Quantitative assessment of the impact of the NDP/NSRF 2007-13 using a macroeconomic model for the Czech Republic   Project 05/5 Ministry of Regional Development – Czech Republic Prague, 23 November 2006 Final presentation GEFRA EMDS IREAS

Report: Table of contents, I Overview about the results Modelling the Czech Economy The HERMIN modelling framework The new HERMIN model for the Czech Republic 4.1 Some characteristics of the Czech Economy 4.2 Some characteristics model results (equations)

Report: Table of contents, II 5. The NSRF Evaluation 5.1 How to analyse the Structural Fund interventions (demand and supply-side effects) 5.2 Implementation into HERMIN 5.3 Some detailed results 6. The future of the Czech NSRF Evaluation A series of technical annexes

1. Overview of the results During the implementation phase 2007-15 (nine years instead of the formal seven year SF interventions) two separate mechanisms work: The demand side effect (mainly through programmes of public and accompanying private investment) The supply-side effect which work through the build-up of stocks of infrastructure, human capital and R&D. After the termination of the programmes in 2015 the demand side effects will vanish rapidly but the supply-side effects will remain for a longer period.

1. Overview of the results, continued When measuring the impact of the NSRF it is important to distinguish between Level effect Growth effect The Level-effect compares the economic outcome relative to a baseline-scenario and can be expressed as a percentage or absolute difference from the baseline. The Growth-effect compares the different growth rates within one scenario with the growth rates in a baseline scenario. Even if there are large level effects the growth rates can be very similar.

1. Overview of the results, continued

1. Overview of the results, continued Revised expenditure profile of the NSRF (euro million per year) And as % of the NSRF per year

1. Overviewof the results, continued Effects of the NSPF on the real Czech GDP Level effect compared to the baseline as %-difference Growth rates effect, as % difference Gradually increasing impact on the level of GDP compared to the baseline-scenario (without NSRF), even in 2020 the level about 2% percent higher then without the NSPR Moderate differences up to one percent during the implementation phase and a significant difference in 2016

1. Overview of the results, continued In 2007 the initial effect on employment compared to the no-NSRF baseline is just over 20 thousand, given the initial low injection by the SF In 2013 this has built up to 196.000 and is still 178.000 in 2015. In 2020 total employment is still 29.000 higher. The NSRF introduces extra productivity gains of around 1% over the baseline. This is notable since even in the baseline there is are substantial increases in productivity.

2. Modelling the Czech Economy Very limited modeling research of the Czech economy Only recently policy-making institutions (MoF or the Central Bank) set-up a structural approach to economic modeling Not all material is in the public domain! Lack of long data series is a serious problem Models developed have a main focus on: Monetary and fiscal policy issues and Long-term growth, structural change and convergence prospects.

3. The HERMIN Modelling Approach A pictorial outline of the model

Important economic relationships Output: Exposed and sheltered sectors Production inputs: Labour and capital Output prices: Price taking and price making Wage determination: Bargaining and sectoral transmission Labour supply: natural growth, migration, participation Consumption: Is there a liquidity constraint? Trade: Modelled as a net trade balance (exports minus imports) Government: General government expenditure, revenue and balance

What determines sectoral output? Manufacturing: Local & external demand; competitiveness Market services: Local demand Agriculture: Productivity Government: Public employment

What determines production inputs? Output Cost of labour compared to cost of capital Technical progress

What determines output prices? Manufacturing: World prices, labour costs Market services: Labour costs Building and construction: Labour costs Agriculture: Common Agricultural Policy (CAP)

What determines wage rates? Consumer prices Output prices Productivity Unemployment rate

What determines labour supply? Population growth, but more specifically Working age population growth Participation rate Net migration flows

What determines household consumption? Income, but more specifically Household income, but more specifically Household disposable income Wealth??

What determines trade? National data on exports and imports are available Net regional trade balance (NTS) determined as production (GDPM) less regional absorption (GDA) NTS = GDPM - GDA

What determines general government revenue and expenditure? Revenue: Tax bases and tax rates Expenditure: Policy decisions (discretionary) as well as policy rules (automatic)

Model calibration “Old” EU models: Simple econometrics (OLS), using data for period 1980-2004 Czech national model: Curve-fitting and selective parameter imposition, using data for period 1995-2004 Other approaches to calibration: (i) Extend data sample, using pre-1995 (or even pre-1989) data? (ii) Panel data from group of countries (imposing cross-country constraints)

HERMIN documentation Data-based description of the economy Theoretical underpinnings of the HERMIN modelling framework Calibration of the behavioural equations Model testing: simulations and shocks Data appendix, model listing: public domain Standardised software:

Uses of a HERMIN-type model Preparation of economic forecasts General economic policy analysis NSRF-related policy analysis Design/evaluation of national industrial strategies

Preparation of economic forecasts Short-term national forecasts (12 months) are widely available Medium-term national forecasts (up to 5 years) are very rare Long-term economic forecasts of any kind are not usually available

4. The new HERMIN model for the Czech Republic Shocking the model to test its properties

5. The NSRF Evaluation How to analyse the SF interventions

Construction phase vs Use phase for cohesion policy During construction phase, there will be large demand-side impacts. These vanish after completion (i.e., after 2013 for next NSRF) Increased stocks of infrastructure, human capital and R&D can generate long-tailed supply-side impacts The size of the supply-side impacts depend on the appropriateness and effectiveness of the NDP

Inserting a CSF/NDP into HERMIN The three aggregate elements of a CSF (a) Physical infrastructure (b) Human resources (c) Direct aid to productive sector Conventional Keynesian expenditure and income impacts (role of policy multiplier) Additional externality effects on output and productivity

Implementation versus Use phase in evaluation During the implementation phase, there will be large demand-side impacts. These vanish after completion (i.e., after 2013/15 for next NSRF) Increased stocks of infrastructure, human capital and R&D can generate long-tailed supply-side impacts The size of the supply-side impacts depend on the appropriateness and effectiveness of the NSRF

Physical infrastructure: PI Demand-side impacts (implementation): PI  IG  I (total investment)  (Keynesian multiplier)  impact on GDP Supply-side impacts (mainly post-implementation): PI  increased stock of infrastructure (KPI)  boost to output/productivity

Human resources: HC Demand-side impacts (implementation): HC  Income & Public expenditure  Keynesian multiplier  GDP Supply-side impacts (mainly post-implementation): HC  stock of human capital (KHC)  boost to output/productivity

Research and Development Demand-side impacts (implementation): R&D  I (total investment)  (Keynesian multiplier)  impact on GDP Supply-side impacts (mainly post-implementation): R&D  increased stock of R&D (KRD)  boost to output/productivity

A serious methodological challenge Ex-ante impact analysis of “yet-to-be-implemented” NDPs Is the NSRF appropriate? How effective will be the implementation? Strict monitoring and evaluation can help, but do not guarantee success

Infrastructure, human capital and R&D: interaction effects The links between infrastructure, human capital and R&D are difficult to measure. A parallel improvement in all three is probably necessary But we cannot say much about the optimum balance between them within an NSRF

Where do the spillover measures come from? International literature on the impact of PI and HC on output and productivity Comprehensive ESRI survey Recent survey of HC impacts by IFS Problems: very little from cohesion countries! nothing from CEE countries no agreement on size of impacts! no agreement on level versus growth impacts!

Presenting model-based cohesion policy impacts Difficult to define an appropriate counterfactual baseline scenario. Difficult to assign values to the spill-over (or externality) elasticities to different countries in he absence of empirical research. Macro impacts are complex, and GDP is an imperfect indicator

5. The NSRF Evaluation

6. The future of the Czech NSRF Evaluation Summing up: the NSRF interventions will have a large impact on the level of GDP during the implementation phase up to 4.5% of GDP until 2015 compared to a baseline scenario and in the long-run the level of GDP will be around 1.5% higher there will be extra productivity gains and employment will be higher then in the non-NSRF scenario. Altogether the SF interventions will have a positive impact on convergence, the size of which will depend on the quality on the interventions.

6. The future of the Czech NSRF Evaluation These outcomes are based on a set of specific assumptions Specific externalities for infrastructure, R&D and human capital These externalities are high when the quality of the interventions are high The likely impact of other issues like the Single Market, enhanced FDI etc. are not explicitly modeled. These linked to the Structural Funds will further enhance convergence.

6. The future of the Czech NSRF Evaluation Future developments: In order to use the HERMIN CZ macro-model as an instrument for policy evaluations, it has to updated on a regular basis. During the implementation phase, and when the exact content of the measures is known, a new and improved classification of funding allocation into PI, HR and APS should be done. In the absence of a comprehensive micro-economic evaluation, the spillover-elasticities have to be assumed on bases of the international literature.

6. The future of the Czech NSRF Evaluation Gains from these improvements: As the NSRF is implemented can how we fine-tune the programme (at the Mid-term Evaluation stage) to optimise its impact on convergence. To do this one must develop a micro-evaluation alongside the macro evaluation of the type described by this report. The characteristics of micro and macro evaluation techniques are set out in the following slide.

Level of disaggregation High (individual projects) Micro (bottom-up) Macro (top-down) Level of disaggregation High (individual projects) Low (sectoral aggregates, whole economy) Use of theory Weak (judgemental, CBA) Strong (macroeconomics) Model calibration Judgemental/informal Scientific(?)/econometric Policy impacts Informal/implicit/ranking/some quantification Formal/explicit/quantified Treatment of externalities Limited or ignored Included/explicitly modelled

How can we know if EU cohesion policy is successful How can we know if EU cohesion policy is successful? Integrating micro and macro approaches to the evaluation of Structural Funds (Bradley, Mitze, Morgenroth & Untiedt, March 2006) Paper available on: www.gefra-muenster.de

Annex to the Presentation

Are HERMIN-based NDP impacts robust and reliable? Demand impacts: role of Keynesian multiplier (crowding out? Rational expectations? QUEST versus HERMIN) Supply impacts: role of externality (or spillover) effects Well-designed NSRF: large spillover effects Poorly-designed NSRF: small spillover effects

Can we give a “point” estimate of NSRF impacts? Almost certainly not! But based on additional evidence (CBA, qualitative review of NSRF, etc.), we can probably suggest whether the spillovers are likely to be high or low. As experience accumulates, we can move towards more precise estimates of the spillover parameters, and more precise long-term NSRF impacts

How can convergence become stronger and self-sustaining? There must be an initial “cluster” of activities, supported by special incentives and local specialised inputs (trained labour force): role of industrial strategy The increased local availability of skilled workers facilitates further growth of cluster: role of human capital Spillovers of information and “learning-by-doing” encourage further cluster growth: role of physical infrastructure National and regional policy stability, and consensual social partnership ensures efficiency is accompanied by equity, and facilitates self-sustaining regional growth

Porter’s Diamond of competitive advantage