The Lithuanian Economy

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1 Macro Research Macro Research - The Lithuanian Economy 31 October, 213 The Lithuanian Economy Newsletter Positive developments in the labour market, but high structural unemployment requires actions Labour market indicators continue improving; unemployment down to 11.7% in Q2 Long-term unemployment is declining, but structural unemployment remains a problem Wages will keep growing at accelerated pace Labour market indicators continue improving The unemployment rate fell to 11.7% in the second quarter of this year down from the peak of 18.2% in 21. This trend has been supported by employment growth, which is increasingly driven by domestically oriented sectors, while exporters have become more cautious. The unemployment rate has been falling despite the rising activity rate, which reached an all-time high in the second quarter. Youth unemployment is retreating due to strong youth employment growth. Registered unemployment and job vacancy data are also showing continued positive developments. Structural unemployment remains a problem Long-term unemployment has been declining in Lithuania due to employment growth, especially in the construction sector. However, the negative output gap is being closed; thus, the still-high unemployment rate might be close to the natural rate of unemployment. This points to the problem of high structural unemployment. Employers are having difficulty finding workers with the necessary skills despite the large number of unemployed. Wages will keep growing at accelerated pace Real net wages have been growing in most of the sectors since the beginning of 213; the largest increases were recorded in the domestically oriented sectors, not least because of the increase in minimum wage. Nevertheless, real net wages have not yet reached pre-crisis levels in most sectors. Continuously falling unemployment rates, the lack of a qualified labour force, somewhat lower labour taxes on low earners and families, and the restitution of wages of public servants will keep the average net wage growing at an accelerated pace for the next few years. Labour market indicators 25% 2% 15% 1% 5% % -5% -1% -15% -2% Employment growth, yoy (ls) Unemployment rate (ls) Activity rate, year olds (rs) Employment rate, year olds (rs) Source: Statistics Lithuania 75% 7% 65% 6% 55% 5% 45% 4% 35% 3% Nerijus Mačiulis , nerijus.maciulis@swedbank.lt Vaiva Šečkutė , vaiva.seckute@swedbank.lt Laura Galdikienė , laura.galdikiene@swedbank.lt October 31, 213 Please see important Please see disclosures important disclosures at the end at the of end this of document this Page 1 of 7

2 Positive developments in the labour market, but high structural unemployment requires actions Labour market indicators continue improving unemployment, including youth and long-term, is declining on the back of growing employment. However, despite the still-large number of unemployed, employers are having difficulty finding workers with necessary skills; this indicates that there is a problem of high structural unemployment. Wages are and will continue growing at an accelerated pace. Employment growth is Unemployment declines increasingly driven by on the back of growing domestically oriented employment sectors Unemployment declines on the back of growing employment Labour market indicators continue improving The robust economic recovery in recent years has had a positive impact on the labour market. The unemployment rate fell to 11.7% in the second quarter of this year, down from the peak of 18.2% reached in the beginning of 21. This trend has been supported by employment growth the number of employed has been growing for six consecutive quarters in annual terms. The employment rate 1 has improved considerably since 21 and is approaching pre-crisis levels. Contrary to the situation in , employment growth is increasingly driven by the domestically oriented sectors, while exporters have become more cautious. In the second quarter of this year, employment growth was mainly led by certain nontradable 2 sectors - construction, administrative activities, public administration, and arts and entertainment. However, a large part of the increase in employment in these sectors was due to Lithuania's presidency of the Council of the EU; thus, many of the jobs created are temporary. Employment decreased mostly in exporting sectors, such as agriculture, transportation, and information and communication; employment growth in manufacturing also decelerated. According to the Lithuanian Labour Exchange, over the first nine months of this year, compared with the same period a year ago, the share of all job vacancies increased in the services sector but declined in the industry and agriculture sectors; this confirms the declining contribution of exporters in job creation. We expect employment growth to become more stable and balanced across sectors given the decelerating export growth the exporting sectors are unlikely to return to dominate it in the near future. Contribution to annual employment growth, pp Tradable sector* Nontradable sector * Includes agriculture, forestry and fishing, mining and quarrying, manufacturting, transportation and storage, information and communic. Source: Statistics Lithuania, Swedbank calculations Registered unemployment and vacancies 17% 4 16% 35 15% 3 14% 25 13% 2 12% 15 11% 1 1% 5 9% * 212* 213* Registered unemployment,% Registered vacancies untill the end of the month, thous. (rs) * As of 211, data are adjusted according to population census Source: Lithuanian Labour Exchange Labour force activity rate is is rising The unemployment rate has been falling despite the rising activity rate, 3 which reached an all-time high of 72.4% in the second quarter. This increase is the result of the working-age population's shrinking more than the labour force's in the same age group: over the last three years, the population in the age group of years has contracted by 6.7%, while the labour force in the same age group has shrunk by only 2.8%. This could be because the majority of recent emigrants were previously inactive in the labour market. In addition, due to the improved economic situation, men and women are entering the labour force by getting employed or starting to look for work actively. This year, the government implemented a 1 The ratio of employed in the age group of years to total population in the same age group. 2 The sectors that produce goods or provide services that cannot be traded internationally. 3 The ratio of labour force (sum of employed and unemployed, but actively looking for a job) in the age group of years to total population in the same age group. October 31, 213 Please see important disclosures at the end of this document Page 2 of 7

3 reform that reduces social benefits for long-term unemployed who are unwilling to find jobs; thus, the activity rate is likely to continue increasing. Registered unemployment is declining, job vacancies are high Youth unemployment is declining sharply Registered unemployment and job vacancy data are also showing that the positive developments in the labour market are likely to continue. In September, the registered unemployment rate fell to 9.9%, the lowest level since 29. Part of this drop is seasonal, but it does show a general downward trend in unemployment. The number of vacancies dropped somewhat from the all-time record reached in May but still remained at a very high level throughout the third quarter., This indicates that, as the demand for labour is high and the vacancies are not easily being filled, unemployment will continue to decline. Youth unemployment is retreating A sharp increase in youth unemployment was one of the major negative outcomes of the recent economic crisis in Lithuania. High youth unemployment can have serious negative consequences for the future labour force not only can it discourage young people from looking for jobs, but some may decide to leave the country, and others, without appropriate experience, will be less productive than otherwise. Various research papers show that people who do not have jobs when they start their careers are likely to have lower wages and higher chances of being unemployed in the future. In Lithuania, the youth unemployment rate spiked from less than 1% before the crisis to over 35% in the beginning of 21. Since then, this rate has decreased to 21% - slightly below the EU average level, but above those in Latvia and Estonia. Most of this sharp decline in youth unemployment can be attributed to strong youth employment growth, as the number of employed year-olds has increased by almost 3% over the last three years. However, the youth unemployment rate can sometimes be misleading as it does not capture the young people who either exit the labour force in order to go back to school or simply decide to stop looking for jobs because they believe there are no jobs for them. Youth unemployment rate (sa), % EU27 Estonia Latvia Lithuania Source: Eurostat NEET rate, % LT LV EE LT LV EE LT LV EE LT LV EE years years 2-24 years years Source: Eurostat The NEET rate has improved Building bridges between education and work and work is crucial is crucial Meanwhile, the NEET rate, 4 which is another closely followed indicator, captures all young people who are not in employment, education, or training. The NEET rate for young people aged years doubled in 21 compared to the lowest rate reached in 27. Most of this increase was due to the rising NEER rate for 2-24-year-olds, while the NEER rate for 15-2-year-olds has not changed much over time and is lower in Lithuania than in the other Baltic countries. This is mostly because compulsory education lasts for ten years in Lithuania compared with only nine years in Latvia and Estonia. Also, in Lithuania fewer young people enter the labour market right after they obtain their compulsory basic education. The share of 2-24-year-olds who are not engaged in employment, education, or training declined from the peak of 21.9% in 21 to 18.3% in 212, mostly because employment is growing and more young people are enrolling in non-university higher education studies in order to obtain professional qualification. Since the majority of university students graduate after the age of 24, it is useful to look at the NEET rate among young people aged between 25 and 29 years. Although the NEET rate for this age group has declined since 21, around one-fifth of young adults aged are still not engaged in employment, education, or training. This indicates, amongst other things, that the Lithuanian higher education system does not function very well. In order to ensure a further decrease in youth unemployment, it is important to build bridges between education and work. According to employers, most young people do not have the needed qualifications; thus, employers should be involved in training the young. A system 4 The share of the total population of young people who are currently not engaged in employment, education, or training. October 31, 213 Please see important disclosures at the end of this document Page 3 of 7

4 Job vacancy rate, % Macro Research - The Lithuanian Economy where companies are subsidised for training their potential employees could help to bring the qualifications of young people closer to the market needs. It is also important to improve the quality of higher education by strengthening competition amongst higher-education institutions, which would increase employment possibilities for university and college graduates. Structural unemployment remains elevated Improving economic conditions and growing employment have helped to combat the problem of long-term unemployment 5 in Lithuania. Long-term unemployment poses serious problems because the longer somebody stays out of work the harder it becomes to find a job: skills and work habits erode, and companies become more reluctant to employ someone who has been out of the job market for a long time. This, in turn, burdens the social system and affects negatively the already declining labour force if the unemployed person stops looking for work. Long-term unemployment is lower In Lithuania, the long-term unemployment rate declined to 4.9% in the second quarter of this year from the 211 peak of 8.8%. Meanwhile, the share of long-term unemployed in total unemployment fell to 42.1%; a similar share was last seen in the second half of 26. The decline in long-term unemployment is associated with growing employment in the country, especially in the construction sector, and, most probably, with higher emigration rates of the long-term unemployed. However, despite this recent improvement, long-term unemployment is still at a high level, pointing to struggles with structural unemployment. 12% 1% 8% 6% 4% 2% Unemployment rate by duration % Share of long-term unemployed (rs) Short-term unemployment rate (ls) Long-term unemployment rate (ls) Source: Statistics Lithuania 7% 6% 5% 4% 3% 2% 1% Beveridge curve IV II 1 26 I 213 II.5 21 I 29 IV Unemployment rate, % Recovery Recession Pre-crisis Source: Statistics Lithuania Negative output gap will be closed this year, indicating that natural rate of unemployment is uncomfortably high There is a mismatch between market needs and labour supply The European Commission forecasts that the negative output gap in the Lithuanian economy will be closed this year, and that output in the economy will finally reach its potential level. However, if the economy is at its potential, unemployment is at its natural level; this means that the still-high unemployment rate of over 11% can be considered as being close to the current natural rate of unemployment. 6 Natural unemployment consists of frictional and structural unemployment. Frictional unemployment arises when people are moving between jobs, careers, and locations and is always present in the economy. Structural unemployment, meanwhile, is a much bigger problem because it is a result of a serious mismatch between what the companies need and what workers can offer. This type of unemployment may occur because of a skills or locational mismatch the workers may lack the requisite job skills, or they may live far from regions where jobs are available and are unable to move there. Structural unemployment is generally considered to be one of the permanent types of unemployment, and improvement may occur only in the long run. The high rate of natural unemployment points to high structural unemployment in Lithuania. Frictional unemployment tends to be rather low, especially in times of economic uncertainty, because people tend to cling to their jobs and are less willing to shop around. The Beveridge curve, which relates unemployment to the vacancy rate, 7 confirms the prevalence of structural unemployment in the country. In general, higher rates of unemployment are associated with lower vacancy rates. However, the vacancy rate has recently increased somewhat without a large drop in unemployment, as would ordinarily be expected. This is taken as evidence that employers are having difficulty finding workers with the necessary skills, despite the large number of unemployed. 5 Long-term unemployed are those who are unable to find jobs for longer than one year. 6 The lowest level of unemployment at which inflation remains stable. 7 The number of job openings divided by the number of jobs. October 31, 213 Please see important disclosures at the end of this document Page 4 of 7

5 Reducing structural unemployment requires more effective retraining programs Wage growth has accelerated Real net wages have not yet returned to precrisis levels in most sectors Real net wage, 28 = Agriculture Manufacturing Construction Trade Transportation Accommodation Information, communic. Financial act. Source: Statistics Lithuania, Swedbank The main reason for the current mismatch between market needs and labour supply is that many of the unemployed used to work in sectors where demand for labour fell sharply during the crisis, mostly in the overheated construction sector. Despite the recent growth of employment in this sector, it is unrealistic to expect that employment in it will reach the precrisis level, which was almost twice the current level. Thus, a large fraction of the unemployed who used to work in constructions are unlikely to find jobs in the same sector, even if the economy continues growing. However, a more intense renovation of the Sovietera buildings would lower structural unemployment as it would boost employment growth in the construction sector. Nevertheless, an effective and long-lasting reduction of structural unemployment requires more effective retraining programs in order to help those currently unemployed attain the qualifications required by the market. Wages will keep growing at accelerated pace Declining unemployment, a lack of skilled labour, and a higher minimum monthly wage have been pushing the average monthly wage upwards at an accelerated pace since the beginning of this year. In the second quarter, the average gross wage was 4.6% higher than a year ago. Thanks to low inflation, the average real net wage increased by 3% over the respective period, boosting the purchasing power of workers. Nevertheless, wage growth has not been even across sectors. Real wages in the information and communication sector, which is one of the most labour supply-squeezed sectors, have been growing since 21, and in 212 they were almost 8% higher than before the crisis. In general, during the crisis wages fell least in exporting sectors, while they contracted most in the construction, real estate, and public sectors, and in most sectors they have not yet returned to pre-crisis levels. Real net wages have been growing in most sectors since the beginning of 213. The largest increases were recorded in the domestically oriented sectors, such as accommodation and food service, construction, and administrative and support service; this was mostly due to the higher minimum monthly wage. Continually falling unemployment rates, the lack of a qualified labour force, somewhat lower labour taxes on low earners and families with children, and the restitution of wages of public servants will keep the average net wage growing at an accelerated pace for the next few years Source: Eurostat Unemployment trap, % EU27 Estonia Latvia Lithuania Motivation to find a job is now higher The unemployment trap, measuring the percentage of gross earnings that is taxed away and the withdrawal of unemployment, and other, benefits when an unemployed person returns to employment, is a good indicator of the motivation for the unemployed to find jobs. A large unemployment trap erodes any motivation to find jobs because the unemployed would not earn much more than their benefits. The unemployment trap in Lithuania has decreased substantially since its peak of 86% in 29, when the rate of unemployment shot up and wages contracted. In 21, the unemployment trap was reduced considerably as a result of lower unemployment benefits; in more recent years, the decline was mostly due to growing gross wages. In 212, the forgone benefits and additional taxes incurred by an unemployed person returning to employment declined to 67% of potential gross wages considerably below the level in Latvia and even below the EU average. This year, the Increased minimum monthly wage most probably reduced the unemployment trap even further by widening the gap between unemployment benefits and the minimum wage and increasing the motivation to work. Next year, the declining income tax rate for low earners will further reduce the unemployment trap. Long-term strategies to lower the unemployment trap include boosting labour productivity and, thus, wages through proper education and a more favourable environment for investments. Laura Galdikienė October 31, 213 Please see important disclosures at the end of this document Page 5 of 7

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