The Bank of Lithuania and the International Monetary Fund (IMF) are holding an international seminar “Macroeconomic Challenges in Lithuania: Strengthening Competitiveness and Building Resilience”. The first part of the seminar will be livestreamed.
Borja Gracia, Head of the IMF Mission to Lithuania, Gediminas Šimkus, Chairman of the Board of the Bank of Lithuania, and Gintarė Skaistė, Minister of Finance, will review recent Lithuanian export performance in the context of russia’s war against Ukraine and increased production costs, and discuss long-term economic productivity prospects.
e e e e e e e e e good morning everyone dear Minister dear Governor um dear members of Academia and students and everyone watching online welcome to today’s seminar titled macroeconomic challenges in Lithuania strengthening competitiveness and building resilience organized by the international monetary fund and the bank of Lithuania and hosted by The Institute of international relations and political science at vnus University my name is simonas I am part of the team at the bank working on the IMF issues and uh I will be guiding you through the event to today um please note that U the first part of the seminar um the first presentation and the panel is being broadcast live on the web and also there’s a photographer um that you can happily post to if you feel like it so this seminar is taking place within the context of the imfs article 4 Mission to Lithuania led by the mission Chief Mr bar uh Bara graia the purpose of the seminar is to disseminate and discuss um with the broader audience the research done not only by the IMF team within the context of the mission but also by the researchers at the bank of Lithuania and we are organizing the seminar for a second year in row now so it is becoming a nice tradition already last year the event took place at the faculty of E economics and business administration this year we are at the Institute of international relations and political science and I know that this is not the first time that Bara is here he delivered a public lecture here in 2022 and let me just say that we are very happy to have Bara and his colleagues back here at vus University and we also feel extremely extremely grateful to The Institute um that uh we are currently in for hosting us for providing the space and allowing the IMF and the bank of Lithuania engage broader academic audiences and students in line with the topics analyzed by the IMF team in this consultation cycle this year the seminar focuses on the issues of competitiveness productivity as well as fiscal policy the seminal the seminar will feature a a highlevel panel discussion on lithuania’s external interal competitiveness um with Finance Minister G who has kindly agreed to join the seminar governor gmina shimkus and the mission Chief we will also have three as you may may have seen in the program three very interesting research presentations but before all that we will have an introductory presentation by Bara graia on the current state of the economy in Lithuania and the world uh let me just say that this is Bar’s last mission um or I would like to say that this is Bar’s Last Dance um and if you know the Netflix documentary uh in you know in this title I’m using it purely because Bara over the years I think it’s since end 2017 has indeed and truly become the Michael Jordan of economic advisers to Lithuania so with without further Ado Bara the stage is yours thank you very much simonas I guess it shows your last remark shows that in lithu basketball I rather than football I would have preferred the sedan of but that’s a personal preference now thank you very much it’s an honor to be here h i the presentation I will give is a structure in three parts is it working yeah yeah so the first part will go over I will cover uh the global Outlook then I will focus on Lithuanian then I will give a preview of the two topics uh of research that will be presented later h on expenditure pressures and on competitiveness so let me let me start with the global Outlook so the the bottom line is after a significant amount of shocks in the last four years starting with Co supply chain disruptions after covid um energy crisis after Russia’s invasion of Ukraine that led to high inflation a coordinated monetary tightening across the world everybody two years ago a year and a half ago was talking about EST St flation and that was in everybody’s mind no growth and inflation well the world economy in the last few years has actually continue to grow during this disinflationary period of the last year and a half and that’s uh remarkable a remarkable achievement and and as you can see here it’s not just been H low or emerging economies but also advanced economies at a lower Pace but growth has been kept also in in those even during the this inflationary period of tighter monetary policy why has this been the case well there there have been some favorable demand developments in particular private consumption has been supportive of growth during this period and that has largely be the result of tight labor markets across the world the if you look at Europe the Euro area at the right this is still the case but less so two things to to highlight here one is the impact of the energy shock in Europe was greater definitely greater than in the US where Energy prices did not increase near as much and so the contrafact is we were expecting the impact to even larger so the fact that still there was some growth and some growth in private consumption it’s important government spending has also been um larger and and supported growth more than we expected two years ago coming out of covid and on the right you can see that there was also a a factor that supported private consumption which was that coming out I mean during covid there was an increase in the savings rate across the world by households and part of the of and the undoing of that increas in savings rate has also supported H growth more moderate in Europe where they also increasing the savings rate was a bit less moderate is the yellow line the Euro area on the right but all these factors on the demand side have supported growth and contributed to that uh development but there have ALS also been some favorable Supply developments first labor markets have behaved better than expected particularly labor force in some countries migration has been important in advanced economies and some other countries actually the the foreign born population growth has been more than and the domestic born and that has supported labor force partic the increase in the labor force but also labor force participation has been a strong that has helped on the supply side all those bottlenecks that were that occur after covid in terms of well you have there the global supply chain uh pressure index and the world contain index that worsen significantly in the end of 2020 especially in 2021 all those factors corrected it’s true that the issues in the Red Sea h have uh reversed partially that Trend but relative to the Peaks During the postco period and relative to even historical average those increases have not been uh as significant so those are still not factors that will will be a significant headwind if no further shocks happen further the increase in Energy prices was also reversed so it proved to be largely temporary in part because uh the production of oil and natural gas increased after the shock more than or faster than it was expected and that was largely driven by by the United States on both gas and and oil and that has also helped H the correction in Energy prices to be very dramatic and and supported um activity so finally what has happened to inflation well and this is something that probably I will show also in Lithuania but the pass through of energy price increases to core inflation happened relatively fast and the same it’s true when Energy prices starting coming down so the large increase has proven not to be as persistent and why this the persistency didn’t happen even though inflation in many countries increased significantly well in part because yes near-term inflation expectation the red line for advanced economies and the blue line dotted line sorry not dotted line the straight line for emerging increas significantly with inflation as expected but once inflation started to come down near-term inflation expectations also started to come down quite significantly and are getting are converging towards the long-term uh targets the fiscal the inflation targets and at the same time long-term inflation expectations never really deviated from Target so either H bank’s monetary policy was the right one but or The credibility of central banks uh is big in any case expect expectations never long-term inflation expectations never de anchor that help the correction in near term inflation expectations and that help reduce the potential risk of sustainable sustainable higher inflation rates H going forward that we fear only a year ago so all these factors have contributed to the global Outlook now I’m not going to get into all the numbers but these are our forecast our recent developments until 2021 but our forecast for the near term growth will continue the adjustment that this inflationary process will finalize in the next year or two in countries but going moving inflation back to Target but in but growth in the near term we project for the world to be just above 3% that is quite lower than growth in the two decades prior to covid which was just below 4% % the wi looks uh that we published in in in in April looks at the underlying reasons in this Dynamic and in our projections and half of it is coming from tfp and I’m not going to get into the details but this is particularly the case for emerging economies the the slowdown in growth going forward relative to to the past and suggest that the global income convergence that we had observed for decades now and it was quite a strong H if our projections are correct will slow down going forward I’m not going also to get into a lot of the details on on on risk but in general which will apply also to Europe as you will see in a second we see the balance of risk to have I mean the balance of risk to have decreased relative to last year so we see a downward risk but upside risk also dominated and especially some risk that we identified last year particularly inflationary risk risk inflation to to remain persistently above Target to have uh to have fallen significantly so these are the numbers uh for most of the the world including the Euro area um I I can go into details about some of this if you want later let me move to Europe the Outlook I mean in in terms of qualitative qualitatively the story is similar but as you saw before the recovery in Europe it’s more gradual and whereas for the world we are already projecting 3% growth the next three years already this year and the next two in Europe that is going to take it’s the the recovery is more gradual this year and particularly next year inflation is also coming down and we expect that basically across Europe Advanced Europe but also emerging Europe uh inflation will reach will get back to Target under our Baseline between next year and the following year a bit later for emerging economies that inflation is proving a bit more more persistent and slightly higher but still and the story is basically the same H in Europe strong labor markets are supporting real real income especially lately when inflation has come down and wages in real terms have increased H as so you can see that Services particularly and the composite index are are picking up faster manufacturing so Services particularly are are are recovering quite strongly manufacturing is lagging behind but there are some signs that it’s already recovering so that’s the the Outlook we have for for Europe now for this Outlook so it’s really a an Outlook of a soft Landing so the disinflation is taking place and growth is gradually picking up for that to happen we have some assumptions first that the tightness of the labor market is AIT and there are some indication that it’s already like for example the vacancies to unemployment that that was H coming out of covid was high both in Advan and emerging Europe it’s already easing but unemployment rates remain this is a historical unemployment R from the 2000 the dotline is the current unemployment and the other is the spread in the last 20 years it it unemployment rates remain very low but the labor utilization and and we will argue that that’s an important factor that has happened in Lithuania It’s relatively low so ours work or per employee fail during covid and it hasn’t recovered to PR so there are mixed signals but at least there seems to be some easing on the labor market that suggest that this risk of wage inflation spiral because of a very tight labor market conditions it should not happen and at the same time the labor market is tight enough to support especially now that inflation is below wage growth to support the recovery in disposible income particularly in CC but now over the last few quarters also in advanced economy to support growth in consumption at the same time we are projecting that the fiscal in general in Europe the fiscal positions are tightening after significant fiscal support during covid but also during the energy crisis the fiscal governments need to rebuild fiscal buffers and we are projecting that that it’s already happening this year in our assessment not as fast as it should but still so for the recovery to take place as we as we saw private concern consumption compensates the private consumption increase compensates the drug on demand that comes from from this fiscal fiscal rebuilding of buffers and investment well investment we expected to be relatively flat in advanced Europe and a bit more supportive in in emerging Europe as you can see on the on the left but still relatively U so especially in for advanc you relatively uh moderate uh contribution to growth so here I just want to stress again this is our projection on what are going to be the contributions mostly private consumption recovering investment gradual but happening particularly in CC not so much in advanced Europe in the middle graph uh wage growth should moderate with inflation and U but as you can see on the right inflation projections are for the Euro area to recover or Advance Euro to to go back to Target these are deviations from Target H sooner maybe half of next year uh the UR in particular will reach the 2% mandate the ecb’s Mandate of um stable below uh close but below 2% and it will take a bit more time in CC where the inflation shock was also larger so what about Lithuania basically the story is similar so we expect the recovery in real in earnings so real wages in Lithuania turned positive in August last year and they are increasingly so because nominal wages are moderating but really much less than the decrease in inflation that is already supporting ER consumption and there are a lot of that started in the last quarter and we will know or we should know now the new q1 data from the statistical office but the expectation is that private consumption will gain Pace during the year supported by what is still the tight labor market and uh so you can see that here these are high frequency indicators and all indicate that there should be a recovery and that the recovery in Industry will happen but more gradual because as we’ve just seen the Euro area especially the Euro Area recovery is more gradual so you have a the a recovery that is first is being driven by domestic demand and then to domestic demand along the year you will have a gradual but still a recovery in external demand particularly the Euro area so both should help uh lithuania’s recovery gaining paays as the year goes now on inflation so this is just to explain so we saw a very dramatic increase in inflation we made Big H I mean in last year consultation we made a big thing of potential inflationary risks I remember the minister was not very happy with with our assessment or didn’t agree fully with our assessment and maybe she was right and we were slightly wrong in in emphasizing so much these risk that have not materialized so what you observe is the increas in inflation headline inflation on the left was very significant twice the Euro area but as I said before and it happened in Lithuania as well you have core inflation in the middle basically the pass through from Energy prices to core inflation happened very fast and the same is true when Energy prices came down and that has been the the main driver of core inflation now services this is the now the big question Mar is whether inflation in services will be more persistent and could prevent or could put some lower um some floor on on the degree of this inflation now this is comparing the Blue Line in the in the right chart is comparing the current disinflationary episode in services to the previous High inflationary episode during the GFC and you saw that at that time the blue line the this inflation in Services continued for longer than we have just seen now it’s stabilized in Lithuania inflation in services in the last couple of months but that’s also expected the the GFC deliver I mean the output Gap became very negative the labor market was very weak nominal wages were negative all this period so the economy was significantly I mean affected and activity was very weak here as we just mentioned the labor market has remained tight real wages are now positive and the output Gap is not near as negative as it was during the GFC so the inflation the persistency in Services inflation is not surprising and should not represent a significant risk inflationary risk going forward let me just mention also I mean since I said that last year we made a big thing about inflation risks what was H the risk we had in mind the risk we had in mind was this inflation wage spiral that higher inflation fits into wages and higher wages fits into inflation and that’s basically what has happened in emerging Europe This is the price level is the straight line and the dotted line is um nominal wages per hour so in in Eastern Europe the in formation of wage expectation has a lot of a backwards component so you try to compensate for what happened in the last period And so there is a lot of there is a lot of persistency in the wage and inflation uh and this is what you saw once prices started to increase in 2022 at the end of 2021 wages followed prices and so in Eastern Europe you have that the dotted line was below the red line very little and not so real wages were never really very negative and not only that but this backward component of wage formation you can see what is h what it’s doing in the last few quarters which is that wages have continue to increase at the the same rate even when inflation has moderated significantly so you have now very high real wages in Eastern Europe in advanced Europe the opposite is true wages are much more sticky they are much more forward looking and that’s where H the non the long-term inflation expectations played an important role so and so the inflation Sur price resulted in a real negative wages and wages very gradually have increased and not near the increase in inflation now what happened in Lithuania it was basically a mix of the two lithu came out of the covid in a very strong position we when we were here in 2021 well I think that was online but when we did the 2021 report we we thought the economy was overheating before all the war and the energy shocks so there was a a already a demand component of inflationary pressures that was manifesting that were that was not the case in other Euro area countries and inflation started to follow the the increase in prices real wages were already high but they were not they didn’t turn negative now after the invas the the energy price increases in 20202 fortunately the behavior was closer to e to Advanced Europe rather than Eastern Europe so it seems that formation wage formation or wage the backward component of wage formation was h less important than in Eastern Europe and more similar to Advanced Europe and that resulted in a in a significant real negative wages and obviously that’s why the last two years have been very tough for for Lithuania it’s one of the reasons because real disposable income has been affected negatively until last August where at the end of the period you see the dotted line started the gap between the dotted and the straight line started to close again real wages started to be positive again so let me so basically what we expect is a recovery that is gaining Pace growth we are going to finalize our new projections but growth we expect it to be between two two and a half this year inflation H has surprised us on the downside so that this inflation it’s it’s quite a strong and probably our new inflation projections for this year will be around on average 1% maybe maybe a bit higher maybe a bit lower but and but the recovery is definitely taking increasing I mean Pace as as we move along as I said there are two areas that we are going to discuss later one one it’s on competitiveness in eonia I will give a small preview of say’s work and then of a coming spending pressures U mostly related to aging but not just so let me start with competitiveness and just to get H to explain what has happened lately so the terms of trade price of exports over relative to the price of imports have been for the baltics in general quite stable and even the Euro area in general for a long period of time at least in the last 20 years8 19 years has been fluctuating but really within a relatively narrow range and if you look at the other two baltics if anything even with the energy shock of the last two years it was if anything improving this is annual data so monthly data shows more more variability but the performance in Lithuania has been dramatically different and Lithuania has had the worst terms of trade shock in recent history or in recent memory and the worst in the Euro area that was the year when Energy prices increased again if you look at monthly data this is more or less at 10% it almost reached 20% and it’s only partially corrected when you look at this and this is very important because at the end the price of exports over Imports the terms of trade tells you it’s an indication of of I mean negative terms of trade means that you can get more less of your import let’s Imports with your exports that as a country you are less H more poor in a way no you need more to produce more to get the same amount of imports so this has significant implication as we saw before the real disposible income was negatively affected let’s step back however so this is the real GDP growth since Independence basically quarterly and you saw the you first had a very spectacular uh growth at the beginning of uh of of the sample with some bumps along the road but once you started growing in the early in the late ’90s growth was around 6.5% real terms for a lot of time but this now we know was not a sustainable growth especially in the last few years after the global financial crisis imbalances grew dramatically and you had a very sharp correction in levels and in growth so real GDP fell significantly during the GFC for a short period of time but very dramatically and growth almost halfed from 6.5 to 3.6 around 3.6 but however this new growth path was sustainable it was sustainable over 15 20 years and it was sustainable without reemergence of uh imbalances and supported on an increasingly competitive economy that was gaining market shares so it was a completely different growth lower but more sustainable than the previous BFC growth there then it came covid and the question mark was how what was going to be the long-term impact of covid well by 20121 basically you Lithuania had got back to the pre-co trend not just the growth levels which only fell on average including the the drop during the quarter of the lockdowns to 3.2 to from 3.6 so you were back at the same growth rate and the trend that you had preo so we thought that the impact the long-term impact of of course was going to be almost negligible but then the energy shock has been quite different and in the last two years H growth has been really flat and still um there is a question mark then on what is the impact of these last two years with these very negative terms of trade shock on the Lithuanian economy so let me focus on a couple of things and just to to for just the final point on on getting some perspective in 2009 after the GFC if you look at the Euro area you were your GDP per capita controlling for price level differences was second to last next to lvia very close to lbia and at around 40% of the average of the Euro area pre in in postco you were 80% you double your and you take over you you left behind let’s put it like that all the the other Baltic significantly particularly Estonia but also countries like Portugal Spain so so this is a a very successful performance so let’s just keep that in mind when we talk about the challenges ahead because there is also a long way that has been that has been walked through the last two years basically I mean I don’t know if you notice but this is 2021 this is 2023 so the last two years you haven’t gained anything but it’s true of every other country there there’s been really the shock has been a big shock for all of Europe but let’s get deep into why this shock so was so different between lvia Estonia and Lithuania for this is the terms of trade shock for two periods the five years before covid and the two last the last two years as as we were saying there was has been a significant deterioration in the terms of tradeit of Lithuania but not in lvia and Estonia but this is not the full picture really the deterioration came from Goods where I mean the deter was M was double the the total terms of trade uh and this is where the difference with Estonia lvia came so what does this mean it means that in Lithuania the price of imports the increase in Energy prices and other prices was not passed through to the price of exports whereas in Estonia and lvia it was and as we will see this helps explain why Lithuania was able to preserve market share at a very difficult time more than particularly Estonia in Services the story is quite different if anything the the terms of trade in the last two years in Lithuania improve as so did in Estonia and a small deterioration in in lva and this also helps explain the behavior of of services last year you reach a historical um High Trade Surplus on services around 10% of GDP which is quite remarkable and again let’s not forget that that the the the the impact of the terms ofer was was the largest in the in the Euro area Second Challenge is that in the last two years we’ve seen a negative H labor productivity particularly in tradable Goods but also nontradable services and this obviously makes a so you had deterioration deteriorated terms of trade negative productivity growth and therefore the questions about it’s competitiveness going to suffer going forward the positive spot is that that’s not true of services tradeable services and probably helps explain the Surplus the the historic Surplus in services that I was just I was just mentioning part of the story and I will I can get into details later if you want is that employment has been positive even when the economy was weakening last year which was very surprising it’s also true that ours work fa during covid more than employment and there was a gap that it still remain so ours work didn’t has have not recovered to preco levels in Lithuania which means that basically if you look at hours work per employee or per person they fall dramatically in 2020 they recover a bit when the lockdowns were over but they are still significantly below uh levels preo so we believe there is some labor hoarding that employment has been preserved even when output was falling and I can again get into details later on that if if you want that suggests that a component a significant component of the negative labor productivity growth over the last two years could be cyclical and with the recovery underway it should be or it could be reversed so what was the bottom line that there has been a loss in market shares if you look at this is only Goods if we look at Goods Lithuania has lost 7% of the market shares in from the peak of 21 Q3 to the end of last year this is similar to lvia that the loss was 6% but look at Estonia it’s 23% Market loss over the same period now we can dig deeper into this and try to see okay you can lose market shares because the markets your markets are disproportionately affected and if you remember at the beginning of the presentation we saw that the Euro area is really the weak the growth in EUR is weaker than in the US than in East Asia so Your Mark and your markets are the Euro area and the EU so there is that demand effect you are you you are exporting to markets that have low demand and therefore as a share of the world uh trade you are falling and this is basically explains 2third of the drop in market shares that your export markets are are going over a weaker than the rest of the world uh situation and in Estonia in lvia it basically explain the whole market share decline but only around 10% of the Market the share decline in Estonia which is quite remarkable and you can also look at the structural Factor competitiveness factors that explain in the case of of of Lithuania onethird basically around one3 of the drop in market shares but 80% around 80% versus in in the case of of or 70% in the case of Estonia and if anything in lvia it seems competitive factors have actually improve not not decrease and then there is an interactive or interaction effect that uh I think uh say will will will get into the details in her presentation but basically the story is yes there’s been a a loss in Market sh it’s largely driven by the man factors in the markets you are exporting and more importantly that’s the same so that’s the minus 7% is that if you take out Russia basically there has been no market share loss but on the other hand the market share loss in Russia Russia should be considered permanent at least for the near term there is that that’s not coming back but so Russia and Russia is due to sanctions so it’s not really due to your competitiveness loss or not loss of competitiveness and if you take out Russia the behavior first the positive thing is your your export Shares are are quite Diversified in terms of the countries and the the experience is mixed but once you take out Russia actually your export shares were held quite nicely during this period of negative terms of trade shock and negative productivity labor productivity and this is on top of a significant increase in market shares in the period which chose 2015 because it was after Russia’s annexation of Ukraine that had an impact of at the time the sanctions at the time had an impact on your export shares so this was from after the loss of export shares in Russia and Belarus at the time but in the in the period 20159 before covid you had a uh in Goods Market market share the increase of 24% three fours of which were we think driven by competitiveness gains so this is a quite remarkable and in Services I hinted already that the terms of trade were positive productivity was increasing even in the last two years so on the right you have the the gains of in the last two years have been above 30% and they deliver the the trade surplus that I was talking about that was on top of almost 60% increasing market shares in the 5 years preo so the services performance has been quite remarkable in in the case of Lithuania so with this and say has many more things to add to this and probably in the panel we will get into some of those let me move to spending pressures and and I know I’m running out of time um sorry apologies for that so there are some shortterm expending pressures related to defense and interest payments but there are other spending pressures that are adding up so you will have already you are already feeling spending pressures from defense and Inter payment and those will only be adding to others related to aging particular in pension Healthcare and long-term care education and on top of that also green transition that requires significant amount of investment so let me just give you our bottom line and and San will go in again more detail over this after lunch but our best estimate is that in spending pressures can be from 5% to 10% over the medium now this is subject to significant uncertainty the longer you try to project the greater the uncertainty some of these are more certain and others but still the the message we want to transmit is that and this is not unique for Lithuania but this is not a marginal problem that can be fixed in a quick easy way adjusting things at the margin this is a significant problem that is going to be increasingly steadily but in but unavoidable going forward and these are using the Aging report the recent version the 2024 version these are the comparable numbers for the Euro area and the EU so these spending pressures were already coming these are some two excerpts from our 2018 and 19 report we already observed that some spending pressures mostly on social spending that has been increasing over time had to squeeze the discretionary part of the budget and that there is so much you can do doing that eventually you you cannot do that anymore and that we are I think the budget in is reaching the point where there is no more discretionary spending to eat from to to address some of those spending pressures and in in in particular the pension system there was a reform in 2018 that significantly improved the sustainability of the system but the cost was that the replacement ratio the ratio of Pensions to wages at the time of retirement was declining from an already relatively low level so the ACR pension enti Ms which means what the pension system owes if suddenly today they had to pay all commitments from people that provided the contributions was steadily declining but in the last three years the pension indexation formula the pensions have increased beyond the pension indexation formula and there this has been reversed in 2020 it’s it’s a bit of a one-off because the economy was very weak so the in percent of GDP it’s a bit distorted but in 20 the latest number we have for 20 2021 is that it increased 60 percentage points of GDP and the Aging report the the number I was showing before that pension spendings it’s 3% in the medium term it’s three times what the pension report uh found aging report found only three years ago because demographic assumptions are worse in the long term not in the short term that are better but in the long term and because of this increases beyond the indexation formula so the the the problem is very significant and so but what are the goals so we we are sting that it needs a comprehensive solution but what are the goals that that we think are important to keep in mind obviously the problem is to accommodate the spending pressures that are a large are unavoidable but the goal is also to do it in a way that preserves stability macroeconomic stability it’s a precondition for growth and therefore for convergence to the extent possible it avoids creating distortions making the economy less efficient disincentivising investment and therefore growth productivity growth that preserves fiscal sustainability and that preserves the proactive fiscal policy that has characterized Lithuania at least since the GFC and remember you are in a currency Union so that’s a rigidity a big rigidity that your economy has you need to compensate that and fiscal policy in terms of policy tools is the main policy tool available for macroeconomic stabilization so this important important of course you can choose extreme Solutions you can accommodate all spending with higher revenues after all your revenues are lower than in Scandinavia well you could do that but the the increase in Reven would be so much that probably you would create more distortions because taxes some taxes are distortionary you would reduce potentially the attractiveness of Lithuania for foreign investments so you could affect private investment and potential growth you could alternatively say okay let’s do nothing an increased debt accommodate with higher deficits but then you will put in question fiscal sustainability and therefore a e microeconomic stability and you would not have you would weaken your fiscal position and therefore fiscal policy will not be able to play an active role to support the economy in bad times and rebuild buffers in good times that has characterized fiscal policy in the last few years so you have a big challenge I mean as a country and it’s to find the right balance between all these objectives all these goals and at the same time accommodating this spending pressure so what do we think could be a reasonable mix of solutions what are the tools you have at your disposal to address this and at the same time try to preserve these goals one is there needs to be there it will have to be some pension reform some parametric pension reform your pension system is benefiting from better than expected Dynamics in the labor market higher labor participation higher employment in the shortterm with high wage growth but aging is kicking and kicking quite significantly this year is the first one that the the new red ties will exceed new members of the labor force and that’s only accelerating going forward and in 2026 the extension of the retirement age stops those two will put pressure on sodra and so the deficits sodra the the surpluses that now sodra experiences will be shrinking and becoming deficits at that increasing Pace especially after 2026 when you so what are the challenges you have well let me make uh a side comment here because we understand there has been a a constitutional Court ruling on the second pillar and that Pro potentially will open the debate again about the second pillar the second pillar is not the solution to the pension challenges it’s part of the solution however what is the pension pillar doing to your system right now the as you go component the dark blue part this is the replacement ratio the ratio at which you get a pension relative to the wage at the time of retirement the black part the dark part is the part that current workers contributions Finance current pensioners with a shrinking population your labor force is going to go from 1.8 million to 1.3 million people in the until 2030 you will have a shrinking amount of work workers paying a significantly increased amount of pensioners so in a payas OS system that can only happen either with massive transfers from the budget that will be problematic from a fiscal point of view or with inadequate pensions what the pillar two is doing is stabilizing that Decline and so it doesn’t increase the replacement ratio but it prevents it from falling in Orange is those who do not did not opt to enter into the pillar two will not do that and will have yes now they are getting an extra part of their salaries coming to them they are not contributing to the second pillar but they will get significantly worse pensions going forward so what is our view is that pillar two is part of the solution that it should be strengthened it should be stabilized L mature H give predictability so people compliance and participation increases participation should definitely be encouraged non participation creates a big problem and withdrawals we understand it’s not constitutional to prevent withdrawals but they should be very discouraged or should be very limited if possible so some mod some reform of the pension system will be necessary Healthcare and education are examples of areas where funding could be increased but there is an efficiency H gain so given the funding you currently have if you compare to peers in Europe your outcomes are poorer so there are efficiency gains that can happen it’s very difficult to quantify if these are large or small but you can do better with the same amount of resources and in an environment where spending presses are so large this is also should be also part part of the solution and again San will will expand on this this afternoon but also I mean there is revenue mobilization is inevitable it’s difficult politically and many the previous government the current government have all tried to some form of tax reform that has proven very difficult to approve but it has to be part of the solution and your Revenue if you look at the difference with the EUR area at the at the right it’s what 9 percentage points of GDP 8 percentage points around 9 8 percentage Point lower it was higher in 2019 it’s 1.3 percentage points lower now so your revenues at percent of GDP have increased in our in our view your tax system depends overwhelmingly on indirect taxes through b and on labor taxes through contributions so ideally those are areas that where the extra revenues should not necessarily come your corporate income tax is low creating an attractive environment for foreign investment there is some potential there your H real estate taxes are low there’s some potential there as well and obviously environmentally related taxes H those are also possible and will also address the environmental externalities now different options here have different implications in terms of economic efficiency some taxes are more distortionary some taxes are less distortionary but there is also a different impact on distribution some taxes affect low-income households more than other taxes so those are all considerations and trade-offs you will need to to address and and understand before but there is a potential to increase revenues while keeping a relative competitive environment economic environment and finally you had a as I said before you have a very strong and proactive fiscal policy that has proven to be very effective for Lithuania now your fiscal framework right now was discussed and designed after the GFC when you were a currency board now you are a Euro area member a member of a reserve currency so you are in some aspects you are an emerging economy but at the same time you don’t suffer the biggest challenge of emerging economies which is to manage Capital flows especially in times of crisis in times of Crisis the EUR is a reserve currency so you will benefit from the stability that that provides so there is room and your rule right now the Constitutional component of your rule will force once the output Gap becomes positive to move to a structural balance or Surplus I mean again we think that a strong fiscal position that delivers a proactive fiscal policy is necessary but you can a achieve that with not such a strong fiscal position so here we just provide a the trade-off of if you I mean a def a structural balance around minus 1% will deliver a debt level that is below 40 between 35 and 40% and will give you space to provide fiscal support in downturns without breaking the master criteria of B three and will there also allow you to rebuild buffers in in in good times so there is some room um that to not have to move to such a strong fiscal position also because the fundamentals of the economy and the part the fact that you belong to the euro area also suggest that you don’t need such a strong levels of of of fiscal strength but again Beyond this it will threaten the stabilization role that fiscal policy plays and the so so as San will discuss we have a table with all possible options and highlighting some of the possible trade-offs I’m not going to get into it but this goes over the four uh areas where where the solutions should come and it analyzes what are the measures what is the potential impact and also the tradeoff in of economic efficiency and distortions and in terms of distribution and I think I’ve gone a bit over time I apologize simonas right thank you um Mor if you don’t mind I think we can move on to the panel discussion and we will have a chance for a Q&A um at the end of it um so please welcome to the stage our distinguished speakers um Miss G Mr gmin shimkus B graia is already here and the panel will be moderated by vaa sh head of macroeconomics and forecasting division at the bank of Lithuania good morning does it work yes good morning everyone uh my name is via I’m the head of macroeconomic forecasting at the Central Bank of Lithuania and today we gathered here to hold a panel discussion on competitiveness uh lethania like many countries has faced significant challenges over the last few years after demonstrating resilience during the pandemic the economy was hit hard by the energy shock which was triggered by Russian inasia into Ukraine and subsequent sanctions since 2022 we have seen subdued income convergence muted GDP growth negative productivity as well as some loss in market shares as we have seen in the presentation before compounding these recent um shocks are long-standing structural challenges such as demographics uh limited Capital deepening as well as inefficiencies in uh labor markets in uh education and in healthcare these developments have raised concerns about the competitive position of liania and its potential for growth in the future so before we begin today uh I would like to go over uh some housekeeping items uh our panel discussion is going to take for one hour at the end of it we will leave 10 minutes for the questions from the audience I would like to kindly ask you to keep your questions brief and to the point so that we can take as many as possible uh I also need to inform you that governor of a central bank who is one of our distinguished guest today will not be able to answer any questions regarding monetary policy decisions or uh macroeconomic forecast this is due to the quiet period which which will last till the uh governing council meeting next week uh so we are honored here today to have three distinguished panelists who will provide us with a comprehensive view on lithian Expert performance uh productivity growth challenges ahead and uh strategies to enhance competitiveness on the global stage so please join me in welcoming our panelist I will introduce them once more uh Mr borha Gracia the head of international monetary fund mission for Le Mrs gas Minister of Finance Foria and gmin shimkus the governor of the Central Bank of lethania so without further Ado let’s start our discussion and I would like to address the first question to Mr Gracia as you’ve shown in your presentation and as we know from the previous IMF uh research lethania has demonstrated a strong growth in tradeables productivity growth sometimes even higher than in other Baltic countries uh what is your assessment what caused this really strong growth what are the reasons behind of strong growth in in lethania in manufacturing sector okay so I’ll Focus particularly in the period post GFC H where where um really it’s when produ productivity and the tradeable and the growth was led by increase in export shares and external competitiveness I think what has happened since then just to contextualize is that productivity the link between productivity and wages has been strong and what the theory predicted so it’s you’ve had significant increase in real wages but that was supported by productivity because at this time you were increasing the market sh it’s difficult to pin down why and especially because when you start thinking of the RIS some of them also apply to Estonia and lva so but let me highlight a few and I’m not going to provide a comprehensive answer but first I think to the starting point the GFC and and and the and the very significant performance since then when you when Lithuania entered the GFC there were the economy was going under significant imbalances but they were the smallest of the baltics yes the current account deficit was 10% but in Estonia it was 15 in lvia it was 20 yes the the savings of the private sector non-financial corporate was very large but in Estonia and lvia also the household sector before the GFC the the savings rate was very negative and in Lithuania really the household sector only joined the party the last two years before the GFC but before then there was not if you look at balance sheets the stren the the deteriation of the balance sheet the net Financial asset position of non-financial corporates in Lithuania was the the was the best I mean the the the iteration was not as large as in lbia and in Estonia so the starting point was relatively stronger balance sheets and the behavior of wages and and productivity since then suggest that the labor market in Lithuania was able to to a larger extent to determine wages at the firm level and so the link between wages and productivity had has been very important and wages have not deviated from productivity now this is important because Lithuania has when we look at manufacturing Goods exports one of the highest share of I mean it it overwhelmingly depends on low Tech manufacturing Goods I think it’s the if not the lowest second to lowest in the Euro area more than in Estonia lbia so price competitiveness for that part of manufacturing is more important and so the fact that wages where still linked to productivity it’s important because your wage level is it’s um it’s obviously um for those uh Goods is is lower it’s also true that we are talking about growth productivity growth and wage growth but also the level of productivity was lower so part of that higher growth is also reflecting catching up that in Estonia for example they the starting point in levels was higher so thank you for this very extensive ensive answer so I would like to invite you to move to the most recent shock now uh Russia’s war against Ukraine resulted in sanctions against Russia and Bas and in a actually significantly stronger price shock in lenia compared to the euro Zone average uh Minister I would like to uh pose this next question to you how has this situation and this shock affected lithuania’s exporters performance and competitiveness have they been able to find uh new uh markets new suppliers maybe I would start from the political answer because I think that the question is is wrong in in many reasons because I don’t think that sanctions are hurting our economy the Putin’s war is affecting our economy and the sanctions is the one of the weapons to fight the Putin’s war and without sanctions we couldn’t do that so effectively so I think that sanctions are inevitable but they are inevitable just because of the war so it’s a maybe a starting point uh that not the sanctions itself are hurting the economy but the main reason is a Putin’s war and without Putin’s War we wouldn’t have sanctions and wouldn’t have the impact that we we are having so the main reason is anyway it’s a war and uh looking at the consequences of of this war maybe there are two tracks one track is uh when we’re looking at the exports to uh the destion like Russia and and Belarus they were affected but I don’t think that they were so important um at the end of the day just because if you’re looking not at the bare numbers of exports to to Russia and Belarus but to the number of goods of Lithuanian origin that’s that’s the main issue because if you’re just re-exporting the goods from uh different member states to Russia and and Belarus uh it’s it’s it doesn’t make such a big difference to to our economy so if you’re looking just at the goods that were produced in Lithuania the be numbers were pretty pretty low so uh at Before the War uh the exports to to Russia was around 2% now they decreased to uh lower than half of the percent and if you’re looking to the belus before the war also the numbers were around half of the percent now it’s a quarter of the percent so it’s pretty low numbers and the impact direct impact from the lowering exports to those destinations I don’t think that we affected very much our economy but the main impact came from the uh energy crisis and uh I think that in some part of of of um the crisis we were prepared we were prepared because of a longterm strategy we do we did had the different possible ways to get the energy through LG terminal through the links uh to Poland and Sweden so we did had possibility to buy energy goods from whatever not from Russia and that gave us a possibility uh be the first country to stop buying energy goods from Russia after the invasion and I think that that was important for our resilience but at the same time we just understood that we are very very dependent on the Imports of of energy and if the prices in international markets increased very sharply because of Russia’s in actions in in the gas market uh in the gas market which affected the electricity market so the prices in Lithuania increased very sharply and we were among the countries we were which were affected one of the most in in EUR in Europe I would say and that gave us also the push to make additional decisions in in making our resilience and electricity uh in energy Market uh more ambitious and now we have a lot of new projects and a lot of ideas how to increase our resilience uh investing into the uh additional uh generation of electricity from Renewables and I think it’s really important our ambition now is to have in to have 2027 100% that electricity that we need inside the country produce inside the country and I think that will make us more resilient we do not have gas we do not have oil but we have uh Sun wind uh water so we can be like a independent island in the terms of of energy and I think that’s really important but uh to to do the final Point um the energy crisis affected all the countries in Europe uh maybe differently but affected really hardly all the countries and we we are seeing that the price of energy are decreasing after after the invasion and the prices of gas normalized maybe the prices of electricity are still a bit above the pre crisis level but if we’re looking at the at at the producer pricer price index if we took a basis of 2021 uh so now lithuania’s producers pricer index is stands at the same number as average European so that means uh it affected us but it affected Us in the same um in average in the same way at as all the other European countries are affected maybe it’s not the same to the external competitiveness to the other parts of the world but at least in Europe the European average is the same number as as a Lithuania thank you uh Governor how do you assess the competitive position of lethania uh and the market share developments what what is your take on that well it’s h quite difficult now to add something on after these two very extensive um extensive um answers but um so I’ll make a couple of remarks um sometimes we refer to ourselves as a small and open economy I don’t like these uh words not basically not the word open but the small we I like we what we are tight economy and uh tight in in many sense because uh many things which is happening uh are basically so to say uh are happening in a couple of in a couple even factories within the country so for instance when Mr borha was referring to growth of the financial sector growth of the exports of services so there are very specific reasons and even companies why this business or why the services were growing that fast for instance last year um getting back to getting back to your question on the on the on the on the competitiveness um yes last year we had a quite substantial contraction of of of goods but um uh according to our estimates and they made quite extensive estim estimates that are published in Lithuanian Economic Review very recent Lithuanian Economic Review published by the bank of Lithuania this is not because of the P of competitiveness reasons but because of his structural and some oneoff factors oneoff factors so this is this largely refers to the re-exports as Minister was pointing this is Putin’s War which uh which uh which was answered by by sanctions but of course in terms of your exports this uh this uh this this this led to the uh to the uh stricter trade controls on the fo countries and then eventually this had effect on on re exorts to the to the Cs countries so but I consider this as a oneoff factor and not like uh something that’s coming from the price competitors let’s take another sector for instance wooden furniture that suff suffered quite heavily in recent years or last year and the year before yes the the the the the the exports decreased but this is this was happening because because of what was happening in the overall real estate sector not only in Europe but worldwide it was shrinking it was sluggish therefore we need for specific so to say items for instance furniture or some other wood items was declined so we had the overall so to say decrease of of exports but this was structural it was affecting everyone and we have didn’t see that we we are losing Market sh here uh and actually Mr Bor was also showing a very interesting chart uh where you split the the decline in exports into demand factor and competitiveness factor and that was very specific lania that which was basically coming from demand two two two3 or uh three fours of it uh and not the price competitiveness so uh long story short we do not so far at least we do not see the loss of competitiveness of Lithuanian exports and of course it’s very much depend on the on the evolution in the future indeed so we see that the competitiv position of theia is is quite good so far uh so Mr Gracia um could I ask you if you see anything special about lethania in the past that allowed to absorb uh the significant input price increase and to some extent limit the decrease in market shares so let me first uh mention the the terms of trade shock so when I showed annual numbers so it was average over the whole year but if you look at monthly data the terms of TR sh iteration in Lithia was at the worst 20% in lvia and in Estonia they were basically almost Z or very small negative at the worst situation that implies that the pass through of but for all of them import prices they were all subject to the increase in import prices it was a slightly larger in in in Lithuania uh the price of import increase around 45% at the worst 40 in Estonia 35 in lva or close to or so that explains part and and and say in her presentation we go the details why H the price of import was more pronounced but I think you also address that in in in Lithuania but the economy has been very dynamic in absorbing that and adjusting to that already so if instead of looking at terms of trade coming from price of export and import which at end is a survey of Representative exports and imports and their prices and evolution but we look at um what it’s called I think unit value indices using custom data very high frequency data and and it’s like it controls for Price effects but also for volumes for quantity effects so it it will show an economy that is adjusting to the change in relative prices we see that using creating a similar terms of trade measure using that and adjusting for the quantity impact we see that that the in the case of of um of of of Lithuania the terms of TR the worst was a minus 20% impact that this only it’s less than half minus 8% and it’s very similar six and four for Estonia and lvia so the economy already adjusted to that now how could companies in in in Lithuania have much less pass through of import prices than in Estonia and laa part of it is that coming out of H so into 2022 before the war H the corporate sector in Lithuania look particularly strong in our me that there are several reasons first it as mentioned before it was already strong traditionally but covid had a less of an economic impact in Lithuania excluding Ireland which is very particular because it HS these global companies Lithuanian economy was the best performer of the Euro area in 2020 so the impact of covid in economic terms was not as big as we expected but the fiscal support then Expos one could argue was disproportionate obviously at the time the uncertainty was so big that it was but that meant that for example in our estimate the the strength of the balance sheet of the corporate sector was stronger in 2021 than it would have been without covid and that manifested in historically High liquidity as you can see in deposits at the banks which still is the case an increasing profitability in 2020 and 2021 that is very clear and it was also very high by historical standards the net financial asset position reached the best in in recorded uh since we have data and so those all were buffers that corporates could use to absorb part of that import so without having an impact on without having to pass through to exports also as I showed the fact that nominal wages did not increase did not were Nega I mean were below inflation was also a margin that allowed the helped the balance sheet of company is not to have to pass through as much now we are observing that real wages are increasing and now it’s profit margins that is absorbing the the the current shock and it’s still the the disinflation is still being H it’s still under way but I think that helps explain why companies in Lithia could absorb the the import price shock thank you uh so indeed uh companies were able to absor absorb uh this significant shock however nevertheless more recently we have seen the decrease in productivity growth uh and I would like to turn to you Governor now and ask how do you assess this most recent decline in productivity according to uh your assessment is it more of a structural or cyclical nature well when you see the decline ining productivity so it’s always uh you know something that which is worrisome and uh whatever The Economist when will eventually say if it is for structural or cyclical we decline in productivity productivity of the of the economy is something that you don’t like so that’s like the general remark and uh but uh and then this is mostly about the future so you ask yourself this is is this shortterm or is this longterm and how this will end up in in in in the overall development of the economy so far I dare to say so far we we we we we we think we value it that this is because of C that this decline in productivity is of cyclical nature and um and there are a couple of things which U let let us think in that way first of all this is the employment this is the labor market uh I think it’s still uh kind of not sufficiently recognized fact that the labor force even with this so to say sluggish economy in the recent two years the labor force increased to the levels which were preu uh accession and that’s substantial because we typically we talk about we typically we talk the about uh shrinking population aging aging population etc etc second is that uh unemployment rate as it was shown again in the chart is one of the lowest in the last 25 years so this labor force was employed so PE companies keep those people working even if uh average hours worked per employee are lower than they used to be before so this phenomenon is called Labor hoarding but is happening the question is why if companies would have believed that this is long-term decline in productivity do you think they will so to say risk the profits and uh keep those people employed I think the obvious answer is no so there is a kind of a belief within the industry within the economy the businesses that this is short-term decline second is that which the other factor that helped the company so to say to accumulate or or or that build the capacities of course this is the overall Financial stance as borha Mr borha was explaining is better than in the preco time but actually the profits in 20122 were elevated in the businesses and uh with the real wage growth being negative or subdued this uh this uh this made the labor force relatively cheaper uh than our production costs and the final Point why I do still still think that uh productivity decline is cyclical this is the Investments again if you don’t believe in the recovery of your economy in in the recovery of the demand of your production so you would not have made the investments into the expans expansion of businesses last year total Investments and to and private private Investments non presential I stress here are highest since the global financial crisis so for me all this creates the environment in which in which I can say in business there is a belief of a temporary decline in productivity and I see them preparing for for a spring uh once we demand external demand in particular comes back and the second and the last thing uh I want I don’t think I don’t know I don’t know if this is the right uh in the right uh place in in terms of in sequence of a question we too little talk about the and that’s what I can’t pronounce but um I try entrepreneurship of Lithuanian economy and Lithuanian businesses it’s high and that’s the third reason I believe that uh the decline in productivity is is um is temporary thank you again a very extensive answer to the question would the other panelists have anything to add on how worrisome could be the recent uh downturn in productivity I think that the main debate about productivity is when we’re starting to debate about the wage growth and especially when we’re starting to debate about the minimum wage level uh so uh I I I just want to say that we have seen the wage growth rate in Lithuania around 9% in the recent decade for for 10 years already from 2016 and every year we have the same debate about is it uh the dead end or we have to do something so from from my perspective what is the final goal we are looking for is it competitiveness itself or do we need the uh healthy uh Rich society and competitiveness is just a weapon in in in a fight for for that so in my opinion yes the rich Society is the final goal and we must look at the all components of the competitiveness just because we need the rich Society so wages itself cannot be the the thing we are fighting against so we are fighting for the high wages but we have to have stable economy to to reach that so I would say that uh from uh in the recent uh uh three years uh the wages grew by double digits every year so and every year we have the same debate about competitiveness and I still think that the Lithuanian economy is healthy and we can absorb such a level of uh the wage growth until this moment yes we have to invest a lot into our productivity but at the same time the wage growth is also one of the drivers of the investment into into the higher productivity because if you’re feeling that you’re paying too much for your workers you have to have additional value from the same the same U uh labor force so I would say that at at this moment so we are seeing that the investment as Governor said uh at a pretty high levels and the the firms are investing into the higher productivity and to maybe to the final point that where do we need to be competitive that we need to be competitive where we are competing so we are competing in their external Market and as as Mr Bor has said uh in a tradable sector more or less competitiveness and and productivity are more or less in line with the wage growth so um I would say that our external competitiveness is at a healthy level precisely now but we should not sleep at this moment and do a our job uh to keep investment high and and to keep our competitiveness at a at a healthy level let me just a couple points I we as we have a similar assessment um just in the last Point our assessment last the last few years has been that in exporting sectors the wage growth has been consistent with productivity and that has and high productivity and that therefore has supported High wage growth at the same time as you were gaining export shares so on the labor holding we also have the same if I can just go on a bit of details why we think that is happening partly the governor mentioned it the expectation is that this is a temporary shock so you don’t react with drastic employment decisions if it’s a temporary shock especially because there is a scarcity of skill labor and particularly because the the issue of of uh skill mismatches in the labor market and the issue of there is a mismatch also of what the skills that the especially tertiary ation system produce and the labor market demands means that the labor force is it’s scarce for companies they invest in human speci firm specific human capital and so if the shock is going to be temporary firms will hold to skill labor will reduce the intensity of the labor so it’s almost an automatic it’s not really real productivity that this is showing and then we also expect that particularly in manufacturing where this is more the case the recovery will come without a strong employment increase because first it will increase the intensity the use of intensity having said this in the fund we are paid to worry so I would have to say yes it’s largely cyclical we expect the productivity labor productivity to pick up as the recovery gain space but there are several bats and it’s the world once the situation normalizes now is not the world pre war in Ukraine geopolitical risks are higher particularly in this in this region interest rates are going to be higher for while and in in Lithuania you are impacted by both the perception of risk that it’s higher in this region and the higher policy rate so the cost of capital is going to be higher than it used to be for quite a few years GE beyond the region there are a fragmentation risks going forward of World Trade has seen an significant integration over the last few decades but there are some question marks about increasing fragmentation in the world that will if they materialize or depending on how fast and how strong they materialize will have an impact on total Factor productivity around the world and we were saying part of the reasons why firms were able to absorve this shock is buffers that they have used but then eventually they will have to rebuild to address the next shock so those buffers are are not exhausted but are are are reduced all those factors are challenges that were not there to years ago but are there now so er my my bottom line is we cannot just I mean the there is there is a need to continue support this productivity growth I guess we we will have an opportunity to to discuss that further in the panel but uh to support because at the end the only way to to support High wage growth in a way over time eventually has to be through higher productivity on the sectors where you compete uh indeed uh thank you for those uh free answers to this very important question uh I would like to go back a little bit now to the labor market and indeed uh we have seen very strong uh nominal wage growth in the recent years and uh as uh we’ve seen in the presentation we are seeing real wage uh growth recovery already and in if we look in the future forecast we are likely to see quite significant real wage growth in the future as well so I would still like to uh discuss a little little bit about this risk how worrisome is that and how it could affect the competitiveness of fanian exporters and On a related matter also maybe what the state should do with a minimum monthly wage for example upet everything what I think about the high wages uh the minimum wage yeah we have the debate every every year and we have different uh decisions made in in the past U but at the present moment I just wouldn’t like to intervene a lot just because we have the procedure when the bank of Lithuania they’re suggesting uh the uh number according to the formula that was previously used and we have that trialogue between unions uh businesses and and government uh discussing about all the outcomes that might uh be uh after the decision will be will be made so I would say that we still expect the the agreement between these three parts and if they will agree on on something last year they agreed on a certain number so uh we are the ones who will uh implement it but if there will be no agreement I think we will look at the numbers of the labor force of the economic grow perspectives um about productivity competitiveness and government will make the decision together with a with the uh process when we will prepare the budget for 2025 but at the pro present moment we still wait for the agreement because I think that social dialogue was really important uh when you can hear all the arguments from different sides and to have your informed decision if there will be no agreement so they still in a process so the wages in Lithuania in the last decades are growing by almost 10% on the average and when I say this to my my fellow colleagues at the other central banks they are shocked that’s substantial growth we should we need to admit that uh according to our March projections uh wages this grow this year will grow by another 10% and if the productivity declining last year and the project according to March projections to increase by almost 2% unit labor cost will growth of unit labor cost will decelerate but will be substantial 7% so what to do the question is and then I think we always try to compare us to this golden average which is EU average so we are definitely approaching EU average according wages but there’s a gap there’s still quite substantial Gap and this Gap is bigger than we lab a productivity Gap to the U average even if it is closing step by step okay then why we are surprised by all this we join the EU for what reason to compete being cheap labor country or we want as Minister said welfare and well-being Rich Society so if you want to live as in Switzerland or any other as in Spain you need to have an economy function more or less at those levels as those economies if you want to compete with countries where textile industry is dominant well we shouldn’t think we shouldn’t talk about high wages then and wage growth so we shouldn’t be surprised by the rise of unit labor cost eventually because it’s inevitable it’s process of convergence having said all this we put so much emphas emphasis then on price competitiveness and too little on nonprice competitiveness and the Richer we become the nonprice competitiveness factors become important and Mr Bor was mentioning skills mismatch uh we could have better so to say system of Education aging Society many these structural factors but they are very important if we think of ourselves in 20 years years from now or even more and uh I think uh this nonprice competitiveness targets goals are a bit out of the agenda of the political agenda but they should get there if you want to so to say if you want to live as any other rich country you should think what those countries are doing and move uh uh to the business or country’s model business sorry economy model as those on minimum wage we here in the country we talk that much how minimum or by how many by by how much the minimum wages should increase next year but the and by this we lose the so to say the oversight why this minimum wage is growing and minimum wage is set in various countries for different reasons in one countries where you have like 80% of population working for minimum wage and high un employment I mean you just control you know the overall level of wages in in that economy is that the case of Lithuania no I can’t show you the chart which is one of the best in that respect charts produced by the bank of Lithuania sorry for promoting the bank but it’s the chat that shows how the wages are evolving over the year in different Diles of uh d St um or categories of people by wages so what we clearly see that wages in this economy in this countries are growing no matter if we increase minimum wage or not so increase of minimum wage is a must to catch up the growth of the average wage in the country why otherwise you would you will have a certain percent of the population which is working for many minimum wage which is not growing because they are V vulnerable part of our society and very much agree with the minister who says that I I rephrase it a little bit this is a a measure of social policy rather than so so so to say setting the wages in the country as such and uh they made my colleagues at the bank of lituania made a very extensive research on the on the subject and what we clearly clear saw that from 2010 to 2019 the increase in minimum wage Shrunk the income inequality by one3 and this effect became even stronger when minimum wage start started growing faster so as I said I believe that I don’t I look at the minimum wage and its increase from the perspective of that this is the measure of income inequality reduction as a measure of social policy and um and um yeah so thank you uh moving forward and now looking into even further future uh Mr Gracia I would like to uh give a word to you now uh could you uh reflect a little bit on the factor that could lead to a structural increase or decline in in productivity I can’t resist making a comment on minimum wages sorry of course I I wanted to provoke [Laughter] you after all it’s the last time I’m coming in my official capacity right so no just to say in Lithuania when you look at for example the impact of fiscal policy in terms of redistribution we haven’t looked at the numbers lately but when we look at that the main Tool uh for redistribution is the pension system so there is this it’s true that since then this was probably 2018 since then social spending social programs have increased significantly and they have become more targeted so maybe the the component of redistribution is different now it seems that since you don’t have a very strong fiscal policy in terms of redistribution you use other tools like the minimum wage I’m not sure if it’s the best most efficient tool to reduce in equality and I just want to add a couple of points of skepticism of some unintended but not unexpected consequences of minimum wages that are high relative to average wages um when you look at the impact of the minimum wage it’s true that the incidence how many people are at the minimum W is relatively small depends on the region depends on the sector but it’s not significantly high if you look at the minimum wage relative to the average weight not at the aggregate level which is the way it’s determined but either by region by economic sector or by age of the employee there is quite a strong correlation which correlation is not cation but there is a strong correlation between the average the minimum wage to the average wage in each of these sub sectors or component and the unemployment rate I think the minimum wage sometimes especially if it’s discussed in vus it tends to underweight the potential impact at the margins that in regions with much lower average wage than the national or for sectors of the economy or ages of Theon workers and that that impact can be much bigger and can have a very Distortion impact and it would be on those that more that need more to be employed and the impact would be obviously higher an employment in those in those sector so that’s where so our point we understand that there is a legal constraint in in in in you cannot have minimum wage in a discriminatory Way by regions or by ages but we understand also that it could be possible to have it by by industry maybe different minimum wages depending on the industry or now in at the European level the is a a proposal to start linking also minimum wage to some measure of productivity now those the discussion is starting but I I think those would be uh steps in the right direction going back to your your question as I said before there are some characteristics of of of Lithuania is that in terms of manufacturing you have a high share of low Tech manufacturing exports on Services is the opposite or at least the growth in Hightech Services has been really what it’s been driving um that sector so let me take I mean I think say will cover this in more detail and and actually uh one paper that it’s coming from San it’s on on the drivers of productivity growth there are some factors that that are positive in the case of Lithuania for example obviously the level of productivity is still far from the frontier and so you will benefit from being able to adopt Technologies and that are already there and so being far being your productivity level being low in a way allows you to have higher productivity growth to catch up because uh adopting new new technologies also investment in in ICT information and communication Technologies seems to be correlated to higher total Factor productivity growth and that’s a a sec particular where investment in the last few years the last three years has been the second highest in the Euro area again from a low level but that those are but I think the governor was right there are non price competitiveness other factors the business environment the regulatory environment definitely the labor market is very flexible but there are still structural issues the high skill mismatch the education system really H we hear that it’s not just not widespread but not also that anecdotal that people with tertiary education then have to go into vocational training so you have invested money and effort and resources and years at the prime age of people that then acquire some education that it’s not you not demanded in the labor market all those factors definitely uh need to contribute but if I may also a step back because uh I I’ve always felt that in Lithuania you have like a very not very optimistic uh perspective of yourselves where the previous performance or future one one of the things why we wanted to show this longer term perspective of performances if in the next 15 years you perform like you have performed in the last 15 years your convergence will continue so it’s not that you you are a success story of course you are still below the European average still a lot of convergence in wage levels in price levels but I think I’m going to use some cliche formulas but there are two that come to mind one is I think it’s in the medical profession is do not harm first do not harm well the there there is a success so far let’s just make sure that whatever you do going forward doesn’t uh eliminate the factors that deliver that success and the other which is related is this thing of if in broken don’t fix it so things don’t seem to be fundamentally broken definitely because there has been a success and what are some of those are more qualitatively but I think one of the lessons in Lithuania was the GFC was an opportunity a crisis that was used as an opportunity your framework improved significantly I talk about your fiscal framework that has been a source of stability that has been very important labor market flexibility with all the shortcomings we’ve just discussed has been very important The Firm level termination of wages has been very important to to support this this performance you need those flexibility from fiscal policy and the labor market because you don’t have it in the exchange rate you had a framework that in terms of Economic Policy I’ve been coming seven years as you mentioned with the previous government with the current government in many countries in Europe You observe that what the first thing a new government does is undo first undo everything that the previous government did and then and subsequently governments do the same here in Economic Policy there is a broad consensus of course every government has different emphasis but there is an over consensus and continuity so there is a lot of predictability in the policy and that provides a lot of stability those are Euro area membership also it’s very important source of stability H in terms of the policies your macroprudential framework has been very proactive and again you need that because you’re you are an open economy a tight open economy but you are subject to all shocks in the world because you are very open to the world and so all those should be preserved and so anything you do I don’t think you need to do reactionary policies you things seem to be working reasonably well so the first thing really going forward is to build on that success so risking to be a little bit pessimist again I will ask Governor now whether you see some challenges which which could actually leads to that uh structural decline in productivity or maybe lower growth in the future depends what you what you consider as future shortterm or longterm uh I very much agree on these short-term uh factors there are many things where that are underestimated and I think in the IMF presentation you’ve seen seen it uh quite quite obviously aging aging demographics uh for instance skills mismatch in in many sense again this was touched upon and uh and uh the other thing we lack investments into Innovations yes we are proud of the fub uh or being a fchub country but this is one specific so to say field of the economy what about the others what about the investments into research and development what about the private and public sector collaboration on Innovations because this is something which is done in the economies which is of rich people and Rich Society uh so these are I think uh these long-term factors which is uh need to be taken in account it I think it’s much easier to say than uh than to do because uh problems are typically solved and they appear and even if strategically one could could elaborate how we should so to say take everything into account what’s 50 or 100 years ahead we fight with climate change I think this is the obvious example how shortterm uh view of people can predominate and uh predominate but getting to so to say to a shorter perspect perspective and even if I I discussed that decline in productivity is cyclical and short maybe temporary but if we subdued demand continues I would consider this as a as a risk to to to our productivity uh we live in in very uncertain times uh we Still project according to our March projection projections the recovery in the economy this year and even more next year and the year years year after but uh in these uncertain times in many cases projections they were not so to say exact as the reality was so I would still consider that there is quite substantial risk of the sub subdue demand and this in this then eventually you know if it takes longer than expected we talked about that companies keep people they invest but if something wrongs goes wrong you know and the economy became sluggish for too long it is a risk for for for productivity uh thank you we yes should have said an and the the words of the governor remind me I think all the micro elements and all the investment I fully agree but the biggest challenge in the next 5 10 years is really how to address those spending pressures because at the end a lot of the decisions that will be made will determine whether that microeconomic stability fiscal sustainability predictability all those things depending on how to address and when to address those so that’s the biggest challenge and that will determine a lot of how the business environment the predictability of policies and things and all that obviously with elections in October it’s the challenge that the next Parliament and the government that comes out of of those of that election will have to face but it’s going to be only an increasing problem it’s already felt and it’s been accelerated because of defense and interest expenditures but it’s only increasing over time and and at an increasing Pace uh as we’re uh moving closer to the end of a discussion and we already delved already a little bit into the strategies and policies which work and we should not change them I would like to address this probably last question to you Minister uh to expand a little bit on those policies which has worked in the past which uh should be pursued in the future in order to increase productivity in order to uh achieve a a resilient economy in the in the future having in mind all those challenges we have discussed here shortterm and long term if we talk about the something what was in the past I think that yes Lithuania is a success story and our growth was impressive from the accession to the EU and part of that success was a uh prudent policy of Lithuanian policy makers but at the same time The Prudent policy of the businesses of Lithuania because if we have a lesson we learn a lesson and if we had the Russia crisis we have annexation of Crimea uh the export to Russia decreased D dramatically and we do not depend anymore on on the Eastern markets the main markets for Lithuania 61% for Lithuanian origin Goods it’s European Union uh 9% it’s us and 5% and more is UK so 75% of our Lithuanian good exports is to a predictable markets and that’s that’s important I think that gave us strength and more predictability in in everything we’re doing uh another strong strong point for Lithuania is our prudent policy in in energy sector uh we do not have a Reliance on deliveries of energy Goods to Lithuania and that’s also the success story The another success story that is still waiting us is a um growth of the renewable part of the energy and then we will be independent from the Imports of of energy from the other countries that’s something that makes us resilient if we’re talking about growth and growth of the productivity of of Lithuanian labor force I would say that the main question is maybe physical capital uh human capital and also Innovation so when we’re talking about the investment level so we are trying to use uh prudently our European funds so 8 billion from 25 2127 uh perspective will come in in Lithuanian economy 2 billions this year and also recovery and resilon funds 2.2 billion from subsidy side 1.7 billion from the loans and uh one of the newest measures uh that we’re doing it’s 1 billion for businesses from the same recovery and resilience fund um loan we are making the uh loan measure for the businesses that are tended to grow so they are big businesses but they’re Innovative they are green they are digital so I think that’s the main weapon we can give them to to grow because they have all the um uh reasons why they are growing but at the same time they have a lack of capital and that’s where we can help also we uh made a major reform during this uh our term our government term so we are uh Consolidated four uh National development institutions that we had previously in Lithuania so now we have one strong uh development not Bank fund institution but it’s really important that we gave them muscles we gave them Capital we gave them uh additional funds to give the loans to businesses and I think that will make the impact especially to the B businesses that are they they have capabilities to grow not the the those who are weak but for those who are strong and might be stronger so I think that’s that’s really important and human capital um yes it’s also one of the questions that are tough questions and difficult to answer and the answers that you are making will make the impact not tomorrow not the day after tomorrow and not even in in a one or two or three years so it is really difficult to make a difference when when the actual outcome will be much later uh but I think our government made a lot of in in all the levels of education and the education levels which sometimes we do not think about for example like uh preschool uh level kindergarten accessibility to kindergartens which make a huge difference when we’re talking about the uh productivity in the longer term because these people who are attending kindergartens they are uh their gains in in a longterm perspective they are much much higher so all these reforms they are giving the effect but it will not be very fast also the um schools uh reform via Millennium schools program also vocational uh uh education now reform is made also higher education reform so a lot of reforms which are not very popular but at the same time the impact of it will be will be will be later but I think that those are the um steps into the right direction and I think they will make their impact in a in a longer term uh thank you all for those insightful and thought Pro voting contributions and we have covered a lot of ground and I’m sure that now the audience must have some questions which panelists would be happy to answer yes please um I’m Mar scant from The Institute of international relations and political science first of all thank you for the presentation and for the discussion uh these were very interesting and and and and useful I have a question about um the structural features of the economy uh structurally uh the Lithuanian economy is dominated by low technology manufacturing and and less knowledge intensive services such as transportation services um these sectors uh and structure structurally the economy probably has some ceiling for productivity and and wage growth uh how high this ceiling is in your opinion and uh a brief uh second question is uh uh these uh cyclical developments you have all uh described and and mentioned how uh what pressures these developments can exert on structural changes because the structural changes as we so far see hasn’t changed uh much during like recent decades so we have like quite stable uh structure of the economy so thank you so it’s true that manufacturing has a very large share relative to other European economies of low tech technology low Tech sector it’s also true that the economy as part of the convergence Stories the share of manufacturing is rink and the share of services is increasing and the good part is that the increase in the share of services is mostly in the Hightech part now one point I didn’t mention when we were talking about the pass through on export prices is that the fact that there is on Goods this low Tech manufacturing is is a sector that depends more on price competitiveness and that also explains why companies needed to absorb the price shock more than for example in Estonia lbia where the share of low Tech manufacturing is low and therefore they can they don’t depend as much on price competitiveness right but the that and that the the trend of the structural transformation is happening and actually for example you can also see in the employment share Services is increasing the employment share manufacturing is decreasing uh the employment share and so I think that is happening as you you would expect in a gradual way for a converging economy and it’s also true and we look at this actually during covid that shocks big shocks that heat manufacturer intend to accelerate that transformation in the sense that for example for in the labor market um shocks that hit the sectors of the economy that are decreasing their labor share there is a further decrease in in in employment beyond the the trend that it’s never recover so it accelerates that process that’s why but one special fact of of covid was that the in relative terms it was manufacturing which is normally the the the sector most affected in big shocks was the least affected during Co because it was the essential sectors that were never locked down and so the that didn’t that transformation didn’t accelerate then let’s see what has happened after this episode maybe what we are we will observe out of this is a slight acceleration of that shift the structural shift in the economy which is something that we could predict but at the same time and contrary to other crisis in the past we’ve argue the labor market has performed particularly strong so maybe this time around that has not that has not happened but the expectation is for that to continue with cyclical variations but really the trend has been there for for a long for a long time very good question but uh I think um you asked this you asked this in a very deterministic way what are the ceilings for wages for wages given the structure of the economy but this the the we are bounded by the territory and most likely by the amount of people we have and we agreed with we have aging population this already fact so there are some so to say predetermined factors that will affect the evolution he has stressed the word evolution of our economy but the economy itself will evolve therefore I’m not that much afraid of increase of minimum wage because with the growth of wages this makes the factor to make a change to our economy not by the government or by institutions by the businesses themselves for instance according to the OCD study risk of automation is one of the in Lithuania is one of the highest this means you could look at this from the positive and negative negative side so there are plenty of opportunities to automate businesses and to to to to arrive at a higher productivity in the in those businesses that’s good on the other side we have one of the highest mismatch between uh needs in industry and uh and labor force and the people laid off from those businesses that started automation what when I going to do with those people if we keep wages low in the country so most likely will will be hired by by the companies which produce lower lower lower lower value added production but if we think that increase of wages and automation moves the economy itself into the production of higher valuated production I think this is how the economy could evolve and here as I said we are we are living in sort in in in in in limit in bounded Eon in bounded country like territory bounded by number of people etc etc this means it it evolves evolves means that you have something new something growing and something you know leaving the market there’s going to be bankruptcies but this leaves this moves into a higher level of the well-being of society so therefore you ask a deterministic question question but but I can answer it’s infinitive my answer is infinitive wees grow wees grows growth grow with the growth of economy changing economy if it doesn’t change it’s most likely we’re going to be we going to see the limit but I I’m optimistic about the economy itself we are a little bit behind the schedule maybe one last question yes yes of course uh hello uh agita from the research center of the bank of liania I have a question to Mr Gracia um about essentially The Firm dynamism role on competitiveness um in the last year there are a couple of raw facts so uh last year the number of bankruptcies in Lithuania increased by 20 20% uh more than actually than 20% and also uh uh there was a record number of businesses registered uh probably the highest in the last two decades uh what are your thoughts on these channels do you think they are important for uh increasing the competitiveness of uh uh the leenan economy and uh uh are we exceptional uh in this this way uh maybe compared to some other countries so I just linking to what the governor just said there will always be bankruptcies and because the economy is evolving is converging so there will be industries that are that are not viable anymore because of loss of price competitiveness if they were depending on that so that is not uncommon now the the issue of bankruptcies we need to be careful because in 2020 in some cases it was actually not possible to issue to register bankruptcy so but in general Co basically H reduced the number of bankruptcies across countries particularly also because companies that were going under difficulty whether for covid or non-co but were supported by the public sector so we actually H look at this H from a balance sheet perspective the transfer of losses from the non-financial corporate and households but in this case non Financial corporate to the public sector across Europe was very large and that help and that an administrative constraints on actually being able to is bankruptcies um meant that that the the the the number of bankruptcies fell significantly in 2021 now the fear when the economies reopen was whether once they reopened a lot of companies were going to go bankrupt again from the macro level we observe that since so the the losses of the private corporate sector had been transferred to the public sector from a aggregate balance sheet perspective across Europe you didn’t see that the the balance sheets were actually strong in general at least they hadn’t deteriorated and in some aspects particular liquidity and leverage they had part increased they have improved and that’s what happened really so what I think the increase last year it’s largely due to a base effect a low base effect two years ago rather than a structural issue that is happening now when you have a flexible economy it’s the same with the labor market there are in a flexible labor market there are a lot of new entrance and new exits so there is a lot of people that lose their jobs that if it’s that’s the only thing happening that’s a problem but if at the same time you have a dynamic economy that adjusts quickly to changing economic developments you also have a lot of new jobs created and I think that is the the the two sides of the flexibility um so I don’t see necessarily the issue of of you can have both a large amount of bankrupcy but new firms uh registering as I mentioned before using the unit value index it seems to suggest that the economy in Lithuania the corporate sector tends to adjust quite quickly to Big shocks and in this case to a big relative price shock and that’s good but that will manifest itself into a lot of new entries and a lot of exits as we draw uh this discussion to an end I would like to give a special thank you to our panelist and to audience for your excellent questions and your active participation uh to wrap up it seems that Leia once again has demonstrated its ability to be resilient amid significant shocks and let’s not forget what helped us to be resilient before and to have the same energy and capacity to navigate between those structural shocks in the future thank you [Applause] again thank you very much so we will now have a coffee break coffee is at the back of this room and we come back at 11:20 for the following presentations thank you e e