GLOBAL INTEGRATION AND

PRODUCTIVITY GROWTH IN

LATVIA

Naomitsu YASHIRO OECD Economics Department, Latvia Desk European Semester: Zoom-in on Productivity Challenges and Supportive policies in Latvia and Baltic States 2 June 2017, Riga, Latvia

1

Across OECD countries, productivity growth has slowed

and inequality has increased

Note: Labour productivity growth is the average annual growth rate of output per hour worked. For LHS the OECD and euro area are GDP PPP weighted averages. RHS is the unweighted average of 17 OECD countries. Source: OECD Income Distribution database; OECD National Accounts database; OECD Productivity database; and OECD calculations.

Labour productivity growth Income inequality is rising Real household disposable income, total population

2

The sluggish productivity growth and inequality are driven by

the divergence between the most productive firms and the

rest

Note: Frontier firms are the 5% of firms with the highest labour productivity by year and sector. Industries included are manufacturing and business services, excluding the financial sector, for firms with at least 20 employees. Source: Andrews, D., Criscuolo C., and Gal P. (2016), “The Best versus the Rest: The Global Productivity Slowdown, Divergence across Firms and the Role of Public Policy”, OECD Productivity Working Papers, No. 05; Orbis data of Bureau van Dijk; and OECD calculations.

Real compensation per worker Index, 2001 = 100

Labour productivity Index, 2001 = 100

Latvia’s productivity growth has also slowed considerably

after the Crisis

Industry contribution to Latvia’s business sector productivity growth Real value added per hour worked, percentage point contribution at annual rate

The business sector is measured as the non-agricultural business sector excluding real estate. It covers mining, manufacturing; utilities; construction; and business sector services. The latter cover distributive trade, repair, accomodation, food and transport services; information and communication; financial and insurance; professional; scientific and support activities. Source: OECD Productivity Statistics (database), February 2016

3

Latvia still needs strong productivity growth to converge

its living standard to advanced OECD economies

Gap in GDP per capita vis-à-vis the upper half of OECD countries

Percentage gap with respect to the weighted average using population weights of the highest 17 OECD countries in terms of GDP per capita (in constant 2010 PPPs).

4

Latvia experienced significant productivity growth as

it integrated into the global economy

Export intensity and Productivity growth

5

Latvia’s export market shares increased in the

aftermath of the crisis

Export performance index

Four-quarter moving average, index 2010 = 100

Note: Export performance is measured as the ratio of actual export volume to the country’s export market. Source: OECD (2017), OECD Economic Outlook: Statistics and Projections (database). 6

Yet, exports are still concentrated in less technology

and knowledge intensive sectors

0

20

40

60

80

100

2010 2015

B. Composition of service exports

Other services

ICT

Financial services

Other business services

Travel

Transport

% of total service exports

2010 20160

20

40

60

80

100

A. Composition of good exports

Other goods

Machinery¹

Agriculture and foodproducts

Wood products andpaper

Basic industry²

% of total merchandise exports

Includes mechanical appliances; electrical equipment; transport vehicles; optical instruments and apparatus (inc. medical); clocks and watches; musical instruments. Includes products of the chemical and allied industries; plastics and articles thereof; rubber and articles thereof; base metals and articles of base metals; and mineral products. Source: OECD (2017),Trade in Service Statistics, Central Statistical Bureau of Latvia,

7

8

Latvia has rooms to enhance its integration into global

value chains in knowledge-intensive sectors

Source: OECD-WTO Trade in Value added Database,

Note: The data after 2011 are estimates based on the 2011 Inter-Country Input-Output (ICIO) table and the OECD Bilateral Trade Database

by Industry and End-Use (BTDIxE).

More intensive use of foreign inputs would boost

productivity, especially in high technology industries

Source: OECD-WTO Trade in Value added Database,

Note: The data after 2011 are estimates based on the 2011 Inter-Country Input-Output (ICIO) table and the OECD Bilateral Trade Database

by Industry and End-Use (BTDIxE). 9

Latvia needs to increase the value added from its

GVC participation

Domestic value added per worker embodied in foreign final demand, 2011

Note: Value added embodied in foreign final demand per worker is computed by dividing the domestic value added embodied in foreign final demand by the number of employment sustained by foreign final demand. Source: OECD/WTO (2016), Statistics on Trade in Value Added (database) and OECD (2016), "Trade in Employment: Core Indicators" in OECD Structural Analysis (STAN) Databases 10

Countries specialising in knowledge intensive activities

draw larger value added from GVC participation

CHE (150), SWE (118)

USA (110)

JPN (92), DEU (86)

LVA (33)

FRA (95), ITA (81)

USA (110)

CHN (12),IND (5)Assembly / Labour intensive service

Base material

Key parts and components

R&D, Design

New product development

Value chain activities

Value added embodied in foreign final demand per worker (Thousand USD)

Distribution

Retail/After sale services

Marketing /Branding

Supply chain management

The figure illustrates the value added associated with different types of value chain activities, with examples of countries with notable competitiveness in each of the different activities. Numbers in the bracket are the value added embodied in foreign final demand per worker, shown in the previous figure.

11

The skill and knowledge intensity of Latvia’s exports

can be raised further

0

8

16

24

32

40

48

SV

K

HU

N

PO

L

CZ

E

ES

T

LV

A

DE

U

FIN

SW

E

A. The share of high skilled jobs in total jobs sustained by foreign final demand¹

2013

0

2

4

6

8

10

12

LT

U

SV

K

CZ

E

PO

L

LV

A

HU

N

ES

T

FIN

DE

U

SW

E

B. The share of value added from knowledge intensive services embodied in exports²

2014 12.2

The figure decomposes total employment sustained by exports derived from OECD’s Inter-Country Input-Output (ICIO) table into three groups of skill intensity defined according to major groups of the International Standard Classification of Occupations 2008 (ISCO-08): High-skilled occupations (ISCO-08 major Groups 1 to 3), medium-skilled (4 to 7) and low-skilled (8 and 9). OECD calculations based on the OECD Inter-Country Input-Output (ICIO) table, the OECD Bilateral Trade Database by Industry and End-Use (BTDIxE) and European Labour Force Survey (EU-LFS). OECD estimates based on the OECD Inter-Country Input-Output (ICIO) table and the OECD Bilateral Trade Database by Industry and End-Use (BTDIxE). Source: OECD/WTO (2016), Statistics on Trade in Value Added (database).

12

Export entry increases the productivity, employment and

wages of Latvian firms

Differences in productivity, employment and wages between exporting and non-

exporting firms after export entry

Note: The chart describes the differences between the average productivity, employment and wages of firms that started exporting and continued exporting for two more years versus the ones of non-exporting firms. By comparing the export entrants only with the subset of non-exporting firms that are initially as productive and large as the export entrants, such differences in performance can be interpreted as causal effect of export entry. Source: The technical background paper for the 2017 Economic Survey of Latvia 13

Such effects are more pronounced for exports associated

with participation in the upstream of GVCs

Differences in productivity between exporting and non-exporting firms after export entry

Note: See the footnote of the previous slide for interpretation. The blank bars correspond to the case where export entry does not result in statistically significant gains in productivity. Source: The technical background paper for the 2017 Economic Survey of Latvia

14

As in many countries, there is a large productivity gap

between exporting firms and domestic firms

0.2

.4.6

-6 -4 -2 0 2 4

Nonexporters Goods exporters

Service exporters

Conditional distribution of ln(lprod)

Labour productivity distribution

Source: The technical background paper for the 2017 Economic Survey of Latvia 15

Fewer Latvian firms export and participate in the upstream

of GVC than Estonian firms

The share of exporters in total number of firms

Note: Small firms are those with less than 10 employees. Note that the numbers are not mutually exclusive since a firm can export muti products and services. Source: The technical background paper for the 2017 Economic Survey of Latvia

16

• Higher productivity

• Larger size

• Foreign capital

• Younger age

• Higher capital intensity

• Access to credit

• Hiring of skilled workers (including managers or employees

who previously worked for MNEs or exporting firms)

What are the factors that increase the likelihood that

Latvian firms enter export?

17

The large fixed costs in export entry (Tybout et al., 1998, Melitz, 2003)

Increased availability of skilled workers is essential

for further integration in GVCs

Source: The Ministry of Economy (2016), “LATVIAN LABOR MARKET OUTLOOK: RECENT TRENDS AND FUTURE CHALLENGES”

Mismatch in Science, technology, mathematics,

engineering, manufacturing and construction

(STEM)

18

The incident of under-skilling is relatively high while

that of over-skilling is low

0

3

6

9

12

15

0

3

6

9

12

15

LUX

PRT

DEU AU

T

ITA

ESP

GBR SV

N

NLD

FRA

DN

K

BEL

POL

HU

N

GR

C

SWE

IRL

SVK

CZE FI

N

LVA

LTU

EST

A. The share of employees reporting lower skill level than required for their current jobs

0

10

20

30

40

50

60

0

10

20

30

40

50

60

LTU

LVA

EST

PRT

LUX

BEL

FRA

ITA

CZE

SVN

NLD

SWE

HU

N

DN

K

POL

SVK

ESP

FIN

IRL

DEU

GR

C

GBR AU

T

B. The share of employees reporting higher skill level than required for their current jobs

Source: CEDEFOP (2016), “Skills Panorama” (http://skillspanorama.cedefop.europa.eu). 19

20

Increasing labour mobility would boost productivity and

investment in skills

0

10

20

30

40

50

60

70

80

0

10

20

30

40

50

60

70

80

LT

U

ME

X³

PO

L

ES

T

SV

K

HU

N

CH

L³

LV

A

SV

N

PR

T

GR

C

CZ

E

ITA

ES

P

NO

R

IRL

AU

S³

ISL

KO

R

GB

R

FIN

LU

X

FR

A

CA

N³

US

A³

BE

L

AU

T

CH

E

SW

E³

DN

K³

NL

D³

DE

U

%%

Rent (private)¹ Rent (subsidized)²

Note: Low-income households with income in the bottom quintile of the net income distribution. For Chile, Mexico, Korea and the United States, gross income is used due to data limitations. Share of households renting their dwelling at market prices on the private rental market. Share of households renting their dwelling at reduced market prices. Data on tenants renting at private include tenants renting at subsidized for Australia, Canada, Chile, Denmark, Mexico, the Netherlands and the United States. For Sweden, data on tenants renting at subsidized are not capturing the full extent of coverage due to data limitations. Source: OECD (2016), OECD Affordable Housing Database, Table HM1.3.3, December (http://www.oecd.org/social/affordable-housing-database.htm).

Share of rental housing in low-income households’ residence, 2014 or latest year

Weak business-based innovation holds back the capacity of Latvian

firms to absorb the knowledge spillovers within GVCs

0

1

2

3

4

5

0

1

2

3

4

5

CH

L

ME

X

LV

A

GR

C

PO

L

SV

K

ES

P

PR

T

LU

X

ITA

HU

N

ES

T

GB

R

NO

R

CZ

E

NL

D

ISL

SV

N

FR

A

OE

CD

BE

L

US

A

DE

U

FIN

DN

K

AU

T

SW

E

JP

N

KO

R

ISR

% of GDP% of GDP

Business sector Other sectors

Research and development expenditure,2015

Source: OECD (2016), OECD Main Science and Technology Indicators (database).

21

Increased collaboration with research institutions would

strengthen capabilities of Latvian firms

0

5

10

15

20

25

0

5

10

15

20

25

ITA

LV

A

LT

U

PR

T

CH

E

GR

C

LU

X

HU

N

CZ

E

SV

K

PO

L

FR

A

DN

K

NL

D

SW

E

DE

U

ES

T

NO

R

ISL

BE

L

SV

N

FIN

AU

T

%%

The share of firms cooperating in all product and/or process-innovating firms, 2012-14

Note: International comparability may be limited due to differences in innovation survey methodologies and country-specific response patterns. Source: Eurostat (2016), Community Innovation Survey (CIS) 2014.

22

Improving resource allocation and access to credit

0

20

40

60

80

100

0

20

40

60

80

100

TU

R

CH

L

GR

C

ES

T

HU

N

LU

X

CH

E

LV

A

SV

K

PO

L

ISR

ITA

CZ

E

ME

X

OE

CD

PR

T

SW

E

ES

P

FR

A

US

A

AU

S

AU

T

NZ

L

DE

U

KO

R

ISL

CA

N

IRL

DN

K

GB

R

SV

N

NL

D

BE

L

FIN

JP

N

NO

R

%%

The recovery of debt from insolvent firms, June 2016

Note: The recovery rate is calculated based on the time, cost and outcomes of insolvency proceedings and is recorded as cents on the dollar recovered by secured creditors. The calculation takes into account whether the business emerges from the proceedings as a going concern or the assets are sold piecemeal. The costs of the proceedings are deducted. The value lost as a result of the time the money remains tied up in insolvency proceedings is also deducted. The recovery rate is the present value of the remaining proceeds. Source: World Bank (2017), Doing Business 2016: Measuring Regulatory Quality and Efficiency (Resolving insolvency database). 23

Framework conditions must be made conducive to

globalisation and innovation

0

5

10

15

20

25

0

5

10

15

20

25

EST LTU LVA EST LTU LVA EST LTU LVA

The size of shadow economy Underreported corporate profits Underreported wages

(% of GDP) (% of actual profits) (% of actual wages)

%%

Note: The aggregate size of the informal economy is estimated from firm-level information. Underreported corporate profits and wage payments by registered firms in the three Baltic countries are based on survey data. Source: Putniņš, T. and A. Sauka (2016), "Shadow Economy Index for the Baltic Countries", Stockholm School of Economics in Riga (SSE Riga).

Estimated size of the informal economy and underreported corporate profits and wages, 2015

24

• As a small open economy, global integration is an essential source of Latvia’s productivity growth.

• Latvia can make better use of trade and FDI as a channel of knowledge transfer by participating more in GVCs in knowledge intensive sectors.

• Latvia is specialising in relatively low value added activities within GVCs. It has to gain competitiveness in knowledge intensive activities (ex: provider of core components or services).

• Latvia should promote a wider participation by Latvian firms in the upstream of GVCs, by improving their access to skilled workers, credit and knowledge.

• Increased access to higher education and rental housing, strong innovation system, efficient judiciary and insolvency regime would contribute to Latvia’s ability to draw larger value added from GVC.

• Some institutions that bias the firm size downward and informality can discourage the globalisation and innovation of Latvian firms.

Discussion/Conclusion

25

LIELS PALDIES!

http://www.oecd.org/latvia/economic-survey-latvia.htm

26

Moving up the Global Value Chains (or Upgrading of

GVC activities)

Examples

Chain Upgrading Participating in or shifting the locus of activitiy to other

GVCs rewarding higher value-added

Samsung (From flat panel TV to

semiconductor to solar cell), Nestle

(from foodstuffs to functional food)

Functional Upgrading Establishing competitiveness in higher value-added

GVC activities through acquisition of new capabilities

(ex: from production to R&D)

Lenovo (acquisition of IBM's R&D

capability and brand),

IBM (from PC manufacturing to

Technology consulting),

Li and Fung (from intermediary to

supply chain organiser)

Product Upgrading Supplying technologically sophisiticated and higher

quality products than rivals. Introducing novel products

or improving old products faster than rivals.

"Hidden Champions",

ASUSTek (inventor of netbook),

Toyota (introduction of the first mass-

produced hybrid car)

Process Upgrading Improving efficiency and productivity significantly faster

than rivals and developing ability to process complex

orders.

Hon Hai Precision Industry (world's

largest OEM firm )

Up

gra

din

g P

ath

by

Ge

reff

i (1

99

9)

Source: OECD (2013a), Interconnected Economies: Benefiting from Global Value Chains, OECD Publishing, Paris. DOI: http://dx.doi.org/10.1787/9789264189560-en 27

The upgrading of GVC activities requires rigorous

investment in technology, skills and better management

Type of Upgrading Essential Knowledge-based Capital

Replicability

Chain Upgrading Firm-specific management skill (acquired from

entrepreneurial trial and error) ,

Flexible organizational structure

Low High

Functional Upgrading Sophisticated technological knowledge and design,

Recognized Brand, Marketing ability, Networks

Product Upgrading Rich knowledge in production technology and quality

management (sometimes embodied in firm-specific

human capital or protected by Intellectual Property

Rights)

Process Upgrading Rich know-how in process management,

Efficient procurement network, Computerized

information High Low

Value created

from upgrading

Source: OECD (2013a), Interconnected Economies: Benefiting from Global Value Chains, OECD Publishing, Paris. DOI: http://dx.doi.org/10.1787/9789264189560-en 28