Macroeconomic Policy Challenges in Southeast Europe

1. Macroeconomic Policy Challenges in Southeast Europe David Vines Department of Economics and Balliol College, University of Oxford; Centre for Applied Macroeconomic Analysis, Australian National University; Research Director, PEGGED Research Programme on Politics and Economics of Global Economic Governance, European Union; and CEPR Paper for Conference on Achieving Sustainable Growth in Southeast Europe Athens, February 11, 2011.

2. 1 Introduction • Advertisement: From Crisis to Recovery edited by Othon Anastasakis, Jens Bastian and Max Watson • This book shows that the European Emerging-Market Convergence Model was very particular – and very different from the convergence model in East Asia • This model has six aspects. It is worth reviewing these • cf the way in which Maynard Keynes examined pre WWI Europe in Chapter 2 of his Economic Consequences of the Peace, in order to understand the growth model of that time • I will briefly discuss each aspect in what follows • I will then discuss the policy agenda looking forward

3. 2 The Emerging-Europe Convergence Model Six aspects of the Emerging-Europe Convergence Model • Capital accumulation, and • FDI and technology transfer • These two aspects create the Jeff Sachs convergence story • Trade liberalisation, and integration of the region’s production system within the European and the global economy • This aspect describes the convergence-through-trade story • Financial liberalisation • Labour-market integration • These two aspects capture the ‘super integration’ story • The Prospect of EMU membership

4. 3 The Jeff-Sachs Convergence Story • “There are three groups of countries in the world” • 1.5 billion people in advanced countries, 4 billion in the middle (led by China), followed by the bottom billion (in Africa and elsewhere) • For the four billion people “in the middle” • Capital accumulation happens as in a Solow model • It is augmented by technical progress which happens through FDI and technology transfer • Asian debate in the ‘90s about capital accumulation: • Perspiration (which happens through savings) versus inspiration (which happens through technical progress) • Interestingly, C19 Europe, like Asia, saved a great deal • cf Keynes, Consequences, Chap. 2

5. In Emerging Europe, savings have not been not high • although savings propensities differed between countries • Need a Ramsey model - with savings choice a policy issue • Interestingly the central idea about global resource allocation is that capital should flow to poorer countries • As Feldstein-Horioka showed, this has not happened • Lucas has suggested why • South East Europe is the one place where this has happened • The results have not been entirely successful

6. 4 The Heckscher-Ohlin Convergence story • Think about a story with 3 sorts of goods: 2 kinds of tradeable goods plus non-tradeables • Exportables • produced but not consumed at home • prices determined in world markets - these are tradeable goods • Importables – which are not produced at home • consumed by not produced at home • prices determined in world markets – these are tradeable goods • Non-tradeables • produced and consumed at home • prices determined within the home economy • A framework for thinking about industrial structure as part of macro strategy: one examines which exports are important

7. One factor price – the interest rate – and one goods price – the price of tradeables – is exogenous here • nb: ‘tradeables’ includes both exportables and importables • The endogenous variables here are the wage and the price of non-tradeable goods • Stolper-Samuelson theorem here shows how the wage and price of non-tradeables are determined • Trade liberalisation lowers the price of imports relative to the price of exports • The trade liberalisation choice can be analysed by this model • One must increase the return to exporting – ie increase the relative price of exportables, as a response to the liberalisation of imports, • One must lower the wage of non-tradeables are labour intensive • One way that growth happens is through such resource reallocation

8. 5 The Susan Schadler Convergence Story – “super integration” • Financial liberalisation: entirely different from East Asia • Enabled SE Europe to make a low-savings high-growth choice • Risky • Possible that this strategy leads to export-led growth • Requires trade liberalisation at same time • More generally requires control of rent-seeking in the tradeable sector • Possible that, instead, this leads to a consumption boom • House prices overshoot upwards and consumers bear this risk • Consumers bear currency risk • Paying back loans may be difficult – requires massive austerity post-crisis – consumers bear solvency risk • But leverage risk seems not to have been a major problem in South East Europe - a feature of the institutional integration process which was chosen

9. ….super integration … continued • Labour market integration: entirely different from East Asia • Transient migration has enabled real wages for Eastern European workers to rise in advance of the convergence of their home economies • Has put upward pressure on the real wage in the home country of migrants • This has helped to tilt the convergence outcome towards • one in SE Europe with a low-savings high-growth aspect • one which is biased towards a consumption boom rather than and away an export-led-growth outcome

10. 6 The Prospect of EMU membership: effects on convergence process • This too has been entirely different from East Asia • Encouraged some good things • Also enabled some bad things • So this too has been risky

11. 7 The core short term for macroeconomic policy • We can learn here from the East Asian recovery after the Asian financial crisis • Massive currency devaluation and export-led growth • That was much easier in the dot-com boom world, in which demand was growing • It required currency flexibility • This is the core issue about macro strategy • This requires curtailment of domestic demand • It also requires the creation of a competitive position • This will differ as between • (i) members of EMU zone – Greece – and other countries with pegged exchange rates • (ii) countries who are floating

12. 8 The core longer term issues for macroeconomic policy It is necessary to reconsider all six aspects of the European Emerging-Market Convergence Model. • The capital accumulation process, and • FDI and technology transfer. • How much should a country save? • Trade liberalisation, and integration of the region’s production system within the European and the global economy. • How will trade liberalisation and increasing openness be managed ? • Financial liberalisation, and • Labour market integration • Is the ‘super integration’ really safe – if not, how to proceed? • Can the uncertainties about EMU membership be resolved?