wiiw - proposal

8/7/2019 WIIW - Proposal

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PROPOSAL

FOR A NEW PHASE OF COOPERATION BETWEEN THE

GLOBAL DEVELOPMENT NETWORK

AND THEVIENNA INSTITUTE FOR INTERNATIONAL ECONOMIC STUDIES

for the period of 2011 to 2013

CRISIS EFFECTS: GROWTH PROSPECT, SOCIAL

IMPACT AND POLCY RESPONSES

IN SEE AND CIS

Rahlgasse 3 Telefon: (+43-1) 533 66 10 E-Mail: [email protected]

A-1060 Vienna Fax: (+43-1) 533 66 10-50 Website: www.wiiw.ac.at

Wiener Institut fr

Internationale

Wirtschaftsvergleiche

The Vienna Institute

for International

Economic Studies


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Contents

1. Introduction ..................................................................................................... 11.1 Global Development Network ............................................................................... 11.2 Co-operation between GDN and wiiw .................................................................. 1

2. Outline of the proposal ................................................................................... 42.1 Motivation .............................................................................................................. 42.2 Areas and regions of research .............................................................................. 52.3 Research competition: Methodology, Areas of Study, and Data ......................... 6

2.3.1 Macroeconomic effects ............................................................................ 62.3.2 Microeconomic effects ............................................................................. 82.3.3 Policy response ....................................................................................... 82.3.4 Improving labour market institutions ........................................................ 92.3.5 Political economy implications ............................................................... 102.3.6 Research competition ............................................................................ 11

2.4 wiiw research....................................................................................................... 112.4.1 Macroeconomic effects. Inequality and the Crisis: A Causal Inference

Analysis ................................................................................................. 112.4.2 Microeconomic effects. Microeconomic analysis of short and medium

term crisis effects on poverty and vulnerability of households in SEE:The cases of Bulgaria and Romania ..................................................... 13

2.4.3 Methodology .......................................................................................... 152.4.4 Data ....................................................................................................... 16

3. Conclusion .................................................................................................... 18References ................................................................................................................... 194. Organization of the project ........................................................................... 21

4.1 wiiw Research Team ........................................................................................... 214.2 Deliverables of the project .................................................................................. 22


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1. Introduction

1.1 Global Development Network

The Global Development Network (GDN) was set up as an offshoot of the World Bank to

promote quality research on economic and social questions of development and transition,

coming from researchers living in these countries. Its objective is to build local research

capacity, produce research that is relevant for policy making in transition and developing

regions and link research institutes from eleven regions with more than 9.500 researchers

in more than 100 countries. GDN has five major activities:

Global Research Projects (GRP), promoting research on specified topics on a global

scale, with a comparative perspective and with the purpose of bridging the gap between

research and policy advice. Currently there are 2 GRPs ongoing, one on the topic of

Strengthening institutions to improve public expenditure accountability and another one

on Varieties of governance: improving public service delivery.

Inter-regional Research Projects (IRP), supporting regional network partners in com-

parative projects that are small in scope than GRPs.

Regional Research Competitions (RRC), encouraging local and regional capacity build-

ing;

Policy Outreach for impact evaluation activities;

Global Policy Dialogues, providing an opportunity for consultation between regional

experts and policy makers, researches and experts from IFIs, supporting the improve-

ment of evidence based policy formulation;

Annual Conferences, acting as fora for researchers from developing and transitioncountries to present their research and be connected to the global research community;

The Global Development Awards and Medals Competition, the largest international

contest for research on development; and

GDNet, its electronic network, a knowledge base and similar dissemination activities

Over the years, GDN was able to substantially increase its output of research and increase

its network. It relocated its headquarters from Washington to New Delhi, demonstrating the

importance it puts on decentralizing know-how and policy advice. In February 2008 it has

become an International Organization. GDN is receiving funds from many governmentsponsors and some private donors.

1.2 Co-operation between GDN and wiiw

Cooperation between the Vienna Institute for International Economic Studies (wiiw) and

the Global Development Network (GDN) with the support of the Austrian National Bank

(OENB) and the Ministry of Finance (BMF) has now been going on successfully for sev-

eral years.


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The aim of the cooperation between wiiw and GDN is to serve as a hub for South-East

Europe (SEE). In this function wiiw works as an independent partner of GDN, setting its

own research agenda and with its own project management. The cooperation supports

research of high quality in the region and connects researchers in the region with the

global activities of the GDN. It is also intended to contribute to the building of capacity forresearch and policy evaluation by connecting economists and social scientists of South-

East Europe with those from the European Union and the rest of the world.

Five rounds of research have until now been conducted on SEE. In the first round

(2000-2002), macroeconomic developments, programmes and policies were analysed.1 In

the second round (2002-2004), reforms, enterprise development and European Union (EU)

integration were the main topics of research. The third round (2005-06) centred on the Im-

pact of Rich Countries Policies on Poverty and the fourth round (2007-08) dealt with mi-

gration. The last round (2009-10) dealt with inequality, income distribution and the contribu-

tion of fiscal systems to alleviate inequality. That phase was finalized at the end of Decem-

ber 2010. For the first time the regional focus of the project was widened to also include

some CIS countries. There was a separate research call and the papers commissioned

through this call were of high quality. The final reports are now being edited. The best pa-

pers from this phase were being presented in a draft version at the Annual Conference in

Prague on January 2010.

wiiws contribution to the cooperation with GDN has consisted of several components:

establishing and implementing the Southeast European Research network through re-

search competitions that are organised by wiiw; guidance for researchers who partici-

pate in the competition, workshops and dissemination activities via the Balkan Observa-

tory (a joint project with LSE) and the European Balkan Observer (a joint project with

the Belgrade Centre for European Integration);

participating actively in the Global Research Project (GRP), through papers by wiiw

researchers; mentoring of young researchers from the region who participate in the

GRP;

contributing to the review process of the Regional Research Competition of GDN via its

Central European hub in Prague (that is run by CERGE);

wiiw in-house research.

Over the years wiiw has succeeded to establish itself as a respected partner of GDN and

continuously increased the ties with GDN and expanded the common activities at the re-

quest by GDN.2:

1 For papers in rounds I and II see The Balkan Observatory at: www.wiiw.ac.at/Balkan2 For further details see Zwischenbericht to OeNB, January 2008 and March 2010.


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at the Annual conference in Beijing in 2007 wiiw organized a panel on Disparities in

Development patterns in Europe and Asia;

at the Annual conference in Brisbane in 2008 wiiw organized a workshop on Inequality

and Public Finance;

for the GRP on migration (2007-2009) wiiw researchers were asked to contribute to thedevelopment of the methodology and mentoring of a research team in Macedonia;

moreover wiiw contributed funds to this project on the basis of the contract with GDN;

at the Annual Conference in Prague in January 2010 wiiw organized a separate work-

shop on Inequality and Public Policy.

In addition to working with GDN wiiw builds on the synergies within the project to increase

its own research capacity on Southeast Europe, expanding its database, particularly the

data on Albania, Bulgaria, Kosovo, Macedonia, Montenegro and Serbia, increasing the

scope and improving the quality of its research. Over the years, a number of younger re-searchers have been employed by wiiw and they have contributed to wiiws ability to study

and monitor the SEE states and economies and to increase its expertise in new areas of

study of particular interest for an institute that deals with international and transition eco-

nomics.

In our view, the cooperation between wiiw and GDN has several advantages for Austria in

general (in addition to the advantages for wiiw), in particular the participation in a global

research network with interest for the research community and capacity building and net-

working within the region and the possibility to contribute to shaping the agenda of policyadvice in SEE. A continuation of this cooperation will further enhance Austrias role as a

regional hub, not just in business but also in scientific discourse.


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2. Outline of the proposal

2.1 Motivation

Distributions (of income, wealth, power) are usually stable and tend to change relatively

slowly (Acemoglu and Robinson 2005). This is clearly and more specifically the case with

the inequality of income and capabilities, but also with other aspects of social differentia-

tion, and with poverty and other measures of absolute deprivation. These slow moving

changes are usually driven by the persistence of growth, by institutional and other devel-

opment, and by the quality of the policy responses. Structural shifts in distributions, how-

ever, are often prompted by either external shocks, like crisis, or by internal shocks, like

regime changes or large scale reforms. Some of these shocks may be reversed, but some

have more enduring effects. The issue then is whether the current economic crisis is such

an external shock and whether in some cases it may lead to enduring changes in the dis-

tribution of incomes, capabilities or other values of interest. First empirical observations

tend to point in this direction at least in countries and regions that are of interest for thisresearch, i.e. Southeast European (SEE) and CIS countries (wiiw (2010).

Due in part to the lag in the available data, previous GDN SEE & CIS research on inequal-

ity, which was just completed at the end of 2010, focused on the pre-crisis developments.

Multidimensional aspects of inequality have been described and analysed for the period of

prosperity for most of the countries neighbouring the EU. Special emphasis was put on the

analysis of the effects of public policy. In the late 1990s and early 2000s the process of

European integration allowed most of the transition economies to aim for the best of both

worlds: equity and economic development. Low real interest rates helped to improve eco-nomic growth and increase financial access which contributed to the reduction of inequal-

ity. Sustained public spending was also instrumental to reducing inequality while also sup-

porting growth in good and bad times. All in all, the emerging social differentiation and in-

come inequality increasingly resembled that in the developed countries, particularly mem-

bers of the European Union.

The social impact of the world financial crisis of 2007 and 2008, however, started to show

up in 2009 when economic activity decreased sharply throughout Southeast Europe and

the CIS region. In most of these countries, the drop in GDP was above the EU average ofabout 4% in absolute terms. As a consequence unemployment started to rise throughout

the region in 2009. Except for Turkey and those countries that are mainly relying on ex-

ports of fuels and metals, growth prospects for the years to come are very modest and a

further increase of already high unemployment is quite likely. It can be expected that espe-

cially less skilled employees and various vulnerable groups will be strongly affected with

rising poverty risk. The number of wage earners is expected to decrease further and the

people eligible to receive various types of transfers or to start living on pensions will in-

crease. These adverse employment and income prospects will have substantial repercus-


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sions for the economic and political developments in the countries in the southern and

eastern neighbourhood of the EU. In other words, current expectation is for a structural

break in growth and development in these regions (Bruegel and wiiw, 2010).

Having that in mind, the main hypothesis to be tested is the following: The crisis shockintroduces structural breaks in the distribution (e.g. increase of inequality) across different

dimensions conditional on the change in potential speed of growth, the quality of develop-

ment, and the induced or adopted policy changes.

2.2 Areas and regions of research

The regions to be analysed are South-Eastern Europe and the CIS. It would be interesting

to also include a region of emerging economies in a wider inter-regional project. Turkey

and perhaps some other countries among the emerging markets may be of particular in-terest because they diverged with the transition countries before the crisis and seem to be

diverging again after the crisis albeit in the different direction at least when it comes to the

prospects for economic growth: in the first instance lagging behind, while currently forging

ahead of the countries in transition, especially those in Southeast Europe. On the other

hand, they share some of the same shocks and some of the same mechanisms of the

transmission of shocks due to trade and financial integration with the economies of the

European Union.

The areas of research are the following:

(i) To check the influence of growth, development, and policies on distributional vari-

ables: the macroeconomics of potential growth, the effects of institutional changes,

and of policy reforms should be looked at and the effects on labour markets and in-

come distribution assessed.

(ii) To look at effects of the crisis on various social groups and households, especially

when it comes to employment, capabilities, and poverty: the microeconomic effects

and impacts of both shocks and policies should be investigated.

(iii) Political economy and sociology of the policy response and of the absorption of

shocks will be included.

As in earlier GDN SEE & CIS projects, some of the research will be done in house and

some through a research call. Current research will not be just a continuation of the previ-

ous work on inequality and public policy but also a check on the robustness of the findings

in the previous research due to changing economic circumstances but also due to chal-

lenges to the political economy of these regions raised by the current crisis. Here we first

describe the areas of research and possible methodologies that should form the basis for

the call for research proposals and, then, describe the research that is to be done by wiiw.


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2.3 Research competition: Methodology, Areas of Study, and Data

At the macro level, the persistence of distributions, e.g. inequality and the structural break

hypothesis is now increasingly being studied with the natural experiment type of methodol-

ogy. The idea is to look at the consequences of shocks on the shift in the distribution of the

variables of interest (e.g. income, wealth, power) and then check for the persistence of thenew distributional regime. In the SEE and CIS regions (and also in the other emerging

economies), there are persistent characteristics, e.g. in the labour markets or in capabilities

that could be explored. There is also the differentiated effect of the crisis that could allow

for natural experiment type of analysis.

In addition, policy impact analysis is clearly needed. On the micro level, policy impact

analysis could be useful. There are developed methodologies to studying local political

economy and the sociology of local communities that could be explored (e.g. the substitu-

tion of social support mechanisms where state support fails and vice versa).

Much of all these studies will involve simulations of various kinds. Clearly, the crisis is an

evolving thing. So, there will be limitations on the data and on information in general. But it

does not make sense to wait for data to accumulate in order to look at these issues. So,

some ingenuity will be needed in the design and implementation of the methodologies and

in the use of data and in the simulation of the effects of crisis and of changes in social dif-

ferentiation, e.g. in inequality and poverty.

2.3.1 Macroeconomic effects

Various methodologies will be employed to determine the possible change in the potential

growth rate and to deduce the types of development and policy constraints that a possible

decline of the potential growth rate may have for development and for distributional vari-

ables of interest (Bruegel and wiiw, 2010).

2.3.1.1 Financial flows and inequality

The key problem in macroeconomic research is the difficulty to identify causal relations and

thus causal effects (Hoover 2001, Gligorov 2010). This is partly because of the need to rely

on micro-founded policy impacts and partly because of the inherently general equilibriumnature of macroeconomics; in that context, causal effects tend to be hard to define and

thus identify. Still, the current crisis has prompted significant policy re-evaluations, espe-

cially when it comes to financial and fiscal policies. It is expected that in some of the re-

gions of emerging Europe, e.g. n Southeast Europe, the availability and the access to fi-

nance is expected to be major constraints in the medium run. That may prove not to be the

case in the CIS region. As a consequence, there may be significant differences in the ac-

cess to finances in these two regions. Similarly, in other emerging markets, e.g. Turkey,

the problem may be that of too much inflow of money and capital and speedy increase in


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access to them by households and corporations. Thus, while Southeast Europe may be

starved to finances, countries in the CIS and in other emerging markets may face the prob-

lem of too much inflow of money and capital. These different financial situations will have

effects on income distribution and on other distributional variables. In both cases there will

be social and distributional effects and possible long term consequences that will be as-sessed.

2.3.1.2 Distributional effects of public spending

The changes in fiscal policies are already having and will undoubtedly continue to have

significant impact on the distribution of income and other distributional variables. These

effects have been increasingly investigated and some of the available methodologies

should be checked, improved upon, and implemented in the current research (Romer and

Romer 2010, IMF 2010, Alesina and Ardagna 2010). Most of the macroeconomic studies

look at the effects of changes in tax systems and policies on the distribution of income andwealth. Much less is known about the effects of public spending, which are particularly

affected by the current crisis, though it is clear that the effects are strong. The problem is

mostly one of proper modelling and measurement of these effects. Income and other dis-

tributional effects of public investments in infrastructure or in human capital should be im-

puted in order to measure the effects on, for instance, income distribution and in order to

be able to project the long term effects of the structure and the level of public spending on

social inequality. This is essentially an ex ante impact analysis which will have to be based

on the method of imputation of direct and indirect effects of the structure of public spending

on the internalised and expected changes in the distribution of income, wealth, power and

other resources.

2.3.1.3 Intergenerational justice and investments

Finally, distributional effects are strongly inter-generational. This is especially true in coun-

tries, like the ones we are studying, that face significant investment needs in order to spur

long term growth and development. This suggests the need to clarify how the social dis-

count rate is determined and what policies are most effective in influencing the relative

importance of current versus future consumption. Countries differ in the amounts that they

spend on e.g. public investments or in other words in how much they value current as op-posed to future consumption. Similarly, countries differ in the amount of private savings

and investments, which again suggests that there are significant differences in the propen-

sity to save and thus that social discount rate, the rate at which future consumption is dis-

counted, is relatively high. Thus, there are significant differences in how inter-generational

justice is perceived in different countries. This is an area of research that has not received

much attention in studies of countries in transition and is especially important in the wake

of the current crisis that challenges the inherited model of growth and also of social and

inter-generational equilibria. We aim to develop methods to identify the determinants of


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differences in the rate at which future consumption is discounted. For instance, in some

Asian emerging markets, social discount rate seems to be quite low, while the opposite is

the case in many countries in Southeast Europe and in the CIS. Current crisis may be

changing that as savings are growing in one set of countries while consumption is pre-

ferred more than before in the other set of countries. The aim is to determine why.

2.3.2 Microeconomic effects

2.3.2.1 Crisis effects on income and poverty

Here the aim is to survey the early effects of the crisis on economic activity, income and

poverty among the SEE and CIS countries. It will also be looked at growth and distribution

forecasts for the medium term. Finally political economy implications of the changes in the

distribution of income will be analysed.

2.3.2.1.1 Early crisis effects

Based on available micro data it is intended to thoroughly describe the effects that the cri-

sis has had on the economic activityand incomes of the populations of Southeast Europe

and the CIS. The developments of wages, transfers and pensions will be distinguished in

detail. This will give an opportunity to identify vulnerable groups that are affected by unem-

ployment, economic inactivityand poverty. Differentiation by age, gender and skills of indi-

viduals will be made. This should give a proper picture of the early consequences that the

crisis had on the distribution of incomes and the incidence of poverty.

2.3.2.1.2 Stress test 2011-2013

Given the fact that longitudinal micro data typically comes with a lag of two years, by mid

2012 it will only be possible to analyse data from 2009 and 2010. Therefore, based on mi-

crodata and longer time series stress tests will be performed for the period of 2011 to

2013. This will give a hint at the potential medium run effects that the crisis has on eco-

nomic activity, income and poverty development.

2.3.3 Policy response

The standard policy response to economic downturns in the transition economies in manySoutheast and CIS countries is based on fiscal adjustments as in many cases monetary

policy is handcuffed by a fixed exchange rate regime. In a few cases, such as Romania or

Serbia a flexible exchange rate regime is being used to counter act external shocks. How-

ever in many cases a currency board or a fixed exchange rate regime is coupled with a

pro-cyclical fiscal policy stance. After bad experiences in periods of hyper inflation at the

beginning of the transition process a fixation of the local currency to the Euro is a social

consensus in many transition economies, such as for instance in Croatia. So far hardly any

country has tried an alternative way to cope with real exchange rate crises. It is mostly Slo-


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venia that is trying to make use of wage policy with the help of a social partnership type of

a model to maintain stable international competitiveness and domestic demand. Slovenia

has a high level of unionisation and collective bargaining coverage as compared to other

transition countries. In general, the continental Western European neo-corporatist industrial

relations system as for instance applied in Austria (see Knell and Stiglbauer, 2009) has notevolved in the transition economies. There, rather a transformation of industrial relations

into a segmented system, which is more similar to the deregulated labour markets of An-

glo-Saxon liberal market economies, can be observed (see Benczes, 2006).

In the research competition we do not want to discourage proposals that deal with fiscal

and monetary issues. However we would like to encourage proposals that deal with the

issues of wage bargaining and social partnership in SEE and CIS countries as an alterna-

tive policy response to external shocks.

2.3.4 Improving labour market institutions

Our hypothesis is that in most countries of the region the wage bargaining system is highly

fragmented and wage inequality is often above the level of benchmark countries. As a re-

sult employment and skills levels are below their potential and domestic demand and ex-

ternal competitiveness are depressed. So far, the literature has mainly described the la-

bour market institutions in transition countries (see e.g.: Funk and Lesch 2004, Mailand

and Due 2004, Avdagic 2005, Arandarenko 2004). Its potential role as a substitute and/or

complement for monetary and fiscal policy was hardly touched upon. We would like to

support research proposals that describe the current state of wage setting processes and

the organisation of vocational training and skill upgrading as well as the potentials for an

improved social partnership providing alternative macroeconomic policy options. The main

motivation being that in the sphere of labour market institutions some of the main channels

for the transmission of the economic crisis on social differentiation can be found and that

these are also of particular interest from a political economy perspective. The crucial impor-

tance of high quality industrial relations was also emphasised by the European Commis-

sion in its latest Industrial Relations report (EC, 2009). Higher trade union density is corre-

lated with lower wage inequality and an increase in wage bargaining coverage is asso-

ciated with lower in-work poverty. Also, Blanchard and Philippon (2004) report that cooper-

ative labour institutions play an important role in alleviating unemployment rates. This is ofutmost importance, especially in the context of the current economic crisis.

2.3.4.1 Wage setting process

The existing status of the labour relations and the social dialogue in the region will be de-

scribed. The prime focus will be on the wage setting processes and the political economy

factors that influence these processes. The organisational level of the employers and em-


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ployees institutions will be examined. The distributional effects of the national labour mar-

ket institutions will be estimated.

2.3.4.2 Organisation of vocational training and skill upgrading

Apart from the wage level also the level of skills is crucial for the development of internaland external demand of the region analysed, as many of these countries have not devel-

oped an internationally competitive manufacturing sector that could provide labour to a

large share of the population. We will therefore study the current organisation of vocational

training and skill upgrading. This includes an analysis of the influence of workers and em-

ployers organisations on the education and training especially in technical jobs relevant for

potentially export oriented manufacturing.

2.3.4.3 Potentials for improved social partnership

Finally we will try to conclude from the above examination of the existing wage settingprocesses and the organisation of in-plant skill enhancement and develop relevant policy

recommendations for an improvement of social partnership in the countries analysed. This

includes an assessment of the political economy factors that are potentially impeding as

well as conducive to a reform of the labour market institutions. The analysis will take care

of the potential macroeconomic role of an improved social partnership in SEE and the CIS

based on seminal papers in this field such as for instance Calmfors and Driffill (1988) but

also more recent papers such as Sidiropoulos and Zimmer (2009).

2.3.5 Political economy implications

Crisis as severe as the current one can be trusted to lead to significant social tensions and

political changes. Both can be expected to have significant effects on the social differentia-

tion as a consequence of the choice of policy responses. These responses, however, need

to be studied with the view of the ability of particular social and political institutions to adopt

specific policies as shaped by the diverse and conflicting social and political interests. This

is the familiar problem of structural reforms and of their consistent implementation. Not

enough is known about the way in which social and political interests are represented in

various counties of the regions that will be studied within this project. For instance, income

distribution is strongly affected by income policies which are often determined with a par-ticular interest in mind. As quite a number of policy changes have been taking place during

and in the aftermath the crisis, analyses of these reforms could reveal the interests that

were the most important in their choice and implementation.

Based on the above analysis of existing data and the forecast exercise, we will make as-

sumptions on the potential political economy implications that the changes in the composi-

tion of income between wage earners and receivers of other forms of income have. This

will also touch upon the issues of sustainability and adequacy of social systems. A host of


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issues will be addressed in order to take account of the complex structure of bargaining

between various social and political interests over various distributional variables.

2.3.6 Research competition

The methodologies, the topics, and the data sources discussed above can be seen as theframework within which research proposal should be formulated. We expect proposals that

describe the methodology and the data sources by the persons applying for research in

this project. One of the main aims of GDN, with whom this project has been developed, is

capacity building, which inter alia implies the ability to formulate the hypotheses and to

develop methodologies to test them. Here we suggest the type of research that we would

like to see and in which research capacity should be developed. As in the past rounds of

research competition, originality and adequacy will weigh heavily on the inclusion of spe-

cific research projects into the overall research program.

2.4 wiiw research

In this section we will describe in more detail the wiiw in-house research.

2.4.1 Macroeconomic effects. Inequality and the Crisis: A Causal Inference Analysis

In the years prior to the world financial crisis, transition economies experienced high (in

some cases double-digit) GDP growth rates. Convergence to the EU average income level

seemed to be feasible within reasonable time. The influx of credit and direct investments

from abroad was the main engine of growth; some countries also experienced rising remit-

tances due to outward migration. A number of transition economies with abundant re-

sources benefited from the ballooning commodity price bubble. Policy makers throughout

Central, East and Southeast Europe (CESEE) differed in their ability to implement policies

to deal with their often overheated economies.

During this period income inequality decreased especially in countries with higher GDP

growth rates. This relationship was found in earlier wiiw GDN-SEE-CIS research on ine-

quality and growth (see Holzner, 2010). Even signs of labour shortages were reported in

several transition economies. Wages were rising and thus stabilising or even reducingpoverty and inequality. The shape of a Kuznets curve was observable, especially with the

sharp increase of inequality in the early stages of transition and a subsequent improvement

after the year 2000 when growth became more robust throughout the transition countries

(see Leitner and Holzner, 2008). Earlier studies have rejected the Kuznets hypothesis for

transition economies (see Wan, 2002), a hypothesis that was thought to be an empirical

regularity confirmed by Barro (2000) and others.


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However, economic growth in CESEE experienced a dramatic trend reversal after the

global financial crisis erupted, international capital flows went dry, and international trade

broke down in late 2008. As many other countries, most transition economies witnessed a

substantial recession in 2009. In the recovery period, however, some countries are faring

better than the others. Those economies that had a large export oriented industry sectorand that performed a more flexible real exchange rate policy were able to gain from the

international trade rebound and could thereby leave recession much quicker.

In our new research we want to estimate the influence that the crisis had upon income

inequality in CESEE. We will employ quarterly data on inequality, GDP growth and growth

explaining factors from before and after the crisis. This data is available for the majority of

transition countries. In order to make a causal inference using the observational database

at hand that most likely suffers from omitted variable and selection bias as well as possible

simultaneous causality we shall employ an instrumental variable (IV) method. The model

applied is a two-stage least-squares (2SLS) model following Acemoglu (2010), respectively

Acemoglu and Johnson (2007). The second stage relationship can be described as fol-

lows.

,ittiitit gI +++= (1)

where Iitrepresents income inequality in country iand quartertand grepresents economic

growth. The parameter of interest , measures the relationship between inequality and

growth. The variables andrepresent country and time dummies respectively and is

the error term. To overcome the problem of biased estimates ofwe define the first stage

relationship to be as follows.

,~~

ittiitit uGg +++= (2)

where G is a growth explaining variable and the remainder consists again of country and

time dummies as well as an error term. The growth explaining indicator G is defined as

follows.

,)1( postitt

pre

ittit GCGCG += (3)

where Cis the intervention dummy for the global financial crisis, that is equal to 1 for all

dates after the third quarter 2008. Gpre

refers to the pre-intervention growth explaining indi-cator and Gpost to the post-intervention growth explaining indicator respectively. Gpre will be

calculated as a normalised index consisting of two major pre-crisis growth explaining fac-

tors, the share of foreign capital influx in GDP as well as the share of fuels, ores and metal

exports in GDP. Consequently, Gpostwill be calculated as a normalised index consisting of

two major post-crisis growth explaining factors, the share of industry in GDP as well as the

index of real exchange rate appreciation. This is not necessarily a permanent new growth

model. However, we consider it to be the relevant one for the immediate period after the

crisis for which data is available.


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Thus, the first stage is based on the theory that global crisis intervention will change the

growth model for the transition economies from a foreign capital fuelled to an export lead

growth model. The second stage is derived from a Kuznets curve type of theory.

The data used will stem from national central banks and statistical offices as well as thewiiw Monthly Database on Eastern Europe and Eurostat. As a proxy for income inequality

we will calculate a simple Gini coefficient using data for average net wages and number of

employed by NACE categories as well as number of unemployed and pensioners and av-

erage unemployment benefits and pensions. This type of data is available for the majority

of transition economies on a monthly, respectively quarterly, basis from national statistical

offices. All the other data is readily available from the national accounts and the balance of

payments.

As a result we expect a confirmation of the hypothesis that the global financial crisis has

changed the growth model of the transition economies and that this in turn has significant

consequences for income distribution in the region. Corresponding policy recommenda-

tions will be drawn from these results. A publication in an international peer reviewed jour-

nal will be aimed for.

2.4.2 Microeconomic effects. Microeconomic analysis of short and medium term crisis

effects on poverty and vulnerability of households in SEE:

The cases of Bulgaria and Romania

Income poverty and social exclusion are still widespread phenomena in the SEE countries.

Although absolute poverty rates have declined due to rising average real incomes in both

Bulgaria and Romania up to the economic crisis, an increase in income inequalities inhib-

ited to reduce significantly the vulnerability and relative poverty of households. In 2008, in

Bulgaria 21% and in Romania 23% of the households are in or at risk of poverty according

to EU methodology. Together with Latvia the latter two SEE countries are those EU mem-

bers with the highest poverty rates in the period before the economic crisis (Atkinson and

Marlier, 2010). This also highlights that fiscal and social policies materialising in the tax and

transfer systems were not designed efficiently to improve the situation of vulnerable groups

in times of high GDP growth rates. However, the financial and economic crisis represents a

substantial shock to the welfare situation of households in the whole CESEE region,thereby further worsening the position of poor households and pushing larger parts of the

population into vulnerability.

In the wiiw analysis of short and medium term effects of the crisis we will examine various

channels of the macroeconomic shock on household welfare. The most important ones are

the labour market and income channel, the credit channel and the changes in the fiscal

and social policies (see Figure 1). In order to detect the structural changes of the income

positions we perform stress-tests (for a more detailed description see 4.2.1 below) based


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on household survey data. Since household survey data is available only with a delay of

two years, in order to analyse even the short term effects of economic shocks on poverty

such stress-tests are necessary.

Figure 1

One of the first immediate impacts of the economic crisis hitting households was a rise in

unemployment rates and an even stronger decline in employment in most SEE countries.

While in many EU countries GDP growth revived in 2010, in the SEE region the current

outlook shows a delay in the economic upswing and a protracted period of sluggish de-

mand development. Therefore the observed loss in employment is expected to lead to

lower labour force participation over the medium term especially for low and medium

skilled groups of the population.

Before the financial crisis lead to a credit crunch in the transition countries, household debt

levels rose swiftly especially in those transition countries that experienced an accelerated

catching-up process. Although levels of indebtedness of households in Bulgaria and Ro-

mania are not as dramatic as in e.g. Estonia, Latvia or Croatia the growth rates of house-

hold consumer and mortgage lending where among the highest in the most recent period

before the crisis. Hikes in interest rates, credit restrictions and currency devaluation caused

rising debt levels and financial vulnerability of households throughout the region.

Furthermore the substantial fall in output led to changes in the transfer and tax policies.

Even more so in the short to medium term governments are eager to reduce their crisis

induced budget deficits by lowering their social expenditures and raising taxes.

The composite effect of the crisis transmitted via the various economic channels is a rise in

poverty. However, the reduction in welfare levels will not only concern the low income

groups but spread throughout the middle class. For our analysis this implies that not only

Income and labour market

Credit market

Policy responses:Changes in the tax and trans-fer systems

Household welfare:Vulnerability & poverty effects

Macroeconomicshock


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the change in the level and structure of poverty and vulnerability is of interest, but also in

the income levels and distribution in general.

2.4.3 Methodology

In order to simulate the effects of the crisis on household welfare, vulnerability and povertyour analysis will pursue the following steps:

First we assess the welfare situation of households in Bulgaria and Romania as well as

their debt service burden before the crisis, based on EU-SILC data. This will give us the

first insight into the structure of poverty in the two countries. Moreover the use of house-

hold survey data allows assessing the poverty-reducing capacity of the tax and transfer

systems. EU-SILC data contains detailed information on taxes on income, wealth and so-

cial contributions, respectively. Moreover the effects of the transfer system can be traced

with the help of 9 different categories of benefits and allowances, included in the surveydata.

In the second step we will identify the vulnerability of households to economic shocks by

comparing the actual debt service burdens to indicative thresholds. Similar approaches

were performed in the literature (e.g. Beer and Schrz, 2007; Albacete and Fessler, 2010;

Tiongson et al., 2010). Local national bank figures on the development and structure of

non-performing loans will be used to calibrate the debt service burden thresholds. In addi-

tion, first crisis effects can be analysed based on the EU-SILC data for 2009, which will be

available by March 2011. Since EU-SILC is a rotating panel it is also possible to keep track

of the majority of households over time.

Third, we perform stress tests, i.e. households are made subject to various macro-

economic shocks induced by the financial crisis in order to simulate the changes in income.

The magnitude of these shocks will be calibrated by making use of aggregate economic

data up to the end of 2011 and forecast figures for the period thereafter. The first shock to

be implemented is the fall in employment and rise in unemployment. The selection of a

particular household to be affected by any of the quoted shocks will be based on an unem-

ployment probability model, as widely used in the literature (see e.g. Pissarides and

Wadsworth, 1989, 1990; Brown and Sessions, 1996). In the case of unemployment, thelikelihood of becoming unemployed of one or more members of the household is drawn

from a probit model, where unemployment is a function of e.g. an individuals socioeco-

nomic background, demographic characteristics or geographic location. In order to account

for the structural changes in the economic downturn we apply in our shock analysis differ-

entiated unemployment and employment changes for population subgroups, e.g. employ-

ment and unemployment changes by gender, educational attainment groups, regions,

economic sectors. The alteration in the labour force participation of the household mem-

bers thus translates into income changes. However, in addition to the changes in employ-


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ment and unemployment further shocks have to be taken into consideration in order to

simulate the changes in the income situation of households. In the course of the crisis also

the incomes of many employed decreased substantially. Thus, employees will be shocked

with the structural changes stemming from national wage data. Furthermore, in SEE coun-

tries for many households, especially those of vulnerable groups, remittances representeda substantial source of income before the crisis. The worsening of the employment situa-

tion of immigrants in EU-15 countries during the crisis led also to a dwindling of remittance

flows into the SEE countries from 2008 onwards. EU-SILC data contains information on

Inter-household transfers that can be used for this analysis. Using a probability model for

remittances households will be shocked with the changes in remittance inflows to the

countries analysed.

In step number four we will analyse the income changes due to alterations in the tax and

transfer structure, stemming from austerity packages introduced by the respective SEE

governments. Due to rising refinancing costs of public debt in the course of the crisis al-

most no CESEE country was able to perform countercyclical fiscal policies. Nevertheless,

the substantial drop in output led to budget deficits, which governments are eager to re-

duce as soon as possible. Therefore a reduction of social expenditures is taking place and

expected to be reinforced in the coming years. We will simulate the effects of these public

policy changes for broad categories of transfers and taxes depending on the availability of

explicit information on public policy changes. In general, EU SILC data contains detailed

social-economic information on individuals and as mentioned above various tax and trans-

fer categories, so that the effects of social policy changes can be assigned to single

households.

The analysis will conclude with an updated picture of the welfare situation of households

stemming from short and medium term effects of the crisis. We expect not only poverty to

rise due to increasing unemployment and other income changes, but also middle income

households to experience precarious welfare losses, thereby sliding into vulnerability. Fur-

thermore, due to the rise of debt to income ratios the financial vulnerability of parts of the

households will increase. Thus the simulation will allow assessing the tax and transfer poli-

cies of the governments in the course of the crisis in terms of efficiency in reducing first

round poverty effects. Since the analysis is based on micro data we will not only be able todescribe the upcoming situation of poverty but also overall distributional changes in house-

hold welfare.

2.4.4 Data

The analysis will draw on different datasets available for transition countries. The basis for

the microeconomic analysis of household welfare will be the EU Survey of Income and

Living Conditions (EU-SILC). Since 2008 Bulgaria and Romania have been covered by the

EU-SILC User database. In the very year a special module was included in EU-SILC, sur-


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veying the wealth and debt situation and structure of households. Thus it is possible to

analyse the vulnerability of the population just before the outbreak of the financial crisis. In

order to simulate the effects of the different economic shocks, we will use most recent na-

tional and EU structural datasets available. Thus, for example, in order to analyse the ef-

fects of labour market and income shocks we will use detailed LFS and wage data. In or-der to incorporate the changes of household debt we will make use of data provided by the

respective national banks as well as by international banks engaged in the region.

In order to improve the robustness of the results we will make use of consumption structure

data based on national Household Budget Surveys (HBS). In the case of Bulgaria and

Romania this can be used as a further tool in order to estimate the extent of the welfare

shock experienced by households.


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3. Conclusion

The main goal of the research that is here outlined is to determine whether the current cri-

sis, which has had severe consequences for growth and social differentiation in Southeast

Europe and in CIS countries, has led to structural shifts in social inequality and through

which channels? This is a project developed and implemented within the research coop-eration between wiiw and the GDN. The execution of the project is in two parts: through

specific projects chosen through research competition in order to satisfy a major goal of

GDN which is capacity building in Southeast Europe and in other developing countries.

The second part consists of the research by the wiiw researchers and is here outlined in

greater detail. The aim is that these research efforts are complementary in order to im-

prove the quality and provide some mentoring to the researchers from the target regions -

Southeast Europe, the CIS, and possibly some other emerging markets (e.g. Turkey).

The main topic is chosen in order to check the social effects of the current crisis and todetermine whether a structural break in the distribution of income and other values has

occurred or can be expected. Increase in inequality, if it happens, tend to have significant

impact on growth and on social and political responses. We aim to test the hypothesis that

a significant shift in distributional variables has occurred in a number of countries and to

look at further social and political consequences both at the macro and the micro levels.

Significant insights into the social effects of financial crisis and possibly policy implications

in order to influence these shifts are expected to be achieved with this research.


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References

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Working Papers, No. 15944.

Acemoglu, D. and Johnson, S., 2007. Disease and Development: The Effect of Life Expectancy on Economic

Growth. Journal of Political Economy, Vol. 115, No. 6, pp. 925-985.Acemoglu, D., J. Robinson, 2005. Economic Origins of Dictatorship and Democracy. Cambridge University

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Albacete, N. and P. Fessler, 2010. stereichische Privathaushalte im Stresstest. In: Finanzmarktstabilittsbe-

richt 19, Juni 2010, Wien, sterreichische Nationalbank.

Alesina, A., S. Ardagna. Large changes in fiscal policies: taxing vs. spending. Forthcoming in Tax policy and the

economy.

Aranadrenko, M., 2004. International Advice and Labour Market Institutions in South-East Europe. Global Social

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Atkinson, A. B. and E. Marlier (eds.), 2010. Income and living conditions in Europe. Luxembourg, PublicationOffice of the European Union.

Avdagic, S., 2005. State-Labour Relations in East Central Europe: Explaining Variations in Union Effectiveness.

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Barro, R.J., 2000. Inequality and Growth in a Panel of Countries. Journal of Economic Growth, Vol. 5, No. 1,

pp. 5-32.

Beer, C. and M. Schrz, 2007. Characteristics of Household Debt in Austria: Does Household Debt Pose a

Threat to Financial Stability? Monetary Policy and the Economy, 2nd Quarter, pp. 58-79.

Benczes, I., 2006. Social Pacts: A Helping Device in Euro Adoption? Transition Studies Review, Vol. 13, No. 2,

pp. 417-438.

Blanchard, O. and Philippon, T., 2004. The quality of labor relations and unemployment. Massachusetts Institute

of Technology Department of Economics, Working Paper Series, Working Paper 04-25.

Brown S. and G. Sessions, 1996. A profile of the UK Unemployment: Regional versus Demographic Influences.

Regional Studies, Vol. 31, No. 4, pp. 351-366.

Bruegel and wiiw, 2010. Wither Growth in Central and Eastern Europe? Bruegel.

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Policy, Vol. 3, No. 6, pp. 13-61.

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Funk, L., Lesch, H., 2004. Industrial Relations in Central and Eastern Europe: Organisational Characteristics,

Co-determination and Labour Disputes. Intereconomics/Review of European Economic Policy, Vol. 39, No. 5,

pp. 264-270.

Gligorov, V., 2009. Causes and Counterfactuals: Simple Ideas. Unpublished paper.

Hoover, K., 2001, Causality in Macroeconomics. Cambridge University Press.

Holzner, M., 2010. Inequality, Growth and Public Spending in Central, East and Southeast Europe. wiiw Work-

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Knell, M., Stiglbauer, A., 2009. Wage Staggering and Wage Leadership in Austria--Review and Implications.

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4. Organization of the project

4.1 wiiw Research Team

The GDN project has allowed wiiw to build up additional research capacity to study South-

East Europe. Synergies from the project in the form of increasing its network as well as

deepening wiiw researchers know-how and experience help the institute to produce the

information on SEE that it offers as a public good.

The researchers involved in this project will be:

Leon Podkaminer (senior economist, wiiw; project leader)

Vasily Astrov (economist, wiiw)

Vladimir Gligorov (senior economist, wiiw)

Peter Havlik (deputy research director, wiiw)

Mario Holzner (economist, wiiw)Michael Landesmann (research director wiiw)

Sebastian Leitner (economist, wiiw)

Josef Pschl (senior economist, wiiw)

Robert Stehrer (senior economist, wiiw)

Hermine Vidovic (senior economist, wiiw)

Statistical assistance will be provided by

Boriana Assenova (statistician)Nadja Heger (statistician)

Beate Muck (statistician)

Monika Schwarzhappel (statistician)

Project management will be provided by

Veronika Janyrova (project manager)


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4.2 Deliverables of the project

Research Competition

wiiw will organise a research competition for researchers in Southeast Europe and the

Commonwealth of Independent States. The areas of research are outlined in section 2.3.

Interregional Research Project

Contribution to an Interregional Research Project will be through cross country macro-

studies, individual country studies and studies using microeconomic data sets. The IRP will

use uniform methodologies and wiiw will provide clear methodological guidelines for all

three types of studies.

GDN Annual Conferences

wiiw will participate in the upcoming GDN Annual Conferences and may again organise its

own panel or half-day workshop at one of those conferences.

CERGE GDN RRC

wiiw will continue to support CERGE-EI in Prague with organising the GDN Regional Re-

search Competition (RRC) for researchers in CEE.

wiiw In-house Research

The work for the Interregional Research Project will be complemented by wiiws in-house

research along the lines outlined in section 2.4.

Policy dialogue

wiiw will organise a policy dialogue on the results of the research conducted with the partic-

ipation of international experts.

wiiw - proposal

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