Wiiw Research Report 352: Western Balkan Countries
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December 2008 Research Reports | 352| Vladimir Gligorov, Anna Iara, Michael Landesmann, Robert Stehrer and Hermine Vidovic Western Balkan Countries: Adjustment Capacity to External Shocks, with a Focus on Labour Markets This report was written by Vladimir Gligorov, Anna Iara, Michael Landesmann, Robert Stehrer and Hermine Vidovic (all wiiw). The authors drew upon background studies elaborated by Arsena Gjipali (University of Tirana, Albania), Miroslav Tomic (Office of The High Representatives, Bosnia and Herzegovina), Valerija Botric (Institute of Economics, Zagreb, Croatia), Avdullah Hoti (University of Pristina, Kosovo), Maja Micevska (University of Klagenfurt, Austria), Ana Krsmanović (Institute for Strategic Studies and Prognoses, Podgorica, Montenegro), Kosovka Ognjenovic (Economic and Social Policy Institute, Belgrade, Serbia), and Nataša Kump (Institute for Economic Research, Ljubljana, Slovenia). Western Balkan The study was carried out for the European Countries: Adjustment Commission within the contract ECFIN/ Capacity to External 169/2007/473194. The sole responsibility for its content lies with the authors. The report does not Shocks, with a Focus on necessarily reflect the opinion of the Commission. Labour Markets Preface The research reported here aims to answer the question about the dependence of external on internal balances in the context of mostly fixed exchange rates in the Western Balkan countries. The theoretical context in which the answer is sought is that of optimal currency areas (OCA). There are prima facie reasons to assume that the Western Balkans do not form an OCA with the euro area, though their currencies are mostly fixed to the euro. In addition, there is some empirical support that indeed it is not because of the optimality of the currency areas that these countries rely on fixed exchange rates. The main reason is high currency substitution that is connected by low credibility of the local central banks. In such circumstances, labour markets play a crucial role. Especially because – in part owing to the overall characteristics of the European transition process and in part because of the fixed exchange rates – trade and current account deficits tend to be high or very high. Thus, an in-depth look at the workings of the labour markets is provided. The imbalances found there, however, suggest that it is mostly not the case that the flexibility of wages and of employment regulations are behind the low levels of employment and high levels of unemployment. The main reasons are structural: low export capacity, skill mismatches, problems with competition in the product markets. Wage setting does not seem to be a problem because it does not appear that wages are, as a rule, growing faster than productivity. One exception perhaps are wages in the public sector. Fast growth of services also does not seem to lead to problems with wages in that sector outpacing productivity. In general, therefore, it does not appear that it is the labour market that may have a destabilizing influence on the external balances and thus on the exchange rates. It is probably the other way around, as the current crisis seems to suggest. High external imbalance create vulnerabilities that may lead to the need to adjust the real exchange rate by lowering consumption and restructuring investments, which may prove to bring additional imbalances to the labour markets. Clearly, high reliance on external financing exposes these countries to the dangers of the sudden stop type of crisis, which is what seems to be happening now. Policy implications are clearly dependent on the problem that is to be addressed. Most of the recommendations here deal with structural reforms and labour market policies. However, in the context of the global crisis, macroeconomic suggestions, also made in this report, should be looked into more attentively. Vladimir Gligorov Contents Executive summary..................................................................................................................i 1 Introduction ....................................................................................................................1 2 Survey of the literature on the adjustment capacity to external shocks of EU candidate and potential candidate countries of the Western Balkans, with a focus on labour markets .................................................................................16 2.1 Introduction....................................................................................................................... 16 2.2 The adjustment capability of the labour markets to shocks in the context of transition ........................................................................................................................... 16 2.2.1 Adjustment mechanisms in transition countries .................................................. 16 2.2.1.1 Wage flexibility ..................................................................................... 16 2.2.1.2 Worker and job flows (flexibility of labour supply and demand) ......... 18 2.2.1.3 Regional and international labour mobility .......................................... 20 2.2.1.4 Informal economy ................................................................................22 2.2.2 Factors shaping the labour market adjustment mechanisms ............................. 23 2.2.2.1 Wage setting mechanisms, reservation wages and the role of trade unions ..................................................................................... 23 2.2.2.2 Employment protection legislation....................................................... 30 2.2.2.3 Institutional aspects affecting mismatch problems ............................ 33 2.3 Conclusions...................................................................................................................... 34 3 Labour markets in the Western Balkans and assessment of the likely impacts of the removal of labour market rigidities on adjustment capacities to shocks .........................................................................37 3.1 Overview of labour market developments in the Western Balkans ........................ 37 3.1.1 Structural features of Western Balkan labour markets ...................................... 37 3.1.2 International labour mobility and remittances...................................................... 50 3.2 Cross-country analyses of labour market flexibility in the Western Balkans: Factors shaping the labour market adjustment mechanisms................................... 56 3.2.1 Wage setting mechanisms and the role of trade unions .................................... 56 3.2.2 Employment protection legislation ...................................................................... 60 3.2.3 Evaluating the effect of EPL on labour market outcomes .................................. 64 3.2.4 Wage flexibility...................................................................................................... 71 3.2.4.1 Analysis of wage-productivity relationship .......................................... 71 3.2.4.2 Results from the VAR analysis............................................................ 81 3.2.5 Export and production specialization ................................................................... 90 3.3 Country-by-country assessment of the likely impacts of the removal of labour market rigidities on adjustment capacities to shocks ............................................... 98 3.3.1 Country-specific assessments of main risks and stability issues ....................... 98 3.3.2 Comparison with peers: Bulgaria, Romania, Slovenia...................................... 105 3.3.3 Assessing the impact of loosening employment protection legislation (EPL) .. 106 4 Summary of findings and recommendations ........................................................111 References .........................................................................................................................115 Appendix A: Robustness check – inclusion of further regressors ............................123 Appendix B: Export and production specialization......................................................125 List of Tables and Figures Table 1 Southeast Europe: an overview of economic fundamentals, 2007 .............................. 15 Table 2 Minimum wages ............................................................................................................. 24 Table 3 Tax wedge for a single person at 2/3 of average earnings, in %, 2006/2007 .............. 26 Table 4 Implicit tax rates (ITR) on labour in the Western Balkans and selected countries, in % ................................................................................................ 27 Table 5 Trade union density and collective bargaining coverage in selected countries ........... 29 Table 6 Serbia: characteristics and rates of informality among wage employees, 2005 .......... 49 Table 7 Population from Southeast European countries in the EU-15 by sending country, numbers, and per cent of home-country population ................... 51 Table 8 Workers’ remittances and compensation of employees in the countries of Southeast Europe, debits and credits as share of GDP, 2000 to 2006 ................... 55 Table 9 Serbia: wages in the formal and informal sectors in Serbia, 2005 ............................... 58 Table 10 Unemployment benefit mid-2000s ................................................................................. 59 Table