· 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 behavior 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 privatized 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 $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 twelve – 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 labor force, resources are used more efficiently, and pensions and health care systems are reformed to avoid them becoming sources of acute fiscal pressure.
“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,” said Pradeep Mitra, Chief Economist, Europe & Central Asia Region, World Bank and author of the report. “Their business and financial sectors are maturing as well, relying less on family and informal sources to fund fixed investments.”
Innovation
The transition from command to market economies saw a pattern of deindustrialization and an expansion in the services industry. Oversized industrial sectors contracted towards norms more characteristic of market economies. Services, which had been repressed under central planning, expanded everywhere.
According to Mitra, “Boosting productivity requires firms either to innovate, developing knowledge new to the world, or to absorb knowledge, integrating and commercializing knowledge new to the firm but not to the world.”
Activities that accomplish innovation and knowledge absorption include adopting new products and processes, upgrading old products and processes, licensing technology, improving organizational efficiency, and certifying quality.
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-the-job training to their workers; and when the availability of mainline telephone services is higher and the incidence of power outages is lower.”
The report shows how certain key aspects of the business environment in the Region are maturing and converging towards those in developed market economies.
Inclusion
Employment growth, which has been sluggish almost everywhere, 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 privatized firms.
The study says that weak job growth in the EU8 and Southeastern Europe is the result of vigorous downsizing in state-owned and privatized firms more than offsetting strong job growth in de novo firms – those firms that were always private. The convergence in labor market outcomes comes from the slowing of both the employment boom in de novo firms and the downsizing in state-owned and privatized firms in country groups farther advanced in the transition. However, convergence does not yet apply to the CIS country groups since downsizing in state-owned and privatized firms is not as strong as in the EU8 and Southeastern European countries.
“Stronger competition,” said Mitra, “which would facilitate convergence in the CIS countries, would also accelerate downsizing in state-owned and privatized firms. Severance payments, retraining programs, and social safety nets for the displaced workers can facilitate convergence by reducing its social costs.”
The report points out that the evolution of employment may now, however, be driven less by such legacy factors and more by factors such as the availability of labor force skills demanded by employers, at least in countries farthest advanced in the transition, i.e., the new EU member states.
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 $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 twelve – 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.”
According to the report, continuing reductions in poverty are possible even without a significant increase in employment. Experience since 1998 shows that productivity growth has been the main driver of poverty reduction, both directly through the labor market and indirectly by making possible more generous safety nets which help those unable to benefit directly from growth.
Integration
A key reform at the beginning of the transition, according to the report, was price liberalization – opening domestic markets of tradable goods to international prices and setting in motion the integration of the countries of Eastern Europe and the former Soviet Union into the world economy. Merchandise exports and imports in those countries expanded from just over 15 percent of GDP in 1994 to nearly 35 percent in 2006. Services, a low priority under central planning, emerged as a dynamic force in such sectors as telecommunications, transportation, energy, and banking, boosting services trade to nearly 7 percent of GDP. But the nature of trade varies greatly across transition groups. Countries that joined the European Union in 2004 are much more open to trade – exports and imports made up 60 percent of their GDP in 2006.
Domestic and external factors worked in harmony as the new member states of the European Union used the anchor of prospective EU accession to lock in the reforms of policies and institutions necessary for rapid productivity growth and deeper integration into the world economy.
“The Czech Republic, Estonia, Hungary, Poland, and the Slovak Republic,” said Mitra, “have attracted large amounts of foreign direct investment, and participate almost as heavily as developing East Asia in producer-driven global commodity chains, such as those for automotives and information technology and export capital and skilled labor-intensive products. In contrast, most CIS countries export natural resources and unskilled labor-intensive products.”
“Indeed,” Mitra added, “the extent to which countries without European prospects can use outside mechanisms – such as the European Neighborhood Policy, WTO accession, subregional agreements – to lock in the institutions conducive to a favorable business environment is an open question.”
Demographics – the third transition
However, as if twin political and economic transitions of the past have not been challenging enough, according to the report, many countries in Eastern Europe and the former Soviet Union now face a third transition – 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 EU8, Southeastern Europe, and middle income CIS countries. This is similar to the change projected for the EU15, deeper than in the United States, shallower than in Japan.
Said Mitra, “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 labor 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 equalizing 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 labor 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.”
