1 Quantitative assessment of the impact of the NDP/NSRF 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

2 Report: Table of contents, I 1. Overview about the results 2. Modelling the Czech Economy 3. The HERMIN modelling framework 4. The new HERMIN model for the Czech Republic 4.1 Some characteristics of the Czech Economy 4.2 Some characteristics model results (equations)

3 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 A series of technical annexes

4 1. Overview of the results During the implementation phase (nine years instead of the formal seven year SF interventions) two separate mechanisms work:During the implementation phase (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.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.

5 1. Overview of the results, continued When measuring the impact of the NSRF it is important to distinguish betweenWhen 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 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.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.Even if there are large level effects the growth rates can be very similar.

6 1. Overview of the results, continued

7 Revised expenditure profile of the NSRF (euro million per year) And as % of the NSRF per year

8 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 Moderate differences up to one percent during the implementation phase and a significant difference in 2016 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

9 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 SFIn 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 and is still in 2015.In 2013 this has built up to and is still in In 2020 total employment is still higher.In 2020 total employment is still 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.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.

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

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

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

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

14 What determines production inputs? OutputOutput Cost of labour compared to cost of capitalCost of labour compared to cost of capital Technical progressTechnical progress

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

16 What determines wage rates? Consumer pricesConsumer prices Output pricesOutput prices ProductivityProductivity Unemployment rateUnemployment rate

17 What determines labour supply? Population growth, but more specificallyPopulation growth, but more specifically Working age population growthWorking age population growth Participation rateParticipation rate Net migration flowsNet migration flows

18 What determines household consumption? Income, but more specificallyIncome, but more specifically Household income, but more specificallyHousehold income, but more specifically Household disposable incomeHousehold disposable income Wealth??Wealth??

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

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

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

22 HERMIN documentation 1.Data-based description of the economy 2.Theoretical underpinnings of the HERMIN modelling framework 3.Calibration of the behavioural equations 4.Model testing: simulations and shocks 5.Data appendix, model listing: public domain 6.Standardised software:

23 Uses of a HERMIN-type model 1.Preparation of economic forecasts 2.General economic policy analysis 3.NSRF-related policy analysis 4.Design/evaluation of national industrial strategies

24 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

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

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28 5. The NSRF Evaluation How to analyse the SF interventions

29 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)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 impactsIncreased 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 NDPThe size of the supply-side impacts depend on the appropriateness and effectiveness of the NDP

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

31 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)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 impactsIncreased 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 NSRFThe size of the supply-side impacts depend on the appropriateness and effectiveness of the NSRF

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

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

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

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

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

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

38 Presenting model-based cohesion policy impacts Difficult to define an appropriate counterfactual baseline scenario.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.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 indicatorMacro impacts are complex, and GDP is an imperfect indicator

39 5. The NSRF Evaluation

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49 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 andthe 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% higherin the long-run the level of GDP will be around 1.5% higher there will be extra productivity gains andthere will be extra productivity gains and employment will be higher then in the non-NSRF scenario.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.

50 6. The future of the Czech NSRF Evaluation These outcomes are based on a set of specific assumptionsThese 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.

51 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.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.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.In the absence of a comprehensive micro-economic evaluation, the spillover-elasticities have to be assumed on bases of the international literature.

52 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.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.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.The characteristics of micro and macro evaluation techniques are set out in the following slide.

53 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/informalScientific(?)/econometric Policy impacts Informal/implicit/ranking/som e quantification Formal/explicit/quantified Treatment of externalities Limited or ignored Included/explicitly modelled

54 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:

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57 Annex to the Presentation

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

59 Can we give a “point” estimate of NSRF impacts? Almost certainly not!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.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 impactsAs experience accumulates, we can move towards more precise estimates of the spillover parameters, and more precise long-term NSRF impacts

60 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 strategyThere 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 capitalThe 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 infrastructureSpillovers 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 growthNational and regional policy stability, and consensual social partnership ensures efficiency is accompanied by equity, and facilitates self-sustaining regional growth

61 Porter’s Diamond of competitive advantage