68824 v1 In Search of Opportunities How a More Mobile Workforce Can Propel Ukraine’s Prosperity Volume I: Summary Report CURRENCY EQUIVALENTS (Exchange Rate Effective: May 9, 2012) Currency Unit = Ukrainian Hryvnias 1 UAH = 0.123 USD 1 USD = 7.944 UAH ABBREVIATIONS AND ACRONYMS AR Crimea Autonomous Republic of Crimea ECA Europe and Central Asia EBRD European Bank for Reconstruction and Development EPL Employment Protection Legislation EU European Union GDP Gross Domestic Product ILO InternationalLabourOrganisation IOM International Organisation for Migration LFS Labor Force Survey LiTS Life-in-Transition Survey NUTS Nomenclature of Territorial Units for Statistics OECD Organisation for Economic Co-operation and Development SES State Employment Service of Ukraine SSSU State Statistics Service of Ukraine UAH Ukrainian Hryvnas ULMS Ukrainian Longitudinal Monitoring Survey UN United Nations UNDP United Nation Development Program ECA Regional Vice President: Phillippe H. Le Houerou ECCU2 Country Director: Qimiao Fan HD Sector Director: Ana L. Revenga HDE Sector Manager: Roberta Gatti Task Team Leaders: Johannes Koettl and Indhira Santos 2 In Search of Opportunities Acknowledgements This report is a product of the World Bank’s analytical and advisory services to Ukraine. The report was prepared by a team of researchers and World Bank staff consisting of Martin Heger (Junior Professional Associate, Human Development, Europe and Central Asia Regional Department, ECSHD), Johannes Koettl (Economist and Task-Team Leader, ECSHD), VladyslavKomarov (Analytical Center BEST), Olga Kupets (Economic Sciences Faculty at the University of Kiev-Mohyla Academy), Anna Olefir (Consultant, ECSHD), Isil Oral (Junior Professional Associate, ECSHD), KaterinaPetrina (Senior Social Protection Specialist, ECSHD), Indhira Santos (Economist and co-Task- Team Leader, ECSHD), Elizabeth Schwinn (Consultant, ECSHD), and YuliyaSmolyar (Social Protection Specialist, ECSHD). The World Bank team received administrative and logistical support in Washington from Katarina Timina (Program Assistant, ECSHD) and Anna Goodman (Program Assistant, ECSHD) and at the World Bank’s Kiev Office fromOleksandraGriaznova(Team Assistant, ECCUA). The report greatly benefited from consultations with the Government of Ukraine (Ministry of Economic Development and Trade, Ministry of Social Policy, Ministry of Education and Science, Youth and Sports, State Employment Service, State Statistics Service), the business community (All-Ukrainian Association of Employers, Confederation of Employers, American Chamber of Commerce,Ernst & Young, European Business Association, Federation of Employers,VasilKisil and Partners), trade unions (All-Ukrainian Union of Workers’ Solidarity, Confederation of Free Trade Unions of Ukraine, Federation of Trade Unions), and think tanks (Institute of Demography and Social Study, Institute of Economy and Forecasting of the National Academy of Sciences, Razumkov Centre, East Europe Foundation). The peer reviewers of this report are William van Eeghen(Lead Economist, Chief Economist Office, Europe and Central Asia Regional Department, ECA) and Pablo Gottret(Sector Manager, Human Development, South Asia Regional Department, SASHD) who provided helpful guidance at the outset of the program and held the team to a high technical standard of quality. Overall guidance to the team was provided by:Paolo Belli (Country Sector Coordinator, Human Development, Europe and Central Asia Regional Department, ECSHD), Qimiao Fan(Country Director for Ukraine, Belarus and Moldova), Roberta Gatti (Sector Manager, ECSHD), JeskoHentschel (former Sector Manager, now Sector Director, SASHD), and Martin Raiser (former Country Director for Ukraine, Belarus and Moldova, now Country Directo for Turkey). In addition, the team received valuable comments by Omar Arias (Lead Economist, ECSHD). The report is organized in two volumes:Volume Iis intended for policy makers and the generalpublic. It summarizes the findings of the analysis in non-technical language. Volume II, on the other hand, is intended for a more technical audience. It presents the analysis in great detail, including the empirical analysis and estimation results. Many of the findings mentioned in Volume I are substantiated in Volume II, and more technically-inclined readersare referred to Volume II for a more detailed discussion of findings. How a More Mobile Workforce Can Propel Ukraine’s Prosperity 3 Table of Contents Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2 Why Labor Mobility Matters in Ukraine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.1 The Importance of a Mobile Workforce . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.2 The Benefits of Dynamic Labor Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.3 Labor and Capital Are Concentrated in Successful Economies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2.4 Ukraine’s Structural Transformation Is Incomplete. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 2.5 Internal Mobility Is Low in Ukraine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 2.6 Ukraine’s Labor Market Lacks Dynamism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 3 Why Workers Don’t Move . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 3.1 Ukrainians Who Move Don’t Go Where Economic Opportunities Are . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 3.2 Significant Barriers Discourage Relocation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 3.2.1 Population Registry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 3.2.2 Access to Housing and Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 3.2.3 Lack of Skills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 3.2.4 Employment Laws and Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 3.2.5 Social Benefits and Other Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 4 Removing the Barriers to Internal Mobility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 4.1 Develop for Density . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 4.2 Move People to Jobs, not Jobs to People . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 4.3 The Importance of Government Policy in Effecting Change. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 4.4 Improving Government Institutions Offers Long-term Solution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 4.5 Expand Mortgage and Credit Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 4.6 Rebalance Labor Market and Social Welfare Institutions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 4.7 Invest in Skills Development and Education . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 4.8 Ukraine’s Urgent Need for a Solution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 5 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 4 In Search of Opportunities Table of Figures Figure 1: The link between labor mobility and economic development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Figure 2: Countries with high workforce mobility tend to have high employment rates . . . . . . . . . . . . . . . . . . 9 Figure 3: Countries with high workforce mobility tend to have low long-term unemployment rates . . . . . . . 10 Figure 4: Concentration of production and population soared in transition countries, but not in Ukraine . . . . 11 Figure 5: Substantial variation in productivity across regions in Ukraine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Figure 6: In Ukraine, labor has not moved to high-productivity sectors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Figure 7: Workforce mobility in Ukraine is low compared to that of other countries . . . . . . . . . . . . . . . . . . . . 14 Figure 8: Migrants leave lagging regions, but do not go to leading regions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Figure 9: There are important differences in wages and unemployment rates across regions in Ukraine . . . . . 17 Figure 10: There are a number of barriers to labor mobility in Ukraine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Figure 11: Housing in Ukraine is expensive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Figure 12: Housing costs are significantly higher in leading regions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Figure 13: There are considerable skill mismatches in Ukraine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 14: Ukraine is among the countries with more stringent employment protection legislation . . . . . . . . 24 Figure 15: The mortgage market is underdeveloped in Ukraine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Figure 16: Growing firms demand skilled workers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Table of Tables Table 1: Labor markets in Ukraine are less dynamic than in neighboring countries . . . . . . . . . . . . . . . . . . 15 Table of Boxes Box 1: Ireland, the most mobile nation in Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Box 2: The United States, the most mobile nation in the developed world . . . . . . . . . . . . . . . . . . . . . . . 27 How a More Mobile Workforce Can Propel Ukraine’s Prosperity 5 Executive Summary Cities are the engines of economic growth: firms and people cluster together in cities to harness the abundance of capital, infrastructure, and knowledge. These benefits, derived from geographic proximity, are what drives economic development. Achieving economic growth and improving living standards requires connecting people to places where economic opportunity flourishes.Bringing people to these regions of growth and jobs is essential to move Ukraine forward. Right now, Ukraine’s economy lacks dynamism, with job creation and job destruction rates significantly below those of its peers. This is both the cause and the effect of people not moving. The rate at which Ukrainians move from one region to another within the country is only half of what we would it expect to be when comparing to it other countries. Large economic gains can be realized if people from lagging regionsare connectedto opportunities in leading regions, benefiting both those who move and those who stay behind. For workers, the pool of available jobs is effectively enlarged, increasing the chances of employment and of getting a job with higher wages. For firms, a mobile workforce increases the chances of finding a worker with the set of skills it needs. Thus, internal labor mobility increases labor productivity, causing the economy to grow and living standards to rise. Moreover, living standards across individuals and regions converge in the process. As people leave poorer areas, wages rise in these lagging regions and unemployment falls.In other words, economic development in Ukraine requires unbalanced economic growth that is concentrated in leading regions, ultimately leading to more balanced living standards in all regions. Yet even the small stream of mobile workers in Ukrainedoes not flow to leading regions.Migrants are not leaving lagging areas with poor labor market outcomes, and they are not necessarily going to regions with better job conditions. Instead, they seem to be pushed outby low levels of social spending in their home regions. This suggests that certain barriers prevent people from seeking economic opportunity, but also that significant gains could be realized from greater internal labor mobility. The main barriers to internal mobility in Ukraine are institutional: (i) administrative procedures that require people to be officially registered at their place of residence, althoughmany people prefer not to registera new residence for various reasons; (ii) underdeveloped housing and credit markets, which make it difficult for people to rent or buy housing in leading regions; (iii) inadequate human capital, as people in lagging regions often lack the necessary skills to access better economic opportunities in high-productivity, modern sectors in the leading regions; (iv) weak formal labor market institutions that reduce dynamism in the labor market, stimulate informal work arrangementsand do not provide workers with enough reliable information about job openings and labor market conditions; and (v) social benefits, housing, and servicesthat are often tied to the place of residence and that could, in some cases, discourage labor force participation in the first place. Addressing these institutional bottlenecks that affect internal mobility will allow people—especially the poor—to access more and better jobs in leading regions. As they do so, aggregate productivity and economic growth will accelerate and living standardsin both leading and lagging regionswill continue to rise and converge. Ukraine will become a more dynamic economy,and Ukrainians will achieve a brighter future. 6 In Search of Opportunities 1. Introduction Ukrainians do not move often, and when they do move, they don’t necessarily go to areas with good jobs and high wages. Internal mobility is about half of what is expected when comparing Ukraine with other countries. The lack of mobility is remarkable, given the availability of more jobs and better wages in several Ukrainian cities. Too few people are taking advantage of economic opportunities, and as a result, Ukraine’s structural transformation has stalled. This is a sharp contrast to many other countries in Eastern Europe, where the transition to a market economy has been accompanied by a shift from widely-dispersed industries to a concentration of capital and production in a few areas, and from low- to higher-productivity sectors. Labor has largely mirrored the movement of capital and production. In Ukraine, however, labor is not flowing as smoothly to areas of high production. This report examines the mobility of workers inside Ukraine and their willingness to physically relocate from one area or region to another in search of better economic opportunities. The report explores the patterns and trends of labor mobility in Ukraine as well as the drivers and constraints of that mobility, and derives policy implications from its findings. Chapter2 of this volume offers evidence of how a mobile workforce benefits the economy. It shows how the economic transition in most of Eastern Europe has been accompanied by the significant concentration of capital and people in a few areas. This has not happened to the same extent in Ukraine. Chapter 3 shows that what little migration we see in Ukraine is not necessarily going to the leading regions. For internal migration to lead to growth and better living standards, workers have to move to the areas of the country where productivity—and therefore, wages— are high, and where unemployment is low. Chapter 3moreoverexamines the factors that prevent Ukrainians from moving. Qualitative and qualitative research reveals a number of bureaucratic and practical obstacles to efficient internal migration: (i) cumbersome administrative procedures; (ii) underdeveloped housing and credit markets; (iii) lack of the skills that are in highest demand; (iv)weak formal labor market institutions;and (v) social benefits that are often indirectly tied to the place of residence. Chapter 4 offers recommendations for creating greater labor mobility in Ukraine. It explains how addressing the institutional bottlenecks that affect internal mobility willallow more people, especially the poor, to access better jobs, accelerating growth and enabling living standards to rise. There are five key areas for improvement: a streamlined and modernized population registry system; better developed housing and credit markets; greater human capital investment (particularly training workers in high-demand skills) and improving the incentives and environment for the educational system to respond to labor market needs; improved labor market institutions that will spur dynamism in the labor market while still protecting workers and provide reliable information about job openings and labor market conditions; and social benefits that are portable and not overly generous. Increasing internal mobility in Ukraine will contribute to Ukraine’s transition to a modern economy. With a population that is aging more rapidly than most, increasing labor mobility must happen sooner rather than later, since an older population is even less likely to migrate to find work. Therefore, an agenda that aims to remove existing barriers to internal mobility can help people access more and better jobs and move Ukraine forward. How a More Mobile Workforce Can Propel Ukraine’s Prosperity 7 2. Why Labor Mobility Matters in Ukraine 2.1. The Importance of a Mobile Workforce The concentration of people, capital and production was fundamental in the development of industrialized countries in North America, Western Europe, and Northeast Asia. Because economic prosperity did not happen everywhere at the same time in those countries, people had to relocate to find economic opportunities and productive jobs. This concentration in turn stimulated further growth and rising living standards. Eventually, such movements caused living standards to rise throughout each country. Labor mobility matters because it leads to more and better jobs. When labor is allocated efficiently across sectors, occupations and jobs, workers are better matched to work. A mobile workforce in turn increases the chance that a company will find a worker with the “right� set of skills it seeks. For workers, the ability to move from one region to another effectively enlarges the pool of available jobs, making it more likely that they can find employment and earn higher wages. Thus, internal labor mobility contributes to increaselabor productivity, rising living standards and greater economic growth (see Figure 1). Figure 1: The link between labor mobility and economic development More internal labor mobility More efficient labor allocation: more and better job matching Employment growth: Productivity growth: more jobs better jobs Rising and converging living standards Source: Authors. 8 In Search of Opportunities A mobile workforcecan also lead to convergence inliving standards among individuals and regions, while reducing overall macroeconomic volatility and contributing to the absorption of shocks. As individuals leave areas with poor labor market outcomes and low wages for those that are economically more dynamic, wages in the stagnant areawill converge to the levels of the growing area. Similarly, when a region experiences a negative economic shock, workers can move to unaffected regions, accelerating recovery in the original area. In the 2009 edition of theWorld Development Report, the World Bank’s annual flagship publication, the Bank proposed that economic prosperity and rising living standards require inclusive development but unbalanced spatial growth (World Bank, 2009b). Growing cities, ever more mobile people, and increasingly specialized production are integral to countries’ economic development, and should be encouraged. 2.2. The Benefits of Dynamic Labor Markets When workers are well-matched to their jobs, the result is more jobs. Empirical evidence suggests that countries where labor markets are more dynamic and labor mobility is higher—across geographic areas and also across jobs— generally have high employment rates and low long-term unemployment rates (Figure 2 andFigure 3). Figure 2: Countries with high workforce mobility tend to have highemployment rates (Employment rate versus mobility within the last 5 years by country, 2005). Note: Mobility is measured by number of labor market transitions, that is, changes of jobs. Source: Danish Technical Institute (2008). A growing literature provides evidence that internal labor mobility has positive effects on countries’ productivity and growth. For example, it is estimated that the economic output of the United States would be twice as high if there were no actual costs of geographic and inter-sectoral labor mobility (Lee and Wolpin, 2006).Similarly, the economy grew significantly more slowly in so-called “closed� cities in the former Soviet Union (those that specifically limited migration) than in uncontrolled cities (Gang and Stuart,1999). Canada’s economic growth in the 1990s and early 2000s benefited from people migrating from the low-productivity eastern provinces to high-productivity western provinces (Sharpe et al. 2007). This study asserts that interprovincial migration was responsible for 1.6 percent of labor productivity growth in Canada from 1987 to 2006, and 6.2 percent of labor productivity growth in 2006. How a More Mobile Workforce Can Propel Ukraine’s Prosperity 9 Figure 3: Countries with high workforce mobility tend to have lowlong-term unemployment rates (Long-term unemployment rate versus mobility within the last 5 years by country, 2005). Note: Mobility is measured by number of labor market transitions, that is, changes of jobs. Source: Danish Technical Institute (2008). In the developing world,one study estimates that 30 percent of India’s urban economic growth is accounted for by the movement of more than 20 million Indians from rural to urban areas in the 1990s (Lall et al. 2006).Bosker(2010) finds that easing China’s hukousystem, which is used to control the movement of people between urban and rural areas, would lead to greater agglomeration of capital and labor, and potentially higher economic growth. People who move to a given region are often more likely to be economically active than those who already live there. In 24 of the 35 countries for which the World Development Report 2009 (World Bank, 2009b) had data on internal migration, those who relocated within their countries were more likely to be in the labor force and employed. Over time, migration canplay a critical role in reducing spatial structural imbalances (Bertola, 2000; Jackman and Savouri, 1992). For example, Bertola(2000) concludes that large and persistent unemployment differentials across European regions arise from low labor mobility in the European Union (EU). Similarly, the argument is often made that inequality in China is intrinsically related to the hukou system of residency permits (Chan, 2009). 10 In Search of Opportunities 2.3. Labor and Capital Are Concentrated in Successful Economies The transition to a market economy in many countries typically has been accompanied by a significant shift of capital and production from widely-dispersed industries to a concentration in few geographic areas, and from low- to higher-productivity sectors. When labor follows this movement of capital and production, large economic gains can be realized. This geographic shift was extraordinarily pronounced in most of the Eastern Europeancountries. Before transition, these countries had deliberately shifted production to lagging regions in an effort to develop them. As the transitionto a market economy began, though, production once again became concentrated in a few areas. Because of the former dispersion, this agglomeration was more pronounced and more rapid in most former socialist countries than anywhere else. However, production has remained much less concentrated in Ukraine than in peer countries. Figure 4 depicts the normalized Herfindahl–Hirschman index—a measurement of concentration, in our case, of production and population—for most countries worldwide in 1990, versus the change of the same indictor between 1990 and 2005.1 It shows that transition countries like Albania, Bulgaria, and Russia underwent the greatest agglomeration between 1990 and 2005: starting from low levels of economic concentration in 1990, production became substantially more concentrated between 1990 and 2005—more than in most countries worldwide. Meanwhile, Ukraine (in red), whichhad widely dispersed production in 1990, has seen little concentration in production since that time. In other words, the agglomeration of production is virtually static in Ukraine: Ukraine’s production has remained where it was before transition—and so has its population. Figure 4: Concentration of production and population soared in transition countries, but not in Ukraine (Normalized Her�ndahl–Hirschman index of GDP and population in 1990 versus the change in the index between 1990 and 2005). Note: Transition countries are depicted with three-letter country code in blue, Ukraine in red. The red vertical line depicts the median across all countries. Concentration is measured with the normalized He�ndahl-Hirschmann Index. Source: World Bank staff calculations, based on Geographically based Economic data (G-Econ, 2012). 1 The Herfi ndahl–Hirschman Index, or HHI, is a measure of the distribution of population (production) density throughout the country and an indicator of howconcentrated the population (production) is. How a More Mobile Workforce Can Propel Ukraine’s Prosperity 11 2.4. Ukraine’s Structural Transformation Is Incomplete In order for an economy to transform itself, it must shift from less productive to more productive sectors. In Ukraine, there are significant gaps in productivity across geographic regions (Figure 5). The most productive manufacturing firms, on average, are located in Kiev, the capital, and the East (Kharkiv, Donetsk, Zaporizhya). These are also the most industrial and highly populated parts of Ukraine. Figure 5: Substantial variation in productivity across regions in Ukraine (Mean total factor productivity in Ukrainian �rms, 2009) Kyiv Volyn Chernihiv Rivne Sumy Zhytomir Kyiv_obl Ternopil Lviv Poltava Kharkiv Khmelnytskiy Cherkasi Luhansk Iv. Frankivsk Vinnitsya Kirovograd Zakarpattya Dnipropetrovsk Chernivtsi Donetsk Mykolayiv Zaporizhya Kherson Odesa Productivity quartiles AR Crimea 4 1 Sevastopol Note: The map shows the distribution of the weighted mean Total Factor Productivity by regions (oblasts) of Ukraine. The numbers in the legend increase with the color intensity and denote a productivity level, with 4 indicating regions with most productive �rms. Gaps such as these in labor productivity are not uncommon in most countries. In fact, they are amplified by significant differences in sectoral composition of output and employment across regions, with large gaps in productivity between the traditional and modern sectors of the economy. For the modern sector to grow, people need to move to those jobs, which will often mean moving from one region to another. To the extent that there are barriers to labor mobility, structural transformation will be impeded and economic growth and development hindered (McMillan and Rodrik, 2011). In Ukraine as well, lack of labor mobility prevents the country from moving forward, and has caused its structural transformation to stall.6indicates that between 2001 and 2008 labor has by and large not moved to high-productivity sectors. While a significant number of workers have left the agricultural sector since the early 2000s—a sector with below-average labor productivity—they have not always moved to high-productivity sectors. Instead, many workers have gone into construction, transportation and retail, the three sectors with the lowest overall labor productivity. Meanwhile, although highly productive sectors such as health have expanded in recent years,they remain relatively small. They have not attracted enough workers to offset the increase in low-productivity sectors. 12 In Search of Opportunities Figure 6: In Ukraine, labor has not moved to high-productivity sectors (Change in the share of employment by sector between 2001 and 2008 in percentage points versus the log of sectoral productivity in 2001, compared to the average productivity in the economy). Note: The trend line is depicted in green. Source: World Bank staff calculations, based on ILO (2012) and UN (2012) data. See McMillan and Rodrik (2011) for a methodological discussion on measuring structural transformation. 2.5. Internal Mobility Is Low in Ukraine Internal mobility in Ukraine is low.Data from international surveys, Ukraine’s household surveysand administrative sources show that internal migration rates areabout half of what we would expect when comparing Ukraine to other countries. According to the Life-in-Transition Survey (LiTS), in Ukraine, 0.5 percent of the population moved within the past year, and 4.5 percent within the last five years(Figure 7). Although data in this survey do not distinguish between external and internal migrations, Ukraine’s migration rates are clearly at the lower end of the distribution when comparing across countries. Only 11 countries displayed lower migration rates, while 21 countries displayed higher rates than Ukraine. How a More Mobile Workforce Can Propel Ukraine’s Prosperity 13 Figure 7: Workforce mobility in Ukraine is low compared to that of other countries (Percentage of population that recently moved, by country and period when migration occured, 2010). Note: Recent moves include both internal and international migrants. Source: World Bank staff calculations, based on European Bank for Reconstruction and Development (EBRD) and World Bank (2010). Ukrainians have little desire to relocate compared to workers in other countries. According to the LiTS data, 2 percent of Ukrainians said they planned to move abroad in the near future, and only 0.9 percent said they intended to move to other parts of Ukraine. Only three countries had a workforce that was less inclined to migrate internally, while 29 countries displayed higher rates. A second survey by Synovate, a global marketing research company, confirmed the findings of LiTS (Synovate, 2010). The survey of labor mobility in Russia, Ukraine, Bulgaria, and Serbia found little desire to relocate by workers in both Russia and Ukraine. Specifically, if offered a 50 percent increase in salary, around 80 percent of respondents in Russia and Ukraine would still refuse to relocate. In Bulgaria and Serbia, only 50 percent would refuse. The studies all confirm that Ukraine’s workersare far less likely to move than those in those in other countries. This is also consistent with local perceptions. In a survey of labor market experts conducted for this report, almost two thirds of respondents, 63.2 percent, said that internal mobility rates in Ukraine are low when compared to those of other Eastern European countries. Only 15.8 percent thought internal migration is high, while 21 percent thought it was at the same level as in peer countries. 14 In Search of Opportunities 2.6. Ukraine’s Labor Market Lacks Dynamism For workers to move, a fluid labor market is essential. High job turnover rates, in terms of recreation of existing jobs and the creation of new ones, increase the chances of employment and the quality of matching between employers and workers. If labor markets are static, people have fewer opportunities to change jobs—and therefore, fewer incentives to look for and move to better jobs, especially when far from home. For new entrants into labor markets, static labor markets are particularly detrimental. Table 1: Labor markets in Ukraine are less dynamic than in neighboring countries (Job flows as a percent of total employment). Ukraine Georgia Moldova Croatia Bulgaria Lithuania Poland 2007 2006 2001 2001 2000 1998–99 1999 Job creation 5,5 8,7 6,7 3,5 6,8 9,7 5,3 Job destruction 2,7 6,6 11,2 4,9 10,8 10,7 10,1 Job turnover 8,3 15,2 17,8 8,4 17,6 20,4 15,4 Job reallocation 2,7 6,6 6,7 3,5 6,8 9,7 5,3 Notes: Job creation is the sum of employment gains in �rms that are expanding. Job destruction is the sum of employment losses in �rms that are contracting. Job turnover is job creation plus job destruction. Job reallocation is the minimum of job creation and job destruction. Source: World Bank (2009a). The labor market in Ukraine is less dynamic than in neighboring countries. The rates of job creation and job destruction are lower than in many other transition economies (see Table 1). This is reflected in relative low job turnover and job reallocation rates. In 2007, only 8.3 percent of all jobs were either destroyed or created, less than half the rate of Lithuania, Moldova, or Bulgaria. Similarly, less than 3 percent of all jobs moved from contracting firms to expanding firms (this is known as the job reallocation rate). This figure is also roughly half the rate seen in other countries. This lack of dynamism in the labor market could reflect low labor mobility—or could be causing it. How a More Mobile Workforce Can Propel Ukraine’s Prosperity 15 3. Why Workers Don’t Move The preceding chapter has shown that Ukrainians move far less often than workers in other countries.One might assume that Ukrainians are moving to the most dynamic regions, just not in large enough numbers to make a difference to the economy. However, an examination of the data for those Ukrainians who do relocate presents a further puzzle: even when they do move, they don’t move to the most productive regions. 3.1. Ukrainians Who Move Don’t Go Where Economic Opportunities Are In Ukraine, those workers who move do not necessarily go to the leading regions with high wages and low unemployment (Figure 8). Although there is a high outflow of people from regions with high unemployment and low wages, there is almost no correlation between the locations to which workers move and labor market conditions there. If anything, the correlation is weakly positive between arrival and unemployment rates. In other words, people are slightly more likely than not to move to other areas of high unemployment.Instead of moving to areas with better opportunities, Ukrainians appear to move for reasons not directly related to the labor market. Figure 8: Migrants leave lagging regions, but do not go to leading regions (Departures and arrivals of internal migrants versus unemployment rates and wages, 2010). 2,0 2,0 1,8 1,8 Arrivals in 2010 (percent of regions' Arrivals in 2010 (percent of regions' 1,6 1,6 1,4 1,4 population) 1,2 population) 1,2 1,0 1,0 0,8 0,8 0,6 0,6 0,4 0,4 0,2 0,2 0,0 0,0 5 6 7 8 9 10 11 12 1000 1500 2000 2500 3000 3500 4000 Unemployment rate in 2010 (percent) Average gross wage in 2010 (UAH) 2,0 2,0 Departures in 2010 (percent of regions' Departures in 2010 (percent of regions' 1,8 1,8 1,6 1,6 1,4 1,4 1,2 population) 1,2 population) 1,0 1,0 0,8 0,8 0,6 0,6 0,4 0,4 0,2 0,2 0,0 0,0 5 6 7 8 9 10 11 12 1000 1500 2000 2500 3000 3500 4000 4500 Unemployment rate in 2010 (percent) Average gross wage in 2010 (UAH) Source: World Bank staff calculations, based on SSSU (2012). The tendency of Ukrainian migrants to leave lagging regions, but not to go to leading regions, is confirmed with more advanced statistical analysis. When analyzing migration flows across regions, labor market conditions only partially 16 In Search of Opportunities explain internal mobility. People appear only slightly more likely to go to areas with low unemployment (the coefficient is only marginally statistically significant and is close to zero), and wages at destination have no effect on internal migration decisions. That is, people are not moving to leading regions with high wages and employment opportunities. Again, the findings are an indication that factors other than labor marketsare pushing people out of their homes. They may also point to financial and credit constraints faced by potential internal migrants, since people need resources to finance their moves. Further analysis of the data reveals that in recent years, public spending, density and demographics have had the biggest impact on migration between regions in the Ukraine. Regions with higher social spending attract more new residents and show higher net inward migration. A parallel pattern appears for density: those regions that are most densely populated attract a high number of new residents. These two indicators, spending and density, may capture important push factors for migration. In other words, public infrastructure and services, together with city-like amenities, appear to attract new residents. Interestingly, regions where there are more youth and fewer children are also more likely to attract new residents. This could reflect education-related migration, since youth will be concentrated in areas with colleges or universities. However, the trend remains even after the number of students is accounted for, possibly indicating an attraction in the general population to places that are young and dynamic. These findings mark a change from Ukraine’s earlier migration patters. Previous research suggests that from 1990 to 1995, at the beginning of the transition, internal migration patterns were more efficient, in that they brought greater economic benefits to people who moved. A 2004 study of the determinants of inter-regional migration in Ukraine found that that the drivers of internal migration in Ukraine have changed significantly over time, with labor market conditions becoming less and less relevant to people’s decision to move as the transition progresses. (Martynenko 2004) Today, workforce mobility in Ukraine is especially low considering the potential gains from internal mobility. Indeed, given that unemployment rates and wages vary considerably across regions in Ukraine, large economic gains could be realized by workers who move to more productive areas with higher wages. Figure 9 shows how both unemployment rates and average wages differacross regions. In particular, in 2011, gross average wages varied from UAH 1,900 in Ternopil to UAH 4,000 in Kiev City; and unemployment rates varied from around 5.6 percent in Kiev City to almost 10.4 percent in Chernihiv, Rivne, and Ternopil. Figure 9: There are important differences in wages and unemployment rates across regions in Ukraine (Average wages and unemployment rates across 27 regions, 2011). Note: Average wages (UAH) refer to left axis, unemployment rates (percent) to right axis. Source: Authors, based on State Statistics Service of Ukraine (SSSU, 2012). How a More Mobile Workforce Can Propel Ukraine’s Prosperity 17 Ukrainians may not be permanently changing their place of residence, but many do in fact commute to other areas to work:they travel for the day to a different locality for work and then return to their home in the evening. According to the Labor Force Survey (LFS), the total number of commuters was above 2.6 million people in 2010, or 13.2 percent of the employed population in Ukraine. But only a small share of these travel across regions. Despite a slight increase in the commuting rate between 2008 and 2010, inter-regional commuting rates (1.6 percent in 2010) remain low when compared to the EU15, although comparable to those observed in Poland, Romania or Bulgaria (Paci et al. 2007). In any case, commuting is only a partial, and imperfect answer to low residential labor mobility. Since the transport costs associated with commuting in terms of money and time are usually lower than the transaction costs and non-economic costs of residential relocation, commuting can be a substitute for labor and residential migration in facilitating transitions out of joblessness and smoothing regional disparities. But commuting to prosperous areas is only available to some, and can be sub-optimal if the reason that people do not change residency is the presence of bureaucratic barriers or underdeveloped markets. 3.2. Significant Barriers Discourage Relocation Ukrainians’ own history of moving in search of opportunityand the benefits to be gained from relocating make it puzzling that internal mobility is so low. The regional differences in labor market conditions across Ukraine represent opportunities for more and better jobs, if people moved to grasp them. The reasons Ukraine’s workforce does not seize these opportunities lies deeper than ignorance or interest in better opportunities. To a large extent, Ukrainians realize they couldimprove their job prospects by moving. To complement itsanalytical work, the team carried out a series of focus group discussions and in-depth interviews in Ukraine to better understand the attitudes of migrant workers, the unemployed and employed towards internal migration, as well as their motivations for moving and the most salient barriers to internal mobility. As one participant said: “At home, I get a low salary. Moreover, it is impossible to find a job according to my specialization.� (focus group participant) Given this awareness, what factor or factors prevent Ukrainians from moving to places where they can get better jobs? The interviews with Ukrainians suggest that a number of entrenched institutional barriers discourage them from migrating. Experts surveyed for this report alsopointedto a number of institutional factors that they believe contribute to Ukraine’s remarkably low workforce mobility. Empirical analysis and administrative data validated these conclusions. The top three barriers were found to be (i) Ukraine’s population registry; (ii) lack of access to credit and the costs of moving;and (iii) an underdeveloped housing and mortgage market (Figure 10). Three of the other barriers shown in the chart above also featured prominently in focus group discussions with workers: lack of skills, labor laws, and the design of social benefits. A detailed discussionof these six major deterrents to internal migrationfollows. 18 In Search of Opportunities Figure 10: There are a number of barriers to labor mobility in Ukraine (Percent of respondents who listed the barrier as one of the three most important). Source: Authors, based on experts’ survey on internal migration carried out for this report. 3.2.1. Population Registry A particular administrative obstacle to workers’ mobility—in the form of a requirement that people register their place of residence—was cited most often by labor market experts and workers in our surveysas critical in limiting internal mobility in Ukraine.Ukraine maintains a system of residential registration. It is an inheritance, albeit reformed, of the Soviet Union’s old “propiska� system, which regulated movement of people. Propiskawas abolished in Ukraine in 2001 and replaced with a new law in 2004, the Law on Freedom of Movement and Free Choice of the Place of Residence in Ukraine (Perrin and Poulain, 2008).Under the new law, all are required to register a new place of residence (defined as the administrative-territorial unit where a person lives for at least six months of the year) with the Ministry of Interior within ten days of arrival. Registration requires a written application, internal passport, proof of payment of stamp duty (or an exemption document) and two copies of the completed deregistration for the previous place of residence (Kupets, 2012). Legally, no other documents are required for registration. In practice, however, documentation of rental or home ownership is often demanded as proof that individuals actually own or rent a home in the new location.According to the Civil Code of Ukraine, the place of residence is where a person permanently or predominantly lives as an owner, a tenant under contract, or under other statutory terms. The difficulty of obtaining residency documentation for the new location creates inefficiencies, as people move to locations where family members are (so they can register the family member’s home as their residence) or even outright absurdities; for example, when people “own� a tiny piece of an apartment. How a More Mobile Workforce Can Propel Ukraine’s Prosperity 19 As a result of these costs and uncertainty, Ukrainians perceive the registration system as a barrier to internal mobility. Particularly for low-skilled workers, the registration system ranked among the most significant problems encountered when moving across regions in Ukraine. Some Ukrainians have opted to move without registering a change of residence at all. However, many people fear that unless they register, they may not qualify for free medical services, education, sick leave, or other benefits. Legally, residency is not a requirement for social services, but this is not widely understood, due perhaps to discretionary enforcement of the law or simply misinformation. “Usually, if you have children in a kindergarten and in school, registration is needed. But in Kiev, this is not a problem.� (focus group participant) 3.2.2. Access to Housing and Credit Very high rates of home ownership, combined with lack of affordable rentalhousing, are critical barriers to internal mobility in Ukraine. Overall, housing-related constraints—high home ownership rates,housing costs, and underdeveloped real estate, rental and mortgage markets—are the second biggest check on relocation, according to local experts (Figure 10). Reflecting this fact, focus group participants said that housing was the main obstacle keeping to them from moving to places with better opportunities, especially Kiev. “When I was working in my hometown, it meant that I lived quietly at home, went to work, and had a small salary [that I could spend on other things]. When I arrived in Kiev, I had to rent an apartment... almost all of my first salary went to rent.� (focus group participant) The Synovate survey mentioned in the previous chapter underlines the problem. The survey found that while Ukrainians were far less willing than Serbs or Bulgarians to relocate for a better job, this would change if they were provided with housing. In that case, more than half of the Ukrainians surveyed said they would change their minds and agree to move, a powerful illustration of the housing market’s importance in determining labor mobility. In fact, Ukrainians explicitly cited imperfections in the housing market as the key constraint on their mobility. (Synovate, 2010). There are several reasons that the housing market significantly affects Ukrainians’ decisions to move. First, there is a very high home ownership rate, with 95 percent of households owning the house they live in. Only 2.4 percent of all Ukrainian dwellings are rentals. This partly reflects a legacy from the transition, when homes were transferred to their occupants at little or no cost. Empirical evidence underscores the relevance of housing to workforce mobility. Home ownership was found to be the most important correlate of internal migration among men and the second most important one among women in Ukraine (Voznyak, 2008). People who own their home as opposed to renting are significantly less likely to move to a different region, even after controlling for a wide set of socio-economic and demographic individual characteristics. Home ownership can discourage mobility because the perceived cost of staying in one’s home is low, weighed against the anticipated costs of relocating. Both owning a house and buying a new one come with transaction costs. Put technically, income-migration elasticity is likely to be lower for homeowners than for renters. Thus, they are less responsive to a higher salary or other perks of a new job. Numerous personal attachments may also make it more difficult to give up an old house. 20 In Search of Opportunities Second, there are significant housing price differentials across regions in Ukraine, with housing in leading regions being significantly more expensive than in lagging regions. Homeowners have high relocation and transaction costs, such as the financial, administrative and time commitments associated with selling an old house. Expensive housing in leading regions and under-developed real estate, rental and mortgage markets make it difficult for people to sell the homes they own in lagging regions and go where the jobs are. “While we were looking for employment and housing, we spent a lot of money. We had to travel back and forth to Kiev a few times, which also costs money. It’s even difficult to find an apartment. We tried to search by ourselves, but we ended up having to pay a broker a lot of money.� (focus group participant) Third, housing in Ukraine is very expensive overall, representing on average more than 15 times annual income (Figure 11). This is the highest ratio in the ECA region after Lithuania and Belarus, and seven times higher than in the United States. Figure 11: Housing in Ukraine is expensive (House price to annual income ratio, 2010). Source: Komarov (2012) for this report. As previously noted, there are also significant differences in relative housing costs across regions (Figure 12). Housing prices are twice as high in leading regions, such as Kiev and Sevastopol, as in other parts of the country. There also are significant regional differences in rental costs. For example, renting a benchmark one-bedroom apartment costs approximately 43 percent of a household’s average monthly disposable income in Kiev and 44 percent in Sevastopol, compared to only half that in Zaporizhzhya or Uzhgorod (Komarov, 2012). In the absence of financing options, people dealing with these price differences in lagging regions have greater difficulty moving to housing in leading regions. “Sometimes it happened that I paid for the apartment and realized that there was nothing left [of my salary].� (focus group participant) How a More Mobile Workforce Can Propel Ukraine’s Prosperity 21 Figure 12: Housing costs are signi�cantly higher in leading regions (House price to annual income ratio, 2010). Source: Authors, based on Komarov (2012). Data is from the State Statistics Service of Ukraine and the joint database of the Association of Realtors of Ukraine. Housing-related issues have been found to increase the cost of internal mobility and reduce the incentive to move in other countries. Home ownership has often been associated with decreased labor mobility (Bloze, 2009; Fidrmuc and Huber, 2003; Green and Hendershott, 2001). In addition, the availability and cost of housing in other regions helps determine internal mobility (Dragunova and Maidanik, 2009; Fidrmuc and Huber, 2003; Ghatak, et.al, 2004). 3.2.3. Lack of Skills Surveys of Ukrainian companies show that skills have become increasingly important in recent years, and skilled labor shortages are now the second most commonly reported constraint on growth in all ECA countries, second only to tax rates, according to surveys (World Bank, 2011). On average, 30 percent of firms considered education and skills to be a major or severe constraint in 2008. In Ukraine the number is considerably higher: 40 to 50 percent of firms say skills are a major constraint, according to the survey. Also, it takes much longer to find workers with the required skills in Ukraine than in other countries in the region. This is especially true for skilled and non-production workers. As previously stated, labor mobility can help improve overall productivity by ameliorating existing skills mismatches. The evidence in Ukraine suggests that there is a considerable skills mismatch in the country. There is a relative oversupply of laborers, as well as sales, services, and skilled agriculture workers, and a relativeundersupply of craftsmen, professionals, and technicians (seeFigure 13). 22 In Search of Opportunities Figure 13: There are considerable skill mismatches in Ukraine (Excess supply of labor over demand by occupation, percent, 2011). Note: The �gure shows which occupations have an excess or de�cit supply of workers. The percentages reflect the netresult after comparing registered unemployment and job vacancies by occupation. A positive value indicates that the unemployment share is higherthan the vacancy share, pointing to excess supply. A negative value indicates the vacancy share is higher than the unemployment share,pointing to unmet demand. Source: World Bank staff calculations, based on SSSU (2012). 3.2.4. Employment Laws and Institutions Employment protection laws that regulate the hiring and firing of workers can be a critical determinant of dynamism of labor markets, especially when regulations are very strict, as they are in Ukraine.The evidence linking regulation with labor turnover and employment outcomes is mixed, as discussed in the upcomingWorld Development Report 2013(WorldBank, forthcoming). There appears to be a threshold over which labor market regulation constricts the market (a so-called “plateau�).In Ukraine, where regulations are stringent compared to other ECA countries, they might make the labor market less dynamic, and therefore labor less mobile (see Figure 14). How a More Mobile Workforce Can Propel Ukraine’s Prosperity 23 Figure 14: Ukraine is among the countries with more stringent employment protection legislation (Stringency of employment protection legislation by country, EPL index, 2007). Note: EPL is an index of Employment Protection Legislation developed by the OECD and adapted by the Institute for the Study of Labor (IZA) for countries in Eastern Europe and Central Asia. It ranges between 0 and 6, 6 being the most stringent labor regulations and institutions. Source: Lehmann and Muravyev (2011). A number of studies have found that the pace of migration varies depending on how conducive labor laws are to labor reallocation. Migration due to regional wage and unemployment differentials is much greater in the United States than in Europe (Blanchard and Katz, 1992; Eichengreen, 1993; and Obstfeld and Peri, 1998). Moeller (1995) further suggests that migration is important for the adjustment of regional labor markets in West Germany, but the speed of adjustment is rather low compared to the United States. Other studies have found that in transition countries with strict labor laws, internal migration has played only a limited role in spatial adjustments. Fidrmuc (2004), for example, shows that asymmetric shocks in transition economies and interregional differences in unemployment rates and earnings have as yet been little eased by labor mobility.Even when there is a strong underground economy, labor rules affect companies’ decisions at the margin (for example, at new firms or for new hires in existing firms). 24 In Search of Opportunities 3.2.5. Social Benefits and Other Subsidies Just as with labor rules, social benefits can either discourage or encourage the open movement of labor. Welldesignedunemployment insurance and social assistance benefits can help people overcome financial constraints and secure work in leading regions. On the other hand, poorly designed social benefits may prevent people from entering the labor market and may drive them to remain in lagging areas. Excessively high social benefits do not seem to be a problem in Ukraine. While social benefitsare widespread, they do not appear to be overly generous, with a few exceptions. About 67 percent of the population receivedat least one social protection transfer in 2007. Social assistance programs cover 42 percent of the population, mainly due to the child allowance and the housing and utility privileges. For the poorest quintile, the last-resort social assistance benefit is not more than a quarter of post-transfer household income. This is considerably less than in other countries. Our empirical analysis hints, however, that even at these levels, higher expenditures on social assistance and health at home may discourage outmigration to other regions. An exception to the relatively low amount of social benefits in Ukraine may be itschildbirth grant. The grant seems exceptionally high when compared to spending on other beneficiaries (see Figure A 10 in the annex of Volume II). Anecdotal evidence suggests that this benefit might indeed prevent people from moving, especially when taking into account the higher purchasing power in lagging, rural areas. In addition to the amount of social benefits, their eligibility criteria can pose another obstacle to labor mobility. If eligibility is tied to the place of residence, and the benefit is not portable across regions, it could prevent people from moving. Technically, this is not the case in Ukraine—people can apply for and receive social benefits or unemployment insurance regardless of where they lived previously. However, at times the receipt of benefits might require personal office visits at the place of official residence. To the extent that people are not officially registered at the place where they actually live, this might require more or less frequent trips to the place of origin and could act as a—albeit probably small—disincentive to move. Finally, outside the social benefit system, other subsidy programs may also provide incentives to stay in unproductive regions instead of moving to highly productive areas. For example, the “Own a House� program makes subsidized loans to individuals for construction or purchase of a house in rural areas. Almost 80,000 loans were granted between 1998 and 2010 (see Komarov, 2012). This subsidy discourages the natural movement of labor to areas where businesses are growing and productivity is high. How a More Mobile Workforce Can Propel Ukraine’s Prosperity 25 4. Removing the Barriers to Internal Mobility Before offering policy solutions for the specific barriers outlined in the previous chapter, we summarize below some of the current thinking on how best to position a country for economic growth, as a context for our recommendations. 4.1. Develop for Density The World Development Report 2009(World Bank, 2009b) identified three key options for managing geography in a way that will promote economic development: density, distance, or division. Density refers to the agglomeration of capital and labor, including the all-important process of urbanization. Creating density—concentrating capital and labor in a few defined locations—makes sense in countries where the least productive regions are already sparsely populated, as in Ukraine. Labor mobility is an integral part of such a policy. Distance is the practice of building connections between companies and workers in unproductive regions to companies and workers in productive regions (in countries where every region is already densely populated). Division, the third type of transformation, is used only when countries are divided by ethnicity, religion, culture, or language. Ukraine falls squarely into the first category: both population and productivity are already concentrated within a few areas. Ukraine, therefore, needs to increase the mobility of capital and labor to places where economic opportunities are abundant. Policies that build up density should be part of any policy of economic integration and are essential for most countries. These policies will create universal institutions without any geographic bias—in other words, according to the World Development Report, policies that are “spatially blind.� Because these policies focus on portable investments in people, they make it easier for them to take advantage of economic opportunity. Such policies invest in and protecthuman capital through education, health care, and social protection, and well-functioning labor, credit, and housing markets. Hence, Ukraine’s focus should be on spatially blind institutions, including basic services provision that aimsto create density by making portable investments in people and helping them to connect to economic opportunity. 4.2. Move People to Jobs, not Jobs to People Policy discussions about how to advance the welfare of people in economically depressed regions very often focus on moving economic production to lagging areas. In other words, policy makers tend to focus on how to bring jobs to people. There are indeed circumstances where such policies are warranted, but they are few. Instead, the experience in most countries has shown that the most effective policy approach is to help people—especially poor people— secure work in regions and industries where economic opportunity flourishes. Economic development excels when production is concentrated, as tends to happen naturally. Policies that aim at dispersing production will fail to reap the benefits of concentration (see World Bank, 2009b). Put another way, modern economiesinvest in people rather than in places. Enhancing labor’s mobility is a part of workforce investment, as can be seen in Ireland. The ability of the population to react to economic developments by moving locally and internationally has served it well, even during the recent crisis. The policies that have supported the mobility of Ireland’s population are based on flexible labor regulations, the development of Dublin as the geographic job center of Ireland, the provision of skills training to workers, and an open-border policy for international migrants, who can bringany skills that are missing in the domestic labor market (see Box 1). 26 In Search of Opportunities Box 1: Ireland, the most mobile nation in Europe. The Irish are the most mobile of all Europeans, with nearly 15 percent of Ireland’s population having moved within the EU. Internally, Dublin has been the preferred place to which the Irish move. Regionally, the United Kingdom, a large, familiar neighbor, has been the preferred destination. Internationally, it is the United States, where more than 10 percent of the population claims Irish ancestry. The reasons the Irish are mobile span culture, geography, and labor laws. First, the Irish have historically reacted to big developments—both good and bad—by moving, and their cultural proximity to the United Kingdom and the United States has made it easy to leave when times are tough. Second, Irish labor laws provide enterprises with the flexibility to manage their workers: indices of economic freedom rate Ireland the freest economy in Europe and the fifth freest in the world. Third, the national development strategy—including the use of cohesion funds—has promoted concentration of capital and production around Dublin, and made workers mobile by investing in their skills. Fourth, Ireland has kept immigration barriers low:it did not impose quotas on workers from the new EU member states, for example. And the quantity and quality of immigration is high—half all immigrants since 1998 have tertiary education. The current crisis has led to a temporary reversal of this in-migration, but the greater mobility of the Irish will help them deal better with the economic distress. Source: Gill and Raiser (2012). The United States, with one of the most mobile labor forces worldwide,offers another argument in favor of increasing labor mobility to the economy.Arguably, as a country of immigrants, mobility has been embedded in US society from its beginning. But the fact that the costs of internal migration are low also plays an important role: the housing market is fluid, rental housing is widely available, buying and selling property is simple and relatively affordable, and the mortgage market is well-developed (albeit, as the crisis has shown, imperfect). Also, just as in Ireland, flexible labor laws allow for high job turnover rates and flexible wages that prompt people to relocate to where economic opportunities are. A high share of tertiary-educated workers also contributes to high mobility (see Box 2). Box 2: The United States, the most mobile nation in the developed world. Labor mobility is much higher in the United States than in other developed countries. Over the past decade, three times as many Americans moved to find jobs and better lives than Europeans. On average, an American moves 11 times during his or her life. Americans consider mobility an essential ingredient in the pursuit of a better life. Housing regulations make it much easier to buy and sell homes than in other countries, and labor regulations allow workers and employers flexibility. This mobility has direct and indirect costs: young Americans often live far from their families, and workers enjoy fewer protections than those in other developed countries. But they also benefit from the ability to negotiate wages, change employers quickly, and start businesses. Countries seeking to create jobs, nudge people back to work, increase earnings and economic growth, and make their economic structures more flexible can draw lessons from how the United States’ policy environment has supported labor mobility. Source: Gill and Raiser (2012). How a More Mobile Workforce Can Propel Ukraine’s Prosperity 27 4.3. The Importance of Government Policy in Effecting Change Before delving into policy solutions for Ukraine’s workforce mobility issue, it is important to understand what informal solutions have emerged in the absence of government action and how these affect the workforce. As noted, people in Ukraine face significant barriers when deciding to move. The institutions that are supposed to help gain them economic opportunity—including government institutions like the population registry, labor, education and social protection systems—are underperforming. As a result, Ukrainians often circumvent these institutions and rely on alternative solutions that are mostly unregulated, createuncertainty, and provide no protection in the event of default. Informal social networks—friends and family ties—are the most important of these alternative solutions. Social networks are only somewhat efficient in overcoming barriers to internal mobility. For example, they can be an efficient complementary means of finding housing, but they also limit a housing search to locations where personal networks are available. They work better the closer one lives to the new location. Further away, homes found through social networks will be limited indeed. Because official rentals are taxed, most rentals are unregistered. The vast majority of people have informal rental agreements that protect neither landlord nor renter. This increases uncertainty on both sides about the true price and default risks of the rental agreement, in turn increasing the disincentive to move to places far from one’s home. Also, having no official rental contract also means not being able to officially register at the place of residence, which could complicate access to certain benefits and services, although Ukrainians usually seem to find ways around these requirements for access. The labor market is an even more telling example of why social networks are a poor substitute for a transparent, reliable formal system. Relying on social networks limits people’s ability to find jobs, especially jobs suited to their skills. Because people circumvent the official labor market by working under the table or by underreporting their wages, wages are associated with high levels of uncertainty. Ukrainians use their social networks for reassurance that the prospective employer can be counted on to pay them, especially so-called “envelope payments.� These are additional wages paid to employees beyond the officially reported salary they receive.Absent reassurances from the social network, the risks and hence the costs of migration are higher. The uncertainty of wage payments also represents yet another manifestation of the pervasive effect of an underground economy on labor markets and mobility. Focus group discussions confirmed these effects, in particular how uncertainty of receiving promised wages affects the decision to move. Finally, in the absence of effective formal social protection mechanisms that support risk management, people must rely on informal social risk management mechanisms. In the absence of formal access to credit, they rely on families and friends for loans. Strong ties to local communities are essential if one is to access these informal risk management and credit mechanisms. While these can be valuable complements to formal institutions, if they are the only option the result is to reduce choices for moving, since people will prefer to go where they can build on an existing network. This might not necessarily be where the economic opportunities are. Strong ties to local communities were also cited by experts in our survey as an obstacle to mobility. Such ties reflect both affective ties to family and communities that link people to their hometowns and provide an identity. For all these reasons, social networks are a poor solution to Ukraine’s labor mobility problem. They are a less efficient and less comprehensive way to improve the economy than government policy changes.Further, when too much reliance is placed on social networks, they—and the underground economy they make possible—undermine the credibility and authority of government. 28 In Search of Opportunities 4.4. Improving Government Institutions Offers Long-term Solution In order to make Ukrainians more mobile and create the conditions necessary to complete the transition to a market economy, it is important for the government to make lasting changes in policy and create effective institutions that support labor mobility rather than standing in the way. Each change will have a ripple effect on the others, and together they will simplify the current system, reduce uncertainty, and provide protection for workers as they navigate the labor market. In the preceding chapter, we listed the population registry as the one of the barriers to moving because it was mentioned by the largest number of respondents to our experts’ survey and participants in our focus group discussions. The registration system per se does not seem to constitute an overwhelming constraint to internal mobility, since many people have found ways around it. Some of these strategies have been discussed previously: living with family members, co-owning apartments, or not registering at all. But these options impose costs and are inefficient. Reforming the registration system could change people’s perceptions about the barriers to moving and reduce inefficiencies in other markets, such as housing and rental,which may also limit internal mobility. However, thekey to improving the system to a large extent lies outside the population registry. To be sure, a number of steps can be taken to simplify the registration process and harmonize and unify the regional population registries (Perrin and Poulain, 2008). But the pervasive effects of the system will be ameliorated only if other factors that make it difficult or unattractive for internal migrants to provide grounds for residency are also resolved. Other governance and institutional weaknesses that create pervasive disincentives also need reform if the labor market is to be truly efficient. True reform of the registration system is likely to require coordinated action from the tax system and the rental markets. As became clear in the focus group discussions and in the consultations for this report, both renters and landlords lack incentives to register rental contracts. For landlords, registering a contract would mean paying additional taxes on rental income; for renters, it would mean paying higher rents, again because of the tax burden. Thus, many people avoid rental contracts so that they can avoid declaring economic activities. This practice will end only if people are given incentives to declare their economic activities. As another example, proof of actual cost of residency is sometimes used by employers to determine envelope payments. Offering incentives to workers and employers to fully declare wages and income would eliminate envelope payments and break the connection between the amount of rent paid and the amount of wages received. This would get rid of an incentive to keep housing private and inflate its cost. It would also bring the labor market closer to a system of compensation that rewards skill and effort. A systemic approach that improves incentives to register by improving overall governance and institutions is, therefore, fundamental.The share of the shadow economy in Ukraine is one of the highest in the world. International comparative studies put the shadow economy at 49.7percent of GDP (average over 1999 to 2007; see Schneider, Buehn, and Montenegro, 2010). Increasing formalization is important for Ukraine’s development, as it would bring important benefits such as increased productivity, greater investment in human capital, and more innovation. Building trust that Ukrainians put into their government and government institutions is the first step to increase the willingness of citizens to declare their economic activities to the state (see Packard, Koettl, and Montenegro, 2012). In addition to labor market regulations and the underground economy, the lack of information on job opportunities and working conditions are major barriers to internal mobility. Empirical results for Ukraine show that the decision to move depends in large part on the distance of the move, reflecting not only relocation costs but also information asymmetries. The farther one moves from home or school, the thinner one’s social networks become.Reducing the asymmetry of information on the labor market is yet another way government can make it easier for its people to seek new opportunities. How a More Mobile Workforce Can Propel Ukraine’s Prosperity 29 4.5. Expand Mortgage and Credit Markets Large housing price differentials across regions, together with the high rate of home ownership, make well- functioning housing, real estate and rental markets a must. Flexible and liquid household markets have been associated with increased mobility (Barker, 2004; Cameron and Muellbauer, 1998). Komarov (2012), for this report, provides a detailed analysis of some of the key features and weaknesses of the housing, real estate and rental markets in Ukraine. For internal migrants, two elements are likely to be critical: having access to affordable rental units but also deepening of the credit and mortgage market. A fundamental constraint on housing in Ukraine is the lack of access to credit and the accompanying underdeveloped mortgage market. Financial markets and the services they provide, such as mortgages and other loans, are crucial for labor mobility (Hoj, 2011; Oswald, 1999; Coulson and Fisher, 2009; Haurin and Gill, 2002; Van Leuvensteijn and Koning, 2004). Well-functioning credit markets help finance the move itself and also finance housing arrangements at destination. They can be particularly useful in Ukraine, where there are significant price differentials in housing across regions and a very high home ownership rate. Critically, these reforms are likely to also have a feedback effect on housing prices. Ukraine’s mortgage market, which was created by law in 2003, is quite small. Residential mortgage debt increased sharply during the pre-crisis years and reached its peak of 11 percent of GDP in 2009. This is comparable to rates in Bulgaria and Slovenia but significantly below the rest of the European Union and OECD countries (Figure 15). This leads to high out-of-pocket payments by homeowners: in Kiev, for example, 80 percent of the cost of housing was paid for out of the homeowner’s savings (Komarov, 2012). This is likely to be a tall order for Ukrainians, especially the young and the poor. Figure 15: The mortgage market is underdeveloped in Ukraine. Source: Komarov (2012) for this report. 30 In Search of Opportunities A fully functional housing marketis fundamental in removing barriers to a mobile workforce. This includes functioning real estate, rental and credit markets as well. Komarov (2012), in background work for this report, suggests a detailed list of policy options directed at improving the overall functioning of these markets. Policies should support deeper mortgage lending while managing risk.In addition to legislative reforms, this will require creating more options for long-term funding, for example through increased participation byinstitutional investors. The smooth operation of the rental and housing markets is also important. Increasing liquidity in the rental market will be of particular help to youth, who are more likely to migrate, but who also cannot afford to buy a home. As mentioned in the preceding section, improvingthe incentives for registering rental contracts would create the necessary institutional backdrop for making renting more transparent and more attractive. 4.6. Rebalance Labor Market and Social Welfare Institutions The lack of strong labor market institutions is evidenced by the lack of dynamism in the Ukrainian labor market (seeTable 1) and the fact that informal social networks are serving as a partial substitute for formal institutions. As discussed in the preceding chapter, overlystrict labor rules reduce dynamism in the labor market and make it difficult for businesses to be flexible. But labor rules are important in the governance of the labor market. In revising them, the government must aim to balance flexibility with protection. For example, labor rules regulate the terms of labor contracts, including their length, notice periods for layoffs, and severance pay. All of these provisions ensure a necessary level of security and certainty that enhance people’s ability to make labor market decisions, including the decision to move. Mobility is less likely in an environment where there is no protection by the law. Without some protection from potential employer misdeeds, workers might be deterred from moving. As with labor laws, the key for social benefits is to balance the amount of the benefit with the disincentive it creates to seek economic opportunities in leading regions, and to ensure that the eligibility criteria for benefits does not bind people to their current place of residence.Social benefits and subsidy programs should be spatially blind, balanced, and promote labor force participation to connect people to more and better jobs. In Ukraine, there seems to be some room to reconsider the design of certain subsidy and social protection programs. Although social assistance programs are not overly generous when compared to other countries, there is some anecdotal and empirical evidence that they could undermine internal mobility. Social benefits appear to be largely independent of the place of registry, but as many people do not officially register in their actual place of residence it could somewhat complicate access to benefits and services. 4.7. Invest in Skills Development and Education The demand for highly skilled labor in Ukraine comes mostly from expanding, highly productive firms. An employer survey from 2005 found that jobs in firms with growing employment are more likely to be skills-intensive (see Figure 16). The most productive firms are in regions that lead the economy, and this is also where employment growth is highest. Building the skills of people in lagging regions is critical for connecting them to the most productive jobs in leading regions. Many of the challenges inherent in improving skills in the workforce can be addressed through effective policy interventions in post-secondary education. As discussed extensively in a recent World Bank report, such interventions should focus on overcoming failures in information and quality assurance that lead many people to make sub- optimal skills investments (too few people acquire the skills needed to become engineers, technicians, and competent managers; see World Bank 2011). Ukraine must overcome inertia to improve the efficiency of its elementary and secondary education systems. It has struggled to reorganize its school networks in the face of shrinking student cohorts, resulting in a misallocation of How a More Mobile Workforce Can Propel Ukraine’s Prosperity 31 scarce resources—for example, in maintenance of nearly empty schools rather than in restoring the attractiveness of the teaching profession (Coupe et al.,2011). Reallocating resources will enable the system to provide a good grounding in the skills most needed in a knowledge-based economy. Figure 16: Growing �rms demand skilled workers (Percentage distribution of human capital to growing and declining �rms, 2005). Note: The skill intensity groups are de�ned as follows: Low = human capital index <= M—0.5*SD. Medium = M—0.5*SD < human capital index <= M + 0.5*SD. High = human capital index > M + 0.5*SD. Where human capital index is an average of the distribution of a �rm’s workforce by educational levels (primary education=0, tertiary education = 3); M= Mean, SD = Standard Deviation. Source: World Bank (2009a). In order to facilitate labor mobility, people need skills that are transferable across sectors and occupations. For this, people need to have the ability to acquire new knowledge—that is, they need a good foundation of both cognitive and non-cognitive skills. For the younger generation, this base of strong cognitive skills can still be provided by the educational system, once it is reformed. For current workers, who are already out of the traditional education system, the policy challenge is to find effective ways to provide these foundations and encourage re-training in new, modern occupations. To meet the challenge of retraining workers, the education system must become more responsive to labor market needs. This will require more direct involvement of the private sector in the design and provision of higher and vocational education, and a more active role in providing students and young workers with on-the-job learning and training opportunities. As mentioned above, people need to know what education or training is most needed in the workplace. Students and workers need access to appropriate labor market data, like prevailing wages, career advancement, and vacancy rates in order to make informed decisions about their educational investment. Labor market observatories and public and private labor market intermediaries could play an important role in providing this information, especially for potential internal migrants. 32 In Search of Opportunities 4.8. Ukraine’s Urgent Need for a Solution In sum, five key areas must be improved so that workers in Ukraine have the freedom to pursue job opportunities throughout the country. First, the population registry system must be streamlined and modernized.Second, housing and credit markets must be fully developed. Third, greater human capital investment must be made, particularly training in high-demand skills. Fourth, labor market institutions must be improved in a way that will spur dynamism in the labor market while still protecting workers, and also provide reliable information about job openings and labor market conditions. Fifth, social benefits must be made portable and adequate. Increasing internal mobility in Ukraine will contribute to Ukraine’s transition to a modern economy. This is crucial given the challenges it faces in the future: an aging population and increasing globalization. For Ukraine, with a population that is aging more rapidly than most, increasing labor mobility must happen sooner rather than later, since an older population is even less likely to migrate to find work. Ukraine’s population is declining faster than almost any other in the world, due to high mortality, low birth rates and outmigration. The country ranks second in the world (together with Bulgaria and Georgia) after Moldova in the speed at which the population is aging. The United Nations classifies it as “already old� because more than10 percent of population is 65 and older. 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