Speech to American University in Kosovo

November 3, 2011

Jan-Peter Olters

Speech Given to Students at the American University in Kosovo

Pristina, Kosovo, November 3, 2011

Jan-Peter Olters

There are two developments that have dominated headlines since late summer—one related to the situation in the North of country and the other to the euro.

I will not talk about the former developments—others are much better qualified than I am to discuss related issues—but I will take the latter crisis as a starting point for today’s discussion.

And this is not only because Kosovo has adopted the euro as its legal tender, which would be a reason valid enough in itself, but because the crisis contains valid lessons that—if learnt correctly—could contribute to Kosovo’s ability to retain and build on its very solid growth performance and, as such, start to close the income gap with other countries in Europe.

I think it is President Barack Obama’s former Chief of Staff and current mayor of Chicago who is credited with the quote,

You never let a serious crisis go to waste. And what I mean by that it's an opportunity to do things you think you could not do before.‖

With that in mind, I should like to start by looking at the crisis currently unfolding in Greece, a crisis that risks affecting other countries in the Southern periphery of the eurozone.

I think there are three root causes that co-exist and reinforce one another.

The one factor most frequently debated is, of course, the fiscal dimension of the eurozone crisis.

This can summarized in a few key indicators and contrasted to the initial design of the eurozone.

The Stability and Growth Pact underlying the current currency foresaw caps on fiscal deficits and the stock of public debt at 3 and 60 percent of GDP, respectively.

Policymakers in the eurozone as a whole have been struggling to enforce these self-imposed policy rules.

While eurozone averages for budget deficits and public debt during the pre-crisis period 2000–08, with 1.9 and 69 percent of GDP, respectively, still appeared relatively sound (albeit with a considerable degree of variance), the situation deteriorated rapidly in the wake of the global financial crisis.

During the post-crisis period 2009–11, budgetary deficits and public debt increased to 5.5 and 85 percent, respectively.

For Greece, the country most affected by the current crisis, the current difficulties reflect the combination of legacy challenges compounded by effects from the global financial crisis.

There was not a single year, in which Greece was in conformity with the fiscal Maastricht criteria.

Even during the pre-crisis years, the average fiscal deficit stood at 6 percent of GDP, double what was foreseen in the Stability and Growth Pact—and that in a situation, in which the stock of public debt exceeded 100 percent of GDP.

During 2009–11, both indicators increased to averages of 11.3 and 145 percent, respectively.

But, in the end, the fiscal problems of the weakest members of the eurozone are but a reflection of underlying challenges of productivity and competitiveness.

While the eurozone, as a whole, can be considered healthy, as reflected by an average 2000–11 current-account surplus of 0.2 percent of GDP, it is characterized by a considerable divergence among its member countries.

During the same period of time, Greece’s current account deficit averaged 9.3 percent of GDP.

And here seems to be the crux of the economic conundrum.

If the exports of goods and services pay for only a small fraction of imports, it is the efficiency of production that is the core problem—especially if an economy operates under constraints of a fixed exchange-rate regime.

In such a set-up, policymakers are precluded from using currency depreciation as an instrument to boost international competitiveness and/or offset wage increases in excess of productivity growth.

In a euroized economy, structural challenges—irrespective of their inherent ―political‖ costs—need to be addressed head on.

If a country proves unwilling or unable to do so, it will struggle with the interplay of low productivity, deficits in the external and fiscal balances.

Such a country would risk suffering from sustained periods of economic stagnation, rising rates of unemployment, and increasing poverty, either gradually (because companies face increasing difficulty in competing successfully in domestic and foreign markets) and/or in the wake of an acute fiscal and/or balance-of-payment crisis.

And this brings us to the third element explaining the severity of the current euro crisis.

With clearly identifiable ―weak links‖ in the eurozone architecture, there is an element of speculation against the euro that has amplified the crisis.

There was never much love lost for the euro in the financial centers in New York and London.

No doubt, economists and political scientists will analyze the role and conduct of credit rating agencies, including the exact timings of the large downgrades, in much more detail.

I am looking forward to papers coming out on this topic, stimulating a really interesting debate.

But I will refrain from having this debate with you today and thus turn closer to home.

What does this all mean for Kosovo?

Before I come to that, let me summarize the starting point as I see it.

There are three key features that describe Kosovo’s economy, viz., (i) it has grown considerably faster than all its neighbors in recent years; (ii) it has unemployment figures much higher than in any other country in the region; and (iii) its per capita income is still quite a bit lower.

That said, the key lesson for Kosovo that I can draw from the euro-related events is the conviction that the focus of any socio-economic development strategy would have to stand on two pillars—protecting fiscal strength and fostering increases in productivity and competitiveness.

On the first point, Kosovo will need to maintain its fiscal strength to be able to (i) protect a fiscal buffer should the external environment deteriorate further; and (ii) create a sufficient fiscal space to implement the ambitious public investment agenda.

Second, any development strategy has to aim at increasing the economy’s productivity and its international competitiveness.

But, for economists, this is a difficult concept.

The ―standard‖ definition of competitiveness—typically related to real wages and the real effective exchange rate—a was challenged by Princeton University professor and Nobel prize winner Paul Krugman, who described it in 1994 as ―a seductive ideal, promising easy answers to complex problems‖.

He warned his colleagues—and, particularly, policymakers—that “[t]hinking in terms of competitiveness leads, directly and indirectly, to bad economic policies on a wide range of issues.‖

According to him, domestic productivity growth, not some measure of competitiveness, determines a country’s welfare—which, in turn, is a function of capital, know-how, and technology that FDI can bring to a country.

This ―broader‖ competitiveness concept thus comprises elements of business climate, legal framework, contract enforcement, labor force qualifications, and the quality of public institutions and infrastructure.

A ―competitive‖ economy would thus be one that managed to foster a high-quality export sector with a stable demand base over the entire business cycle and the capacity to easily adapt to changing (especially unfavorable) environments.

The bar seems high, but the challenge, in Kosovo’s case, appears more daunting on first glance than it actually is.

To be successful, the country would need to exploit the so-called ―latecomer advantage‖.

Against that backdrop, policy priorities seem evident and would comprise measures to narrow the gap in infrastructure, technology, and skills with higher-income countries.

In short, Kosovo would need to absorb the relevant standards and their experiences.

However, for this to work, and to provide the foundation on which to foster developments that allows for productivity to increase at a sufficiently dynamic pace and, in consequence, vacancies and wages to rise, it appears most effective to concentrate efforts on attracting strategic domestic and foreign direct investments from companies that are able to bring in capital as well as technology and know-how.

This means that the quality of investors matters as much as the funds that they are able to bring into the country.

Once here, we are back on safe territory, as, in many respects, investors are easy to understand.

Their motivations are clearly defined and consistent across origin, sector, and firm size.

To consider Kosovo as a possible location for investment, entrepreneurs would need to have confidence in their ability to amortize their outlays within a reasonable period of time and earn profits thereafter.

And the ―confidence‖ aspect is critical—especially for domestic or foreign factory owners whose networks do not reach into the highest echelons of government.

Overall, countries tend to be more successful in attracting investments if investors have developed trust in institutions and their ability to apply laws, rules, and regulations uniformly and, in so doing, establish a level playing field for all companies in the market.

This is often referred to as a country’s ―soft‖ infrastructure.

In Kosovo’s case, high-quality, productivity-increasing investments have happened in the—professionally supervised—banking sector, but they remain outstanding in several other potential growth areas.

It is thus not surprising that the European Commission’s recently published Progress Report highlights these very areas as priorities for reform.

As such, the document provides critically important input to the derivation of strategic medium-term policy priorities, which, if implemented, will serve two purposes at once, namely to facilitate the realization of Kosovo’s overarching political objective (EU integration) and economic policy goals (more jobs and better living conditions).

There is no single policy measure that can foster the increase in productivity, allow for tangible employment growth, and improve overall living conditions.

The key to success lies in a series of reforms aimed at strengthening the legal framework, the functioning of public institutions, and the quality of services provided by the public administration—and all that within a sustainable budgetary framework.

And with a little self-promotion, it is here where I think the World Bank can contribute the most and is providing support to bring Kosovo’s economy onto a trajectory of dynamic, sustainable, and inclusive rates of growth.

It remains an arduous journey, but a clear vision of direction is half the success.