ECONOMICS AND POLICY ADVICEA Farewell Seminar for Mr. Antti Suvanto

Christian KASTROPDirector of the Policy Studies BranchEconomics Department, OECD, Paris

Helsinki, Monday, 11th April 2016

Rebalancing is happening in China ?

2Source: OECD Economic Outlook.

Mac

ro fo

reca

sts

- W

orld

Financial exposures and vulnerabilities have increased in EMEs

3Source: OECD Economic Outlook.

Mac

ro fo

reca

sts

- W

orld

Increase in debt levels End- period stock, % of GDP

Advanced economies have therefore been more resilient

4Source: OECD Economic Outlook.

Mac

ro fo

reca

sts

- W

orld

Revisions to OECD Economic Outlook projections between June and November 2015

But there were growth shortfalls in the euro area

5Source: OECD.

Mac

ro fo

reca

sts

- W

orld

The estimated impact on GDP growth in 2015 of changes in forces acting since June 2014

Difference from baseline, percentage points

Growth recovery is still very subdued

6Source: OECD Economic Outlook.

Mac

ro fo

reca

sts

- W

orld

Global GDP growth

What keeps investment down in important European countries?

7

Source: OECD Economic Outlook.

Mac

ro fo

reca

sts

- E

urop

e

Total investment

Overall unemployment - except few countries - only slowly comes down

8

Mac

ro fo

reca

sts

- E

urop

e

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0

2

4

6

8

10

12

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Unemployment rate (%, left axis) Coefficient of variation¹ (right axis)

Unemployment dispersion in the European Union

1. Weighted standard deviation of unemployment rate observations for European Union (28) countries divided by the average EU unemployment rate.Source: Calculations based on Eurostat (2016), “Employment and unemployment (LFS)”, Eurostat Database.

Inflation is projected to remain below the target

9Source: OECD Economic Outlook.

Mac

ro fo

reca

sts

- E

urop

e

Harmonised index of consumer prices

Interest rates are low

10Last observation: 1-Feb-16.

Mon

etar

y po

licy

Policy determined and money market interest rates

Central bank assets expanded

11Source: Board of Governors of the Federal Reserve System, European Central Bank, Bank of Japan, and Bank of England; and OECD calculations.

Mon

etar

y po

licy

Non-performing loans have been coming down – but not in all countries

12Source: OECD Economic Outlook.

Mon

etar

y po

licy

As a percentage of gross debt instruments

Inflation expectations still low

13Source: Thomson Reuters; and Consensus Economics.Last observation: 2-Feb-16.

Mon

etar

y po

licy

Proxies for long-term expected inflation Euro area

Interest rates now negative for short term maturity

14Source: Thomson Reuters.

Mon

etar

y po

licy

2-year government bond yields

German government bond yield curve

Besides some austerity successes fiscal space is limited in many euro area countries

15

Source: OECD Economic Outlook.

Fisc

al p

olic

y

Debt-to-GDP ratioMaastricht definition

Fiscal now neutral or slightly positive -Recent and planned consolidation

16

Source: OECD Economic Outlook.

-2

-1

0

1

2

3

4

5

6

7

PRT

GRC ES

P IRL

USA ITA

NLD

SVN

SVK ISL

NZL

POL

CZE

DNK

EST

AUT

CAN

FRA

HUN

AUS

BEL

JPN

DEU

GBR

KOR FIN

CHE

ISR

SWE

NOR

-4

-3

-2

-1

0

1

2

3

SVN

GBR JP

N

SWE

BEL

AUS

FRA

ISR

NZL

ESP

CAN

USA ISL

FIN

GRC PO

L

CZE

CHE IRL

SVK

NLD ITA

EST

HUN

PRT

KOR

DEU

AUT

NOR

DNK

2011 - 2014 2014 - 2016

Change in the underlying primary balance

Fisc

al p

olic

y

Consolidation relied to a large extent on tax increases up to 2014

17Source: OECD Economic Outlook.

Change in key components of the primary balance

Fisc

al p

olic

y

In the coming years, the focus is going to be expenditure restraints

18Source: OECD Economic Outlook.

Change in key components of the primary balance

Fisc

al p

olic

y

In the past, some countries have adjusted public investment

19Source: OECD Economic Outlook.

Change in key components of the primary balance

Fisc

al p

olic

y

Juncker’s problem: Divergent product market regulation harms investment

20

Fisc

al p

olic

y

Product market regulation heterogeneity Deviation from OECD average bilateral heterogeneity, 2013, per cent

“Source: Fournier, J.-M. (2015), “The Negative Effect of Regulatory Divergence on Foreign Direct Investment”,OECD Economics Department Working Paper No. 1268 (forthcoming), OECD Publishing, Paris.

A 20% reduction in regulatory heterogeneity across EU countries could increase cross-border FDI in the EU by around 15%

Fiscal tools have a different impact on growth and inequality

21

Growth EquityShort-term Long-term

Short-term

Long-term

Spending cutsEducation -- -- - --Health services provided in kind -- - - -Other government consumption (excluding family policy) -- + -Pensions ++Sickness and disability payments - + -- -Unemployment benefits - + -Family - - -- --Subsidies - ++ + +Public investment -- --

Revenue increasesPersonal income taxes - -- + +Social security contributions - -- - -Corporate income taxes - -- + +Environmental taxes - + -Consumption taxes (other than environmental) - - -Recurrent taxes on immovable property -Other property taxes - ++ +Sales of goods and services - + - -

Source: Cournède, Goujard and Pina (2014).

Fisc

al p

olic

y

22

Optimal consolidation packages (growth/equality) in OECD countriesFi

scal

pol

icy

Ranking from most to least desirable instruments of consolidation

EducationChildcare and family

Social security contributionsHealth services in kind

Public investmentConsumption taxes Sickness payments

Sales of goods and servicesOther gov. consumption

Rec. taxes on imm. propertyEnvironmental taxes

Corporate income taxesPersonal income taxes

Unemployment insuranceOther property taxes

PensionsSubsidies

0 2 4 6 8 10 12 14 16 18Instrument rank

Equal weights

Simulated interdec i le range

Source: Cournède, Goujard and Pina (2014).

23

Limits to sustainability: – Debt sustainability depends on market

assessment of the probability to default, which is state contingent and, therefore, debt sustainability limit can vanish quickly, if market confidence evaporates.

24

Country by country prudent debt target

0

25

50

75

100

125

150

Prudent debt levels

0

1

2

3

4

5

6

7

Average annual fiscal effort

25

• The role of the prudent debt target: effective in anchoring expectations about future fiscal policy. The prudent debt target serves as the reference point to define numerical fiscal rules.

• Fiscal rules:– Role: Ensure fiscal discipline and long term growth

(well-being)– Objectives: (1) anchor fiscal policy expectations by

targeting a prudent debt level and (2) allow for macroeconomic stabilisation.

– Benchmarking existing rules: Budget balance + spending rule seem the best.

… and effective fiscal frameworks

Budget balance Structural balance Expenditure rule Revenue rule Fiscal stabilisation - + + - Fiscal discipline ++ + + -+ Side-effects and risks - -- - -

26

EU fiscal rules support debt-sustainabilitywith a set of several rules

Fisc

al r

ules

Source: Barnes, Botev, Rawdanowicz and Strasky (forthcoming).

EST

LUX

SWE

CZE DNKPO

LSV

KFI

NDEU NLD

HUNSV

NAU

TES

PFR

ABEL IR

LPR

TIT

A0

20

40

60

80

100

120

140

160starting debt levels (2016) 2026

Debt levels in 2026 if EU fiscal rules are followed exactly( % of GDP) Debt rule

(both nominal and cyclically-adjusted; backward- and forward-looking)

Nominal budget balance rule

Structural budget balance rule

Expenditure rule

The Productivity Problem: Aggregate productivity growth goes down even before the crisis

Labour productivity growth since 1990GDP per hour worked (China and India refer to GDP per worker)

Diffusion from frontier is key !Average of labour productivity across each 2-digit sector (log, 2001=0)

Source: Andrews, D. C. Criscuolo and P. Gal (2015), “Frontier firms, technology diffusion and public policy: micro evidence from OECD countries”, OECD Productivity Working Papers No. 2.

Diffusion comes easier to some economies than others

Estimated frontier spillover (% pa) associated with a 2% point increase in MFP growth at the global productivity frontier

Source: Saia, A., D. Andrews and S. Albrizio (2015), “Public Policy and Spillovers From the Global Productivity Frontier: Industry Level Evidence”, OECD Economics Department Working Papers, No. 1238.

0.0

0.1

0.2

0.3

0.4

0.5

Trade with the Frontier Participation in GVCs Efficiency of skillallocation

Managerial quality Business R&D

Minimum (Italy)

Minimum(Italy)

Minimum (Austria)

Maximum(Finland)

Maximum(Belgium)

Maximum(Sweden)

Maximum(Canada)

Minimum(Australia)

Minimum (Canada)

Maximum(Belgium)

Globalisation Reallocation Knowledge-Based Capital

Finland

Policies shape the diffusion of new innovations from the global frontier

Estimated frontier spillover (% pa) associated with a 2% point increase in MFP growth at the global productivity frontier

Source: Saia, A., D. Andrews and S. Albrizio (2015), “Public Policy and Spillovers From the Global Productivity Frontier: Industry Level Evidence”, OECD Economics Department Working Papers, No. 1238.

0.0

0.1

0.2

0.3

0.4

0.5

Barriers to Entrepreneurship Cost of Bankruptcy Legislationfor Entrepreneurs

Basic Research University-Industry Collaboration

Minimum (Sweden) Minimum

(Norway)

Maximum(Greece)

Maximum(Italy)

Maximum(France)

Maximum(Belgium)

Minimum(Belgium) Minimum

(Italy)

Entry and Exit Innovation policiesFinland

Skill mismatch and public policy

Source: Adalet McGowan, M and D. Andrews (2015), “Skill mismatch and public policy in OECD countries” OECD Economics Department Working Paper, No. 1210.

Maximum

Maximum

Maximum

Maximum

Maximum

Maximum Maximum

Maximum

MaximumMaximum

Minimum

Minimum

Minimum

MinimumMinimum

MinimumMinimum

Minimum

Minimum

Minimum

Minimum

MinimumMaximum

Maximum

(POL)

(DEU)(FRA)

(ITA)

(BEL)

(SWE) (AUT)

(SVK)

(NLD )(AUT)

(ITA)

(ITA)

(NLD )

(USA)(CAN)

(NOR)(DNK)

(FIN)

(CAN)

(KOR)

(USA)

(KOR)(DNK)

(FIN)

0.14

0.18

0.22

0.26

0.30

0.34

Pro

duct

mar

ket

regu

latio

n

Em

ploy

men

t p

rote

ctio

n le

gisl

atio

n…

Em

ploy

men

t pro

tect

ion

legi

slat

ion

(tem

pora

ry w

orke

rs)

Cos

t of c

losi

ng a

bus

ines

s

Tran

sact

ion

cost

s

Ren

t con

trol

Tena

nt-la

ndlo

rd re

gula

tions

Cos

t of o

btai

ning

a b

uild

ing

perm

it

Res

pons

iven

ess

of h

ousi

ng s

uppl

y

Cov

erag

e ra

te o

f c

olle

ctiv

e ba

rgai

ning

agr

eem

ents

Par

ticip

atio

n in

life

long

lear

ning

Man

ager

ial q

ualit

y

Framework policies Housing policies Other policies

FinlandProbability of mismatch

Skill mismatch as a constraint on labour productivity

Source: Adalet McGowan, M and D. Andrews (2015), “Labour market mismatch and labour productivity: evidence from PIAAC data ” OECD Economics Department Working Paper, No. 1209.

Skill mismatch, particularly over-skilling, is harmful for productivity because it constrains the ability of innovative firms to attract skilled workers and grow

• Global Economy: China and EME/ Trade and Capital flows/ Data ?

• Monetary: Macro via bubbles ?, Financial markets and Real Economy/ Channels / Long Term Expectations

• Fiscal: Hysteresis, Multipliers and Non-Linearities • Structural: Macro/Micro Data, Pass through QSR/

Global Integration-Technology/ GNP accounts• Dynamic change of preferences, Behaviour and

(individual and group) “rationality”

If economists know what they don’t know, do they tell ?

THANK YOU