THE STANDARD OF LIVING IN LATVIA: CAN WE / SHOULD WE TRY TO CATCH ESTONIA?

Līva Zorgenfreija06.03.2017

Latvijas Universitāte

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

"COMPARISON IS THE THIEF OF JOY"Theodore Roosevelt

4

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

5

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

6

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

7

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

WHERE COULD THE DIFFERENCES STEM FROM?

9

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

10

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, %

11

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

12

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

13

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

14

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%

15

THESE DIFFERENCES CREATED DIFFERENT STARTING POSITIONS

16

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

17

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%

18

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

19

GDP GAP – HOW FAST SHOULD LATVIA GROW TO CATCH UP WITH ESTONIA?

20

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

21

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)

22

CAPITAL

23

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

24

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)

25

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

26

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

27

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

28

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)

29

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).

30

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

31

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

32

CILVĒKRESURSI

33

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%

34

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

35

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

36

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%

37

TOTAL FACTOR PRODUCTIVITY

38

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

39

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

40

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

41

WHAT COULD BE DONE?

42

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.

43

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"

44

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

45

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.

THANK YOU FOR YOUR ATTENTION!

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