World Bank Chief Economist talks of solutions

Brussels, July 7 - Pradeep Mitra, the World Bank’s chief economist for the Europe and Central Asia Region (ECA) spoke in a candid interview to Tejinder Singh about his experience and vision for European and Central Asian countries. Mitra was in Brussels to launch a World Bank study with the title, Innovation, Inclusion and Integration: From Transition to Convergence in Eastern Europe and the Former Soviet Union, on July 2. Starting on a positive note, “Countries of Eastern Europe and the former Soviet Union have put the crisis of the 1990s behind them and a lot of progress has happened,” Mitra said, “But they are now facing new challenges as they integrate into global economy.”

“Central and Eastern European countries are already plugging into global networks like automobiles and Information Technology whereas part of the trade that the Commonwealth of Independent States (CIS) does, especially ‘low income countries’ are in natural resources and items that use predominately unskilled labour force.” It was more traumatic for CIS countries during the Russian crisis and that had sent tremours through these countries but there has been a turnaround and they are improving although there is a differential rate.”

There is a marked difference in the pattern of integration between the way the Central and Eastern European states and CIS states.” The anchor of prospective EU accession worked in harmony with the domestic and external factors helping the new member states of the European Union to lock in the reforms of policies and institutions necessary for rapid productivity growth and deeper integration into the world economy.”

Pointing out that, “The CIS countries do not have this EU membership prospect,” Mitra said, “so the extent to which countries without European prospects can use outside mechanisms – such as the European Neighborhood Policy, WTO accession, sub-regional agreements – to lock in the institutions conducive to a favorable business environment is an open question.” “These things may act like anchor and they do have a role to play but they are not nearly as powerful as the concept of EU accession,” added Mitra. “The convergence is more pronounced in the new European Union member states. The countries in the CIS are followers, though some distance behind,” Mitra noted.

Demographic factors

The report noted that many countries in Eastern Europe and the former Soviet Union now face another headache an aging populations. Demographic projections suggest that by 2025 the average Slovene will be 47 years old, giving the country one of the oldest populations in the world. One in five Bulgarians will be over 65. Ukraine’s population will shrink by a fifth, and Russia’s by more than a tenth.

Aging will lead to the share of the working age population (15-64 years) in total population declining rapidly after 2015 – less than a decade from now – in the EU 8, Southeastern Europe, and middle income CIS countries (“middleincome” CIS countries include Belarus, Kazakhstan, Russia, and Ukraine). This is similar to the change projected for the EU 15, deeper than in the United States, shallower than in Japan. EU- 8 countries, including Eastern Europe’s largest economies Poland and the Czech Republic, joined the EU in 2004. Romania and Bulgaria entered the bloc in 2007.

Asked to comment on this threatening phenomena and the ways to face it, the chief economist of the World Bank said, “All of Europe is aging but Eastern Europe is aging more rapidly. Add to that migration problems as for example, people from Poland went to England and people from Romania to Italy and Spain thus generating labour market shortages in those countries.

“The challenge posed to economic growth by rapidly-aging populations in a large swath of transition countries in Central and Southeastern Europe, as well as Russia, Ukraine, and Belarus, is serious and systemic. Offsetting it requires, first, getting the most out of the existing capital stock and labour force – through all the reforms of the business environment needed for productivity growth.

“Second, it calls for using all and not just part of a country’s human resources by raising and equalising the retirement ages for men and women and, where the fiscal situation allows, reducing taxes on labor that make hiring labor expensive.

“Third, it requires reform of pensions and health care systems, so that fiscal pressures do not crowd out desirable spending on infrastructure and social safety nets and the private investment for productivity growth.

“Finally,” Mitra added, “international circular migration of labour that is coordinated between sending and receiving countries and respects migrants’ rights can supplement such a policy package. Migration involves complex political, economic, and social factors, and it is for this reason that policy experiments might be needed to improve the frameworks that regulate it.”

Business Models

On the question of the development of the business models in these countries, Mitra said, “Their business and financial sectors are maturing as well, relying less on family and informal sources to fund fixed investments,” adding, “When it comes to the importance of competition for restructuring activities in firms, the transition economies are following in the footsteps of developed market economies.”

According to the report, productivity growth – the only viable route to lasting prosperity – depends on there being a supportive business environment, specifically one that delivers competition, a deep financial sector, good governance, and superior skills and infrastructure. 

“Productivity growth,” said Mitra, “is higher in firms when they face stronger pressure from domestic competitors to develop new products and markets; when they are in industries that rely more on external finance in countries with more developed financial sectors; when rules and regulations are more predictable and there is greater confidence in the legal system; when they offer more on-thejob training to their workers; and when the availability of mainline telephone services is higher and the incidence of power outages is lower.”

According to Mitra, “Boosting productivity requires firms either to innovate, developing knowledge new to the world, or to absorb knowledge, integrating and commercialising knowledge new to the firm but not to the world. “Stronger competition,” said Mitra, “which would facilitate convergence in the CIS countries, would also accelerate downsizing in state-owned and privatised firms. Severance payments, retraining programs, and social safety nets for the displaced workers can facilitate convergence by reducing its social costs.

“While nearly one in five people – or 85 million – lived in poverty around 1998/99, only one in 12 – or 35 million – did so around 2005/06,” said Mitra. “Income poverty can fall further provided the business environment continues to be reformed even if employment prospects and labor force participation do not improve. But those excluded from employment report being more dissatisfied with their lives, so building inclusive societies by addressing the constraints to job creation should be a priority.”

Energy & Food Prices

The global ripple effects of meteoric rise in energy and food prices has not left these countries unaffected as the report noted that this has put enormous financial pressure on the poorest citizens of these countries. “Some calculations that we’ve done suggest that a five percent increase in food prices increases poverty rates by two to three percentage points in some of the low-income CIS countries,” Mitra said. The World Bank labels low-income CIS countries to include Armenia, Azerbaijan, Georgia, Kyrgyzstan, Moldova, Tajikistan, and Uzbekistan.

“Two to three percentage points is not a small number. This is a kind of ECA-specific phenomenon. A lot of the poor in low-income CIS countries are pretty close to the poverty line. So a little change in prices can tip them in the wrong direction.” Replying to a question on the ways to protect these vulnerable citizens, he urged: “Given what we know about the impact of food price increase on poverty, it is important that countries ‘top up’ their targeted social assistance schemes.

“A number of countries in our region have fairly well-functioning social assistance schemes – it’s important that they ‘top up’ whatever assistance is necessary in order to help the poor.” With regard confronting rising energy prices, Mitra lamented that the region’s energy efficiency has traditionally been very low, adding that it will be wise to implement wide scale energy-saving measures wherever possible.

Eurozone Aspirants

With Slovakia standing at the doorstep of the Eurozone (15 EU Member States who use Euro as a common currency,) there are many more economies in Eastern Europe wanting to join the Eurozone as quickly as possible, despite their public skepticism about the process, Mitra noted. The Czech Republic, Hungary and Poland, all have delayed plans to start using the Euro in 2010 but will be watching how Slovakia’s economy performs when it starts using the Euro in January, said Mitra.

According to European Union rules, the country aspiring to join the Eurozone, must spend two years in the European Exchange Rate Mechanism, which stabilises its currency against the Euro. Although all countries acceding to the EU are obliged to join the Eurozone at some point of time, only Estonia, Lithuania, Latvia and Denmark have started using the exchange-rate mechanism while Poland and other countries are yet to take this step.

Commenting on the significance of joining the elite club of Eurozone, Mitra said, “Joining the Euro is a signal that the country has arrived. It follows the macro-economic policies which are comparable to advanced Western countries so it is a signally mechanism to the markets.”

Inflation: Global Macroeconomic Problem

On the global rise of biting inflation, Mitra agreed, “Yes, Inflation is back. It was something that countries thought they had put behind them, but not only is it back, it’s back in double digits. Often for reasons that the countries themselves – certainly the oil importers – are not in a position to control.

“Inflation is a worldwide problem and it should be tackled as a macro-economic problem with tightening of fiscal policies and not trying to do price control which will not solve this inflation problem.”

Concluding, Mitra urged the regions’ central banks to “stay focused on inflation management” and especially refrain from imposing controls on trade, which could work against the food supply in the longer term.

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World Bank Report

Innovation, Inclusion, and Integration: From Transition to Convergence in Eastern Europe and the Former Soviet Union. Countries of Eastern Europe and the former Soviet Union have put the crisis of the 1990s behind them, but they need to innovate, include all their citizens in the development of their countries, and integrate with the broader global economy if they want to sustain growth, said a new World Bank report. Launched on July 2 in Brussels, the study, concluded that:

Productivity growth – the only viable route to lasting prosperity – depends on there being a supportive business environment, specifically one that delivers competition, a deep financial sector, good governance, and superior skills and infrastructure.

Key aspects of the business environment, such as competition and finance, that shape the behaviour of firms are maturing and converging towards those in the developed market economies of Western Europe. This convergence is more pronounced in the new member states of the European Union. The Commonwealth of Independent States (CIS) are followers, though some distance behind.

Employment growth has been sluggish almost everywhere, and has reflected the interplay between (i) job growth in new private firms that were able to occupy market niches nonexistent under central planning; and (ii) downsizing in state-owned and privatised firms.

Productivity growth and public transfers fed by rising fiscal revenue have moved 50 million people – out of 400 million – out of absolute poverty (those with an income of less than USD 2.15 a day in purchasing power parities) between 1998-99 and 2005-06. While nearly one in five people – or 85 million – lived in poverty around 1998/99, only one in 12 – or 35 million – did so around 2005/06.

Countries in Eastern Europe and the former Soviet Union now face a third transition – aging populations, which will slow economic growth unless more of the population is brought into the labour force, resources are used more efficiently, and pensions and health care systems are reformed to avoid them becoming sources of acute fiscal pressure.

(www.worldbank.org)