First, lower oil and minerals prices may be here to stay. Oil-exporting countries have suffered large terms-of-trade losses that reduced national income far more than it reduced GDP; in Azerbaijan, for example, national income declined by roughly 25 percent over the last two years. In the absence of a recovery in prices, commodity exporters will have to take steps to ensure that the recent exchange rate depreciations result in shifts in production to manufactures. Space has to be created for new entrepreneurs in export sectors. Large companies that depended on oil revenues and construction orders, and that benefited from lending by related financial institutions, are unlikely to become internationally competitive in new sectors and under new circumstances.
Second, the decline in investment rates in the European Union may well be part of a new normal, reflecting reduced resources as trade deficits shrank after the financial crisis. Lower investment over the long term will mean slower growth, unless policies are adopted to improve productivity. Schooling systems, labor market regulations, and financial intermediaries have to adjust to rapidly changing industrial organization, to take advantage of the emergence of the sharing economy and more atomized production methods.
Third, divergence within the European Union—as a result of diminishing international competitiveness of countries in Southern Europe—could well presage mounting tensions within the currency union.
In this environment, cyclical macroeconomic policy can be only a small part of the solution. In the western part of the region, there is some room for fiscal stimulus after austerity in previous years, while monetary stimulus is reaching its limits.
In the eastern part of the region, the opposite is true. Looser monetary policy is a real option, while fiscal policies have to adjust further to lower oil revenues and reduced remittances. However, these cyclical policies will do little to address the pervasive structural challenges. In fact, pure cyclical stimulus can frustrate the necessary adjustments to cope with these structural challenges.
Perhaps the most complicated structural challenge is the growing social and political tension in many countries. Throughout the region there is a tendency toward populism. Voters’ preferences are polarizing, as support for the middle of the political spectrum is dwindling. Mistrust in existing institutions and general anxiety are increasing. Surveys show especially concerns about the lack of job security.
The political polarization likely has many causes, and economic challenges or rising distributional tensions may well have played a role. However, this report shows that there is no clear link between the observed anxiety and a simple measure of income inequality. Inequality, measured by the standard Gini coefficient, has actually fallen over the past 10–15 years in some countries in the region. There are, however, indications that the anxiety is correlated with other measures of distributional tensions.
Since 2010 individuals have become more pessimistic about their position in the income distribution, opportunities for upward economic mobility have deteriorated, and incomes have become less secure over time. The latter is caused by rapid increase in temporary and part-time work, and shifts in the demand forskills, driven by new digital technologies, which affect more severely people employed in occupations of the middle the distribution. In addition, there is some evidence that inequality of opportunity, i.e. inequality due to circumstances beyond the control of the individual, has been structurally increasing. If efforts matter less for achieving secure jobs and growing incomes, than people will get discouraged, underinvest in their education or give up their search for employment.
Slow overall growth has also likely reduced support for traditional parties. Econometric evidence suggests that political populism in ECA is related to the extended period of slow growth since the financial crisis. The biggest challenge for societies and governments is to provide new perspectives in a new economic era without falling back on fixes that worked in the past under very different circumstances. Coping with the structural challenges and limiting the rise in political polarization will require policies that support adjustment to these new economic realities while limiting the pain that such adjustments can cause. Given the uncertainty surrounding many of these issues, research is essential to guide policy choices.
This report consists of two chapters. Chapter 1 summarizes the short-term outlook before briefly outline the main structural challenges to growth and prosperity facing the region over the longer run. Chapter 2 examines some of the changes that may have increased social and political anxiety.
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