OPINION

Increased Social Fragmentation

Mamta Murthi

Banka – financial and business monthly

January 15, 2014

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Interview with Mamta Murthi, World Bank Director for Central Europe and the Baltic States for Banka – financial and business monthly, published, January 2014

Mamta Murthi, World Bank Director for Central Europe and the Baltic Countries, talks about economic growth and employment as the most powerful tools to reduce poverty and inequality in Croatia and globally. The objective of promotion of shared prosperity demands that we worry not just about whether GDP is growing but whether the welfare of the poorest segment of society is improving.

Poverty, social protection, pensions and demography are the areas of expertise of Mamta Murthi, World Bank Director for Central Europe and the Baltic Countries. She holds a PhD from Oxford, joined the World Bank in 1995 and before that she was a Research Associate at the London School of Economics. As a co-author of the “Growth, Poverty, and Inequality” report, she recommends that public policies focus on: accelerating shared growth and job creation; improving public service delivery; strengthening social protection; and poverty reduction.   In the interview for Banka we asked her about her views on these issues now that she oversees 11 EU countries: Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic and Slovenia.

Q: We do not see extreme poverty in Europe as for instance in Africa and India. Nonetheless, the World Bank is pointing to an increase in ‘new poverty’ in Central Europe caused by loss of jobs due to the crisis. What is recent data showing?

A: Indeed, when we look at the countries of Central Europe, we do not find extreme poverty as defined by a person living on less than $1.25 a day.  The economic crisis increased the number of poor and vulnerable in the region so when we measure poverty in this region we look at the disposal income of an individual. If that income is less than 60 percent of the median income in the country that person is considered to be at risk of monetary poverty. In the 11 EU countries the percentage of the population living below the relative poverty line ranged from 10 percent in the Czech Republic to 22 percent in Bulgaria and Romania. Other EU 11 countries with high rates of relative poverty are Croatia (21 percent), Lithuania (19 percent) and Hungary (19) percent.

Q: In 2010 the World Bank was to first to report on the new poor in Croatia: urban and unemployed because of the crisis. Is there a new report on Croatia? 

A: We regularly monitor poverty developments as part of our corporate mandate. The prolonged recession contributed to the rise in unemployment, with the survey-based unemployment rate now breaching 17 percent. This has to a large extent affected the new poor – those who were previously active at the labor market. While the focus should remain on the long-term poor, which are also socially excluded segments of population, the short-term policy response needs to prevent that the new poor turn from a transient to a long-term poverty.

Our simulations show that poverty rose from around 13 percent in 2008 to around 20 percent in 2013. In 2011, when the most recent official poverty assessment was carried out, the highest poverty incidence, above 40 percent,, was found in households headed by either an unemployed or an inactive person. Poverty incidence is also substantially higher in rural areas than in urban areas (around 24 percent compared to 9 percent) and in the Continental rather than the Adriatic region. The poverty incidence among households having six and more members is also high - above 27 percent, which then reflects on youth poverty.

Q: Youth unemployment is second highest among all European Union members.  How can we employ them?

A: Vulnerable groups are most affected by the poor labor market situation with the greatest burden falling on the youth and the low-skilled. The youth unemployment rate in Croatia is the third highest in the EU after Greece and Spain—close to 50 percent. This follows five years of negative economic growth and significant barriers to effective youth employment, such as barriers to entry in some professions and the mismatch between education outcomes and market needs. This also reflects the higher redundancy costs and more rigid labor market regulations associated with older workers including pre-retirement protection periods.

Q: How do labor market reforms, which are being implemented by the Croatian government and supported by the World Bank, affect employment and competitiveness?

A: Back in 2011, the World Bank benchmarked Croatia’s labor legislation and identified legal constraints to achieving a dynamic and flexible labor market. Theory, as well as an extensive analytical body, notes that while stricter employment protection legislation (EPL) leads to higher employment protection, it comes at a price of increasing the cost of labor leading to a lower employment level. It does then create a dual labor market: the primary market, where workers enjoy job security and the benefits of regulations, and the secondary market -informal, the self-employed, and contingent workers- where these benefits are absent. Under such conditions, it is difficult for outsiders, such as the unemployed, to find a good job in the primary sector. Outsiders are from disadvantaged groups: new labor market entrants, including youth, and low-skilled workers.

The labor market situation in Croatia is unsatisfactory. Labor force participation is low and unemployment continues to increase. The employment rate for the population aged 20–64 is currently below 56 percent; the EU2020 strategy target rate is 75 percent. Close to 60 percent of the unemployed are long-term unemployed. This huge gap suggests underutilization of labor in Croatia. Part of the problem lies with the strict labor legislation, and part of it with social policies.

By European standards Croatia’s EPL is strict. The OECD EPL index for Croatia is well above the EU15 average and is in a group with Greece, Spain and Portugal. Dealing with redundancies is considerably more difficult and costly in Croatia than in most other neighboring countries. It is also more difficult than in regional competitors like Bulgaria, the Czech Republic, or Hungary. However, until recently, Croatian employers also faced high hiring costs resulting in high unemployment rate and longer length of unemployment. At the same time, multiple social benefits have also raised the so-called reservation wage after which social welfare beneficiaries would accept, usually, lower-paid jobs.

Q: The registered rate of unemployment  in Croatia stood  at  around  21  percent and is the second  highest  among  all  EU  member  states.

A: In the region of Central Europe the labor market has yet to benefit greatly from the nascent recovery. Despite higher overall growth rates in the EU11 region, employment during the crisis suffered more than in EU15, as employers in EU11 were more prone to cutting employment than working hours. In none of the EU11 countries the employment level has reached the pre-crisis peak, but the performance of individual countries differs greatly.

In the case of the Czech Republic and Poland, current employment levels are close to the pre-crisis peak, as labor hoarding continues in the former, while stronger growth helped protect jobs in the latter. In Latvia and Lithuania the current employment rate is still around 20 percent lower than the pre-crisis rate, reflecting large economic adjustment in 2008-09 as well as significant migration. Estonia has improved most considerably over the past two years driven by strong economic rebound, which led to large job creation in manufacturing, construction and transportation.

Altogether, the number of employed people in the EU11 in the second quarter 2013 stopped falling and stabilized at around 44.7 million. This does not alleviate concerns of the unemployed. Currently around 4.9 million people in the EU11 are jobless, representing an increase of 1.8 million from the historic low recorded in August 2008. With the exception of the Baltic countries, unemployment rates remained stubbornly high. In Croatia and Slovenia they continued to increase as growth contracted. 

Q: Where do you see growth potentials in Croatia?

A: With its fantastic location as a gateway to South East Europe, a long coastline, as well as arable land in the eastern part of the country, Croatia has many comparative advantages and even more so when it comes to its innovation potential and human capital. However, the efficiency of using these resources has a large scope for improvement. Croatia has one of the lowest labor participation rates in Europe, and large public sector employment at the expense of private sector development, Equally so, the economic landscape - from transport (ports, rail, ferries, air, roads) to energy (electricity, district heating) to even tourism (hotels and prime real estate) or food production is dominated by state-owned companies. State-owned assets comprise around 68 percent of Croatia’s GDP, which puts Croatia behind only four countries in Europe in terms of the value of state-owned assets. The weak performance of Croatian SOEs, relying on significant fiscal support in terms of guarantees (around 12% of GDP), a direct debt assumption (over 3% of GDP), or direct state subsidies (at 1.7% of GDP more than double the EU27 average), has contributed to Croatia’s excessive public debt and deficits.

Q: The most recent Eurostat data shows that one third of Croatia's population lives at a risk of poverty or social exclusion. Only Latvia, Romania and Bulgaria are doing worse. However, these countries in 2104 are expecting their GDPs to grow while the opposite is expected in Croatia.  According to the recent Country Partnership Strategy between the World Bank and the Republic of Croatia, the target is to reduce the number of poor from 1.4 million in 2011 to 1.3 million in 2020.  Could you please clarify the numbers?

A: Croatia, as a new EU member state committed to the Europe 2020 Stability and Growth Agenda. One of the indicators monitored and committed to by all EU member states as well as Croatia is a reduction in the number of poor and those at the risk of poverty by 2020. Croatia has yet to commit to these numbers as a member state. The policies recently launched by the government that focus on better targeting, activation and employment, if followed by strengthened VET and LLL education efforts would help in reaching these targets.

Q: Is there a conflict in goals between fiscal austerity and prosperity?

A: These are not conflicting goals for countries that face fragile market access or credibility of their fiscal policies for controlling their indebtedness. There is plenty of research that proves that. It is the speed at which the consolidation takes place and how it affects growth that matters. Countries in Europe that have consolidated their finances faster are enjoying growth over the last three years and have avoided a double-dip recession.

Q: Poverty risks are also linked to the consumer and companies’ debt crisis. Could you give us your views on credit activity in Central Europe?

A: Credit demand has shown some signs of recovery across Central Europe, which is consistent with the observed turnaround in the business cycle. In Slovenia, Latvia, Hungary and Croatia, lending to households is still experiencing a decline. However, although the demand for loans grew in 2013, credit standards tightened, particularly on commercial real estate loans and consumer loans. That said, on the supply side, we observe the gradual shift in funding sources toward local deposits, partially offsetting the decline in foreign funding.

In fact, local deposits account for more than two thirds of funding sources for most EU11 countries. So, the issue is the supply and demand mismatch for some segments of the population. On the one side, deposits of households are growing, on the other side there are some segments of population that are unable to service their debt. Reprogramming of loans, restructuring of debt, as well as personal bankruptcy frameworks in some countries, are helping with the household debt resolution. Employment, however, is the most powerful instrument.

Q: How can the Croatian government get public support for reforms? 

A: Croatia is indeed going through a very difficult period and all segments of society have been affected. The government is facing a very challenging task of having to reduce its expenditures while at the same time trying to protect the vulnerable. This is never easy, especially as results of reforms and the benefits are not seen and felt overnight. 

Q: How does the social welfare system function in Central Europe in comparison with the Croatian one?

A: Croatia has an extensive, but costly and fragmented social assistance system, with a large number of categorical entitlements. At around three percent of GDP, spending on social assistance programs is higher than in other Central and East European (CEE) countries, with a large share of spending going to war veterans and families. The Government is working on the consolidation of cash administration for social welfare programs, family policy programs and unemployment benefits, aiming to improve the efficiency and targeting of its social assistance. Measures such as data exchange between the social protection information system and other public databases have brought about some savings. However, the largest fiscal gains would be generated through the introduction of means testing for various social benefits programs, ensuring that the most vulnerable groups in society are better targeted.

Q: The new World Bank strategy highlights promotion of ‘shared prosperity’.  What does that mean?

The goal is to boost income growth of the bottom 40 percent of the population which demands that we worry not just about whether economies are expanding, but we look at whether the welfare of the poorest segment of society is improving.  The idea of shared prosperity is more complex than simply raising incomes. This is an important objective for all countries.

Achieving shared prosperity requires linking lower income people to the economic growth process in an environmentally, socially and fiscally sustainable manner, such that the gains will be secured for generations to come. This is the approach that we are taking in our work with the EU11 countries. When we in partnership with the respective countries, develop engagement strategies, we make sure that our programs which include lending and policy advice focus on the immediate challenge of trying to accelerate economic growth in a very difficult economic environment. For lower income groups to prosper it is necessary for the overall economy to prosper.

Q: Your office is in Brussels. How do you cooperate with the European Commission?

Having my office in Brussels provides me and my team with many advantages. First of all I am much closer to the 11 EU member countries that I oversee. It is faster for me to travel there and there is no time difference allowing me to be more effective in my work and respond to our partners’ requests. Second of all, I am able to instantly communicate with our colleagues at the European Commission in the different directorates. As one of our main objectives is to help the 11 EU members converge with the old EU members and help them attain the goals set out in the European Union 2020 Strategy we have regular meetings with EC colleagues and discuss how the World Bank’s work can complement these efforts, especially in areas which may not be supported through EU funds. The European Commission highly values our sector analyses, the knowledge we bring on different issues not just on EU member states but globally and the work we do to help bring forth the needed institutional and structural reforms in our countries.