# **II. THE BUSINESS ENVIRONMENT AND THE LABOR MARKET PERFORMANCE**

_Do countries with better business environment have better labor market performance? Which institutions are most important for a good employment record?_ Those are the two very important questions this section attempts to shed light on. We proceed in two stages. First, we perform a **graphical analysis** of the data in order to explore possible correlations between the investment climate and labor market outcomes. Second, **multivariate analysis** is used to estimate the contribution to employment of the different institutions considered here.

# **II.1. A first approximation to the data: bilateral correlations**

The first approximation to the data comes in the form of simple scatter-plots of the different dimensions of the business environment previously described against service employment rate, purged from the GDP per capita.<sup>7</sup> The rationale is that service employment rate is a good proxy for employment created by the new private sector since it is the only sector increasing its share of employment in all transition countries. It is also where new business opportunities can be mostly found. To separate the effect of economic development from the direct effect of the business environment institutions on the growth of the service sector, we use a corrected measure of service employment rate which controls for the GDP per capita.<sup>8</sup>

# **Box 3: Why do we use service employment instead of total employment rate as a labor market indicator?**

The focus of this paper is the employment generated by the new private sector. Hence the service employment rate is a better labor market indicator than the total employment rate.

The reason is that total employment is the sum of employment created by the public and by the private sector. Countries with a large public sector have, in general, a large total employment rate, which can be compatible with a bad business environment. That is because public employment does not respond to any of the business environment institutions we are interested on in this paper.

7 The service employment level comes from the ILO database. It is the sum of the employment in the following sectors: wholesale and retail trade; repair of motor vehicles, motorcycles and personal household goods; hotels and restaurants; transport, storage and communications; financial intermediation; real state, renting and business activities. Hence we do not include employment in public administration and defence, employment in education, health and social work and other community, social and personal services. The reason is that employment in the latter sectors does not come generally from private initiative, which is the focus of the paper. In most cases data are from Labour Force Surveys, which ensures comparability. However, for the following set of countries the data source is official estimates: Azerbaijan, Bulgaria, Kyrgyzstan, and Uzbekistan. The service employment rate is calculated as percentage of working age population (15-64).

8 To control for the economic development we run a regression of the service employment rate against the GDP per capita. The residuals from that regression represent the service employment rate NOT explained by the development of the economy. The residual is what we call the “service employment rate controlled for GDP per capita.” 10