Structural Reform challenges in SEE countries

1. Structural Reform challenges in SEE countries BoG – Oxford Uni Conference on: “Achieving sustainable growth in South East Europe: Macroeconomic policies, structural reforms, socio-political support, and a sound financial system” Athens, February 11, 2011 Dr Tassos Anastasatos Senior Economist

2. A definition of structural reforms • Structural reforms: Policy measures that reduce or remove impediments to the efficient allocation of resources in order to promote long-term growth • Definition includes: competitiveness enhancing measures, fighting of oligopolistic features in product and labour markets, restructurings of organisations to increase their efficiency. • Structural reformsaimed at promoting domestic financial development and trade liberalization, can be important components of a strategy to invigorate economic growth (McKinnon1973, Krueger 1997, Henry 2007) • “Structural reforms are a more elusive concept to measure than standard macroeconomic policies, where gauges—interest rates, liquidity measures, or the budgetary balance—are typically readily available for most countries” (IMF, 2008)

3. Structural reforms and the SEE region • Structural reforms are in the narrative of the SEE region for a long time, given the transition from a centrally planned economy to a market economy. • Objectives of structural reforms pertaining to SEE countries: Transition to a market economy, integration into the world economy, diversification of the production and export bases, development of the financial sector, promotion of “high quality” growth, quality of institutions (budgetary and social security, the Central Bank and financial regulation), governance issues (IMF, 2001) • SEE had gained experience in adjusting to structural changes; this helped to escape the crisis relatively unscathed and can prove valuable in the future.

4. Structural reforms and the SEE region • Grouping of countries with dissimilar characteristics and structure of their economies, and thus with different needs, is inappropriate but there are features common among them. • Pre-crisis growth model: rapid growth (avg 7.4%) based on domestic demand, fuelled by capital inflows (optimism about future prospects) and consequently rapid credit growth, expansion of consumption and real estate, overheating, real appreciation, external deficits / debt; policy making centered around the objective of integration with the EU and convergence, EMU goal provided anchor for policies. • Present situation: inflows slowed down, below potential GDP growth, uneven speed of economic recovery across economies, supply-side inflationary risks, unemployment remaining high but with stabilizing labour market conditions, personal indebtedness & lower incomes, banks’ consolidation, fiscal consolidation efforts but most countries in the region in a much better shape compared to their EMU peers. • Ensuring access to the financial markets and promoting medium-term macroeconomic stability will necessitate step up of fiscal consolidation efforts. • In an environment of fiscal consolidation, slow recovery of price competitiveness, bank lending and risk perceptions, structural reforms are even more critical for increasing potential output, which was harmed by the crisis.

5. Structural reforms and the SEE region • Along with the recovery, imbalances are returning too: current account deficits are on the upside, gross financing requirement is a concern in some “IMF” countries and exchange rates face jitters. • This should strengthen the resolve of SEE countries to precipitate what would be unavoidable and desirable anyway, namely a switch to an export-driven model of growth. Convergence: less quick, more sustainable • All structural reforms should be judged on the criterion of how they improve export performance. • First structural reform is fiscal consolidation: crowding-in of exports / investment, reallocation of expenditure away from counter-productive public consumption . • Short-term: adjustment of wages to productivity (e.g. better bargaining systems, reduce oligopolising of product markets and wage rigidities) - especially if pegging to avoid real appreciation • Medium-term: motivate production switch from non-tradeables to tradeables, especially in countries where FDI was focused on real estate and financial services • support credit for SMEs, control mortgages, land to firms, educating entrepreneurs, reducing bureaucratic burden on entrepreneurship, some tax exempts (but no subsidies or protectionism)

6. Structural reforms and the SEE region • Longer-term: sustainability can only be achieved if SEE countries move away from the current medium tech model of production. The increase in the standards of living means that the region will not be able to compete in terms of low cost indefinitely. • Instead, it should pursue in a coordinated way to switch to specializations that embody a higher technological content and hence a higher value added, in other words enhance its quality competitiveness. • Value of exports has increased but they mostly concern parts production of medium-high technology • This is no easy task and it will require large investments in education, training, machinery and R&D. • However, there are more immediate measures that can help in this direction and which bear little or no fiscal cost. • Many countries in the region suffer from an anti-productive public administration that deters FDI by increasing the time, compliance and tax burden.

7. Structural reforms and the SEE region • Rodrik and Subramanian (2003): quality of institutions isthe most important factor in in increasing TFP (50% of growth). • Measures: enhancing the rule of law, fighting bureaucracy in launching and reallocating entrepreneurial activity, protecting property rights, simplifying legislation and making it more transparent, fighting corruption and multiple local and peripheral jurisdictions in business-related policymaking (veto points). • These reforms especially benefit the more efficient (and thus more cost-alert) high-tech sectors which are also more desirable as they can produce knowledge spillovers to local businesses and spur the quality transformation. • While those measures also reduce fiscal costs, their implementation is a politically complicated process: institutional provisions necessary to facilitate the adherence of policymaking to the longer run, beyond the political cycle. • Regional policies will be needed too to protect cohesion. • Addressing ageing (problem worse than Western Europe) also preserves competitiveness as social security contributions weigh heavily at production cost: policies to increase participation in the labor force, human capital-enhancing policies • ECB (2007): countries that follow quality improvements as a strategy to converge. experience RER appreciations. Therefore, applying for monetary union prematurely in not advised.

8. II. Structural reforms in retrospect 1989-2011 Transition Indicators average score per year Source: EBRD Transition reports Scale 0 to 4, 0=low progress 4=high progress • EBRD Transition indicator: survey of managers evaluating countries in the areas of large & small scale privatization, enterprise restructuring, price liberalization, trade, competition, banking & interest rate liberalization, securities markets, overall infrastructure • Countries have made great progress since 1989. However, the rate of change has slowed down in recent years.

9. III. Structural reforms in times of international financial crisis-the global view Source: World Bank Doing Business 2007 and 2011 Reports, processed data • According to Doing Business reports, 100% of SEE countries had at least one reform during 2006-2011 with the exception of Romania and Serbia during 2008, and of Turkey during 2010.

10. III. WB Top-ten reformers in 2004-2010 World Bank’s Ease of Doing Business Source: WB Doing Business Reports • Individual SEE countries scored well in the boom years 2004-2010

11. III. Cumulative change before the crisis Doing Business Change Score (2005-2007) Croatia Source: Doing Business 2006 and 2008 Reports, processed data Bulgaria FYROM Romania Bosnia Serbia Albania Turkey • How individual countries rank compared to all other countries in terms of change in business regulationscores.

12. III. Cumulative change during the crisis Doing Business Change Score (2008-2010) Source: Doing Business 2009 and 2011 Reports, processed data FYROM Croatia Serbia Albania Bosnia Bulgaria Turkey Romania • FYROM moves up the pack, Albania and Turkey maintain their relative position, others fall behind

13. IV.2 Mixed picture in the Ease of Doing Business rankings 2007-2010 Source: Doing Business 2008 and 2011 Reports, processed data

14. Serbia Bulgaria Croatia FYROM Romania Turkey Bosnia Albania IV.2 Areas of improvement in Ease of Doing Business Performance indices normalized to account for the relative change within the whole group of countries: scale 0 (lowest) to 100 (best)-50 average Source: Doing Business 2008 and 2011 Reports, processed data

15. IV. The catalytic role of IMF programs • Structural conditionalities in IMF-supported programs may play a role in spurring structural reform (Ghosh and others, 2005) • Literature on IMF conditionalities: [Vaubel (1983), Bird (1984), Diwan and Rodrik (1992) Collier et al. (1997) and Dreher and Vaubel (2004)] • IMF conditionalities: • lend credibility to the programs • induce governments to pursue policies they would not have chosen without the offer of financial aid • solve the IMF’s selection problem in environments of asymmetrically imperfect information (adverse selection) • restrict the way government is spending aid in raising the recipients’ welfare (principal agent problem) • address the problem of moral hazard. IMF lending may be interpreted as (subsidized) income insurance against adverse shocks. The insurance cover induces the potential recipients to lower their precautions against such damages. • However, authorities’ ownership of Programs critical to their success

16. IV. Conditionalities: Structural benchmarks & Quantitative performance criteria * Poverty Reductionand Growth Facility, **Extended Facility

17. V.Top problematic factors in SEE economies according to business executives Source: WEF Global Competitiveness Report 2010-2011 Information drawn from 2010 edition of the World Economic Forum’s Executive Opinion Survey

18. V. Upgrading infrastructure high priority for all countries in the area Managers’ survey, ranking of priorities from 1 to 10 Source: WEF 2010, processed data, • Public Investment: define and prioritize areas of comparative advantage, sectors which maximize externalities for private investment (ICT, Power, and transportation), finance projects by criteria of economic efficiency

19. V.OECD score aggregates for SEE region and main results Indicators of OECD report. Scores range from 0 (lowest) to 5 (highest) Source: OECD Investment Reform Index 2010 • Indicators and key findings of the OECD report show a good progress overall in all categories listed above in the 2006 – 2010 period, however there is need for additional reforms • Human Capital Development is still considered high priority: profile of skills supplied in labor force does not match what is required by employers Limited Access to Finance, accentuated by the crisis, poses a major concern

20. Conclusions • Structural reforms: supply-side policies that increase quality- and price-competitiveness, while demand management preventing overheating. • In an environment of fiscal consolidation, risk spillovers from the Eurozone and slower growth, SEE must proceed even more quickly and decisively to structural reform as this is the only way to ensure market confidence in the long-term. • Reforms should be judged on ability to incur technology transfer: product-quality upgrading, better organizational structures, improvement in institutions and behavioral practices. • Prospects of SEE remain bright: the area possesses the factors of production which important to long term growth: well-educated labor force with still modest wages, industrial culture, strategic geographic location, low capital intensity and thus high returns on capital.

21. THANK YOU FOR YOUR ATTENTION! My thanks to the Research Department of Eurobank EFG for able research assistance and support For more info, please consult the Eurobank website: http://www.eurobank.gr/research • New Europe: Economics & Strategy Monthly edition on the economies and the markets of New Europe • Economy & Markets: Monthly economic research edition • Global Economic & Market Outlook: Quarterly review of the international economy and financial markets Subscribe electronically at http://www.eurobank.gr/research