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Strengthening the Economic Engine: Prosperity and Resilience of CESEE Economies in a Changing Trade Landscape

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Via IMF (Den Internationale Valutafond)

Strengthening the Economic Engine: Prosperity and Resilience of CESEE Economies in a Changing Trade Landscape

June 12, 2019

As prepared for delivery

Introduction & Theme

Good morning! Thank you, President Draghi, for inviting me today and for
your opening remarks. I hope in my speech to build upon your excellent
insights and complement your ideas on how to build stronger Central,
Eastern, and Southeastern European economies (CESEE).

[1]

It is appropriate that this conference — the 8th ECB conference on the
CESEE region — is focused on navigating the changing trade and financial
landscape. Why? Because the region’s success story is linked to

integration within the European Union and throughout global markets.

Over the past three decades, integration has been the driver of
CESEE’s rapid economic growth and acceleration that helped
dramatically raise living standards. And the region’s success has, in turn, fueled the success of the EU more broadly.

Now you may have noticed that I chose my words carefully this morning. Driver. Acceleration. Fuel. It is not
because I am thinking about attending the Formula One German Grand Prix
next month. No, it is because the CESEE economies are like a powerful
engine, one that is about to be put to the test.

We meet at a moment when support for global cooperation and multilateral
solutions is waning. Global trade growth has been subdued for more than six
years and the largest economies in the world are putting up new trade
barriers.

These troubling developments will create headwinds for the CESEE growth
model — a model that relies on openness and integration.

So, this morning, I would first like to look under the hood and discuss how
the region’s powerful economic engine was built.

Then, I want to describe new IMF research, being released today, which
shows how trade tensions pose a challenge to the region’s economies.

And finally, I will outline the road ahead and demonstrate how a renewed commitment to reforms is essential to strengthen
resilience and secure a bright future for the CESEE economies and Europe as
a whole.

I.
CESEE: How a Powerful Economic Engine was Built

When the Berlin Wall fell, Central and Eastern Europe embarked on a
difficult transition from communism to capitalism and democracy. Few could
have imagined the remarkable journey that brought the region to where it is
today.

Since the mid-1990s, annual real per capita growth in CESEE has averaged
nearly 3¾ percent,

almost triple the per capita growth rate in the rest of the EU.

As a result, living standards in the region have rapidly increased, and
some now approach those of Western Europe.

The region’s GDP per capita, adjusted for differences in purchasing
power, has more than doubled. In the Baltic states, per capita income
has tripled.


But we all recognize the journey is far from complete.

In the Western Balkans, per capita income remains less than one-third of
German levels; and economic activity in the region, just as in the rest of
the world, has slowed since the global financial crisis.

The reality is that continued convergence is not a given.
As the CESEE story demonstrates, convergence is an economic engine
propelled by tireless policy efforts and supported by international
integration and cooperation.


How was the region’s economic engine built?

The most important driver of growth was the bold and sweeping reforms undertaken to shake-off the
legacy of nearly half a century of central planning.

Democratically elected governments liberalized prices, stabilized public
finances, privatized state assets, and built new institutional and
governance frameworks.

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Economic integration played an important role as well. The right policies enabled CESEE countries to access foreign markets,
attract foreign capital, and integrate themselves deeply into cross-border
supply chains.

Economic and financial integration, in turn, accelerated growth. It allowed
countries to specialize in more productive sectors and fostered the
transfer of technology and knowledge.


Since 1995, exports from CESEE grew at an average pace of over 8½
percent per year
. By 2014, more than three-quarters of CESEE exports were linked to supply
chains, compared to two-thirds of exports from other EU countries.

The auto industry is perhaps the best example of how one sector has been
able to leverage CESEE’s combination of geographic location, skilled labor
force, and cost advantages.


Over the past 20 years, the region quadrupled its share of world gross
exports of car and car parts

— from less than 2.5 percent in 1997 to over 10 percent in 2017.

Slovakia is now the second-largest producer of cars per manufacturing
worker in the EU. And now you see why my engine metaphor is an especially
good fit for this region!

Of course, the region’s integration into global value chains goes beyond
cars. It ranges from aerospace in the Czech Republic and Poland, to
computers and electronics across the Visegrad countries, to apparel and
shoes in Romania as well as Bosnia and Herzegovina.

Success has attracted investment. In the decade leading up to the global
financial crisis, the region received a large influx of private capital,
averaging more than seven percent of GDP per year.

This capital helped CESEE economies upgrade their infrastructure, improve
access to credit, and strengthen the banking sector.

The increased investment was a sign of broader European support for the
region.

And the promise of EU membership helped policymakers in each country
implement difficult reforms.

In turn, the EU provided capital, trade opportunities, and benchmarks for
the region to aspire to.

Mario, as you recently said, “

The European Union has been an economic success because it has provided
an environment in which the energies of its citizens have created
widespread and lasting prosperity.”

[2]


That is precisely right and the success of the CESSEE region helps prove
your point.

The global community has played a role as well. International financial
institutions helped relieve financing pressures, and provided advice,
training, and technical assistance wherever it was needed. At the IMF, we
created a new lending instrument specifically designed to address the needs
of former communist countries.

[3]

All of these components helped build CESEE’s economic engine. But now, as
we meet in 2019, we have to ask ourselves whether the engine can handle new
terrain.

II.
Headwinds from the Changing Trade Landscape

A retreat from global integration by some advanced economies will challenge the CESEE growth model. The high level of
openness and specialization, which has delivered enormous benefits, has
also left the CESEE economies exposed.

CESEE countries are now an integral link in the supply chains for a wide
variety of products and services: when one link in the supply chain breaks,
the entire network can feel the effects.


The economic engine, while powerful, is complex and interdependent.


Today, we are releasing a new paper that studies the complexity of this engine.

The paper considers a hypothetical scenario in which the US imposes a 25
percent tariff on imports of cars and car parts.

Two key takeaways emerge from our research:

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First,
only a small portion of the impact of the US tariff shocks on CESEE
economies would occur in the countries that directly export cars or car
parts to the US. Most of the impact would be felt by other trading partners and in sectors
that are part of existing supply chains.

Second,
the losses from higher car tariffs would spread out across more European
economies than the gross export data suggests.

Consider the case of the Czech Republic. Direct exports of car and car
parts from the Czech Republic to the US are very small — less than one
tenth of one percent of GDP. This means traditional analysis relying on
trade statistics indicates the Czech Republic should be largely immune to
our simulated higher US car tariffs. But that is not the case.

Our research shows that the Czech Republic would be the fourth most
affected country by car tariffs in all of Europe.

[4]

Why? Because a large amount of the Czech Republic’s value added is
incorporated into other countries’ car exports to the US.

Our research also shows that CESEE’s greater trade openness has

increased the region’s vulnerability to what happens outside of Europe.

Despite these vulnerabilities, there are no clear signs yet

that the changes in the global trade landscape have negatively affected
the CESEE region to date
.
Since 2011, exports from the region have continued to grow at almost
double the rate of GDP. 


This means that now is the perfect time to strengthen the region’s
economic engine and ensure it does not stall in the days ahead.

III.
Policies for Navigating the Uncertain Road Ahead

To adjust to the changing trade landscape, CESEE economies need to upgrade
their growth model. We can all be better mechanics.


A new generation of reforms is needed to support this transition and
ensure that the benefits of economic success are more broadly shared
. This will require a renewed political commitment to reform.

After all, countries in this region are not only facing a shifting trade
and financial landscape, but are also seeking to address long-term trends.
Here I am thinking of the impact of aging and migration on the labor force.

As always, priorities will differ across countries, but today I want to
highlight three key policy areas that are critical for all
nations:



First, investing in human capital and boosting the labor supply
. Widespread labor shortages and rising skill mismatches in the region
will soon be exacerbated by daunting demographic trends.

Enhancing vocational education, training, and lifelong learning will be
instrumental. In addition, countries can raise the retirement age, increase
the labor force participation of women, and support the hiring of more
foreign workers.

In Poland, Slovakia, and the Czech Republic, procedures for hiring
short-term foreign workers from select non-EU countries have recently been
simplified. This has helped increase labor supply and is a step in the
right direction.

I hope we will have a chance to discuss this particular issue in greater
detail at the joint IMF-Croatian Nation Bank Conference in Dubrovnik next
month, which will focus on the demographic challenges of the CESEE region.

But it is only one challenge for the region.

Another is strengthening anti-corruption efforts. By modernizing institutions, especially judicial systems, countries can
rebuild trust in institutions. Good governance and effective institutions
are vital for productivity and investment, as well as sustainable and
inclusive growth.

When corruption becomes institutionalized, it poisons the ability of a
nation to attract investors and create jobs. Young people understand this reality better than most. A
recent survey of global youth showed that young people identified
corruption — not jobs, not lack of education — as the most pressing concern
in their own countries.

[5]

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To me, it makes sense.

Because corruption is the root cause of so much of the injustice people
feel in their daily lives. That is why the IMF is focusing on this
issue and including governance in more of our surveillance work going
forward.

Progress is being made. In Bulgaria a new unified anti-corruption agency
was established in 2018 along with reforms to enhance judicial
independence.

For the Western Balkans, in particular, a focus on meeting governance
standards and EU accession requirements is key. This can be a catalyst that
will lead to further regional integration.


The idea of integration leads to my third and final priority area


improving international cooperation on trade.

Even if the right reforms are implemented, CESEE economies will not succeed
unless all countries work together to improve global trade. We can start by
making every effort to de-escalate the current trade disputes and continue
constructive dialogue.

Where should this dialogue lead? To a place where, through cooperation, we
can fix and modernize the global trade system.

This means avoiding tit-for-tat tariffs and instead finding ways to
unlock the full potential of e-commerce and trade in services.

It also requires a renewed focus on the distortionary effects of state
subsidies, improving the enforcement of intellectual property rights, and
ensuring effective competition.

These policies should go hand-in-hand with building a global trading system
that is more effective in delivering for every citizen, especially those
hurt by the disruptions that come with rapid technological change.

Taken together, these domestic and international reform priorities can help
us recalibrate, build resilience, and deliver a more prosperous future for
all people in the region.

Conclusion

Let me conclude. There is no question this is a challenging time for CESEE,
and Europe as a whole.

But we can draw inspiration from one of the great leaders of Europe’s past
integration success. A visionary who helped build the original engine.

Vaclav Havel famously said,

“It is in the moment of profound doubt that we can give birth to new
certainties.”

That was true of Europe after the fall of the Berlin Wall. And with hard
work and cooperation, it can be true for Europe once again today.

Thank you very much.




[1]

In this speech, CESEE (Central, Eastern, and Southeastern Europe)
refers to EU newer member states and countries in the Western
Balkans. EU members comprise Bulgaria, the Czech Republic, Estonia,
Croatia, Latvia, Lithuania, Hungary, Poland, Romania, Slovakia and
Slovenia. The Western Balkan countries include Albania, Bosnia and
Herzegovina, Kosovo, Montenegro, Northern Macedonia, and Serbia.


[3]

Systemic Transformation Facility (STF). During 1993‐1995, the STF
provided temporary assistance to countries in transition from
centrally planned to market economies facing balance of payments
difficulties.


[4]

Estimated losses exceed the country’s direct exports of cars and
car parts to the United States. The losses calculated using value
added exports (i.e., taking into account GVCs) are 0.1% of GDP or
$184 million, while gross exports of cars and car parts to the US
are 0.07% of GDP or $156 million.

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Phone: +1 202 623-7100Email: MEDIA@IMF.org

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