of the government, % of respondents
Dissatisfied Neither satisfied nor dissatisfied
Satisfied0
10
20
30
40
50
60
70
Latvia Estonia
• Even though since 2010 there had been a decreasing trend in dissatisfaction with the
governement's tax policies, the share increased in 2015
• Latvians are less satisfied with the quality of business legislation than Estonians (dissatisfied
35.4% (LV) vs. 27.4% (EE), satisfied – 25.3% (LV) vs. 36.4% (EE)).
• Sauka's research suggests: Latvian firms engage in more shadow activity because they are more
dissatisfied with the tax system and the government.
Source: T. J. Putniņš & A. Sauka, Shadow economy index for the Baltic countries 2009 – 2015 (2016)
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DUE TO THE HIGH LEVELS OF SHADOW ECONOMY IN LV AND DESPITE THE LARGELY SIMILAR TAX RATES TO EE, GOVERNMENT REVENUES AS A SHARE OF GDP IN EE ARE HIGHER THAN IN LVLatvia, government revenues, mil EUR and % of GDP Estonia, government revenues, mil EUR and % of GDP
19951997
19992001
20032005
20072009
20112013
20150
100020003000400050006000700080009000
05101520253035404550
Source: Eurostat
19951997
19992001
20032005
20072009
20112013
20150
100020003000400050006000700080009000
0.05.010.015.020.025.030.035.040.045.050.0
VAT revenue Tax on income, wealthSocial contributions Capital transfersOther Budget revenues, % of GDP (rhs)
In EE VAT revenues are as large as in LV in absolute terms, even though EE is a smaller country and its weighted average VAT
rate is very similar to that of LV (2014: 12.6% LV vs. 13.0% EE).
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IN ESTONIA, A SIGNIFICANTLY LARGER SHARE OF BUDGET IS ALLOCATED TO INVESTMENT (ESPECIALLY HISTORICALLY) THAN IN LATVIA
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
20112012
20132014
20150.0%2.0%4.0%6.0%8.0%
10.0%12.0%14.0%16.0%18.0%20.0%
0%
2%
4%
6%
8%
10%
12%
Difference Estonia Latvia
Source: Eurostat
Investment, % of budget
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ESTONIA'S LARGER INVESTMENT HAS NOT BEEN FINANCED BY HIGHER BORROWING
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
20112012
20132014
20150.05.0
10.015.020.025.030.035.040.045.050.0
0.05.010.015.020.025.030.035.040.045.050.0
EE LV
Source: Eurostat
Government debt, % of GDP
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CILVĒKRESURSI
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AFTER JOINING THE EU LABOUR MOVEMENT WAS MADE EASIER; THIS DID NOT RESULT IN HIGH EMIGRATION IN EE: THE RICH COUNTRY IS CLOSE BY AND ESTONIANS CAN WORK THERE WITHOUT ACTUALLY EMIGRATING
1995 2000 2004 2015 2030 205065707580859095
100105
Latvia Estonia
1.4 milj.2.5 milj.
1.1 milj.1.7 milj.
Source: OECD; PIXABAY
Population, 1995 = 100%
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HIGH EMIGRATION COULD BE ONE OF THE REASONS INCREASING THE NEGATIVE NATURAL POPULATION GROWTH, SINCE IT IS OFTEN THE YOUNG THAT EMIGRATE
Change in population size, % of total population in Estonia
20002002
20042006
20082010
20122014
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
Natural change of population Net migration Total
Change in population size, % of total population in Latvia
20002002
20042006
20082010
20122014
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
Source: Statistics Estonia, CSB
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UNEMPLOYMENT (AS WELL AS YOUTH UNEMPLOYMENT) IN ESTONIA IS MUCH LOWER THAN IN LATVIA
Unemployment, % of the economically active population Youth unemployment, % of the economically active
20002002
20042006
20082010
20122014
20160.05.0
10.015.020.025.030.035.040.0
EE LV
Source: Eurostat
20002002
20042006
20082010
20122014
20160.05.0
10.015.020.025.030.035.040.0
EE LV
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REGIONAL DIFFERENCES IN LATVIA ARE MUCH HIGHER THAN IN ESTONIA
Registered unemployment in Latvia, june 2016, % of the labour force
Registered unemployment in Estonia, june 2016, % of the labour force
Source: NVA, Eesti Tootukassa
To view these maps interactively, press here
Riga: 4%
Viļāni: 23.7%
Ida Viru: 10.6%
Tartu: 3%
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TOTAL FACTOR PRODUCTIVITY
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TECHNOLOGY ADOPTION WAS ENCOURAGED BY THE ESTONIAN GOVERNMENT AND TECHNOLOGIES ENTERED ESTONIA MUCH EARLIER THAN LATVIA
19921993
19941995
19961997
19981999
20002001
20022003
20042005
20062007
20082009
20102011
20122013
20142015
20160
102030405060708090
100
Latvia Estonia
Source: Eurostat; PIXABAY
Internet users out of 100 inhabitants
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ESTONIA ALLOCATES A MUCH LARGER SHARE OF GDP TO R&D EXPENDITURE
R&D expenditure in Estonia by source, % of GDP
20002001
20022003
20042005
20062007
20082009
20102011
20122013
20142015
0.0
0.5
1.0
1.5
2.0
2.5
Business sector Government Higher education Private non-profit Foreign
R&D expenditure in Latvia by source, % of GDP
20002001
20022003
20042005
20062007
20082009
20102011
20122013
20142015
0.0
0.5
1.0
1.5
2.0
2.5
Source: Eurostat
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LATVIA APPEARS TO BE PERFORMING WORSE IN GOVERNANCE INDICATORS
Source: World Bank Governance indicators, PEF
World Economic Forum Competitivneness index, estimation of selected indicators (1-7 (best)), survey based
World Bank Governance indicators (various sources, including survey based), % of the best
Public trust in politicians
Judicial independence
Favoritism in government decisions
Waste of public spending
Burden of government regulation
Innovative products in governments' procurements
0246
2006-2007 EST 2006-2007 LVA2016-2017 EST 2016-2017 LVA
Voice and Accountability
Political Stability and Absence of Violence
Government Effectiveness
Regulatory Quality
Rule of Law
Control of Corruption
0
50
100
2014 EST 2014 LVA 2000 EST
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WHAT COULD BE DONE?
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COPYING OTHER COUNTRIES' EXPERIENCE DOES NOT GUARANTEE ACHIEVING THE SAME RESULTS :• Experience of other countries may be based on specific circumstances that are
impossible to repeat (Latvia cannot repeat Estonia's experience, for instance starting to cooperate with the (former) Scandinavian technological giants etc.);
• their experience is past – different political and economic situation, therefore many reforms today could not provide similar results;
• they have probably made mistakes as well.
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WHY ESTONIA?
• EE and LV are neighbours and are competing for the same international investors with an interest in this region; however,
Paraphrasing the former leader of Singapore Lee Kuan Yew:
• "As long as we are only as good as our neighbours, businesses do not have a reason to choose Latvia"
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THEREFORE LATVIA CAN:
• set its own goals according to its own idea of achieving better quality of life;
• try to reach these goals with the available resources either by adopting suitable policies of other countries or by forging its own policy paths;
• to do so irrespective of whether these reforms help Latvia advance in any international rankings
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FOR EXAMPLE, SEVERAL POTENTIAL FUTURE REFORM DIRECTIONS CAN BE HIGHLIGHTED
• Reforming the education curriculum;• Establishing a stable and transparent tax system for the
long term;• Eliminating budget deficits at times of economic growth;• Regional reform to account for the changing
demographic situation in the regions;• Reforming active labour market policies;• Reforming the government institutions;• Judicial reform.
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THANK YOU FOR YOUR ATTENTION!
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