Structural Reform challenges in SEE countries

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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
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1. 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 reforms aimed 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 gaugesinterest rates, liquidity measures,
  or the budgetary balanceare typically readily
  available for most countries (IMF, 2008)

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1. 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.

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1. 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.

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1. 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)

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1. 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
  RD.
• 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.

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1. Structural reforms and the SEE region

• Rodrik and Subramanian (2003) quality of
  institutions is the 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.

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II. Structural reforms in retrospect 1989-2011
Transition Indicators average score per year
Source EBRD Transition reports Scale 0
to 4, 0low progress 4high 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.

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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.

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III. WB Top-ten reformers in 2004-2010
World Banks Ease of Doing Business
COUNTRY Among Top 10 Reformers
Albania 2008
Bosnia Herzegovina
Bulgaria 2007
Croatia 2006 , 2007
FYROM 2007 , 2009
Romania 2005 , 2006
Serbia 2005
Turkey
Source WB Doing Business Reports

• Individual SEE countries scored well in the boom
  years 2004-2010

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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
  regulation scores.

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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
Turkey
Bulgaria
Romania

• FYROM moves up the pack, Albania and Turkey
  maintain their relative position, others fall
  behind

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IV.2 Mixed picture in the Ease of Doing
Business rankings 2007-2010
  Rank 2007 among 178 Rank 2010among 183
Albania 136 81
Bosnia Herzegovina 105 110
Bulgaria 46 51
Croatia 97 89
FYROM 75 36
Romania 48 54
Serbia 86 90
Turkey 57 60
Source Doing Business 2008 and 2011 Reports,
processed data
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IV.2 Areas of improvement in Ease of Doing
Business
Change in scores in Reform areas for the period 2007-2010
AGGREGATE 96 82 60 84 93 40 54 57
Starting a Business 89 31 84 64 86 38 79 28
Construction Permits 50 94 2 96 83 71 1 57
Registering Property 48 97 7 78 82 73 79 48
Getting Credit 94 80 77 70 97 82 93 76
Protecting Investors 99 71 69 65 93 72 81 89
Paying Taxes 59 4 46 85 78 2 51 54
Trading Across Borders 72 46 15 58 86 20 22 28
Enforcing Contracts 57 9 88 47 93 86 11 89
Closing a Business 39 21 16 15 8 96 98 69
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
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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 IMFs 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

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IV. Conditionalities Structural benchmarks
Quantitative performance criteria
Albania 2006-2008 Bosnia 2009-2012 Bulgaria 2004-2006 Romania 2009-2011 Serbia 2009-2011 Turkey 2005-2008
Type of program PRGF EFF Regular SBA Precautionary SBA Regular SBA Regular SBA Regular SBA
Banking system ? ? ? ? ?
Fiscal rules ? ?
Pension Social Security ? ? ?
Public sector (public wages, state-owned enterprises, tax administration) ? ? ? ? ? ?
Labor market ? ?
Product markets (regulation, business environment, privatizations etc) ? ? ? ? ?
Quantitative ceilings ? ? ? ? ? ?
Poverty Reduction and Growth Facility,
Extended Facility
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V. Top problematic factors in SEE economies
according to business executives
Source WEF Global Competitiveness Report
2010-2011
Among top 10 factors seen by business executives as the most problematic for doing business in their economies Albania Bulgaria Bosnia Croatia FYROM Romania Serbia
Access to financing x x x x x x x
Corruption x x x x x x x
Inefficient government bureaucracy x x x x x x x
Tax regulations x x x x x x x
Inadequate supply of infrastructure x x x x x
Inflation x x x
Poor work ethic in national labor force x x x x x
Inadequately educated workforce x x x
Policy instability x x x x x x
Crime and theft x x x x
Tax rates x x x x x
Restrictive labor regulations x x x
Information drawn from 2010 edition of the World
Economic Forums Executive Opinion Survey
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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

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V. OECD score aggregates for SEE region and main
results
Indicators of OECD report. Scores range from 0
(lowest) to 5 (highest)
Investment Policy and Promotion 3.5
Human Capital Development 3.0
Trade Policy and Facilitation 3.5
Access to Finance 2.7
Regulatory Reform and Parliamentary Process 3.1
Tax Policy Analysis 2.7
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

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1. 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.
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