The World Bank’s Office in Warsaw released today the second EU-8 Quarterly Economic Report. The report provides an update on key economic developments and reform initiatives in the first „wave“ of new EU member countries.
The authors of the report point out at the EU-8 countries membership of the European Union in May as a major political achievement, although the potential economic gains will have to be earned. Income levels range from 40-80 percent of the EU average, regional income disparities are large and rising, unemployment is high in most countries, and pockets of poverty persist in all countries. While full access to the internal market and EU aid programs offers significant opportunities, the challenges are equally daunting. There will be a long period of catching up ahead, for some spanning several decades.
Euro adoption is now the main medium-term economic policy goal, but for some countries the road ahead will be long and painful. All new member countries submitted their convergence programs to the EC in May. Already meeting the key Maastricht criteria or being very close, a few countries joined the ERM-2 in June (Estonia, Lithuania, and Slovenia) and plan to adopt the Euro from January 2007. The Visegrad countries (in particular the Czech Republic, Hungary, and Poland) will need a longer period to bring fiscal deficits – and in some cases inflation (Hungary and the Slovak Republic) – under control, and will not be in a position to adopt the Euro until 2009-10. Sticking to convergence plans will be more important for credibility than the actual timeframe.
The report observes, that weak popular support for governments and political instability in some countries is complicating economic policy-making and reform implementation. Elections to the European Parliament in June were characterized by low voter turnout and poor support for incumbent governments in most countries (also the case in Western Europe). Meanwhile, political instability continued in several countries. This likely reflects rising income inequalities, high unemployment in many countries, doubts about the benefits of EU membership, and in some countries persisting governance questions. Meanwhile, populist movements have gained ground in several countries. This is complicating the implementation of key fiscal and other needed reforms.
The authors of the report point out that the external environment weakened somewhat. Higher oil prices were no help to the wavering recovery in Europe, and higher inflationary pressures led to an increase in U.S. and U.K. interest rates as well as emerging market bond spreads.
Output growth accelerated further, but inflation also increased. EU-8 output growth reached close to 6 percent in Q1-2004 as growth picked up in the several of the Visegrad countries (notably Poland, Hungary, and the Slovak Republic) on the back of stronger domestic demand. Meanwhile, inflation ticked up in most countries, reflecting in part one-off factors related to EU accession.
Monetary policy was appropriately tightened in some countries. With inflation rising toward target ceilings in Poland and the Czech Republic, and core inflation also edging up, both countries moved to raise interest rates in June. Interest rates were also raised in Latvia. Meanwhile, the Slovak Republic continued to reduce interest rates in an attempt to slow the appreciation of the currency. The current challenge is to control inflationary expectations on the back of large temporary factors, and avoid price increases feeding into wage settlements.
Fiscal policy was supported by buoyant revenues related to high nominal output growth, but further underlying adjustment remains illusive. Most countries are on track to meeting fiscal targets in 2004, but reforms and measures that would support the planned reduction in deficits in countries where it is most needed have not yet been agreed or implemented.
The report recommends that budget plans for 2005 in these countries build in adequate flexibility to ensure that fiscal targets for next year will be met.
In addition to rapid growth (external convergence), countries also aim for balanced regional development (internal convergence), but there may be a trade-off in the medium term. The EU-8 countries target growth rates of 4-6 percent depending on their initial level of income, but at the same time National Development Plans aim for balanced regional development. Experience from existing EU member countries, including the cohesion countries, suggests that there may be a trade-off between external and internal convergence, at least over the medium term.
During the launch one of the main authors of the report, the World Bank’s lead economist for Central Europe and the Baltics, Thomas Laursen stated, that: „Sound economic policies are key to reducing this trade-off. Securing macroeconomic stability, accelerating structural and institutional reforms, and pursuing a growth-oriented regional policy in the context of EU aid are the key elements in this regard.“
He pointed out that the report recommends that the National Development Plans under preparation for 2007-13 should be improved relative to existing plans. Notably, regional policy should be discussed in the context of broader economic and social objectives, financial and absorptive capacity constraints, and the comparative advantage of various policy instruments.
In addition the EU aid and national co-financing should be directed toward the highest long-run economic returns. This likely includes investment in human capital and key infrastructure projects, particularly in support of emerging, market driven growth poles within countries, as well as spending aimed at improving the overall investment climate. Meanwhile, administrative and technical capacity needs to be strengthened to facilitate full and efficient absorption of EU aid.
This report is the second in a new World Bank series aimed at monitoring economic and reform developments in the eight Central European and Baltic new EU member countries. The report has been prepared by a team of the World Bank economists in the region, led by Thomas Blatt Laursen, Lead Economist for Central Europe and the Baltics and Anton Marcincin, Country Economist for Slovakia.