A New Growth Model for Central and Eastern Europe

The full implementation of “The Warsaw Consensus” should allow CEE countries to accelerate GDP growth. (left: Bohuslaw Sobotka, PM od the Czech Rep. and Ewa Kopacz, Poland's PM; CC By NC ND KPRM)

Although Poland and the other CEE countries have coped well with the current crisis, the pace of convergence is gradually slowing. The remedy can be found in “The Warsaw Consensus”- a complex growth model for the region, which can lead to a steady development.

 

Poland and its peer countries in Central and Eastern Europe (CEE) have so far coped well with the market turmoil originated by the debt crisis in Greece and stock market jitters in China. The region should grow by around 2.4 percent this year. Poland, the regional economic powerhouse, will be the second fastest growing economy in the EU, with a 3.6 percent growth rate. In 2016, GDP growth will pick up slightly more steam, on the back of strengthening euro economy, low oil prices, and strong domestic demand, and exceed 2.5 percent. Convergence with the euro zone, which is projected to grow at 1.7 percent, will thus continue.

However, the pace of convergence is gradually slowing, pushing into a more distant future the moment when Central and Eastern Europe could reach the Western European levels of income and quality of life. There is thus a need to re-adjust the region’s growth model to accelerate the pace of convergence to at least 1.5 percentage points per year, in line with the empirical findings underlying the convergence theory, but also to strengthen the region’s economic foundations and better insulate it from future crises.

The new growth model, which I call “The Warsaw Consensus”, is based on the prescriptions of economic growth theory, diagnosis of the most important binding constraints to growth in the region and lessons from the 2008-09 global crisis. “The Warsaw Consensus” is focused on the following 10 pillars:

High domestic savings and investment

High employment rate

High labor productivity growth driven by innovation and skills

Controlled real exchange rate appreciation

Openness to immigration

Low income inequality

Diversified exports

Strong supervision over the financial sector

Full integration of the EU market and further EU enlargement

Focus on well-being and happiness going beyond GDP.

 

Let us look at the selected policy pillars in more detail. First, CEE countries do not save enough to support high investment rates and lessen reliance on imports of volatile foreign capital. The solution is to raise private and public saving through more attractive voluntary third pension pillars, more robust domestic financial markets and stricter fiscal rules and corporate tax harmonization to reduce public dis-saving.

The target should be for the domestic savings rate to amount to at least 25 percent of GDP, up from around 20 percent currently, and to raise the investment rate correspondingly to be more in line with the high investment ratios experienced in the past by successful catch-up countries, such as Japan, Korea, Singapore and Taiwan.

The 2014 World Bank report on savings found that for Poland to continue to expand at 3.5 percent annually, the country’s savings would need to increase from 18 percent to at least 23 percent of GDP.

Second, CEE countries need to raise the employment rate to Western European levels. The current rate of employment among 20-64 year olds in the EU-10 region oscillates around 67 percent in 2011, much below the 75 percent target of the EU 2020 Strategy. Poland and Slovakia are the least effective in utilizing its labor force, with employment rates of only 66.5% and 65.9%, respectively. The solution is to raise effective retirement ages, lower taxation on low-skilled workers, enhance access to child care and modernize labor codes to allow elders to work more flexibly and remain in the workforce.

Third, CEE countries need to focus on productivity growth driven by innovation. As the region moves closer to the global technology frontier, it will need to increasingly transition from importing ideas to exporting ideas, from imitating to innovating, from copies to originals. However, so far R&D spending across the region has been partly, amounting to less than 1 percent of GDP in Poland and Slovakia. One part of the solution is to fundamentally modernize the public innovation support system so that it shifts from a focus on absorption of EU funds to results, puts businesses in the driver’s seat, invests in top-notch institutions quality and opens up and connects the innovation ecosystem to the world.

Fourth, it is imperative that the region opens itself up for immigration. Given the fundamental social and cultural changes, even best pro-family policies will not be sufficient to stem the accelerating demographic decline and population aging. The solution is to fully open the countries’ labor market to high-skilled immigration, especially from Eastern Europe, create clear paths to citizenship, and implement top-notch support systems for the newly arrived immigrants. The aim would for the foreign-born citizens to represent at least 5 percent of total population, up from negligible levels today.

Finally, given the diminishing returns to well-being and happiness from rising income above the already relatively high levels achieved by CEE countries, the governments in the region should increasingly focus on well-being and quality of life going beyond GDP. The solution is to focus economic policies not only on expanding GDP, but also on promoting well-being, including quality of natural environment, ample and productive leisure time, and strong social networks, all factors that are critical to satisfaction and happiness.

Knowing the right direction for policies, however, is not sufficient on its own. The devil is in the details of policy implementation. Given considerable ex ante uncertainty and large margins of efforts in the ever more complex world, policies under ‘”Warsaw Consensus” should be guided by a new policy approach based on experimenting, evaluating and being pragmatic. Keep what works, ditch the rest.

The full implementation of “The Warsaw Consensus” should allow CEE countries to accelerate GDP growth and to better insulate the region from the future economic shocks. This should help them fully catch up with developed countries within a life of one or two generations, for the first time in the region’s history.

Marcin Piatkowski – Assistant Professor of Economics at Kozminski University, Warsaw, Poland. Former chief economist of bank PKO BP, and Advisor to Poland’s Deputy Premier and Minister of Finance. The text is based on the paper entitled “The Warsaw Consensus: The New European Growth Model”.

Share this post

TOP