Ewald Nowotny: Achieving balanced growth in the CESEE countries
Opening remarks by Prof Dr Ewald Nowotny, Governor of the Central Bank of the Republic
of Austria, at the Conference on European Economic Integration (CEEI) 2012, jointly
organized by the central banks of Finland and Austria, Helsinki, 26 November 2012.
* * *
Good morning, ladies and gentlemen,
Let me reflect, first of all, on the title of this conference: Why is balanced growth an
important issue?
We are now already in the fifth year of the crisis and the storm is not over yet. The crisis has
taught us that the economic difficulties of many countries in Europe reflect long-term
problems inherent in economic and political institutions. There are no quick fixes for these
long-term issues, but it is crucial to take the right measures now.
On the one hand, it is important to contribute effectively to business cycle stabilization and to
support a smooth recovery in Europe. For instance, the reduction of both public and private
sector indebtedness is necessary for regaining the trust of international investors. At the
same time, however, a vicious circle of consolidation measures which erode domestic
demand and therefore delay the recovery has to be avoided.
On the other hand, from a medium-term perspective, the right measures have to be taken to
avoid a renewed build-up of unsustainable economic positions. Achieving sustainable
economic growth and thereby rethinking the appropriate growth model is of utmost
importance in solving the current economic challenges.
This especially holds true for the countries in Central, Eastern and Southeastern Europe
(CESEE), where the boom-bust cycle has been extraordinarily pronounced and the
catchingup of income levels to those in Western Europe has been set back for several years since
the outbreak of the crisis.
From my point of view, one of the most relevant questions in this context is the following:
How can we implement a sustainable growth model that remains crisis-resilient and
promotes the catching-up process in CESEE? Let me look into both issues -
sustainability and convergence - in more detail now.
Sustainability
What is our understanding of balanced or sustainable growth? It means - first and
foremost - that we aim to avoid large business cycle fluctuations as the frequent occurrence
of sizable boom-bust cycles is associated with significant economic costs, affecting the
longrun growth potential of an economy. Second, sustainable growth also implies that economic
growth is diversified as much as possible to avoid the economy's dependence on the
performance of a few sectors, which makes the economy more vulnerable in the case of
asymmetric shocks. Last, but not least, I also want to point out the social dimension of
growth - every group in society should benefit from the growth process such that the build-up
of social inequalities and the resulting pressure on political economic institutions can be
contained.
With these considerations of balanced growth in mind, let us briefly look back on the
precrisis economic developments in CESEE in order to have a reference for the intensity of
the recession in 2009 and the related adjustment process since then.
Chart 1
High Growth Correlated with the Build-Up of Severe
Vulnerabilities and Imbalances
High Growth Correlated with the Build-Up of Severe Vulnerabilities and Imbalances
Average Annual GDP Per Capita Growth (2000-07) Current Account Deficit (2007)
% % of GDP
Bulgaria
Estonia
Latvia
Romania
Lithuania Estonia
Lithuania
Latvia
Bulgaria Romania
Slovakia Hungary
Croatia Croatia
Czech R. Poland
Hungary
Slovakia
Poland Slovenia
Slovenia Czech R.
2 4 6 8 10 12
0 5 10 15 20 25 30
Average Annual Growth In House Prices (2004-07)
Share of Foreign Currency Loans (2007)
% of total loans
%
Latvia Latvia
Estonia Lithuania
Croatia Bulgaria
Hungary
Estonia
Lithuania Poland
Romania Slovenia
Bulgaria
Slovakia
Poland
Czech R.
Slovakia
Hungary
Czech R.
Croatia
Slovenia
Romania
25 50 75 100
0 5 10 15 20 25 30 35 40
Source: wiiw, Eurostat, NCBs, Ameco, IMF, BIS, ECB, National Statistical Offices, REAS.
Between 2000 and 2007, the CESEE countries were - besides China and India - one of the
fastest growing regions in the world (average real GDP per capita growth: 8.2%). This
outstanding growth performance was mainly driven by large foreign capital inflows, which
fuelled domestic credit growth, led to a surge in asset prices (in particular house prices) and
considerably boosted domestic demand.
However, as you can see in chart 1, the sizable GDP growth was generated on the back of
rising vulnerabilities. Soaring prices and wages were one of the consequences of sharply
rising domestic demand. As a matter of fact, double-digit inflation rates were not unusual
during the boom years. On top of very strong lending growth in the years preceding the
crisis, a large part of domestic loans to households and companies was - and in some
countries still is - denominated in foreign currency.
Growing internal imbalances were also reflected by the development of the external sector.
Increasing internal demand led to an appreciation of the exchange rates in countries with
floating exchange rate regimes, which made exports more expensive and led to the build-up
of substantial current account deficits.
Several institutions, including the OeNB, pointed out the macrofinancial risks associated with
these widening imbalances. However, during the boom years it was admittedly hard to
predict whether these developments were actually unsustainable and a threat to growth or
just the outcome of a brisk catching-up process, which would eventually reach an equilibrium
point. In other words, the borderline between a buoyant convergence process and an
overheated economy is a very narrow one - at least for real-time assessments.
In the end the capital inflow-based growth model proved to be unsustainable. As a
matter of fact, up to 2008 nobody could imagine, first, that advanced economies will be
confronted with such a severe recession and, second, that a shock originating from Western
economies would spill over to such a strong extent to the countries in CESEE. But the
accumulated vulnerabilities fully materialized when capital flows into the CESEE countries
dropped sharply after the default of Lehman Brothers in September 2008. This situation,
combined with the collapse of global trade and limited room for maneuver for countercyclical
policy measures, led to a deep recession in 2009. It has been widely acknowledged (for
example by the EBRD in its transition report1 or a recent book by the IMF's European
Department2) that the countries that had the largest imbalances before the crisis were hit
hardest afterwards.
Chart 2
Real GDP Growth per Capita in the Long Run
Real GDP Growth per Capita in the Long Run
2008=100, average in PPP
recovery
110
100
90
80
early transition
bust
70
60
boom
50
40
30
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Baltics (EE, LV, LT)
Central Europe (CZ, HU, PL, SI, SK)
Southeastern Europe (BG, HR, RO)
Source: Ameco.
Chart 2 shows that the output loss related to the 2009 recession was extraordinarily large in
the Baltics, followed by Southeastern Europe and Central Europe. It took at least until the
end of 2011 to reach again the 2008 per capital real GDP levels. While this also holds true
for Western European EU Member States, it becomes clear from chart 2 that the catching-up
of income levels in CESEE to those in Western Europe has lost considerable momentum.
Convergence
This brings me to the second part of my remarks: convergence.
Since the fall of the Iron Curtain more than 20 years ago, the CESEE countries have
undergone an impressive catching-up process. Europe has grown together in many ways:
increased trade and FDI integration, improved infrastructure, greater regulatory and legal
homogeneity and the adoption of best practices with respect to the setup of institutions and
corporate governance. All these factors led to a substantial narrowing of income differences
during the last two decades.
Chart 3
Growth Differential of the CESEE EU Member States vis-à-vis the Euro Area
Growth Differential of CESEE EU Member States vis-à-vis the Euro Area
Percentage points
4,0
forecast period
3,5
3,0
2,5
2,0
1,5
1,0
0,5
0,0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Difference between growth in CESEE EU MS and growth in EA-17
Note: 2012-2017 IMF forecast (World Economic Outlook) from October 2012: Estonia, Slovakia and Slovenia are included in both aggregates.
Source: Eurostat, IMF.
The 2008-09 crisis had a significant negative impact on this convergence process. Chart 3
shows that the medium-term growth differential between the CESEE EU Member States
and the euro area has decreased from 3-4 percentage points before the crisis to less than
2 percentage points now. The positive growth margin of the CESEE EU Member States was
reduced to 0.5 percentage points in 2010 and remained positive only thanks to the robust
performance of Poland. As a result, the catching-up process will take more time than
expected during the pre-crisis boom years. In fact, OeNB simulations show that if the growth
differential remains below 2 percentage points, it will take more than 50 years for the CESEE
region to reach the income level of the euro area (compared with only 37 years if the growth
differential would regain its pre-crisis level of 3 percentage points)3. Also, the catching-up is
less smooth due to large swings in CESEE cycles, particularly for small countries, as will be
discussed tomorrow in a presentation of the OeNB4.
A delayed catching-up process poses serious challenges to further economic and
institutional reforms in CESEE and might affect the people's support for European
integration. A continuous reduction of regional inequalities in Europe is also in the interest of
Western Europe, given that - according to recent studies - a reduction of income inequality
has beneficial effects on the long-run growth potential of an economy.
Conclusion
Let me conclude:
Pronounced boom-bust cycles not only lead to high output volatility but also hurt the
longterm growth prospects of an economy. This is especially valid for the CESEE economies that
experienced a sharp output decline in 2009 and - according to our latest OeNB-BOFIT
projections - there might even be a second recession phase in the wings in several countries
of the region.
The main lesson from the 2008-09 crisis is that the foreign capital inflow-based growth
model is not sustainable in the long run and cross-country contagion via trade and financial
channels from Western to Eastern Europe can be quick and substantial.
Many countries undertook severe restructuring programs during the last years which aimed
at reducing their public and private sector indebtedness and increasing their external
competitiveness. However, we will have to watch the success of these programs very closely
in the upcoming years.
We also saw that the economic adjustment costs caused by high output volatility are
substantial, as they have a direct impact on the speed of the catching-up of Eastern
European income levels to those in Western Europe. A substantial delay in the convergence
process cannot be in our interest.
Therefore, ladies and gentlemen, we have to find new growth models that prove to be
sustainable and crisis-resilient and continue to promote the convergence process -
and this is one of the goals of this year's CEEI. Ladies and gentlemen, I once again welcome
you to this year's CEEI, I wish you a stimulating and productive conference and thank you for
your attention.