Navigating Europe’s Socio-Economic Crisis: The Impact of Inflation, the Energy Crisis, and the Conflict in Ukraine on the Czech Republic and Beyond 3031448723, 9783031448720

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Navigating Europe’s Socio-Economic Crisis The Impact of Inflation, the Energy Crisis, and the Conflict in Ukraine on the Czech Republic and Beyond Edited by Robin Maialeh

Navigating Europe’s Socio-Economic Crisis

Robin Maialeh Editor

Navigating Europe’s Socio-Economic Crisis The Impact of Inflation, the Energy Crisis, and the Conflict in Ukraine on the Czech Republic and Beyond

Editor Robin Maialeh RILSA Prague, Czech Republic

This study was partly supported by the Ministry of Labour and Social Affairs of the Czech Republic IP70203 ISBN 978-3-031-44872-0    ISBN 978-3-031-44873-7 (eBook) https://doi.org/10.1007/978-3-031-44873-7 © The Editor(s) (if applicable) and The Author(s), under exclusive licence to Springer Nature Switzerland AG 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Cover Pattern © Harvey Loake This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG. The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland Paper in this product is recyclable.

Contents

1 Introduction  to the Current Challenges  1 Robin Maialeh 2 A  Panel VAR Granger Causality Analysis of Wages and Labour Productivity: Evidence from Czech Regions 13 Umut Ünal and Robin Maialeh Introduction  14 Literature Review  19 Data and Methodology  21 Results  22 Conclusion  26 References  28 3 Convergence  in the Labour Market: Evidence from the Czech Republic 31 Umut Ünal and Robin Maialeh Introduction  32 Literature Review  35 Data and Methodology  38 Results  40 Conclusion  44 References  46

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4 Migration  and the Labour Market of the Czech Republic 49 Bohdana Kurylo Introduction  50 Overview of the Migrant Population in the Czech Republic  54 Determinants of the Location Choices of Ukrainian Refugees and EU Dispersal Policies  58 Ethnic Networks  58 Unemployment Rates and the Availability of Job Places  61 Dispersal Policies: Previous Experience of EU Member States  63 Labour Market Outcomes of Immigrants in the Czech Republic  66 Conclusion and Policy Recommendations  74 Appendix  76 References  76 5 Inflation  Inequality: Drivers and Composition in the Czech Republic and Beyond 81 Davit Adunts and Robin Maialeh Introduction  82 The International Context of Inflation Inequality  85 Cross-Country Comparisons of Inflation Mitigation Policies  94 The Case of the Czech Republic  97 Results and Discussion 102 Conclusion 106 References 110 6 Weathering  the Storm: The Socioeconomic Impact of the Energy Crisis113 Filip Mandys Introduction 114 Literature Review 118 Data 122 Dataset Construction 122 Household Expenditure Data 123 Price Data 127 Methodology 129

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Results and Discussion 132 Energy Inflation in the Czech Republic 132 Energy Inflation in Europe 139 Conclusion 145 References 148 7 Policy  Recommendations and Concluding Remarks153 Robin Maialeh References 168 Index171

Notes on Contributors

Davit  Adunts  is a senior researcher at the Research Department of Migration and International Labour Studies at the Institute for Employment Research (IAB), the Research Institute of the Federal Employment Agency in Nuremberg, Germany. Prior to joining IAB, Davit worked as a junior researcher at the Research Institute for Labour and Social Affairs (RILSA). Since 2015, he has been a PhD candidate at the Center for Economic Research and Graduate Education–Economics Institute (CERGE-EI), a joint workplace of Charles University and the Economics Institute of the Czech Academy of Sciences. His research interests lie at the intersection of applied econometrics, the economics of migration, and the economics of education. His research focuses on migration selectivity and sorting, refugee labour market integration, and the impacts of migration opportunities on gender inequalities. Bohdana Kurylo  is a postdoctoral researcher at the Research Centre for Education and the Labour Market (ROA) at Maastricht University. Prior to joining ROA, Bohdana worked as a junior researcher at the Research Institute for Labour and Social Affairs (RILSA). From 2016, she was a PhD candidate at the Center for Economic Research and Graduate Education–Economics Institute (CERGE-EI), a joint workplace of Charles University and the Economics Institute of the Czech Academy of Sciences. Her research areas are empirical labour and education economics, with a specific interest in the impacts of schools and teachers on student outcomes, and educational inequalities between different groups of students. ix

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Robin  Maialeh  is an economist and social scientist who holds a PhD from the Prague University of Economics and Business. He is working as the Director of the Research Institute for Labour and Social Affairs (RILSA) in Prague, which conducts independent socioeconomic research in close cooperation with its founding organisation the Ministry of Labour and Social Affairs of the Czech Republic. Prior to his appointment to RILSA, Robin Maialeh was a Vice-President at Unicorn and an Assistant Professor of Economics at the Czech Technical University in Prague and the University of Chemistry and Technology in Prague. He has also held visiting research positions at Princeton University and the University of California, Berkeley. His research focuses on socioeconomic inequalities, the political economy, and the methodology of science. Filip Mandys  is working as a senior researcher at the Research Institute for Labour and Social Affairs (RILSA) in Prague. Previously, he worked as a research consultant in the Research & Market Analysis (RMA) division of the European Investment Fund (EIF) in Luxembourg. He holds a PhD in Economics from the University of Surrey, United Kingdom, as well as an MSc in International Economics, Finance, and Development and a BSc in Economics and Finance from the same university. His research interests include energy and environmental economics, labour economics, and applied econometrics. Umut  Ünal holds a PhD in Economics from Florida International University (2012). He has a diverse academic career, including roles as a lecturer at Florida International University, faculty at Turgut Ozal University, adjunct faculty at Middle East Technical University, and a visiting scholar at Philipps Universitat Marburg. He holds the position of Head of Macroeconomic Analyses department in the Research Institute for Labour and Social Affairs (RILSA). His research endeavours are concentrated in the field of macroeconomics, with a central focus on empirical applications. His papers have appeared in well-known international journals such as Regional Studies, Kyklos, and Empirical Economics.

List of Figures

Fig. 3.1 Fig. 3.2 Fig. 4.1

Fig. 4.2 Fig. 4.3

Fig. 4.4

Fig. 4.5

Final labour productivity convergence clubs across the Czech Republic42 Final real wages convergence clubs across the Czech Republic 42 Foreign nationals in the Czech Republic, 2005–2022. (Note: Data on the number of foreign nationals in the Czech Republic in 2022 is available only as of 30 September 2022. The latest data on the population is available as of 30 June 2022; hence, the share of foreign nationals in the figure is reported as of this date) 55 Annual migration flows in the Czech Republic, 2004–2021 56 Main countries of origin: Shares of immigrants in the Czech Republic, 2012–2022. (Note: The number of foreign nationals in the Czech Republic for 2022 was reported only as of 30 September 2022) 57 Regional distribution (See the application of Münich and Hrendash (2022) on the dynamics of the regional distribution of Ukrainian war refugees) of Ukrainian war refugees. (Note: The visualisation is based on data available as of 31 March 2023 obtained from the Ministry of the Interior of the Czech Republic (2022b)) 58 Relationship between the numbers of Ukrainian immigrants and Ukrainian refugees (as of 31 December 2021). (Note: The visualisation is based on data obtained from the Ministry of the Interior of the Czech Republic (2022b)) 59

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List of Figures

Fig. 4.6

The distribution of available job positions across districts. (Notes: Based on data obtained from the Ministry of Labour and Social Affairs (2022) and the Ministry of the Interior of the Czech Republic (2022b). Each point on the graph on the right corresponds to a district. We excluded the three districts with the largest numbers of available job positions per 1000 inhabitants (15–64 years), i.e. Tachov, Mladá Boleslav and Český Krumlov from the right-hand figure) Fig. 4.7 Occupational skill levels of immigrants, as of 31 December 2021 Fig. 4.8 Wage development across immigrant groups, by country of citizenship, 2012–2021 Fig. 4.9 Blinder-Oaxaca Wage Gap decomposition across the wage distribution spectrum. (Note: The figures above reflect the immigrant-native wage gap according to deciles after controlling for an extensive set of observable characteristics including gender, education, years of experience, size of the firm, marital status, number of children, occupation, level of urbanisation of the region and year-fixed effects. The results were weighted applying probability weights) Fig. 4.10 Gender composition of the Ukrainian diaspora in the Czech Republic. (Note: Based on data obtained from the Czech Statistical Office (2021)) Fig. 5.1 Overall shares of expenditure. (Source: Own calculation based on data from the Czech Statistical Office) Fig. 5.2 Shares of expenditure by income group, 2021. (Source: Own calculation based on data from the Czech Statistical Office) Fig. 5.3 Shares of expenditure by family characteristics, 2020. (Source: Own calculation based on data from the Czech Statistical Office) Fig. 5.4 Year-on-year changes in the consumer price index by household income quantiles and family characteristics, December 2022. (Source: Own calculation based on data from the Czech Statistical Office) Fig. 5.5 Contributions to the year-on-year change in the CPI from the considered product categories for five population subgroups based on income quantiles, December 2022. (Source: Own calculation based on data from the Czech Statistical Office) Fig. 5.6 Contributions to the year-on-year change in the CPI from the considered product categories for the defined population subgroups based on family characteristics, April 2022. (Source: Own calculation based on data from the Czech Statistical Office)

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70 76 100 102 103

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  List of Figures 

Fig. 5.7

Fig. 6.1

Fig. 6.2 Fig. 6.3 Fig. 6.4

Fig. 6.5 Fig. 6.6 Fig. 6.7 Fig. 6.8 Fig. 6.9 Fig. 6.10 Fig. 6.11 Fig. 6.12 Fig. 6.13

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Loss of purchasing power over the last 12 months (from April 2021 to April 2022) by income groups and family characteristics. (Source: Own calculation based on data from the Czech Statistical Office) 106 The share of energy expenditure in total household expenditure, comparing 15 OECD countries with the highest energy costs share in 2021. (Source: The data was obtained from the OECD, namely the Final consumption expenditure of households) 115 Disaggregated average household general expenditure for all households in the Czech Republic, between 2017 and 2021 124 Disaggregated average household energy expenditure for all households in the Czech Republic, between 2017 and 2021 126 Development of the monthly price indices of the four largest goods and services categories in the Czech Republic (2017–2023)—the price of “housing, water, and energy”, “food and non-alcoholic beverages”, “transport”, and “recreation and culture” 127 Development of the monthly disaggregated energy price indices in the Czech Republic (2017–2023)—prices of electricity, gas, solid fuel, liquid fuel, heat, and automobile fuel 128 Percentage annual increase in overall prices by consumer socioeconomic group between February 2022 and February 2023132 Percentage annual increase in energy prices by consumer socioeconomic group between February 2022 and 2023 133 Annual financial losses by consumer socioeconomic group caused by overall inflation, in Czech crowns (February 2022 to February 2023) 135 Annual financial losses by consumer socioeconomic group caused by energy inflation, in Czech crowns (February 2022 to February 2023) 136 Financial loss as a share of income across the socioeconomic groups due to overall inflation, between February 2022 and February 2023 137 Financial losses as a share of income across socioeconomic groups due to energy inflation, between February 2022 and February 2023 138 The twenty European countries with the highest annual general inflation rate between February 2022 and February 2023 140 The twenty European countries with the highest annual energy inflation rates between February 2022 and February 2023 141

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List of Figures

Fig. 6.14 The twenty European countries with the highest household financial losses from overall inflation as a share of income, between February 2022 and February 2023 Fig. 6.15 The twenty European countries with the highest household financial losses from energy inflation as a share of income, between February 2022 and February 2023

143 144

List of Tables

Table 2.1 Table 2.2 Table 2.3 Table 3.1 Table 3.2 Table 3.3 Table 4.1 Table 5.1 Table 6.1 Table 6.2

Pesaran (2015) weak cross-section dependence test results Panel unit root test results (Fisher PP) Panel—granger causality test Logt test results for all regions Initial convergence club specification Testing for club merging for labour productivity Detailed Blinder-Oaxaca decomposition: The effects of certain observable characteristics National inflation mitigation policies Annual average per capita household energy expenditure, Czech Republic (2018–2021) Types of energy policies aimed at mitigating the energy crisis effects (June 2023)

22 23 24 41 41 42 72 95 125 147

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CHAPTER 1

Introduction to the Current Challenges Robin Maialeh

Abstract  In the dynamic landscape of the global economy, rigorous research that addresses key socioeconomic issues plays a pivotal role in terms of shaping equitable societies. This book explores several critical aspects of the economy of the Czech Republic, shedding light on topics such as the relationship between wages and productivity, the integration of immigrant workers and the distributional effects of inflation. These chapters, characterised by their thorough analysis and methodological precision, both contribute to the academic discourse and provide valuable insight for policymakers. The Czech Republic’s unique economic challenges, regional disparities and labour market dynamics provide fertile ground for exploration. The chapters reveal the intricate connections between wage dynamics, productivity and regional disparities, while addressing immigrant labour market integration and the impacts of inflation on different socioeconomic groups. By offering nuanced insights and employing advanced methodologies, this book advances the overall level of economic understanding, informs policy decisions and paves the way

R. Maialeh (*) RILSA, Prague, Czech Republic e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. Maialeh (ed.), Navigating Europe’s Socio-Economic Crisis, https://doi.org/10.1007/978-3-031-44873-7_1

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towards a more sustainable, inclusive and prosperous future for the Czech Republic and beyond. Keywords  Socioeconomic research • Labour market • Inflation • Public policy • Distributional effects In the ever-evolving landscape of the global economy, where complexities and disparities abound, rigorous research into pivotal topics plays a commanding role in terms of shaping more equitable and just societies. This book considers a range of critical issues that lie at the heart of socioeconomic research. The chapters featured herein, each of which embodies meticulous analysis and methodological rigour, shed light on fundamental aspects of the economy of the Czech Republic. By exploring the intricacies of the relationship between wages and productivity, the distributional effects of inflation and the labour market integration of immigrants, this collection both advances the academic discourse and provides indispensable insight for policymakers and stakeholders alike. In recent years, the Czech Republic has provided fertile ground for economic transformation and has been faced with formidable challenges, which has prompted both scholars and policymakers to consider the intricacies of the country’s economic dynamics. The Czech Republic comprises distinct regions, each with its own socioeconomic characteristics and potential for growth. This heterogeneity provides an ideal “laboratory” for the investigation of the factors that contribute to regional disparities and the dynamics that underpin the convergence or divergence of economic performance across regions. Secondly, the prevalence of relatively low wages in the Czech Republic serves as a crucial point of interest for scholars and policymakers alike. The country’s labour market landscape is characterised by a competitive environment in which low wages have the potential, as the archetypal textbook conclusion suggests, to attract foreign investment and stimulate employment. However, it should be noted that such conclusions are conditioned to numerous aspects and generate mixed effects. Low wages may also push the unemployment rate below sustainable levels. A low unemployment rate may, in turn, then serve as a balancing factor that acts to support already weaken consumer demand caused by low wage levels.

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In addition, the low-wage scenario also raises questions concerning the adequacy of remuneration for workers and the negative impact on standards of living and, potentially, income inequality since the income composition of the top earners is usually dominated by capital rather than labour incomes. Moreover, the examination of the role of policies and labour market institutions in terms of determining wage levels becomes paramount in the quest to shape a sustainable and inclusive economy. Furthermore, the juxtaposition of regional economic disparities and low wages leads to the uncovering of several intriguing connections between these factors. How do regional disparities influence wage levels, and vice versa? Does the prevalence of low wages in certain regions exacerbate disparities, or does it present an opportunity for economic convergence? Unravelling these interrelationships allows for a nuanced understanding of the broader economic landscape and the discovery of potential pathways for fostering equitable and robust economic growth. In addition to the structural differences in regional economic development, the Czech Republic’s recent experience with a substantial influx of war refugees from Ukraine and the challenges posed by rampant inflation have further solidified its position as an exemplary case for investigation. The significant influx of refugees has introduced complex dynamics into the Czech Republic’s social and economic fabric. The integration of these refugees into the labour market and society at large presents unique challenges and opportunities. The investigation of how the arrival of war refugees impacts the labour market, wage dynamics and overall economic performance has the potential to yield valuable insight for policymakers facing similar situations globally. Forming an understanding of the potential impacts on the labour supply, skills transferability and human capital development is vital in terms of designing targeted policies that promote inclusive growth and social cohesion. Moreover, the issue of rampant inflation has emerged as a pressing concern for the Czech Republic, and the detailed study of its impacts on society is crucial. High inflation rates potentially erode purchasing power, exacerbate income disparities and impact wage bargaining dynamics. The analysis of inflationary pressures in the context of incomes and regional disparities assists policymakers in terms of devising measures aimed at protecting vulnerable groups and maintaining economic stability. Moreover, the exploration of the link between inflation and labour market outcomes sheds light on the efficiency of monetary policies and their implications for employment and wage levels.

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The combination of the shocks that have severely affected the Czech Republic over recent years provides a unique opportunity to set the background for examining the interconnectedness of these phenomena. The integration of war refugees into the labour market and society, coupled with the impact of inflation on different social groups, and regional labour market disparities, presents a multifaceted economic landscape. Via the exploration of these intricate dynamics, researchers are able to provide evidence-based recommendations for policymakers in terms of fostering social cohesion and sustainable economic growth in the face of complex and interconnected challenges. As we embark on this scholarly journey, the various chapters in this book offer a testament to the enduring pursuit of knowledge in the field of economics and policy research. Each contribution represents a step forward with concern to enriching the understanding of the key economic phenomena that shape the Czech Republic’s economic landscape. The rigorous methodologies employed in these chapters underscore the commitment to empirical precision and intellectual rigour and converge at the vanguard of contemporary economic research by illuminating critical themes that resonate with the host of complexities of the global economy. Through diligent inquiry and methodological precision, the book provides a major contribution to the understanding of the economic dynamics of the Czech Republic. As we navigate through the chapters that lie ahead, the insight gleaned from this collection will serve to foster a deeper appreciation of the interplay of economic forces that will pave the way towards a more sustainable, inclusive and prosperous future for the Czech Republic and beyond. The second chapter proposes that the intricate relationship between real wages and labour productivity lies at the heart of economic performance, and includes a thorough analysis of the causal dynamics that underpin this pivotal relationship in the regional context of the Czech Republic. Leveraging an extensive panel dataset spanning the period 2000 to 2021, the study comprises a comprehensive investigation into the intertwined trajectories of real wages and labour productivity. Aimed at unravelling this complex interplay, the chapter applies the panel vector autoregression (VAR) Granger causality test, which is widely recognised as offering an effective methodology for such investigations. In addition, the research employs the generalised method of moments (GMM) methodology, which is known for its capacity to address diverse econometric challenges, including endogeneity issues. The results provided by the rigorous analysis shed light on the reciprocal relationship between real wages and

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labour productivity across the various regions of the Czech Republic. The identification of this interdependence, which suggests that changes in real wages have the potential to influence labour productivity, while shifts in labour productivity concurrently impact real wages, is of profound significance. These findings reveal the intrinsic nexus that binds these two key economic indicators, which has ramifications for both policymakers and stakeholders. As we progress through this scholarly endeavour, the significance of understanding the causal relationship between real wages and labour productivity becomes evident. The chapter provides important insight into the determinants that shape economic performance within the regional landscape of the Czech Republic, and the findings pave the way for the implementation of informed policy interventions that optimise the interplay between real wages and labour productivity and foster sustainable economic growth and social well-being. Policymakers should leverage these research findings so as to design targeted strategies that enhance labour productivity, thereby elevating real wages and promoting the economic prosperity of the nation as a whole. Moreover, the application of advanced econometric methodologies such as the panel VAR Granger causality test and GMM makes a significant contribution to the application of this methodological repertoire and bolsters the credibility and robustness of the economic research. By employing these sophisticated techniques, this chapter addresses potential endogeneity challenges and serves to enhance the level of accuracy concerning the causal relationship between real wages and labour productivity. Continuing with the issue of wages and productivity and with concern specifically to the realm of regional economic dynamics, forming an understanding of labour productivity and real wages convergence patterns is of paramount importance. The third chapter undertakes a rigorous analysis aimed at investigating and dissecting the diverse convergence patterns across the fourteen distinct regions of the Czech Republic over the period 2000 to 2021. Employing the clustering algorithm, this chapter ventures into uncharted territory by offering novel insight via the modelling of the variables in a non-linear manner, thus accommodating both heterogeneity and transitional dynamics at the regional level. The exploration of the outcomes provides valuable information on the nuanced dynamics that underlie labour productivity and real wages and, further, serves to shape our comprehension of the diverse economic performance and wage levels that are evident across the regions. In the absence of conclusive evidence

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in support of overall convergence, the identification of two (three) sub-­ convergence and one non-convergence group for labour productivity (real wages) revealed the varied trajectories and distinct factors that influence regional economic growth and wage distribution in the Czech Republic. The findings should serve as a call to action for policymakers and researchers to meticulously analyse and comprehend the intricate convergence patterns that underpin regional economic dynamics. By gaining a comprehensive understanding of the unique factors and influences that shape labour productivity and real wages in each region, targeted strategies can be devised aimed at addressing regional disparities, fostering inclusive economic growth and ensuring an equitable wage distribution across the Czech Republic. The analysis of labour productivity and real wages convergence patterns stands as a cornerstone in the quest for equitable regional economic development. The understanding of the presence of sub-convergence and non-convergence groups helps to unravel the complexity of regional disparities and dynamics, thus presenting new opportunities for policymakers to tailor intervention measures that address the specific needs and challenges faced by different regions. The insight offered by this chapter enriches our understanding of the heterogeneous nature of regional dynamics and serves as a crucial reference point for guiding policymakers and researchers towards the design of informed strategies that promote economic growth, mitigate regional disparities and bolster an equitable wage distribution system. Continuing with the theme of the Czech labour market, the immigrant labour market integration process comprises a complex and critical area of inquiry in an increasingly interconnected global economy. The fourth chapter provides an incisive overview of the labour market integration of immigrants in the Czech Republic employing comprehensive data obtained from the European Union—Statistics on Income and Living Conditions (EU-SILC) survey over the period 2006 to 2021. As the nexus between immigrant-native wage differences and the effectiveness of immigration and integration policies becomes ever more pertinent, this chapter presents a nuanced exploration of this relationship and offers valuable insight for policymakers. Moreover, it explores the various factors that shape the location choices of Ukrainian war refugees in the Czech Republic, including the influence of ethnic networks and employment prospects, that contribute towards the unequal distribution of refugees. Employing the Blinder-Oaxaca decomposition for unconditional quantile regressions method, the chapter rigorously quantifies wage differences

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across the entire wage distribution spectrum and provides crucial insight into the economic realities faced by immigrants. The analysis reveals that immigrants from Eastern and Southern Europe, on average, earn lower wages than native Czechs. Notably, low-­ earner immigrants face a more considerable wage disadvantage than their high-earning counterparts. These disparities underscore the urgency of investigating the determinants responsible for the immigrant-native wage gap across the entire wage distribution spectrum. The chapter reveals the myriad unobservable factors that comprise the key determinants in terms of shaping wage disparities, thus enriching our understanding of the multifaceted interplay of diverse variables. Education and experience play pivotal roles in determining wage disparities between immigrants and natives. Immigrants often encounter lower returns on their education and experience, which can be attributed to the imperfect transferability of skills, challenges in terms of the recognition of foreign educational qualifications, and lower returns on foreign education. This finding underscores the necessity for the implementation of targeted policies that address the specific hurdles faced by immigrant workers concerning in particular ensuring equitable access to opportunities and resources and facilitating the seamless integration of immigrants into the labour market. The findings of the fourth chapter resonate as a clarion call for the design and implementation of more effective integration and equal treatment policies aimed at narrowing the immigrant-native wage gap. By acknowledging the complexities of labour market integration, policymakers will be better able to craft informed strategies that foster social cohesion and promote inclusive growth by leveraging the potential of immigrant workers for the collective benefit of society and the economy. The knowledge provided by this chapter offers a valuable lens through which to comprehend the immigrant labour market integration dynamics at work in the Czech Republic. The contribution of this chapter extends beyond mere data analysis; it serves as a beacon for guiding policymakers towards designing evidence-based intervention measures that prioritise inclusive economic growth and social cohesion. By placing immigrant labour market integration at the heart of policymaking, we can collectively create a more harmonious and prosperous society that nurtures the diverse talents and contributions of all individuals, thus fostering an environment of equal opportunities and shared prosperity. Currently high levels of inflation comprise a further important issue for the labour market. As the global economy experiences bouts of

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inflationary pressures, the exploration of the distributional effects of this phenomenon is imperative in terms of forming an understanding of the implications for different socioeconomic groups. The fifth chapter presents a comprehensive analysis of the distributional effects of currently high inflation rates, focusing specifically on the investigation of studies that have addressed inflation in the European context. Drawing upon innovative methodologies that integrate microeconomic surveys with national accounts and employ panel quantile regression with fixed effects, the chapter unravels the intricate relationship between inflation and income inequality. The findings highlight that higher inflation rates exacerbate income inequality, particularly in regions characterised by lower initial income inequality. Moreover, the chapter explores the complex interplay between inflation and well-being by disentangling the contributions of profits, wages and import prices to inflation dynamics within countries. In the context of the Czech Republic, the chapter adopts a meticulous approach employing data obtained from the Czech Household Budget Survey and the Consumer Price Index to create consumer price indices for various population subgroups. This thorough analysis allows for a nuanced understanding of the distributional impact of inflation on different segments of society, particularly those whose budgets are most affected. Notably, the chapter emphasises that subgroup-specific inflation rates align closely with that of the inflation rate for the non-elderly population, with the exception of single-parent households, which experienced a higher inflation rate in 2022 than the other subgroups. Although this difference was reasonably modest, the findings are significant in view of the potential negative implications for the well-being of single-parent households. Importantly, the fifth chapter sheds light on the disproportionate burden borne by low-income and single-parent households in terms of inflationary costs related to essential expenses such as housing, water, electricity, gas and other fuels. While all households are facing the impact of rising living costs, the analysis indicates that single-parent and low-income households are particularly vulnerable to the inflationary pressures that arise from these essential items. The stark contrast in terms of the inflation burden between single-parent and two-parent households, especially with regard to housing, water, electricity, gas and other fuel costs, reveals the heightened susceptibility of single-parent households to the adverse effects of inflation The disparities identified in the distributional effects of inflation signal the pressing need for the introduction of targeted policy intervention

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measures that specifically address the challenges faced by vulnerable households. In particular, the recent increases in electricity and gas prices underscore the urgency of providing government support aimed at mitigating the adverse impacts on single-parent households. By prioritising support for single-parent and low-income households, policymakers will contribute towards fostering social equity and stability, alleviating the burden of rising living costs, and promoting a more inclusive economic recovery. The insight gained from this analysis serves as a critical reference point for informed policymaking that aims to mitigate the adverse consequences of inflation on the most susceptible segments of society and support the creation of a more equitable economic landscape. The results presented in this chapter contribute to forming a more complete understanding of the complex interplay between inflation and income inequality, thus paving the way for a more resilient and just economic future for all. Finally, European countries have recently found themselves grappling with a pervasive surge in inflation, exacerbated especially by the rapid escalation in energy prices. The Czech Republic has been hit particularly hard by the ongoing energy crisis. The implications of such inflationary pressures warrant meticulous investigation. Thus, the sixth chapter explores the phenomenon of general and energy inflation in the Czech Republic. Employing data obtained from highly respected sources including the Czech Statistical Office, Eurostat, ONS and OECD, the chapter endeavours to explore the profound economic ramifications of the crisis, identifies those socioeconomic groups that have been most severely affected and suggests strategies for targeted governmental support aimed at mitigating the losses incurred. Of all the realms of economic dynamics, inflation represents one of the pivotal indicators; it significantly influences the financial well-being of households and shapes overall economic performance. The sixth chapter attempts to explain the specific drivers of inflationary pressures focusing particularly on energy prices, the rapid increase in which has exacerbated the already precarious economic situation. Drawing upon a comprehensive dataset spanning the period February 2022 to 2023, the chapter quantifies the toll inflicted by general inflation and the exclusive impact of energy inflation on the average Czech household. The alarming findings indicate that households have suffered a staggering loss of 12.2% of their annual net income due to overall inflation and an additional 3.5% due to energy inflation alone. These figures both underscore the gravity of the crisis and underline the urgent need for the introduction of effective policy

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intervention measures aimed at alleviating the burdens borne by vulnerable segments of society. Moreover, the chapter strives to identify the distinct socioeconomic groups that have borne the brunt of energy-crisis-driven inflation. Through rigorous analysis, pensioners, the poorest families in society, single parents and households located in small municipalities were identified as the most vulnerable group and those that experienced the most substantial financial losses. The implications of these findings are profound and signal the need for targeted government support that prioritises the addressing of the unique challenges faced by these groups. By devising measures that align with the specific needs of these socioeconomic segments, policymakers can contribute towards fostering social cohesion, reducing inequalities and safeguarding the well-being of the most vulnerable members of society. Aimed at contextualising the Czech Republic’s position in the wider European landscape, the chapter further compares the nation’s inflationary experience with that of other European countries. The identification of the Czech Republic as the fourth most affected country in Europe emphasises the gravity of the crisis and underscores the shared urgency for cohesive, collaborative solutions at the regional level. The experience of other European nations provides valuable information for the development of policy measures that effectively address inflationary pressures and their consequences on the overall economic stability and social welfare of the region. In summary, in the context of today’s rapidly evolving socioeconomic landscape, the three pivotal topics explored in this compendium—the relationship between wages and productivity, the influx of immigrants and the distributional effects and decomposition of inflation—have emerged as fundamental issues for economic research and policy decision-making. These interconnected themes have the potential to reshape our understanding of economic dynamics, labour market efficiency and income distribution in the face of evolving global challenges. The nexus between wages and productivity has a number of critical implications for policymakers who wish to encourage economic growth and increase productivity levels. A comprehensive understanding of the labour market integration of immigrants is imperative in terms of effectively harnessing their economic potential. The examination of the distributional effects that arise from inflationary pressures is essential in terms of devising equitable policies that act to reduce socioeconomic disparities and ensure macroeconomic stability. As we progress through the diverse chapters of the book,

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the intrinsic value of these topics for current socioeconomic research becomes increasingly apparent. The findings and methodologies presented in this compendium contribute to the shared knowledge base that guides policymakers and researchers in terms of formulating evidence-based policies, fostering inclusive growth and mitigating economic imbalances. The insight provided resonates with the complexities of the contemporary global economy as we strive to build a sustainable, equitable and resilient future for the Czech Republic and beyond.

CHAPTER 2

A Panel VAR Granger Causality Analysis of Wages and Labour Productivity: Evidence from Czech Regions Umut Ünal and Robin Maialeh

Abstract  The main objective of this chapter is to conduct a thorough analysis of the causal relationship between real wages and labour productivity within the regional context of the Czech Republic. An extended panel dataset covering the period 2000 to 2021 was employed to perform a comprehensive investigation into this relationship. We applied the panel vector autoregression (VAR) Granger causality test, which is widely recognised as being an effective methodology for such investigations, in the research. The test was conducted using the generalised method of moments (GMM) methodology, which is known for its ability to handle various econometric challenges and address issues such as endogeneity. The results revealed the reciprocal relationship between real wages and labour productivity across the various regions of the Czech Republic. This finding suggests that changes in real wages potentially impact labour productivity, while shifts in labour productivity also potentially influence real

U. Ünal • R. Maialeh (*) RILSA, Prague, Czech Republic e-mail: [email protected]; [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. Maialeh (ed.), Navigating Europe’s Socio-Economic Crisis, https://doi.org/10.1007/978-3-031-44873-7_2

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wages. The interdependence between these key economic indicators has significant implications for both policymakers and stakeholders. Keywords  Real wages • Labour productivity • Regional economics • Causal relationships • Panel vector autoregression

Introduction The labour market in the Czech Republic displays several distinctive characteristics that consistently demand new approaches and research. A comparison with the mid- to long-term averages of the European Union (EU) reveals that the Czech Republic has the lowest unemployment rate, a higher rate of economic activity and a lower proportion of low-skilled employees. However, according to Eurostat, labour productivity in the Czech Republic stands at around 80% of the EU average, while Czech wages, despite recent improvements, remain at around two-thirds of the EU average. In addition, the Czech Republic is the most industrialised country in the EU with the highest employment rate in the secondary sector (Unal & Specianova, 2023). Furthermore, the tightness of the labour market is driven by a significant number of vacancies, which in this specific case indicates a multi-structural mismatch with notable rigidities (Posta, 2020) rather than a typical overheated labour market with wage-price pressures. Productivity is of significant importance in the field of economics since it represents a key factor in terms of (intensive) economic growth. Increases in productivity entail the attainment of a higher output per unit of input. Economic growth is closely associated with productivity growth since the optimisation of resource utilisation plays a crucial role. By making the optimal use of resources, countries are able to increase production, thereby driving economic growth. On the other hand, wages refer to the compensation paid to employees for their work within a specified period. Wage labour prevails in a world of commodified labour, and the amount of wages earned has vital implications in terms of meeting the physiological, economic, social and cultural needs of dependent employees and their dependents. Wages also serve as the primary source of income for individuals, thus influencing their future prospects. Wage disparities across regions within countries both contribute to and result from interregional development differences.

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The complex and multifaceted relationship between real wages and productivity is a topic of interest from various theoretical perspectives, which offer distinct critiques and insights into the dynamics between wages and productivity and shed light on the various aspects of the labour market. It is evident that real wages play a significant role in determining aggregate demand, which, in turn, affects productivity levels in the economy. Higher real wages potentially lead to increased consumption and aggregate demand, thus stimulating economic growth and productivity. This is known as the “wage-led growth” hypothesis, which was pioneered by Nicolas Kaldor. In other words, when workers receive higher wages, they have more purchasing power, which translates into increased demand for goods and services. This increased demand, in turn, encourages firms to invest in production capacity and innovation, thus leading to higher productivity levels. From this perspective, higher real wages act as a catalyst for economic growth and increases in productivity. This chapter also considers the perspective from which workers are paid wages that are lower than the value they create through their labour. The relationship between wages and productivity is, under capitalist production conditions, always in conflict to a certain extent; firms (and their owners) have an incentive to keep wages low in order to maximise their profits. This creates a situation in which productivity levels may increase, but the benefits of the increased productivity are not proportionally shared with workers in the form of higher wages. This dynamic leads to a tendency for the gap between productivity and wages to widen over time, thus resulting in increasing economic inequality. When formulating the labour market demand curve, neoclassical economics assumed that labour is homogeneous and that changes in real wages do not affect labour productivity. According to neoclassical economics, changes in the labour demand curve provide explanatory factors for changes in real wages. Furthermore, neoclassical economics posited that real wages are determined by the equilibrium of supply and demand in a labour market that is characterised by perfect competition.1 However, following the Great Depression, economic theory shifted towards Keynesian macroeconomic ideas. This shift was motivated by two main factors: (1) the existence of involuntary unemployment, where individuals 1  In this particular scenario, unemployment in the labour market was characterised as voluntary, i.e. it indicated the preference of individuals to remain unemployed rather than to accept employment at the real wage rates prevalent in the labour market.

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wished to work for prevailing wages but were unable to find employment, and (2) the belief that economic instability in total demand is responsible for fluctuations in short-term economic activity (Van Biesebroeck, 2015; Bradley, 2007; Cahuc & Zylberberg, 2014).2 With concern to contemporary labour economics, several theories have recently gained prominence in terms of offering valuable insight into the dynamics of the labour market and shaping the research agenda in the field. These theories provide a foundation for understanding the various aspects of labour market phenomena and offer valuable tools for both policymakers and researchers in terms of the analysis of labour market outcomes. The human capital theory provides an example of a previously prominent theory in the field of labour economics. Stemming from the work of economists such as Gary Becker, this theory emphasises the roles of education, training and skills in terms of determining an individual’s productivity and earnings. The human capital theory posits that investment in education and training leads to higher productivity and, subsequently, higher wages. The theory highlights the importance of the investment of individuals in acquiring skills and knowledge, as well as the role of formal education institutions and vocational training programmes in terms of shaping labour market outcomes. Despite its contributions, the human capital theory overlooks a number of the crucial structural aspects of labour markets. It fails to consider the influence of institutional factors, power asymmetries and market imperfections that shape labour market outcomes. Moreover, the theory neglects the impact of structural changes in the economy and the broader social implications of labour market dynamics. By focusing solely on the investment of individuals in education and skills, the theory results in an incomplete understanding of labour markets. It was subsequently understood that a more comprehensive approach was required so as to account for these structural aspects and to promote inclusive and equitable outcomes. Theories concerning labour market discrimination are highly influential in the field of contemporary labour economics. Such theories investigate the existence and persistence of wage disparities among individuals or 2  During the mid-twentieth century, the prevailing assumptions faced criticism from New Keynesian economists who argued that alterations in real wages exert an impact on labour productivity. Moreover, they posited that real wages are not determined solely by the interplay of supply and demand in the labour market. Aimed at addressing the issue of involuntary unemployment, New Keynesian economists created effective wage models that provided explanatory frameworks (Bradley, 2007).

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groups based on factors such as gender, race or ethnicity. They serve to shed light on the impact of biases and prejudices on labour market outcomes and highlight two prominent forms of discrimination: statistical discrimination and taste-based discrimination. These theories reveal the mechanisms through which discrimination potentially affects wages, employment opportunities and occupational segregation. Moreover, there has been a tendency towards the acceptance of behavioural approaches in the research of labour economics. Such approaches incorporate insights from psychology and the behavioural sciences so as to examine both the afore-mentioned discriminatory issues and how individuals make decisions in the labour market. Behavioural labour economics acknowledges that individuals may well deviate from strictly rational behaviour due to the influence of psychological bias, social norms and the provision of incomplete information. The search and matching theory provides an example of another influential theory in the field of labour economics. This theory, developed by economists including Peter Diamond, Dale Mortensen and Christopher Pissarides, focuses on the job search process and the matching of workers to job vacancies. The search and matching theory recognises that the labour market is characterised by frictions and information asymmetries, which lead to the coexistence of unemployment and job vacancies. The theory provides a valuable insight into the determinants of job search behaviour, the dynamics of unemployment and the efficiency of labour market matching. The economics of migration comprises a further important area in the field of contemporary labour economics. Migration theories explore the various factors that influence migration decisions, the effects of immigration on native workers and the native economy, and the determinants of immigrant labour market outcomes (Erol & Unal, 2022). These theories consider factors such as wage differentials across countries, labour market conditions and migration policies in terms of explaining migration patterns and the economic consequences of immigration.3 In combination with the neoclassical international trade theory, it is supposed that labour shifts from regions with lower wages and higher unemployment rates to regions with higher wages, which acts to promote welfare by reallocating 3  Internal migration may result in similar outcomes. A notable example in this respect concerns a study by Erol and Unal (2023), which provides a comprehensive analysis of the economic consequences of internal migration movements.

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resources and reducing the regional disparities in factor prices. During the nineteenth century, regional market integration played a crucial role in the economic development of many European and American countries. The reallocation of productive factors across regions led to structural changes and increased efficiency and accelerated economic growth rates (Rosés & Sánchez-Alonso, 2004). Consequently, the relationship between economic integration and the convergence of living standards has formed the subject of numerous studies both at the international and regional levels. Employing the extensive knowledge base described above, this chapter examines the causal relationship between real wages and productivity within the regional context of the Czech Republic, aimed at achieving which we employ a panel vector autoregression (VAR) Granger causality model applying the generalised method of moments (GMM) methodology developed by Abrigo and Love (2016). The findings reveal a bi-­ directional causality between real wages and labour productivity in the Czech Republic at the regional level. This analysis holds significance for a number of reasons. Firstly, forming a comprehensive understanding of the causal link between real wages and productivity offers the potential to enhance the functioning of the labour market via the identification of factors that influence wage levels and worker productivity. This knowledge can then be applied in the formulation of policies that foster higher wages and promote productivity growth, thereby enhancing living standards and facilitating economic expansion. Secondly, the comprehension of the dynamics between real wages and productivity at the regional level enables policymakers to effectively address concerns including regional inequality and disparities in economic development. Addressing these issues has the potential to contribute towards attaining more equitable growth across nations and to promote overall economic stability. Finally, exploring the relationship between real wages and productivity at the regional level helps to provide a deeper insight into the macroeconomic landscapes of countries and their internal mechanisms. Such an understanding, in turn, contributes in terms of anticipating future trends and making informed decisions concerning economic planning and development. The chapter consists of five sections. Section 2 provides a brief review of the relevant literature. Section 3 discusses the data and methodology used in the research. Section 4 presents a discussion of the results and Sect. 5 the conclusions.

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Literature Review The empirical literature has devoted considerable attention to the relationship between real wages and productivity as a consequence of its crucial role as a nexus in the labour market. Although numerous studies have explored this relationship, attaining definitive consensus on the nature of the link between these two variables remains a challenge. Erenburg (1998) investigated the impact of private and public capital on productivity and explored the relationship between real wages and productivity in the United States from 1948 to 1990. Controlling for private and public capital stock, the study found that real wages exhibit a countercyclical pattern, with diminishing returns to labour, positive returns to public capital and the procyclical impact of capacity utilisation on real wages. Addressing the issue of the spurious regression bias caused by non-­ stationary variables, the study estimated long-term relationships between productivity, real wages, the employment-to-capital ratio and the public-­ to-­private capital ratio. Based on the resulting estimates, the study concludes that maintaining the historical 1948–1965 ratio of public capital stock would have resulted in productivity levels of 2.4 to 2.9 percentage points higher, and real wages of 2 to 2.8 percentage points higher, assuming all else was equal. Millea (2002) examined the bi-directional feedback between wages and productivity in several industrialised countries with the aim of distinguishing between conventional and efficiency wage behaviour. The study employed Geweke’s linear feedback technique to estimate the interrelationships between wage changes and productivity changes across a sample of countries. The results revealed variations in the relationships between wage changes and productivity changes across the selected countries, which could most likely be attributed to differences in terms of institutional arrangements. The study suggests that higher union representation leads to higher wages as worker productivity improves, and it concludes that countries with more than 25% union coverage show evidence of conventional productivity-driven wage behaviour. In contrast, the United States, with less than 25% union coverage, evinced no evidence of conventional wage setting. Wakeford (2004) utilised time-series econometric methods to explore the relationship between labour productivity, real wages and the unemployment rate at the macroeconomic level in South Africa. The results identified a significant structural break in 1990, after which all three

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variables experienced rapid growth. Initially, the break negatively impacted employment and subsequently affected per-worker wages and productivity. The study further revealed a long-term equilibrium (cointegrating) relationship between real wages and productivity, while finding no connection between unemployment and the system, thus providing support for the insider-outsider theory. The estimated long-term wage-­productivity elasticity of 0.58 indicated that productivity grew faster than wages, which is consistent with the observation of a decreasing labour share of gross output over the past decade. These trends can be attributed to the implementation of job-shedding technology and capital intensification. Strauss and Wohar (2004) examined the long-term relationship between prices and wage-adjusted productivity, as well as between real wages and average labour productivity using a panel of 459 US manufacturing industries from 1956 to 1996. The study employed various methods so as to overcome limitations in the panel unit root and panel cointegration procedures. The panel cointegration test results strongly rejected the null hypothesis of no cointegration between prices and wage-­ adjusted productivity, as well as between labour productivity and real wages. Furthermore, the study demonstrates that many individual industries exhibit a cointegrating relationship between these variables. The stability tests served to confirm a constant long-term relationship and a stable cointegration equilibrium across most of the industries in the panel. The Granger causality tests indicated that prices weakly exogenously result in movements in unit labour costs. The relationship between prices and unit labour costs was less than one-for-one, although partial support for a one-­ for-­ one relationship was detected for some industries. Bi-directional Granger causality was identified between real wages and productivity, while a one-to-one relationship between real wages and productivity was strongly rejected. The study concludes that increases in labour productivity are associated with a less than unity increase in real wages. Christopoulos and Tsionas (2005), on the other hand, addressed the longstanding concern regarding the relationship between productivity and inflation in fifteen European Union countries. Panel-based unit root and cointegration estimation procedures were employed to mitigate power distortions in small samples and to ensure accurate conclusions. The fully modified ordinary least squares (OLS) technique was applied to a heterogeneous panel aimed at examining the long-term relationship between inflation and productivity growth, while an error correction model was employed to analyse causality over both the long and short terms. The

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empirical analysis revealed unidirectional causality from inflation to productivity growth over the long term. In addition, short-term causality was determined between productivity growth and inflation in five out of the fifteen countries examined, as well as within the panel as a whole.

Data and Methodology Using a panel dataset comprising 294 region-year observations from the period 2000 to 2021, this chapter investigates the causal relationship between real wages and labour productivity. Labour productivity is measured by dividing the output produced by the number of hours worked. The relevant data was obtained from the Czech Statistical Office. To examine whether wages affect labour productivity, labour productivity affects wages, or if there exists a feedback loop between the two, we employ the panel VAR Granger causality test on our region-level panel dataset. The estimation of the panel VAR model is conducted using the generalized method of moments (GMM) developed by Abrigo and Love (2016). It is important to note that the Granger causality test requires the use of stationary time series data. In other words, if the data is non-stationary in its level form, it needs to be transformed into a stationary form for the Granger causality test (Huang, 1995). Therefore, prior to conducting the causality tests, we perform panel data unit root tests to examine the stationarity of our variables. The utilisation of panel data unit root tests has gained widespread popularity among empirical researchers due to advancements in time series econometrics and panel data analysis over the past three decades, as initiated by Levin et al. (2002). Currently, a variety of unit root tests for panel datasets are available, categorised into two generations: first-generation and second-generation tests. The former assumes convenience in the absence of correlation between cross-sectional units, while the latter category of tests rejects the hypothesis of cross-sectional independence (Hurlin & Mignon, 2007). In this regard, before applying the appropriate unit root test to our variables, we utilise a simple test of weak cross-section dependence (CD) proposed by Pesaran (2015). Our panel VAR Granger causality model takes the following form:

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m

ln  Labour Productivity it   0   l ln  Wages i ,t l l 1

m

  l ln  Labour Productivity i ,t l  i  uit l 1

(2.1)

m

ln  Wages it   0  l ln  Labour Productivity i ,t l l 1

m

 l ln  Wages i ,t l  i  uit



l 1

(2.2)

where it is assumed that the disturbances uit and uit′ are uncorrelated. Equation (2.1) indicates that the variable wages Granger results in labour productivity provided that the βl’s are statistically different from zero as a group, whereas the γl’s are not statistically different from zero as a group. Similarly, labour productivity Granger-causes wages given that βl’s are not statistically different from zero in Eq. (2.1) while the set of the lagged wages coefficients in Eq. (2.2),  λl’s, are statistically different from zero. Feedback, or bilateral causality, is indicated when the sets of wages and labour productivity coefficients are statistically different from zero in both equations (Erol et  al., 2023). The most important feature that distinguishes the panel VAR model from the VAR model in the time series is the individual effects (μi) in the model.

Results Table 2.1 shows the results of the Pesaran (2015) weak cross-section dependence (CD) test, which provides strong evidence for rejecting the null hypothesis of cross-section dependence for both variables. Table 2.2 provides a summary of the results of the Fisher-type test, which performs unit-root tests to each panel by combining the p-values from the panel-specific unit-root tests employing the methodology Table 2.1  Pesaran (2015) weak cross-section dependence test results Variable

CD-test

p-value

ln(labour productivity) ln(real wages)

44.679 44.744

0.000 0.000

14 14

Panels 51.924 57.983

Chi2 0.004 0.001

p-value –3.150 –3.781

Inverse Normal 0.001 0.000

p-value –3.215 –3.908

Inverse Logit

0.000 0.000

p-value

3.197 4.007

Modified Inv Chi2

0.000 0.000

p-value

Notes: The AR parameter is panel specific. The time trend term is not included; the cross-sectional means are removed. The Newey-West-based lag length was chosen as 4. The results are insensitive to further lags

ln(labour productivity) ln(real wages)

Variable

Table 2.2  Panel unit root test results (Fisher PP)

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Table 2.3  Panel—granger causality test Direction of causality Labour productivity → Real Wages Real Wages → Labour productivity

chi2

Lags

12.833*** (0.012) 41.713*** (0.000)

4

Notes: Cluster-robust standard errors at the regional level were used to mitigate potential heterogeneity and autocorrelation concerns. The p-values are shown in parentheses

proposed by Choi (2001). The findings strongly reject the null hypothesis that all the panels contain a unit root for our variables, thus indicating stationarity. Hence, it was possible to proceed with the Granger-­ causality test. Table 2.3 presents the comprehensive results of the Granger causality Wald tests incorporating the suggested lag length for each of the equations of the underlying panel VAR model as estimated using the GMM methodology developed by Abrigo and Love (2016). Given the sensitivity of the Granger-causality test to the chosen lag, the appropriate order was determined using order selection criteria. This study employs the CD:R2 criterion, which signifies the overall coefficient of determination for GMM models and captures the proportion of variation explained by the relevant panel VAR model. The results indicate a lag length of 4. Based on the results presented in Table 2.3, we concluded that a bi-­ directional causality existed between wages and labour productivity in the Czech Republic at the regional level from 2000 to 2021. This reciprocal relationship suggests the presence of a positive feedback loop. Higher labour productivity leads to higher wages, which, in turn, acts to motivate workers to further enhance their productivity. This cycle contributes to overall economic growth and development in the regions. Moreover, the findings emphasise the significance of investing in human capital and skills development. Investment in training, education and technology acts to enhance labour productivity, thus resulting in higher wages. Simultaneously, higher wages serve as an incentive for individuals to invest in their skills, thereby further boosting labour productivity. The results suggest primarily that higher labour productivity levels contribute to increases in wages. As labour productivity improves, firms become more efficient, which results in the production of higher levels of output per hour worked. The increase in productivity leads, in turn, to

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higher profits, which is, theoretically, associated with allowing firms to offer higher wages so as to attract and retain skilled workers. The crucial aspect in this respect is that although highly concentrated sectors of the economy may pay higher wages, the enhanced market power also leads to economy-wide welfare losses (Rodríguez-Castelán, 2015) and greater labour market inequalities (Ennis et al., 2019). The study results also indicate that higher wages exert a positive impact on labour productivity. The traditional explanation in this respect is that when workers receive higher wages they are motivated to improve their skills, invest in their human capital and increase their productivity levels. Higher wages serve as an incentive for individuals to enhance their performance and thus to contribute more effectively to the production process. This relationship implies that higher wages are able to lead to improved labour productivity via enhanced worker motivation and engagement. In the context of the Czech economy, these results have a number of important implications. The Czech Republic has experienced significant economic growth and transition since the 1990s; it has attracted significant amounts of foreign investment and has become a hub for manufacturing, as well as (partly) for technology-based industries. The findings suggest that policies aimed at fostering productivity growth should be accompanied by strategies aimed at increasing wage levels. By ensuring that workers are adequately rewarded for their increased productivity, the Czech economy will be in a good position to both sustain its growth trajectory and retain its motivated and skilled workforce. Furthermore, the results underscore the significance of investing in human capital and skills development. Policies that promote access to quality education, vocational training programmes and technological advancement already contribute significantly to enhancing labour productivity in the Czech Republic. By equipping workers with the necessary skills and knowledge, such investment both fuels increases in productivity and enables the economy as a whole to remain competitive at the global scale. It is worth noting that the regional-level analysis conducted serves to highlight the importance of considering regional disparities within the Czech Republic. Regional characteristics such as industrial specialisation, infrastructure availability and the workforce composition are all able to influence the dynamics of the wage-productivity relationship. Policymakers should, therefore, tailor their strategies so as to address specific regional

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challenges and opportunities, thus fostering balanced development across the various regions of the country. In conclusion, the results of the study provide compelling evidence of the bi-directional causality between wages and labour productivity in the Czech Republic. These findings emphasise the need for the introduction of policies that promote productivity growth and ensure fair and competitive wage levels. By investing in human capital, motivating workers through higher wages and addressing regional disparities, the Czech economy is able to encourage sustainable economic development, enhance its global competitiveness and improve the well-being of its workforce. Our findings are consistent with those of Millea (2002) who examined the connection between wages and labour productivity in the manufacturing sector employing annual data on six developed OECD member countries. Millea’s study covered the period 1950–1998. In a similar way to our research, Millea (2002) determined evidence of an inter-­ relationship between wages and labour productivity. However, it is important to note that the nature and extent of this relationship varied across the studied countries due to differences in their labour market structures, wage policies and other, institutional, factors.

Conclusion The main objective of this chapter was to examine the intricate connections between real wages and labour productivity. In order to thoroughly investigate this relationship, the study employed a comprehensive panel dataset spanning the period 2000 to 2021 focusing specifically on regional levels within the Czech Republic. We employed the panel VAR Granger causality test for the analysis of the causal relationship; the Granger test is generally recognised as providing an effective methodology for such investigations. The test was estimated employing the generalised method of moments (GMM) methodology, which is known for its ability to handle various econometric challenges and to address issues such as endogeneity. The results of the analysis revealed a reciprocal relationship between real wages and labour productivity across the various regions in the Czech Republic, which suggests that changes in real wages are able to exert an impact on labour productivity and shifts in labour productivity are able to influence real wages. Studies on these two variables reported to date in the expert literature have generally been conducted via the construction of macroeconomic

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models. However, such models are often accompanied by problems in terms of detecting real relationships due to a number of reasons, including their containing a priori information for, and the restriction of, the variables. In this context, the correct determination of the relationship between these two variables in a given economy will have a guiding feature for economic policy practitioners. Therefore, this study can be evaluated from a number of perspectives. Firstly, models that adopt the PVAR technique in the context of the GMM approach clearly reveal the relationships between these variables since they impose no restrictions on the variables. Secondly, the results provided in this study provide evidence for and against macroeconomic equations. Finally, the existence of a relationship between these variables serves to assist in the creation of macro models. Our study, therefore, has the potential to serve as a guide for employment policy practitioners since, crucially, it identifies real relationships between wages and productivity. Since labour productivity and real wages are mutually dependent, increases in productivity result in higher wages over the long term. Therefore, policymakers should prioritise improving productivity so as to both enhance the economic growth of the Czech Republic and increase real wages. This can be achieved by investing in research and development, education and training aimed at enhancing the skills and knowledge of the workforce. A more skilled workforce is likely to be more productive, which will lead to higher real wages over the long term and a higher value-­ added economy from the national-level perspective. A further crucial policy recommendation relates to encouraging (especially, but not exclusively) domestic investment. The government should incentivise local businesses to invest in new technologies and equipment according to regional development requirements by offering tax incentives and subsidies. This would both contribute to higher productivity levels and potentially attract foreign investors, thus creating new job opportunities and stimulating economic growth. In addition, the support of small and medium-sized enterprises (SMEs) should be prioritised since they play a significant role in terms of both economic growth and the creation of jobs. The government should facilitate access to credit, streamline the respective bureaucratic processes and provide training and technical assistance so as to help SMEs to flourish. This would contribute to higher productivity and employment and, ultimately, lead to higher real wages. Furthermore, policymakers should focus, in line with EU requirements, on strengthening collective bargaining so as to ensure that wages are, in

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fact, linked to productivity growth. This would help to ensure the fairer distribution of income and maintain the growth of real wages in line with productivity. Finally, the promotion of selected regional development should be prioritised. By providing infrastructure, education and training opportunities in more under-developed regions, the government is able to stimulate the creation of jobs and increase productivity, thus leading to higher real wages in these areas. By implementing these policy recommendations, the government would foster economic growth and improve the standard of living of, and promote equitable outcomes for, the whole of the population. Although economic theory examines the relationship between labour productivity and wages via a range of mechanisms, empirical studies have, to date, failed to provide a general picture. For instance, in periods of economic expansion labour productivity and wages tend to increase simultaneously. Conversely, during periods of economic contraction wages often decline, thus prompting employees to exert greater efforts in order to safeguard their employment. Aimed at enhancing the generalisability of the research findings, it would be beneficial to explore the influence of business cycles. Moreover, it is crucial to acknowledge that the nature and strength of this relationship varies across time periods and regions. Consequently, the conducting of further research and analysis is imperative in terms of validating and forming a comprehensive understanding of the specific implications of the bi-directional causal relationship between labour productivity and wages across the regions of the Czech Republic.

References Abrigo, M. R., & Love, I. (2016). Estimation of panel vector autoregression in Stata. The Stata Journal, 16(3), 778–804. Bradley, M. E. (2007). Efficiency wages and classical wage theory. Journal of the History of Economic Thought, 29(2), 167–188. Cahuc, P., & Zylberberg, A. (2014). Labour economics (2nd ed.). MIT Press. Choi, I. (2001). Unit root tests for panel data. Journal of International Money and Finance, 20(2), 249–272. Christopoulos, D. K., & Tsionas, E. G. (2005). Productivity growth and inflation in Europe: Evidence from panel cointegration tests. Empirical Economics, 30, 137–150. Ennis, S. F., Gonzaga, P., & Pike, C. (2019). Inequality: A hidden cost of market power. Oxford Review of Economic Policy, 35(3), 518–549.

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Erenburg, S. J. (1998). Productivity, private and public capital, and real wage in the US. Applied Economics Letters, 5(8), 491–495. Erol, I., & Unal, U. (2022). Employment effects of immigration to Germany in the period of migration policy liberalization, 2005–2018. Eurasian Economic Review, 12, 531–565. https://doi.org/10.1007/s40822-­022-­00199-­4 Erol, I., & Unal, U. (2023). Internal migration and house prices in Australia. Regional Studies, 57(7), 1207–1222. Erol, I., Unal, U., & Coskun, Y. (2023). ESG investing and the financial performance: A panel data analysis of developed REIT markets. Environmental Science and Pollution Research. https://doi.org/10.1007/s11356-­023-­ 28376-­1 Huang, D. (1995). Essays on information, financial markets, and the international economy. Columbia University. Hurlin, C., & Mignon, V. (2007). Second generation panel unit root tests. https://halshs.archives-­ouvertes.fr/halshs-­00159842/ Levin, A., Lin, C.  F., & Chu, C.  S. J. (2002). Unit root tests in panel data: Asymptotic and finite-sample properties. Journal of Econometrics, 108(1), 1–24. Millea, M. (2002). Disentangling the wage-productivity relationship: Evidence from select OECD member countries. International Advances in Economic Research, 8(4), 314–323. Pesaran, M. H. (2015). Testing weak cross-sectional dependence in large panels. Econometric Reviews, 34(6–10), 1089–1117. Posta, V. (2020). Time-varying rigidiy of the Czech Regional labor markets. Journal of Economics, 68(3), 252–268. Rodríguez-Castelán, C. (2015). The poverty effects of market concentration. World Bank Policy Research Working Paper Series. Rosés, J. R., & Sánchez-Alonso, B. (2004). Regional wage convergence in Spain 1850–1930. Explorations in Economic History, 41(4), 404–425. Strauss, J., & Wohar, M. E. (2004). The linkage between prices, wages, and labour productivity: A panel study of manufacturing industries. Southern Economic Journal, 70(4), 920–941. Unal, U., & Specianova, J. (2023). Labour productivity convergence in the Czech Republic. Applied Economics Letters. https://doi.org/10.1080/1350485 1.2023.2259590 Van Biesebroeck, J. (2015). How tight is the link between wages and productivity. A Survey of the Literature. ILO.  Conditions of Work and Employment Series No. 54. Wakeford, J. (2004). The productivity–wage relationship in South Africa: An empirical investigation. Development Southern Africa, 21(1), 109–132.

CHAPTER 3

Convergence in the Labour Market: Evidence from the Czech Republic Umut Ünal and Robin Maialeh

Abstract  The main objective of this chapter is to analyse and investigate labour productivity and real wages convergence patterns across the fourteen regions of the Czech Republic with reference to the period 2000 to 2021 applying the clustering algorithm developed by Phillips and Sul (Transition modelling and econometric convergence tests. Econometrica, 75(6), 1771−1855, 2007). The algorithm enables the modelling of selected variables in a non-linear manner, thus allowing for the incorporation of heterogeneity and transitional dynamics at the regional level. Our findings indicated no conclusive evidence in support of the presence of overall convergence across the examined regions. Rather, we found evidence of two (three) convergence clubs for labour productivity (wages) along with one distinct non-convergence group for each variable. The results thus serve to highlight the diverse and nuanced dynamics that underlie labour productivity and real wages in the Czech Republic. It is clear that the country’s regions experience varying convergence and

U. Ünal • R. Maialeh (*) Research Institute for Labour and Social Affairs (RILSA), Prague, Czech Republic e-mail: [email protected]; [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. Maialeh (ed.), Navigating Europe’s Socio-Economic Crisis, https://doi.org/10.1007/978-3-031-44873-7_3

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non-convergence patterns, which suggests the existence of several distinct factors and influences that impact the economic performance and wage levels in each region. Obtaining a comprehensive understanding of these convergence patterns will allow policymakers and researchers to devise targeted strategies aimed at addressing regional disparities and fostering economic growth and an equitable wage distribution across the Czech Republic. Keywords  Real wages • Labour productivity • Regional disparities • Convergence patterns • Clustering algorithms

Introduction From the perspective of firms, the concept of productivity in economic theory is considered primarily to comprise marginal productivity, which represents the contribution of the last unit of a production factor to output, which is further optimised via the labour/capital costs of the firm. However, due to the various practical challenges in terms of the measurement of the labour market, average labour productivity is commonly considered at the macro level and calculated as the ratio of total output to the whole of the workforce. The concept of labour productivity,1 which is determined by dividing the GDP, which comprises the value added by all economic sectors, by the number of hours worked, is widely employed to measure and compare productivity across countries. Wages, on the other hand, consist of the compensation paid to employees for their work over a period of time. In a world in which dependent work is the norm, the amount of wages earned in return for work is of vital importance in terms of meeting the physiological, economic, social and cultural needs of dependent employees and their own dependents; moreover, wages are  The concept of productivity is defined by the Organisation for Economic Co-operation and Development (OECD) in both its narrow and broader senses. In the narrow sense, productivity is calculated as the ratio of output to one specific factor of production, whereas in the broader sense efficiency is an abstract concept that gauges the efficacy and sensitivity of tools in terms of attaining economic objectives. The International Labour Organisation (ILO) identifies the factors of production as: land, capital, labour and technical organisation, and measures productivity as the ratio of production to these factors. However, some economists view productivity as a consequence of various factors, including attitudes, motivation, business practices and social cultures, which influence the efficiency of firms beyond mere technological processes. Thus, productivity, in its broadest sense, is seen as “a measure of the effectiveness of scarce resources employed in production to satisfy human needs.” 1

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usually the only source of income for determining their future welfare. At the country level, wage disparities across regions comprise both one of the causes and one of the consequences of differences in interregional development. The enhancement of competitiveness comprises one of the pillars for establishing a robust economy. At the micro level, firm-level competitiveness refers to the ability of firms to produce at lower costs than their competitors in national and global markets, while being equal to or surpassing their competitors in terms of factors such as product quality, service and product appeal, as well as the capacity for innovation and invention. High quality, low costs, efficiency, innovation and creativity make up the key factors in terms of determining competitive power. As emphasised by Maialeh (2020), the market mechanism not only incentivises microeconomic agents in terms of enhancing their competitiveness, but also renders overcoming competitive pressure a necessary condition for the allocation of resources in capitalist economies. Increasing the competitiveness of firms contributes to the overall competitiveness of the country at the macro level. Country-level competitiveness is defined as the ability of a country to produce goods and services that meet the requirements and standards of international markets, while simultaneously increasing the country’s real income over the long term. Success in terms of global competitiveness relies on a country’s ability to allocate resources to superior productivity performance economic activities and high real wages. Against this background, this chapter examines convergence patterns between wages and productivity across the various regions of the Czech Republic. The aim is to provide a comprehensive understanding of the dynamics between these variables. The analysis both helps to identify and to evaluate regional disparities and empowers policymakers in terms of developing targeted policies that address inequalities and promote more balanced economic development. Moreover, the findings contribute to forming a deeper understanding of the various factors that influence competitiveness and economic growth. By identifying those regions with growth potential and formulating strategies aimed at enhancing productivity and wages, policymakers will be better able to encourage overall competitiveness and economic expansion. In this context, we investigated the convergence of real wages and labour productivity across the 14 regions of the Czech Republic applying a powerful and innovative econometric method developed by Phillips and Sul (2007) for the modelling and analysis of economic transition

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behaviour that takes into account various time pathways and individual heterogeneity. The formulation applied is particularly effective in terms of monitoring the transition to a long-term growth path or a common steady state. Furthermore, Phillips and Sul (2007) argue that rejecting convergence does not imply that there is no evidence of convergence in panel subgroups. In other words, club convergence can be claimed if economies converge towards several steady-state equilibrium levels (Tian et  al., 2016). Our findings indicated no overall convergence across the regions of the Czech Republic in terms of either labour productivity or real wages. Instead, the club-clustering analyses revealed two (three) convergence clubs for labour productivity (wages) and one distinct non-convergence group for each variable. The examination of convergence patterns concerning labour productivity and real wages is of significant importance for several reasons. Firstly, forming an understanding of these patterns facilitates the identification of regional disparities in terms of both labour productivity and wages. This knowledge subsequently empowers policymakers and researchers to assess whether certain regions are lagging behind or catching up with others in terms of economic development. Such insights are crucial with respect to formulating targeted policies aimed at addressing regional inequalities and fostering balanced regional growth. Moreover, the identification of convergence clubs and non-convergent groups allows policymakers to evaluate the impact of specific policies on labour productivity and real wages across regions. Equipped with this information, policymakers can then effectively design future policies that aim to promote productivity enhancement and wage increases in those regions where they are most needed. In addition, a comprehensive understanding of convergence patterns both enables policymakers to allocate resources following a strategic approach, i.e. to those regions that require additional support, thereby bolstering labour productivity and wages, and facilitates informed decision-­ making with respect to investment in infrastructure, education, skills development and other factors that drive economic and wage growth. Furthermore, convergence analysis plays a pivotal role in terms of assessing the overall competitiveness of regions. In this context, regions that have higher levels of labour productivity and wages are more likely to attract investment and talent, thereby further enhancing their competitive edge. Consequently, an understanding of convergence patterns empowers policymakers to identify those regions with growth potential, thus acting as drivers of the country’s overall economic competitiveness.

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This chapter consists of five sections. Section 2 provides a brief literature review. Section 3 discusses the data and methodology used in the study. Section 4 presents a discussion of the results, and Sect. 5 the conclusion.

Literature Review The extant literature coverage of the convergence behaviour of regional labour productivity at the sectoral level although limited, has increased noticeably over the past few years. The most recent research has tended to employ conventional β- and σ-convergence methodologies aimed at investigating the existence of convergence or divergence in regional labour productivity across both developed and developing countries. Kinfemichael and Morshed (2019) examined labour productivity convergence for states of the US using highly disaggregated data obtained from the US Bureau of Economic Analysis for the period 1987–2015. Unlike previous studies that focused on the state-level GDP per worker, the study explored sectoral unconditional convergence aimed at investigating the role of sectors and sectoral composition changes in terms of explaining overall convergence outcomes. The findings revealed a general slowdown in the rate of labour productivity convergence during the second half of the analysed period, with manufacturing driving convergence in the period 1987–1997. However, the importance of the manufacturing sector was observed to evince a diminishing trend over time, due most likely to factors including decreased interstate migration, rising housing costs in major cities, agglomeration effects and structural changes in the US economy. Chanda and Panda (2016) employed the dual growth accounting framework in the investigation of the roles of multi-factor productivity (MFP) growth and factor accumulation in the goods and services sectors of US states from 1980 to 2007. The results indicated that while MFP growth in the goods sector was relatively high and exhibited convergence, it was low and exhibited divergence in the services sector. The low MFP growth in the services sector was attributed to declining real user costs, and the trend towards divergence was found to be driven by variations in the growth of wages. Moreover, the study determined that the gap between productivity and wage growth was wider in the goods sector, while the two series exhibited stronger correlation in the services sector.

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Furthermore, states with higher initial human capital experienced higher rates of growth for both sectors. Domínguez et al. (2021) analysed sectoral productivity convergence in Japan over the period 2003–2012 employing input-output data and network analysis. The study identified highly interconnected sectors via the application of community detection algorithms and characterised the dynamics of these communities by assessing the evolution of productivity dispersion via parametric and nonparametric frameworks. The results revealed two dominant communities: community 1 primarily comprised service-related industries, while community 2 consisted mainly of high-­ tech manufacturing industries. The convergence analysis demonstrated robust convergence for community 1, whereas weak divergence was observed for community 2 across all industries in Japan. Moreover, the study provided insight into the factors that influence sectoral productivity convergence and divergence and emphasised the significance of considering the input-output structure of the economy in the analysis of productivity. Bhattarai and Qin (2022) employed various econometric models, including static and dynamic ordinary least squares (OLS), generalised method of moments (GMM) and quintile panel data models, in their investigation of the convergence of labour productivity across 31 provinces and 8 production sectors in China from 2003 to 2019. The study revealed evidence of both beta and sigma convergence towards the steady state of labour productivity across both provinces and production sectors. However, the convergence pattern was observed to be asymmetric across the various sectors according to the quantile panel regression analysis. The study also revealed that the convergence pattern becomes more pronounced when controlling for factors such as human capital, FDI, industrial concentration and inequality, which served to enhance the robustness of the analysis. Moreover, the findings indicated that the effects of human capital and FDI on productivity convergence vary asymmetrically across provinces and sectors, while higher levels of inequality or industrial concentration lead to divergence in terms of both simple and quantile panel estimations. The study concluded that policies that promote competition and equitable distribution are more effective in terms of fostering labour productivity convergence across provinces and sectors in China. Castellanos-Sosa (2020) examined the impact of the Global Financial Crisis (GFC) on the convergence process of seventeen economic sectors in Mexico from 1999 to 2014. The study also investigated whether the

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sectoral composition influences the labour productivity convergence patterns of Mexican states and explored the differential impacts of the crisis on various regions. The findings indicated that the GFC resulted in convergence in 13 economic sectors and changed the trend in 15 sectors. The northern region of Mexico was observed to have been impacted the least by the GFC, while significant changes were observed in the central and southern regions. In addition, the study revealed that the sectoral composition of states exerts a marked influence on their labour productivity patterns. With respect to the broader context of Czech labour market regional disparities, Koišová et al. (2018) assessed and compared employment and average wage development trends for the regions of Slovakia and the Czech Republic from 2007 to 2016. The analysis revealed significant regional differences in the labour markets of both countries, with the Czech labour market performing better than that of Slovakia. These disparities were attributed to various factors including primary potential, development opportunities, economic structures, demographic variations and infrastructure levels. The authors employed statistical indicators to measure the variability of the observed phenomena and descriptive characteristics, including the simple arithmetic mean, to establish a position. NUTS III level territorial units were selected for the analysis. Similarly, Kvíčalová et al. (2014) focused on identifying and forming an understanding of the economic differences between the regions of the Czech Republic. They employed mathematical and statistical methods in their analysis of various indicators related to the income situation of Czech households. The selected indicators included the gross domestic product, net disposable income, the income structure, taxes on personal income and health and social insurance factors. Via the examination of these indicators, the authors aimed to identify similarities and differences between the regions and to highlight the various inter-dependencies. The analysis resulted in the identification of three clusters based on the GDP and income structure, which provided insight into the economic characteristics of each region. Hampl (2007) revealed a high level of territorial inequality in the distribution of economic activity, thus resulting in internal social and territorial polarisation. Baštová et  al. (2011) found that interregional differences in socioeconomic indicators such as GDP per capita and the unemployment rate were minor and did not change significantly between 2000 and 2008. Svatošová (2012) assessed changes in regional disparities between 2005 and 2010 and discussed the potential

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for the use of aggregated indicators for assessment purposes. Overall, the research conducted to date suggests that while regional differences in economic development exist in the Czech Republic, the extent and nature of these differences appears to vary depending on the indicators employed and the time period studied.

Data and Methodology Our sample contained data on the 14 regions of the Czech Republic for the period 2000−2021, as published by the Czech Statistical Office. We measured labour productivity by dividing the number of hours worked by the output produced, and real wages were calculated by adjusting nominal wages for the GDP deflator. The examination of income differences between regions and countries over time has long been a subject of interest in the field of growth economics. The neoclassical growth model suggests that under the similar steady states condition, per capita income tends to converge between countries and regions with similar characteristics. This convergence hypothesis is closely related to the concept of diminishing returns, according to which the growth rate decreases as the economy approaches steady state equilibrium. As a result, countries and regions with lower initial capital stock and per capita income exhibit higher growth rates (Mankiw et al., 1992). In other words, less developed regions have a natural advantage that eventually leads to rapid growth, thus enabling them to close the income gap with wealthier regions over time. This phenomenon is referred to as β-convergence. In addition, σ-convergence refers to reductions in income disparities between countries and regions over time, as indicated by a decrease in income dispersion (measured as the standard deviation of the income differences). However, the performance of convergence analysis employing cross-sectional regression to test for β-convergence potentially yields biased estimates and invalid test statistics due to the fallacy of regression to the mean, a hazard known as Galton’s fallacy (Quah, 1993). On the other hand, σ-convergence may also yield misleading results in cases where the data is non-stationary, due potentially to natural variance growth (Phillips & Sul, 2007). Given these considerations, the convergence analysis employed the logt test proposed by Phillips and Sul (2007), which is based on the following decomposition of the variable of interest:

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   log yit   it  it  t   it t , t  



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(3.1)

where φit is the district (i) characteristic component, δit the time-­varying idiosyncratic element that captures the deviation of a district i from the common growth path μt, and εit is the error term, which is weakly dependent over t, but iid(0,1) across i. The test focuses on the evolution of individual transition paths compared to the common growth component: by removing the common growth path in the form of the cross-sectional average from the original variable yields hit, the relative transition coefficient comprises: hit 

log yit



 it

1 / N   i 1 log yit 1 / N   i 1 it N

(3.2)

N



Equation (3.2) identifies the relative deviation of district i from the common growth path μt and measures individual behaviour in relation to other districts. The logt test is based on a time series regression, where a transformation of the cross-section variance of hit  it2 is regressed on log(t). Coefficient b is then employed to test for convergence.

 



2  log  h21   2 log  L  t    c  b log  t   ut   ht 

for t  rT  , rT   1, , T (3.3)

where r∈ (0,1) and L(t) are the slowly varying function. For T ≤ 50, based on Monte Carlo simulations, Phillips and Sul (2007) suggest using L(t)=log(t) and r=0.3. In the case of convergence, hit ➔1 for all i as t➔∞. Using a one-sided test, the null hypothesis of convergence (b ≥ 0) is tested against the alternative b