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Macroeconomic Policy Challenges in Southeast Europe

David Vines

Department of Economics and Balliol College, University of Oxford;Centre for Applied Macroeconomic Analysis, Australian National University;

Research Director, PEGGED Research Programme on Politics and Economics of Global Economic Governance, European Union; and CEPR

Paper for Conference on Achieving Sustainable Growth in Southeast Europe

Athens, February 11, 2011.

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1 Introduction

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This book shows that the European Emerging-Market Convergence Model was very particular – and very different from the convergence model in East Asia

This model has six aspects. It is worth reviewing these

cf the way in which Maynard Keynes examined pre WWI Europe in Chapter 2 of his Economic Consequences of the Peace, in order to understand the growth model of that time

I will briefly discuss each aspect in what follows

I will then discuss the policy agenda looking forward

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2 The Emerging-Europe Convergence ModelSix aspects of the Emerging-Europe Convergence ModelCapital accumulation, and FDI and technology transfer

These two aspects create the Jeff Sachs convergence story Trade liberalisation, and integration of the region’s production system within the European and the global economy

This aspect describes the convergence-through-trade story

Financial liberalisation Labour-market integration

These two aspects capture the ‘super integration’ storyThe Prospect of EMU membership

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3 The Jeff-Sachs Convergence Story

“There are three groups of countries in the world” 1.5 billion people in advanced countries, 4 billion in the middle

(led by China), followed by the bottom billion (in Africa and elsewhere)

For the four billion people “in the middle” Capital accumulation happens as in a Solow model It is augmented by technical progress which happens

through FDI and technology transfer Asian debate in the ‘90s about capital accumulation:

Perspiration (which happens through savings) versus inspiration (which happens through technical progress)

Interestingly, C19 Europe, like Asia, saved a great deal cf Keynes, Consequences, Chap. 2

In Emerging Europe, savings have not been not high although savings propensities differed between countries

Need a Ramsey model - with savings choice a policy issue

Interestingly the central idea about global resource allocation is that capital should flow to poorer countries

As Feldstein-Horioka showed, this has not happened Lucas has suggested why

South East Europe is the one place where this has happened

The results have not been entirely successful

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4 The Heckscher-Ohlin Convergence story

Think about a story with 3 sorts of goods: 2 kinds of tradeable goods plus non-tradeables Exportables

produced but not consumed at home prices determined in world markets - these are

tradeable goods Importables – which are not produced at home

consumed by not produced at home prices determined in world markets – these are

tradeable goods Non-tradeables

produced and consumed at home prices determined within the home economy

A framework for thinking about industrial structure as part of macro strategy: one examines which exports are important

One factor price – the interest rate – and one goods price – the price of tradeables – is exogenous here nb: ‘tradeables’ includes both exportables and

importables The endogenous variables here are the wage and the

price of non-tradeable goods Stolper-Samuelson theorem here shows how the wage

and price of non-tradeables are determined Trade liberalisation lowers the price of imports relative to

the price of exports The trade liberalisation choice can be analysed by this model One must increase the return to exporting – ie increase the relative

price of exportables, as a response to the liberalisation of imports, One must lower the wage of non-tradeables are labour intensive

One way that growth happens is through such resource reallocation

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5 The Susan Schadler Convergence Story – “super integration”

Financial liberalisation: entirely different from East Asia

Enabled SE Europe to make a low-savings high-growth choiceRisky

Possible that this strategy leads to export-led growth Requires trade liberalisation at same time More generally requires control of rent-seeking in the

tradeable sector Possible that, instead, this leads to a consumption

boom House prices overshoot upwards and consumers bear this

risk Consumers bear currency risk Paying back loans may be difficult – requires massive

austerity post-crisis – consumers bear solvency risk But leverage risk seems not to have been a major problem

in South East Europe - a feature of the institutional integration process which was chosen

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….super integration … continued

Labour market integration: entirely different from East Asia

Transient migration has enabled real wages for Eastern European workers to rise in advance of the convergence of their home economies

Has put upward pressure on the real wage in the home country of migrants

This has helped to tilt the convergence outcome towards

one in SE Europe with a low-savings high-growth aspect

one which is biased towards a consumption boom rather than and away an export-led-growth outcome

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6 The Prospect of EMU membership: effects on convergence process

This too has been entirely different from East Asia

Encouraged some good things Also enabled some bad things

So this too has been risky

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7 The core short term for macroeconomic policy

We can learn here from the East Asian recovery after the Asian financial crisis

Massive currency devaluation and export-led growth

That was much easier in the dot-com boom world, in which demand was growing

It required currency flexibility This is the core issue about macro strategy

This requires curtailment of domestic demand It also requires the creation of a competitive

position This will differ as between (i) members of EMU zone – Greece – and

other countries with pegged exchange rates (ii) countries who are floating

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8 The core longer term issues for macroeconomic policy

It is necessary to reconsider all six aspects of the European Emerging-Market Convergence Model.The capital accumulation process, and FDI and technology transfer.

How much should a country save?Trade liberalisation, and integration of the region’s production system within the European and the global economy.

How will trade liberalisation and increasing openness be managed ?

Financial liberalisation, and Labour market integration

Is the ‘super integration’ really safe – if not, how to proceed?Can the uncertainties about EMU membership be resolved?