3 Real Convergence to EU Lncome Levels: Central Europe from 1 990 to the Long Term
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Real Convergence to EU 3 lncome Levels: Central Europe from 1990 to the Long Term Peter Doyle, Guorong Jiang, and Louis Kuiis For transition cnuntries in the process of joining the EU, the prospects for the real secror will be critical in determining the appropriate policy frameworks both before and after accession. This chapter discusses the key factors likely to shape the nature and pace of growth in five of rhese countries in central and eastern Europe thar form the focus of this book: Poland, the Czech Republic, the Slovak Republic, Hungary, and Slove nia-known collectively as the CECS. The discussion is based on the standard growth accounting frame work thar decomposes growth into the growth of factor inputs and a residual-total factor productivity (TFP) growth.9 The chapter reviews the growth performance of the CECS du ring the 1990s, noring thar the available evidence points to a significant diversity-with the most: rapidly growing countries exhibiting growth thar is intensive in TFP rather than in factor inputs, while the less successful countries exhibit the reverse tcndencies over this period. lt also notes evidence of differ entiai producrivity growrh in the rradable vis-à-vis the nontradable secrors and the implications for the real exchange rate. The prospects for growth in the CECS are then discussed in relation to the patterns of growth in Europe from the 1950s onwards and of east 9Thc growrh accounting framework urilizes the fo llowing idcntity: dY/Y = c:ulK/K + [3dL/L + dA/A, where the production function cakes the form of Y = AK«L�. and Cl. and � are rhe elasric iry of ourpur with respect ro capital and labor. ln practice, Cl. and � are <lpproximared by rhe profit and labor shares in national income, and dA/A (rmal factor producriviry growth) is calculated as a residual. ©International Monetary Fund.l3 Not for Redistribution 14 Real Convergence to EU lncome Levels Asia from the early 1960s. This review, alongside more formai studies of the determinants of economie growth in the long run from a wide sam pie of countries, suggests thar TFP growth rather than growth of factor inputs is expected to continue to be the driving force behind output growth in the CECS. Finally, a set of growth calculations for the accessants is oudined, drawing on the evidence that TFP growth will be the major contributor to GDP growth. These calculations highlight significant uncertainties about the investment thar will be required to sustain projected growth, the flow of private domestic savings that will be forthcoming to finance it, and the nature of the business environment that will be most con ducive to promoting TFP-intensive growth in these countries. These un certainties will form central inputs into the design of appropriate fiscal and structural policies. Sources of Growth During Transition Perhaps the most fundamental economie criticism leveled at the plan ning mechanisms in place prior to 1990 in these countries was that they inhibited TFP growth. During thar era, these economies grew-some times at impressive rates-on the back ofheavy investment in fixed cap ital and in shifts of labor from agriculture into industry. These sources of growth eventually ran their course, and from the 1960s onwards, growth slowed inexorably under the weight of externat shocks and lackluster if not negative TFP growth. By the eve of transition, inefficiencies and shortages were pervasive, labor and capital were fundamentally misallo cated, and the range and quality of goods and services produced left much to be desired. Against this background, it is little surprise that in the early phase of transition, when these inefficiencieswere exposed by the liberalization of priees and international trade, output feU sharply. This was accompanied by decreases in employment and the capital stock, and by declines in pro ductivity in the wake of labor hoarding. Between 1989 and 1991, 10 per cent of jobs were lost in the CECS countries on average (!osses ranged from 5 Yz percent in the Czech Republic to 17 percent in the Slovak Republic). A sizable part of the capital stock became obsolete ovemight. After bottoming out in 1991-93, output recovered (Figure 3.1, pages 16-17). GDP troughed in 1991 in Poland, in 1992 in the Czech Repub Lic and Slovenia, and in 1993 in Hungary and the Slovak Republic. The strength of the recovery since then has generally been modest, though ©International Monetary Fund. Not for Redistribution Sources of Growth During Tr ansition 15 with significanr variation between countries. The cumulative increase in GDP between 1991 and 1999 was only 9 percent in the Czech Republic and ranged from 17 to 26 percent in Hungary, the Slovak Republic, and Slovenia. Poland has been the oudier, with a cumulative increase of 48 percent.10 Job lasses generally conrinued long after the immediate post-transition recessions. Though many new (especially service sector) finns were open ing up, it cook time before these were sufficient ro absorb the sready on going flow of labor released from aider contracting enterprises. After the initial collapse of output in 1991, with overall growth still modest, con tinued restructuring led to significant further reductions in employmcnr in Hungary and, to a lesser extent, in the Czech Republic and Slovenia ( 18, 7, and 10 percent, respectively, between 1991 and 1999). ln Poland employment dccreased by only 2.4 percent in this period, whereas in the Slovak Republic employment actually incrcascd (by almost 10 percent) as fiscal and privatization policies were adjusted so as to slow the pace of restructuring. 1 1 As a result of these output and employment trends, Poland, Hungary, and Slovenia experienced strong labor productivity growth: 52, 40, and 40 percent, respectively. In the Czech and Slovak Republics, the increase in labor productivity was significantly lower during this period: 17 and Il percent respectively. As output growth resumed, the ratio of investment t0 GDP rose, although differences in the leve! of those ratios benveen countries have persisted. The share of investment ro GDP bottomed in 1991-93 in ail countries, at roughly the sarne time as output, but after 1991, the invest ment to GDP ratios increased gradually (Figure 3.2, page 18). However, du ring the 1990s, the share of investrnentto GDP was substantially lower in Hungary, Slovenia, and Poland than in the Czech Rcpublic and, in particular, the Slovak Republic. IOBerween 1989 and 1999, rhe cumulative increase in GDP ranged from -6 percenr in rhe Czech Republic ro 28 percem in Poland (and in Hungary, rhe Slovak Republic, and Slovenia ir was-0.8, 2, and 5.8 percenc, respecrively). 11The fa li in employmenr during transition led to a significanr decrease in rhe rario of em ployment ro total population. Thisfall was parricularly sreep in Hungary: around 15 percent, compareJ w sorne 5-8 percent in the orher counrries. The particularly large fali in employ menr in Hungary has nor led to a relatively large increase in measured unemployrnem as many laid-off people withdrew from rhe tabor fo rce alrogether. ©International Monetary Fund. Not for Redistribution 16 Real Convergence ro EU lncome Levels Figure 3. 1. CECS: Sources of Growth, 1989-99 Czech Republic Czech Republic llOr-----------..., 320 r------:------:---:-------, 55 Cap ital stock, os shore 300 of GDP (constant priees) ,,.· 54 105 • (left scole) 53 Lobor productivity, :' ....... ... 1989=100 52 100 51 95 240 Employmenf, os shore 50 of fatal population 220 (righi scole) 49 90 •· 48 200 5 47 8 GDP, 1989= 100 180 46 80 160 45 1985 1987 1989 1991 1993 1995 1997 1999 1985 19871989 1991 19931995 19971999 Hungary Hungary 140 r------------..., Lobor productivity, , '' 130 1989=100 ,' 260 50 120 240 Capital stock, os shore of GDP 110 220 .._ ... (constant priees) 45 (leftscale} : GDP, 1989=100 . -. 200 40 180 0 160 35 8 1985 1987 1989 1991 1993 1995 1997 1999 1985 1987 1989 1991 19931995 19971999 Poland Poland 150r-------------------..., 280 49 Employmenf, as shore 140 260 of total population 47 Labor productivity, ., . ·• (righi scale) 130 1989=100 45 220 43 . ... - ........."' . 200 Capital stock, :. os shore of GDP : 180 constant priees} : 39 (leftscole} • 80 0 37 1985 1987 1989 1991 1993 1995 1997 1999 16 1985 1987 1989 1991 1993 1995 1997 1999 ©International Monetary Fund. Not for Redistribution Sources of Growrh During Transirion 1 7 Figure 3. 1. (concluded) Slovak Republic Slovak Republic 120.--------------------. 320.---------���---- � Capita l stock, os shore Lobor productivity, 310 of GDP (constant priees) 1989=100 .... 110 300 .: •., (/eh sco/e) 55 : . 290 ... : . ' : ' . - 280 .. .. 50 ........._ .. 2� 45 250 Employment, os shore of 240 toto/ population 230 (righi scole) Slovenia Slovenia 135 280 70 Capital stock, os shore 270 • GDP 65 125 Lobor productivity, •• of (constant priees) 1989=100 .' 2� (/eh scole) .� . ' 250 : ' � 115 , . ' : ' 240 55 ' 105 230 . .. 50 , 220 . '. .. ---- 210 Employment, ' 45 200 as shore of total population 40 190 (right scale) - 75 180 35 1985 1987 1989 1991 1993 1995 1997 1999 1985 1987 1989 1991 1993 1995 1997 1999 Sources: IMF, World Economie Out/oak; and IMF staff estimotes. The remarkable increases in tabor productivity achieved in the more successful economies-notably Poland and Hungary-appear to reflecr TFP growth, rather than increases in the capital stock. Even before ex amining the statistical evidence for this, the strength of this proposition at an intuitive leve! is apparent. For capital accumulation to have ac counted for a large part of growth during transition, a very large part of the pre-transition capital stock must have been made redundant upon transition or/and the depreciation rates on capital must have bcen very ©International Monetary Fund. Not for Redistribution Figure 3.2.