Reaccelerating Convergence in Central, Eastern and Southeastern Europe—The Role of Governance and Institutions

IMF News, July 11, 2017

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Speech by Poul Mathias Thomsen, Director, European Department, IMF; Dubrovnik, Croatia; July 11, 2017.
Purpose: frame discussion on the role of governance and institutions in reinvigorating growth and convergence after an initial period of rapid catch-up during transition.
Key observation: potential growth in the region is now only about half of what it was before the crisis.

Early transition reforms that delivered large productivity gains:
- Liberalization of prices
- Lifting of quantitative controls
- Privatization
- Phasing-out of subsidies
These measures produced early reallocation of labor and capital to more productive uses, yielding prolonged rapid catch-up gains.

The environment ahead is assessed as less supportive than the first 20–25 years of transition. Three explicit headwinds:

1. Demographics and skills shortages

Apart from Turkey, the region is aging fast.
Strong emigration, especially of skilled workers, is set to continue.
In the past 25 years, some 20 million people left the region: that’s 5.5 percent of the population and most of them were young and well educated.
IMF empirical analysis suggests that already by 2012, real GDP would have been 7 percent higher on average in the region in the absence of emigration.

2. External economic environment

The world economy is finally picking up steam, but medium-term growth prospects remain subdued and uncertainty high.
Potential growth in the Euro Area—the major trading partner for the region—is projected to be some 20 percent below what it was before the crisis.

3. External political environment and EU integration prospects

The EU has been a powerful anchor through adoption of the acquis communitaire and integration processes.
For countries not yet in the EU, prospects for accession or closer association agreements appear less certain, reducing the catalytic effect of EU integration on domestic policy reform.

Question posed: Is mobilization of broad political support for reforms more difficult today than during early transition when momentum for change was high?
Rising political tensions and populist dynamics (cited as political turmoil in the US and the UK) might affect reform feasibility and appetite.
Increased tensions within the EU between some new member states and the European Commission/older member states have raised concerns about potential reversal of governance and institution-building progress.

The Fund has become increasingly concerned about maintaining central bank independence in several countries in the region.
Central bank independence was an area of early and significant progress for the region; backtracking would be a major setback.
This concern underscores that governance and institutional progress are not inevitable and can be reversed.

Governance and institutional reforms are presented as the critical "next generation" reforms to reinvigorate growth and the convergence process.
Characteristics of these reforms:
- Complex
- Time-consuming
- Slow to show strong results
Conclusion: because reforms take time to deliver, they cannot be delayed—there is urgency to act now.

The region has become increasingly heterogeneous:
- Some countries still operate hybrid models with considerable state control.
- Others have joined the ranks of advanced countries.
Despite heterogeneity, governance and institutional reforms remain a common and relevant theme across the region.
Final assessment: strong confidence that countries in the region will ultimately succeed based on the substantial progress of the last 25 years and demonstrated capacity for change.

Speech prepared for delivery by Poul Mathias Thomsen, Director, European Department, IMF.