Romania and transition

1. Welcome and Introduction

Good afternoon.

It’s great to be back in Romania.

And a real pleasure to return to the University of Economic Studies, nursery for so many distinguished figures in public life here – as well as for many Romanians working for the EBRD.

So a real breeding ground for the global elites!

Before I begin, let me say a big thank you to our hosts for inviting me to address you for what will be a second time.

Notably, to Gheorghe Hurduzeu, dean of the Faculty for International Business and Economics, and to the Rector, Nicolae Istudor.

But also to my old friend Liviu Voinea, Vice-Governor of the National Bank, who has helped organise today’s event as well.

2. Some anniversaries

On my last visit to the AES, five years ago, when you did me the great honour of awarding me a doctorate, I drew on the lessons of my career to argue the case for public service and to define what that service actually involves.

There will be some echoes of those ideas in my remarks to you today.

But my subject this afternoon is not drawn from my personal experience, although I do feel very much invested in it myself.

It is Romania and the challenges of transition.

So, as you can see, I am not shying away from the major issues of our time.

Let me also acknowledge the even broader sweep of history by congratulating the people of Romania on the 100^th anniversary this year of the unification of all Romanian provinces in one democratic state.

And by saying how much I am looking forward to your first presidency of the EU Council next year.

Many of the priorities you have already set for what will be a momentous opportunity to help lead Europe are very much ours as well.     

I am thinking, in particular, of sustainable development and growth, innovation, competitiveness and connectivity.   

3. The big picture

If we look at the big picture and modern Romania’s achievement in it, we should hail the country’s very impressive long-term record.

Its economic performance has been characterised by periods of high growth.

But there have also been moments of sharp contraction.

We have seen the steady progress of reforms.

But some reversals as well.

Like many of the other states which joined the EU in the first decade of this century, Romania has done well in terms of income convergence.

Especially in the years before the crisis and more recently.

Indeed, if we compare the growth of its per capita income over the last 20 years with that of similar economies with roughly the same population elsewhere, Romania has performed almost a third better than the others.  

To put it another way, back in 2000 Romania’s GDP per capita, measured at purchasing power parity, was a mere 33 per cent of the EU average.

By 2017 that percentage figure had jumped to almost 60.

A huge leap and certainly cause for celebration!

And yet Romanians, quite rightly, aspire to still higher levels of income - and to close that gap still further.

Unfortunately, the history of other countries’ income convergence demonstrates that sustaining so impressive a performance over the long term is very hard.

The same model rarely delivers consistently for more than a decade or two.

Successful economies need to reinvent themselves – and to move up the value added chain as they do so.

That is Romania’s current challenge as well.

4. The recent past

Before analysing the nature and scale of that challenge, let me take you on a brief trip into the recent past.

Romania had a difficult start in the early transition years.

The pace of structural reforms was uneven and slow.

Inefficient state-owned enterprises could not be reformed, leading to high fiscal deficits, inflation rates of over 300% and deep recessions following periods of unsustainable growth.

That narrative changed dramatically in the 2000s, thanks to deep structural and institutional changes driven by EU accession.

The most significant included privatisation and the restructuring of SOEs, as well reforms improving the business environment and increasing the efficiency and independence of public institutions.

One result of that was the more than tripling of household income between 2000 and 2008.

Booming consumption was also accompanied by more investment, particularly foreign direct investment, which on the eve of the crisis reached 8.9 percent of GDP.

Public investment also increased thanks to EU accession funds.

This period witnessed the highest period of sustained growth in Romania’s recent history: averaging six per cent annually in the eight years up to 2008.

So when it hit, that year’s global financial crisis had a chilling effect. GDP contracted two years running due to the sudden fall in capital flows and external demand.

Since 2008, the economy has been growing at a rate far below the pre-crisis levels, at a mere 1.9 per cent on average.

While the economy grew by an impressive 7 percent last year, this has been mainly driven by pro-cyclical fiscal policies and accompanied by growing external imbalances.

5. Where we are today

That lightning excursion into recent history now over, I want to return to the main challenge confronting Romania today – and tomorrow.   

It is this.

The fact that Romania has not been able to record the same pre-crisis growth rates without aggravating macroeconomic imbalances suggests that it is at risk of falling into the middle income trap.

This phenomenon, the middle-income trap, has preoccupied policymakers since Asia’s financial crisis at the end of the ‘90s, when economies in that continent suffered a marked slowdown.

The trap may not exist at any particular level of income.

And yet the analysis in EBRD’s most recent annual Transition Report shows that middle-income economies do tend, on average, to experience a slowdown in productivity growth at income levels between one and two thirds that of the United States.

This has been the case for Romania since 2008, as we have just seen in our look at your recent history.  

As economies’ incomes rise, productivity growth fails to keep up, with countries finding it difficult to shift from a growth model based on investment and the adoption of existing technology to one driven by innovation and the development of new technology.

Indeed, more than 40 per cent of all lengthy periods of strong growth end in protracted periods of poor performance.

Just as in the EBRD regions as a whole, Romania’s growth prior to 2008 was driven predominantly by rising productivity, the greater efficiency with which capital, labour and human capital combine to produce goods.

Those productivity gains were achieved as inefficiencies that had existed under Central Planning were eliminated.

And the technology and knowledge transfer from FDI contributed much needed capital and expertise to make production more efficient.

In recent years, however, the main contribution to growth has come from the accumulation of fixed capital.

Yet investment rates have been lower compared to pre-crisis times.

In recent years gross fixed capital formation averaged 25% of GDP, down from 35% of GDP pre-crisis.

Emerging Asia’s economies invest on average 30% of GDP, by way of comparison.

Gross inward FDI in Romania has also declined to a mere 2% of GDP. In particular, green field FDI has stagnated at levels below €100 million a year.

6. Avoiding the trap: infrastructure and the labour supply

So, let us now look at some of the ways economies can avoid falling into the middle income trap, many of which we at the EBRD are very much involved with.

One is more investment in infrastructure.

Romania currently ranks 102^nd out of 137 in the quality of its transport infrastructure, as measured by the Global Competitiveness Index.

Roads are in particular need of investment. And, when such investment is forthcoming, it can deliver sizable benefits.

Our most recent Transition Report also showed that major upgrades to the road network increase trade within a country and halt outward migration from previously poorly connected areas by increasing employment.

That research was about Turkey. But the same potential holds good for Romania.

An increased labour supply, on the other hand, is not going to be a reliable source of growth for the Romanian economy in the future.

The labour force shrank from 11.6 million people in 2000 to 8.8 million in 2017, a dynamic exacerbated by emigration.

With a fertility rate among the lowest in the EU, such demographic trends are likely to continue, something we discuss, by the way, in our next Transition Report, to be published in November.

7. Avoiding the trap: productivity

This leaves productivity.

The lower productivity growth of recent years reflects the slowdown in structural reforms.

EU accession is no longer the spur to reforms it was 15 years ago.

Yet many areas of the business environment are in urgent need of reform.

Our joint BEEPS survey with the World Bank suggests that the complexity of the tax system, corruption and informality are persistent obstacles to business in Romania.

Creating a more nurturing environment for firms will certainly help to enhance their productivity.

For now, Romania has many productive firms. But it also has many very unproductive ones too, more even than the other new EU member states, let alone Germany.

So how does Romania raise productivity and attract more investment?

The answer has to be more innovation, better skills and agile policy reform in response to the changing economic environment.

Middle-income transition is largely about the shift from importing and imitating existing technologies to developing new products and services.  In sum, it is about innovation.

Here Romania already has major advantages, such as a highly developed broadband infrastructure and a fast growing IT services sector which ranks among the top outsourcing destinations in Europe.

However, overall levels of spending on R&D are among the lowest in the EU. And high technology makes for only a modest share of total exports.

What one needs is investment in skills, vital for maintaining competitiveness as Romanians’ salaries (hopefully) continue to rise.

And upgrading skills is not just for graduates.

It is also a matter of helping older people in an economy with an ageing workforce retain and update their skills.

To make innovation happen, one also needs specialised finance, such as equity, venture capital, private equity, not just debt finance.

But non-debt finance remains less well developed in Romania than in many neighbouring countries.

Lastly, I mentioned technological change.

With it comes what might be called job polarisation.

Jobs requiring medium-level skills disappear and are replaced by low-skilled ones, as well as some involving high skills.

This is already happening in Romania and the trend will accelerate as Romanians’ incomes rise and technological transformation takes hold.

Dealing with the resulting rising inequality is going to be a priority for policymakers, not least through the strengthening of social safety nets.

8. How we can work together for tomorrow’s Romania

Ladies and Gentlemen, the middle income trap exists and EBRD countries of operation – Romania included - are at risk of falling into it.

The good news is that the stratagems for avoiding it are all very much part of the EBRD playbook.

Via our projects, we are already delivering sustainable and inclusive growth through investing in infrastructure, much of it green, upgrading skills in the workforce, spurring innovation and tapping into new sources of finance.

We are already doing this here in Romania, where our total investment to date stands at well over €8 billion.

And we are busy doing so for your neighbours as well, whether within or outside the EU, as well as in economies much further afield.  

If I may, let me end with an echo of my speech here of five years ago.

That was, if you recall, an appeal for the values of public service.

Back then I called on the EBRD and those who work for “it to be much more vocal and challenging of governments….on policies”.   

It is up to public servants, broadly defined, to help deliver structural reforms to improve the business environment and up the standards of governance.

Today I believe that more than ever.

Politicians – and I am speaking here of politicians in many countries - are too often hostage to short-term thinking driven by the electoral cycle to do so on their own. 

Here in Romania, I believe that we will build on the achievements of the recent past to close the transition gaps that remain.

That work is already underway.

And I am confident that, together, we can help Romania achieve its goals.

We can. We must!

Thank you very much.