EBRD head warns that Romania risks falling into the middle-income trap

Sorin Melenciuc 18/09/2018 | 07:00

Romania risks falling into the middle-income trap as it has not been able to record the same pre-crisis growth rates without aggravating macroeconomic imbalances, and it has two main tools in order to avoid remaining into the trap, the European Bank for Reconstruction and Development (EBRD) president Suma Chakrabarti said on Monday in a speech at Bucharest’s Academy of Economic Studies.

“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,” he said in front of a panel of Romanian economists and students.

The phenomenon of 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.

A recent BR Analysis showed that Romania is one of the best candidates for the “middle-income trap” category, according to many economists, who suggest middle-income countries need to invest in infrastructure and to remove barriers to entrepreneurship in order to become part of the high-income world.

According to EBRD head, the trap doesn’t exist at any particular level of income.

“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,” Chakrabarti said.

According to the economists, 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.

“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,” EBRD president points out.

For those countries, the technology and knowledge transfer from foreign direct investment (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,” Suma Chakrabarti indicates.

According to official data, gross fixed capital formation averaged 25 percent of GDP in Romania in recent years, down from 35 percent of GDP pre-crisis. Emerging Asia’s economies invest on average 30 percent of GDP, by way of comparison.

Gross inward FDI in Romania has also declined to a mere 2 percent of GDP in recent years, while green field FDI has stagnated at levels below EUR 100 million a year.

Two good options

According to EBRD head, Romania has two main tools to avoid remaining into the middle-income trap.

“One is more investment in infrastructure. Romania currently ranks 102nd 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,” Chakrabarti said.

According to EBRD, major upgrades to the road network increase trade within a country and halt outward migration from previously poorly connected areas by increasing employment.

The second tool is raising productivity.

“The lower productivity growth of recent years reflects the slowdown in structural reforms. (…) 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,” Suma Chakrabarti underlined.

EBRD head warns that Romania has many very unproductive firms, more even than the other new EU member states.

“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,” Chakrabarti said.

However, he pointed out that overall levels of spending on R&D in Romania 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,” EBRD head indicates.

The top banker warned also technological change could threaten many jobs in Romania.

“With it (technological change) 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,” Chakrabarti estimates.

In the future, dealing with the resulting rising inequality is going to be a priority for Romania’s policymakers, according to EBRD head.

“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,” says Chakrabarti.

EBRD’s total investment to date in Romania stands at over EUR 8 billion.

But Romania’s choices depend on its leaders, EBRD head warns.

“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,” Chakrabarti points out.

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