Speech

Reaccelerating Convergence in Central, Eastern and Southeastern Europe—The Role of Governance and Institutions

July 11, 2017

As prepared for delivery 

Good morning to all of you and thank you for coming.

Indeed, it is symbolic that the conference takes place in Dubrovnik, a city with a rich history that has reinvented itself many times over the centuries.

We are meeting here to discuss and learn from each other about a difficult and complex subject: the role of governance and institutions. It is a subject that is relatively new to main-stream economics and the world of economic policy-making, and our understanding of the issues is clearly still evolving.

I expect that our discussion will show that this is one of those subjects on which everybody easily agrees that it is critically important, but where there probably is much less agreement on what good governance means and in particular on how to bring it about.

Why are we meeting to discuss it now? As my colleagues will explain in much more detail, after a period of rapid catch-up, countries in the region have generally seen a significant slowdown in their convergence with the more advanced countries in Europe. In our estimates, potential growth is now only about half of what it was before the crisis.

To some extent, this was of course to be expected as the low-hanging fruits—in terms of their economic impact—have by now been largely picked. Liberalization of prices, lifting of quantitative controls, privatization and phasing-out of subsidies lead to an early reallocation of labor and capital to more productive usages and thus to a prolonged period of rapid-catch up gains in productivity.

As these measures have largely run their course, growth has slowed, and the debate has increasingly focused on the next generation of reforms—the reforms of governance and institutions.

I shall not start discussing the substance of the issues in these brief opening remarks, but will try instaed to frame the discussions, to provide some context. My main point is that during the first twenty years of the transition process—and here I leave out the period following the global financial crisis—countries in the region benefitted from a confluence of positive developments that are unlikely to be replicated.

Looking forward, the headwinds are likely to be stronger. Let me make three points in this regard:

First, the region’s adverse demographics and skill shortages will pose an increasingly serious challenge.

• Apart from Turkey, the region is aging fast.

• In addition, strong emigration, especially of skilled workers, is set to continue. In the past 25 years, some 20 million people left the region: that’s 5.5 percent of the population and most of them were young and well educated.

• Empirical analysis that we have done at the Fund suggests that already by 2012, real GDP would have been 7 percent higher on average in the region in the absence of emigration.

Second, the external economic situation is unlikely to provide the same sustained tailwinds as before.

• While the world economy if finally picking up steam, medium-term growth prospects remain subdued and uncertainty high.

• Crucially important for the region, we project that potential growth in the Euro Area—the major trading partner for the region—to be some 20 percent below what it was before the crisis.

Third, the external political environment might also be less favorable. Here I am thinking in particular about the prospect for those countries that have not yet joined the EU to do so or to enter into to closer association agreements with the EU.

• The EU has truly been an anchor. The importance of the EU during the first 25 years is difficult to overestimate. The adoption of the acquis communitaire and the process of integration more generally have contributed enormously to the economic success of the region.

• EU leaders are assuring those still not inside that the EU door remains open despite the political forces of disintegration that so evidently have been at play in recent years. I am concerned that the reality is that policy makers in countries still outside are beginning to doubt—rightly or wrongly—those assurances. The prospect of EU integration already appears to be less of a catalyst of good policies than in the past. I hope that Servaas will convince you that I am wrong.

I wonder if there is a fourth headwind, in particular, the political economy setting? To what extent is the political turmoil that we have seen producing significant changes, not least in the US and the UK, and considerable apprehension and anxiety elsewhere also affecting the countries in Central and Eastern Europe? Is mobilization of broad political support for reforms more difficult today than it was? At the beginning of transition, there was a natural momentum and appetite for change and reform. With so many policy-makers around the table, one issue that we are particularly interested to hear your views on is the political economy of reforms. Is it getting harder?

In this regard, as you know, we have seen increased tensions within the EU between some new member states, on the one side, and the European Commssion and older member states on the other side. This has been associated with concerns about reversal of progress in the area of governance and institution building. Whether such concerns are justified more generally I don’t know—on this issue too, we are here to listen to what you have to say—but the fact is that we in the Fund have become increasingly concerned about maintaining central bank independence in several countries in the region. Central bank independence is an area where the region made early and significant progress, and it would be a major setback if we were to see backtracking in this area. This is a timely reminder not to fool ourselves into believing that governance and institutional progress are inevitable—that such progress is an unstoppable outcome of steady evolution.

If I am right that the environment going forward is less supportive than it was, this only serves to underscore the importance of governance and institutional reforms if we are to reinvigorate growth and the convergence process. These reforms are complex, they will take time, and they will take even longer to show strong results—which is of course why they cannot be delayed. There is urgency to what we will be discussing.

One final point. The region has in many ways become increasingly heterogeneous. Some countries have still considerable degree of state control, and are in effect operating hybrid models between market-based and planned economies, while other countries have already joined the ranks of advanced countries.

We are finding it increasingly difficult in our cross-country work to identify themes that are relevant for the region at large and are indeed rethinking our approach to such work the region.

However, governance and institutional reforms is a topic where I still see a common theme across the region. Indeed some of the threats of reversal that I mentioned before are evident in some of the most advanced countries in the region.

While I have emphasized the headwinds, let me end by stressing that I have no doubt that the countries in the region will ultimately succeed. The progress during the last 25 years has been astonishing. Having been part of the process since the beginning of the transition, I remember clearly how daunting the task was at the outset, and how grim the outlook was back then. The challenges that policy-makers face today are in someway of the garden variety compared to what policy-makers faced back then. The people and the politicians of Central and Eastern Europe have shown a great capacity for change and this—ultimately—is what will make they succeed again.