Expenses already cut, now it’s time to think of revenues

Obserwator Finansowy: Olivier Blanchard, chief economist of the IMF has recently written that large and steady fiscal consolidation, decreasing the debt-to-GDP ratio from, say, 100 per cent to 60 per cent is a slow process, likely to take decades. Do you expect the current crisis to continue for decades?

Erik Berglöf: I agree with Blanchard that it’s going to take time to get the debt down to such levels, but you don’t have to think of the whole process as a crisis. In my own country, Sweden, we had a crisis in the early 1990s, but fiscal consolidation took a longer time. We had at that time quick growth in productivity and many other positive effects. Yet, it is true that we were doing this in a different time when the rest of the world was more cooperative, when global economic conditions was more positive.

Of course, it’s much better to have fiscal consolidation through growing revenues than through cutting expenditure. But I think what Blanchard had in mind and what is also a concern of mine, and of most economists, is that with so many countries pursuing austerity at the same time, it’s hard to see where demand will come from and how income can be generated. I think we need to have a more careful approach in recommending more austerity.

During the annual EBRD conference in Istanbul, you said that the policy argument about fiscal austerity versus economic growth stimulus plan was not the most important issue for the EBRD region. On the other hand, Dr Ritzberger-Grünwald of the Austrian central bank assessed that in the Central and Eastern Europe fiscal policy is the key to success because high food and high energy prices cannot be influenced by central banks. So what kind of fiscal policy do we need?

These are slightly different issues. I understand that monetary policy may be of limited reach, but the same is true of fiscal policy. We need fiscal discipline, but our countries have already done a lot in this regard. Just look at Poland, you have no more fiscal space because of your self-imposed – but I think good – debt ceiling in the Constitution. Public debt is not a problem in the countries of the Central and south-eastern Europe, with one or two exceptions. The main problem is that little is being done to further improve the investment climate and increase competitiveness. We don’t see a lot of progress where the main gains are to be had. If you look at the success in the Baltics: austerity worked there, and people had to make very deep sacrifices, but the key reason why it worked was that they had implemented structural reforms; they had an investment climate that allowed them to grow out of the crisis.

The EBRD revised down to 2.2% its forecast for economic growth this year across its 34-country operating area. Next year this figure is to stand at 3.2%. Why should the next year be better?

It is a good question. There are now some positive signs in the United States, the emerging markets as a whole are still growing at a reasonable rate. This should have some impact on European growth at some point in the future. But I must say that I don’t feel very confident about this recovery yet.

3.2% growth is way better than recession in the eurozone, but still below the of the Emerging Europe potential. You wrote that “it was clear even before the crisis that emerging Europe was losing many of the strengths that explained its success”. What strengths have we lost?

A lot of the positive things that have happened in Central and Eastern Europe happened in the period leading up to membership in the European Union. What I worry about now is that the countries of the region have basically gone through the crisis without significant structural changes whereas the rest of the world is moving on. Some countries continue growth based on low cost strategy whereas others, such as China, are moving out of low cost to higher value added strategy. Unfortunately, you don’t necessarily see that same transformation in Central and Eastern Europe. What is clear is that for those countries to maintain their competitive advantage they need to focus much more on core skills, more investment, particularly, in the university system.

In Poland we are having a debate on the so-called middle-income trap. Do you think we are really facing this danger, and if so, how can it be avoided?

That is a very interesting debate. When China started the debate, the rest of the world wanted to have it….

So it’s not necessary, the debate in Poland?

Yes, it is necessary. There are many examples of how hard it is to make this transition. In the 1960s, the World Bank drafted a list of 101 middle-income and then they looked at it in 2008, and only 13 countries had made that transition. These were some Asian countries, but also Greece and Portugal. The problem is that today we are probably less convinced that they have made this transition in a sustainable way. Ireland was there, too; but in this case I would say the country has completed the transition successfully. Well, the transition out of the middle-income trap is not easy to make. I think Poland has done a lot to put in place the building blocks of that transition, but it still has to happen.

What should be the next steps? Because, as we said, monetary or fiscal policy will not help here.

No, it all has very little to do with monetary or fiscal policy. You need to have a stable macroeconomic framework, but what I have in mind is much deeper structural reform. You need to rely more on growth based on improved productivity. That is where investment in education, the innovation system and financial markets that complement the banks come into the picture. You need to find other ways of funding innovation. You have to transition from the imitation-driven growth based on foreign direct investment to something that is coming more from within, something based on your own research and development, something that can encourage multinationals to locate more high-end activities and more qualified jobs to Poland.

By Marek Pielach