BRUEGEL POLICY CONTRIBUTION ISSUE 2012/21 NOVEMBER 2012 SMART CHOICES FOR GROWTH GEORG ZACHMANN Highlights • Recovery in Greece, Italy, Portugal and Spain is held back in part by structural barriers. Overcoming these requires structural reform and public investment. Given the limited availability of political and financial capital, prioritising reform efforts and spending is important, but difficult. The different success factors for individual sectors are complementary. Using the example of the high-tech industry, we make the case that only investing in one success factor (eg broad- band infrastructure) without having a sufficient endowment of others (eg edu- cation) is unlikely to make the sector successful. • One consequence of the complementarity of the different success factors is that public investment and reform efforts should be fine-tuned in order to match the endowment of other factors. This might imply an increase in efforts to tackle several structural barriers at the same time, but it might also imply reducing Telephone +32 2 227 4210 investment in less promising fields. This in turn requires strategic thinking about [email protected] whether it is worthwhile pursuing development strategies that require invest- www.bruegel.org ment in many success factors but that do not promise much success. Such a strategic approach to public investment and reform efforts might make the allo- cation of scarce public financial and political capital more efficient. Georg Zachmann ([email protected]) is a Research Fellow at Bruegel. The author acknowledges excellent research assistance from Philine Schuseil and Amma Serwaah. BRUEGEL POLICY CONTRIBUTION SMART CHOICES FOR GROWTH Georg Zachmann 02 SMART CHOICES FOR GROWTH GEORG ZACHMANN, NOVEMBER 2012 TOGETHER WITH OTHER EUROPEAN UNION drivers of growth, by for example reducing COUNTRIES, Greece, Italy, Portugal and Spain saw aggregate demand. However, the crisis is itself negative average annual growth rates in 2008-11 partly caused by structural barriers to growth. (see Map 1). In contrast to most EU economies, Overcoming the crisis and restoring growth however, they expect no or even negative growth requires two strands of action: reforms targeted at to continue in 2013 (Figure 1). Restoring growth the macro-economic and institutional dimension is essential for these countries to achieve the of the European sovereign bond and banking sustainable budgets that are necessary to crisis2, and the resolution of structural barriers to maintain the integrity of the euro area in a manner economic development. In this Policy Contribution that is both socially bearable and politically we focus on the structural reform aspect. supportable1. Their economic decline is intrinsically tied to the European sovereign bond Countries’ long-term growth prospects are and banking crisis, which has affected various fundamentally determined by structural factors such as infrastructure, human capital, financial Map 1: Annual average GDP growth rate 2008-11 sector development and the quality of regulation3. Table 1 on page 3 shows that the southern EU countries and those that joined the bloc in 2004 and afterwards continue to lag behind in several of these factors. The southern countries experienced pre-crisis growth for a number of >2.5% 1% to 2% reasons (eg convergence, cheap capital fuelling 0% to 1% internal demand); however, their competitiveness 1. See Darvas and Pisani- -1% to 0% substantially deteriorated4 not least because the Ferry (2011). -6% to -1% long-term structural determinants of their growth 2. This includes legislation, formal institutions and did not improve. In addition, structural barriers actual governance. A dis- prevented quick adjustments in those countries cussion of the institutional to the changing economic environment during the deficits can be found in Source: Eurostat. crisis. This has proved particularly detrimental for Pisani- Ferry, Jean (2010) ‘Euro-area governance: Figure 1: Expected growth rates for 2013 (%) what went wrong? How to repair it?’ Policy Contribu- 4 tion 2010/05, Bruegel. 3 3. See for example Barro 2 and Sala-i-Marin (1995). enia 4. For example, according to 1 v Darvas (2012b) ‘Composi- 0 Greece Spain Portugal Cyprus Italy Slo tional effects on productiv- ia EU v -1 akia eden v ity, labour cost and export Malta ustria Lat w France Poland A Ireland Finland Estonia ingdom S Bulgaria Belgium Slo Hungary Republic adjustment’, Romania Policy Contri- embourg Denmark Germany Lithuania -2 K x bution 2012/11, Bruegel, etherlands N Lu ech -3 z the unit labour cost in C United Greece, Italy and Spain -4 increased by more than 30 percent between 2000Q1 -5 and 2008Q1. Source: IMF World Economic Outlook, October 2012. Table 1: Structural shortcomings in EU countries inEU shortcomings 1:Structural Table sources and notes, see Darvas and Pisani-Ferry (2011). sources andnotes,seeDarvas andPisani-Ferry by nomorethanonestandarddeviation; Dark green: Dark Source: Bruegel (Darvas and Pisani-Ferry, 2011). Source: Bruegel(Darvas andPisani-Ferry, Professional servicesProfessional regulation Infrastructure Long term Retail sectorregulation Business regulation term Medium Innovation Human Capital Institutions andcontracts N Labor marketinefficiency etwork regulation the indicator is better by more than one standard deviation that the average; isbetter thattheaverage; the indicator bymorethan one standarddeviation old Austria new old orange: Belgium new old West N worse than the average between one and two standard deviations; betweenoneandtwostandarddeviations; worse thantheaverage France ote: the scoreboard is relative to the ‘advanced’ OECD countries, ie OECD countriesapart countries,ieOECD ote: thescoreboardisrelativeto ‘advanced’OECD fromMexicoandthecentralEuropean new old Germany new old Netherlands new old Denmark new old Finland new North old Ireland new light green: light old Sweden new old UK new better than the average but by no more than one standard deviation; butby nomorethanonestandarddeviation; better thantheaverage old Greece new old Italy South new red: old Portugal worse than the average by more than two standard deviations. For fullinformationon For bymorethantwostandarddeviations. worse thantheaverage new old Spain new old Czech Rep. new old Hungary new Central old Poland new old Slovakia new old Slovenia new old Estonia new yellow: old Latvia member states. Colour codes: member states.Colour new worse than the average but worse thantheaverage old East Lithuania new old Bulgaria new old Romania new old United States new 03 CONTRIBUTION Georg Zachmann Zachmann Georg SMART CHOICES FOR GROWTH FOR CHOICES SMART POLICY BRUEGEL BRUEGEL POLICY CONTRIBUTION SMART CHOICES FOR GROWTH Georg Zachmann 04 euro-area countries that were unable to devalue to drivers of economic growth, productivity and improve their competitive positions5. social protection, and generally a source of high value-added and well-paid employment”. The different structural factors behind sectoral success are inter-related, and this should be taken In this Policy Contribution we will describe the into account when addressing structural weak- complementary relationship between different nesses. Figure 2 illustrates that in some cases, types of reforms and public investment for where there are complementary relationships success in the high-tech sector. Subsequently, we between success factors, shifting efforts between discuss the implications of this complementarity different policies might simultaneously reduce for the mix of public investments and reform costs and increase benefits. This holds not only policies in times of scarce fiscal resources and for public investment, but also for reforms that limited political capital. complement public investment, such as cutting red tape for innovative young companies. COMPLEMENTARITY OF REFORMS AND PUBLIC INVESTMENT General structural factors such as education, infrastructure and regulation encompass a wide Success in high-tech industries builds on various range of sub-divisions. Infrastructure, for example, factors including specialised education, the entails access to water, electricity, material and presence of communication infrastructure, and immaterial communication. Each of these sub- good regulation. Map 2 indicates that the divisions features different dimensions that policy peripheral countries of the south and east are less makers might influence, for example the speed, equipped in terms of an educated workforce (ie price and reliability of data connections. Individual PISA scores6). Maps 3 and 4 illustrate weaknesses sectors require different sets of structural in modern communication infrastructure and strengths to be successful. Consequently, network regulation (ie broadband connections in unleashing sectoral growth potentials requires households,) relative to other countries in the EU. addressing structural factors relevant for the Map 5 demonstrates that these countries also individual sector. Thereby, the individual structural spend relatively little on R&D. These indicators strengths are complimentary. To illustrate this correspond to these countries' below average point we will in the following focus on the high- employment in high-tech sectors and below tech sector. The motivation for this choice is that average high-tech exports, as shown by Maps 6 this sector is a typical target for sectoral and 7. development policies because, as Eurostat puts it, “high-tech sectors and enterprises are key Table 2 on page 6 highlights the