Slides

1. NAEC Seminar, 20 November 2014
EFFECTS OF GROWTH-ENHANCING
POLICIES ON
MICROECONOMIC
STABILITY
Boris Cournède, Paula Garda, Peter Hoeller, Volker Ziemann
Public Economics Division of the OECD Economics Department

2. The impact of reforms on instability: an
integral part of NAEC
• OECD Going For Growth publications have recognised side-effects
of growth-promoting policies on income inequality, the
environment, government budgets and external accounts.
• The recent financial crisis has underlined the damage that
economic instability can inflict on welfare.
• Looking at macroeconomic stability is not enough.
• This study moves one step closer to people and analyses
microeconomic stability focusing on firms, households and
individuals.
• Instability also affects growth and social mobility.

3. Microeconomic volatility and inequality
are tightly linked
• Both influence welfare through similar channels
• Microeconomic volatility tends to be higher in more unequal
countries
Cross-sectional standard deviation of household disposable income growth and Gini coefficient, 2005-10
60
55
50
45
40
35
30
25
Source: OECD (2014, forthcoming).
AUS
AUT
BEL
KOR
CAN
CZE
DEU
DNK
ESP
EST
FIN
FRA
GBR
GRC
HUN
ITA
LUX
NOR NLD
POL
PRT
SVK
SVN
SWE
USA
20
0.22 0.27 0.32 0.37 0.42
Microeconomic volatility, %
Income inequality

4. Volatility can be measured in different
ways at the micro level
• Rolling window: fluctuations are measured for each individual
around average growth. Very natural but few degrees of
freedom (estimation risk).
• Incidence of large changes: the measure counts the
proportion of people who undergo large changes (here,
greater than 20%). It allows separate analyses of large
increases and decreases.
• Cross-sectional measure: it evaluates the dispersion of
individual changes around the average. It is less demanding
on the data but implicitly assumes constant average growth
across the population (model risk).
• The three measures are very highly correlated: correlation
coefficients are very high and 99% statistically significant.

5. Greater microeconomic volatility is
associated with poorer life satisfaction
Cross-sectional standard deviation of household disposable income growth and self-reported life satisfaction, 2005-10
KOR
Source: OECD Better Life Index and OECD (2014, forthcoming).
8
AUS
AUT
USA
BEL
CAN
CHE
CZE
DEU
DNK
ESP
EST
FIN
FRA
GBR
GRC
HUN
ITA
LUX
NLD
NOR
POL
PRT
SVK
SVN
SWE
60
55
50
45
40
35
30
25
20
4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0
Microeconomic volatility
Life satisfaction

6. Volatility is very different at the micro
and macro level
• Household-level disposable income volatility is much higher than at
the aggregate level.
• There is no cross-country correlation between macroeconomic and
microeconomic volatility:
80
70
60
50
40
30
20
10
0
Line y=x
0 2 4 6 8 10 12
Microeconomic volatility, %
Macroeconomic volatility, %
Note: Each observation represents a country at a specific year for the period 1994-2010. Microeconomic volatility is measured by the cross-sectional standard
deviation of disposable income growth across households in a given country. Macroeconomic volatility is calculated as the 3-year rolling standard deviation of
real disposable income growth measured in the national accounts.
Source: OECD (2014, forthcoming).

7. Mapping policy influences on micro-level
volatility and economic welfare
Changes in economic
conditions
- Financial and trade openness
- Product market regulation
- Financial market regulation
- Network structure
1
Firm-output volatility
- Bankruptcy legislation
- Creditor rights
- Labour market policies
- Wage flexibility
3
Firm
turnover
Employment
volatility
- Barriers to entrepreneurship
- Wage bargaining (risk premia, bonuses)
- Tax and benefit system
- Labour market policies
- Financial markets (insurance, credit)
6
7
Earnings
volatility
Earnings
growth
10 11 12
Consumption growth Consumption volatility
- Level of risk aversion
+ −
Welfare
13
2 4
8
5
9

8. Regulatory settings differ between countries with
high and low firm turnover
Government ownership
0.5
0.3
0.1
-0.1
-0.3
-0.5
-0.7
-0.9
(BR)
Low turnover
High turnover
Barriers to competition
(PMR)
Barriers to trade and
investment (PMR)
Public ownership (PMR)
EPL (regular workers)
EPL (temporary contracts)
Source: Bartelsman, Haltiwanger and Scarpetta (2013) and OECD (2014, forthcoming).

9. Many steps lead from individual labour earnings
to household disposable income
Individual
labour
income
Source: OECD (2014, forthcoming).
Household
labour
income
Household
market
income
Household
disposable
income
Capital income
Family formation
and composition
Taxes and cash
transfers
Hours
worked
and hourly
labour
income

10. Worker-level instability takes different forms
• Changes in jobs (including into or out of employment),
working-time or hourly earnings.
• All three forms of economic instability are high and vary
considerably across countries.
Worker reallocation rates Volatility in hours worked and hourly labour earnings
2007 1995
Source: OECD (2014, forthcoming).
30
25
20
15
10
5
0
GRC
LUX
CZE
ITA
HUN
SVK
PRT
BEL
SVN
DEU
EST
CHE
AUT
FRA
POL
NLD
GBR
IRL
SWE
FIN
NOR
ESP
ISL
AUS
DNK
AUS
AUT
FRA GBR
BEL
CAN
CHE
CZE
DEU
DNK
ESP
EST
FIN
GRC
HUN
IRL
ITA
KOR
LUX
NLD
NOR
POL
PRT
SVN SVK
SWE
USA
45
40
35
30
25
20
15
15 20 25 30 35 40
Cross sectional standard deviation in hourly earnings within a full time job
Cross secrional standard deviation in annual hours

11. Three types of empirical analysis have
been pursued
Panel data econometric investigation of individual-level data
covering 26 countries from 1994 to 2010
• Country-level aggregate measures of individual volatility
• Individual-level measures of volatility
are regressed on policy indicators and other relevant
factors. Regressions include country and time fixed-effects.
• Sector-level regressions provide indications about
causality

12. Empirical results of policy effects on
micro-level volatility
Worker
reallocation
Volatility of annual
hours worked
Volatility of hourly
earnings
Employment protection (regular workers) * *** *
Centralisation of wage bargaining *** ***
Generosity of unemployment benefits * *
Active labour market policies **
Product market regulation **
Credit intermediation *** *** ***
Source: OECD (2014, forthcoming).
The findings regarding EPL and PMR suggest that countries with tight
policy settings may find themselves in “gradual-reform traps”:
• Marginal growth-enhancing reforms can come at the cost of
increasing instability;
• Deeper reforms can boost growth without increasing instability.

13. Hourly earnings volatility decreased
after Estonia relaxed EPL considerably
0.35
0.3
0.25
0.2
0.15
0.1
0.05
EPL
Note: The curve shows the estimated relationship between the volatility of hourly earnings measured as cross-sectional standard deviation of labour income
growth across individuals the and EPL, based on the estimates of panel data regressions at the country level for the period 1996-2010. See Cournède et al.
(2014) for details on the empirical strategy and detailed estimates. Volatility of hourly earnings is measured using the cross-sectional standard deviation.
Rectangles are data for Estonia pre-reform (average 2006-09) and post-reform (2010). The vertical line shows the OECD average for the EPL indicator for
2010.
Source: OECD (2014, forthcoming).
EST 2010
EST 2006-09
0
0.3 0.8 1.3 1.8 2.3 2.8 3.3 3.8 4.3
Volatility of hourly earnings
OECD
average

14. Large changes in individual labour
earnings are strongly attenuated…
Probability of avoiding a large (20%) change in household income when experiencing a
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
large change in labour earnings, 2005-10
SWE
SVN
NOR
DNK
NLD
FIN
BEL
DEU
CAN
FRA
CHE
CZE
LUX
AUT
HUN
IRL
PRT
AUS
SVK
GBR
GRC
EST
ITA
ESP
USA
KOR
POL
Source: OECD (2014, forthcoming).

15. …largely owing to other household
members and tax-and-transfer systems
Decomposition of the change in household disposable income when the income
of the household head drops by more than 20%
Taxes K inc Transfers Indiv labour earnings Other HH members labour earnings Disposable income
Source: OECD (2014, forthcoming).
80
60
40
20
0
-20
-40
-60
-80
-100
AUS
AUT
BEL
CAN
CHE
CZE
DEU
DNK
ESP
EST
FIN
FRA
GBR
GRC
HUN
IRL
ITA
KOR
LUX
NLD
NOR
POL
PRT
SVK
SVN
SWE
USA

16. Tax-and-benefit systems differ between
high and low attenuation countries
Cash transfer progressivity
Unemployment benefit
progressivity
Tax progressivity
Family cash transfers
Source: OECD (2014, forthcoming).
Total taxes/GDP
1.5
1
0.5
0
-0.5
-1
-1.5
Personal income tax
Property tax
Social contributions
Consumption taxes
Total social
expenditure/GDP
ALMP
Unemployment benefits
High Low
Size and cash transfer mix
1
1
2 1
2
2
1

17. Many pro-growth reforms raise trade-offs
with stability and inequality
Effect of change on:
A pro-growth change:
Income
equality
Micro-level
stability
Easing EPL for regular workers +
Increasing product market competition +1
Boosting ALMP spending + +
Lowering unemployment insurance
replacement rate +2 -
Reducing the total tax-GDP ratio - -
Reducing the size of social transfers - -
Reducing PIT progressivity - -
1. Earlier results were mixed, but recent evidence points to overall reduction in inequality (OECD, 2015).
2. Overall inequality diminishes owing to employment effects. However, cutting benefits going to groups with low employment
prospects can increase inequality.
Source: Joumard et al. (2014), OECD (2014, forthcoming), OECD (2015).

18. The growth-volatility frontier provides an
exploratory tool to analyse this trade-off
0.12
0.1
0.08
0.06
0.04
0.02
0
-0.02
-0.04
-0.06
0.15 0.2 0.25 0.3 0.35 0.4 0.45
Cross-sectional volatility of real disposable income growth
Trend real disposable per capita income growth
Note: Trend per capita disposable income growth is calculated with aggregate national accounts data. Household disposable income growth volatility is derived
from household surveys and is corrected for year-fixed effects.
Source: Cournède, Garda and Ziemann. (2014, forthcoming).

19. Policy settings appear linked to the
distance to the growth-volatility frontier
Link with distance to growth-volatility
frontier
Looser employment protection
Higher pending on ALMPs *
Lower unemployment benefit
replacement rates
**
Less centralisation in wage
bargaining
**
More competitive product market
regulation
Note: All policy indicators are standardised and centred. Estimation based on a sample of 173 observations across 21 countries. Time-fixed and country-fixed effects
are included. The shapes indicate the estimated relationship between policy estimators (rows) and the distance to the frontier (columns). Stars reflect confidence levels
for the linear and squared term: ** stands for for 95% and * for 90%.If significance differs between the linear and squared terms, the lower level is shown. For
employment protection and the credit intermediation ratio only the squared term is significant.
Source: Cournède, Garda and Ziemann. (2014, forthcoming).

20. The detailed results are available in:
• OECD (2014), “Effects of Pro-Growth Policies on the Economic
Stability of Firms, Workers and Households,” OECD Economic Policy
Papers, forthcoming.
• Garda, P. and V. Ziemann (2014), “Economic Policies and
Microeconomic Stability: A Literature Review and Some Empirics,”
OECD Economics Department Working Papers, No. 1115.
• Cournède, B., P. Garda and V. Ziemann (2014), “Effects of Economic
Policies on Microeconomic Stability,” OECD Economics Department
Working Papers, forthcoming.
Additional references:
• Joumard, I, P. Hoeller and I. Koske (2014), Income Inequality in
OECD Countries: What are the Drivers and the Policy Options, World
Scientific Publishing.
• OECD (2015), Going for Growth: Economic Policy Reforms in OECD
Countries.