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OPINION September 21, 2018

It Would Be Far Worse to Have the Highly Educated People Remain in Croatia but With No Jobs

Interview with Hans Timmer, the World Bank Chief Economist for Europe and Central Asia, originally published in the print edition of the Lider, Croatian business weekly, on September 21, 2018.

The 25th anniversary of the partnership between the World Bank and Croatia coincides nicely with the 10th anniversary of the Day of Big Plans conference, providing one of the largest regional business gatherings with the opportunity to mark the two anniversaries thanks to the participation the Bank’s Chief Economist for Europe and Central Asia, Mr. Hans Timmer. During this quarter of a century, the Bank, where the Dutch expert has been active for the past eighteen years, financed over 50 projects amounting to US$3.5 billion and provided more than 300 technical assistance activities, studies and policy notes.

The World Bank’s current program in Croatia is focused on the transport sector and the restructuring of public roads and railways companies and the development of the Rijeka Port. The Bank is also supporting improvements in the business environment, including land administration modernization, promoting entrepreneurship by simplifying the business registration processes. The most recent activities include cooperation with the Ministry of Regional Development and EU Funds on the establishment of the strategic planning system and the preparation of the National Development Strategy (NDS) - Croatia 2030, and assistance to the authorities in defining growth opportunities in Slavonia, Baranja and Srijem. In his interview for Lider, Timmer gave away what he would highlight at the conference, including the Bank’s forecasts for the near term and clarifying the institution's view on the increasingly challenging global environment that is going through big changes.

Lider: What are the expectations for the near future in Europe and what can we expect during this and the coming year?

Hans Timmer
Hans Timmer: As far as Europe is concerned, we can expect decelerated growth, which peaked last year. When you look at the data for the first half of this year, you can see somewhat slower growth, and that is reflected in our forecast. That is a reflection of the fact that in most countries there is no longer spare capacity, it has been used up with employment levels back at pre-crisis levels. Also linked to that is the expected unwinding of the monetary stimulus in Europe, that will start at the end of this year and bring certain risks. Still, we do not see that as a cause for concern but as a reflection of macroeconomic conditions. The factors driving the forecasts include big changes in technology that are really disrupting markets which changes really taking off after the crisis in an environment where the new technologies could thrive. The structure of production and the labor markets have been disrupted by these changes, leading to social unrest, so we are closely monitoring this matter, as well as the other essential factor, the reversal of integration and globalization.

Lider: You don’t see this slowdown, especially in the Eurozone, as a threat?

HT: The growth we have witnessed over the past year was above potential and this cannot be sustained, so that’s why this slowdown is not worrisome; on the contrary, the slowdown is probably healthy. We expected growth to drop to two or even below two percent in the Eurozone, which is realistic, although it may be a little bit higher than that. We do not think that there is a threat of falling significantly below that percentage, partly because of the structure of recovery. When you have a financial crisis, recovery is always long and slow and you do not see a bounce back in the investment rates as you would see in normal cyclical developments because it is very difficult to get the credit for the investment.  In conclusion, this is a healthy recovery.

Lider: How does the World Bank perceive the record levels of debt throughout the world? Is this a threat to the global economy?

HT: This is a concern, as well as an uncertainty, because we are to some extent in uncharted territory. We have quantitative easing in the United States, Europe and Japan, and there is no previous experience of the consequences of the unwinding. The problem of debt is mostly concentrated in the private sector, and somewhat less so in the public sector. A good example is Turkey, where there is a lot of uncertainty about the continuation of the capital flows to sustain the debt in the private sector, and here we see that the consequences can be quite harsh. Potentially there is concern for other countries and that is the reason why we call the slowdown in many parts of the world healthy. There is a danger that too much monetary stimulus may be dangerous, because it can lead to rising real estate prices and the more this continues the harder the fall is.  

Lider: Can this be interpreted as a repetition of the practices that led to the previous crisis?

HT: I do not believe that history is repeating itself, because the current situation is different from the uptick that usually precedes a financial crisis. The large monetary stimulus that followed after the crisis made sense, and without it the crisis would have been far worse. There are also many studies which have compared the Great Recession, what we now call the global financial crisis and the Great Depression of the 1930s, and the conclusion is that the magnitude of the crisis and the fall in all kinds of indicators, financial and real sector, was as steep in the recent crisis as it was in the Great Depression,  but the big difference is that 1930’s crisis lasted many years. While within a year of the recent recession we saw a rebound, all because of timely policy reactions. This was an unprecedented move as there was no previous experience, but even now there are dangers. It is a very strange situation that ten years after the crisis we still have very low interest rates and large balance sheets of central banks, which is why it is good to resolve that as soon as possible. At the same time, central banks need to be careful that they are not harming the recovery, so the quest for the right balance is a very delicate process.

Lider: How will American protectionism affect the global economy?

HT: I will broaden the question a bit to discuss what the dangers are of reversing globalization and integration, because there is more to this than the US trade policy. There is the anxiety about immigration, excessive flow of foreign capital and investments in certain countries and there is Brexit. More than short-term disruptions, we are more concerned about the damage in the long-run on growth and on productivity. We recently released our report, Critical Connections, which says that the integration that we’ve seen in the past is not about winners and losers in the short run, but that integration is something that has sustained growth over a longer period because it is linked to knowledge transfers. The report highlights that it is very helpful to be connected to other countries, particularly to those that are themselves well-connected to the rest of world, and that the benefits of such integration help more the people at the bottom of the income ladder than those with average income.  The other point the report makes is that these different dimensions of connectivity reinforce each other so that   for example, the benefits from open trade are even larger when they are accompanied by more immigration, the presence of more foreigners in corporate management and openness to capital flows. The great danger posed by closing borders or imposing tariffs, or concerns about immigration is that the gains of the past will be undone.

Lider: But recently the EU and U.S. have been reluctant to accept this transfer of knowledge to other countries, particularly China, and they are attempting to stop this.

HT: I believe this is short-sighted. China is the most prominent example among many developing countries where the opening of borders which started in the 1990s has created high growth. At the beginning of the 1990s, average growth in the developing world was three percent annually, and now it is close to seven percent, at a sustained rate, and it has contributed a lot to increasing the prosperity of these countries but also created opportunities for wealthy countries. The world would have been very different if not for that opening of borders.  So, this behavior is short-sighted, and it is happening because development always creates tensions and challenges, so to that extent you can understand the anxiety. The problem is that people never compare the current situation with the counterfactual, but rather with what happened 20 or 30 years ago and think that it was better then and that that period could have been sustained forever.  Even without globalization, that situation of 20 or 30 years ago would not have been the same now because you have technology changes, and all kinds of developments that create these changes, so it’s much better to embrace the situation and see where your own comparative advantages are and where you can avoid certain groups of people falling through the cracks.

Lider: Are we witnessing a deep shift in the global balance of power and a move toward the Far East?

HT: That is one way of looking at it, and it is not the first time in history. And all kinds of policy actions are consistent with that move. For example, since the Industrial Revolution until the Second World War, global economic power largely rested with the United Kingdom, which was at the time the biggest advocate of free trade. After WW2, the power shifted to the United States, which was a big adjustment for Europe and the UK. At that point, the US took over the role as the main advocate of free trade and began providing lots of global public goods, starting with the Marshall plan. Now these processes are shifting toward Asia, where China, as the world’s second largest economic power, is taking up the role of providing global public goods and is the strongest advocate for global free trade. There is another way of thinking about that, and it’s what we prefer in the World Bank. We see this as a move toward a multipolar world where there is no longer one single center that dominates everything, not only because there are other economic centers, but partly because the economy has moved beyond national borders. In the case of many companies, it is hard to pin down which country they belong to, because both their employees and owners are scattered throughout the world. In any case, I cannot argue with your description of the shift in power.

Lider: Has globalization damaged the welfare state as we know it?

HT: There are definitely challenges to the existing welfare state. And we’ll soon publish a report on this topic, Rethinking the Social Contract, which acknowledges that the welfare state is no longer functioning for everyone. That might be partly related to globalization, the changing comparative advantages, immigration and competition from low-wage countries. But we think that a much more important factor are changes in technology. We see a dramatic change in the way the economy is organized. Over the past 200 years, we’ve had progress through economies of scale, standardization and concentration of work in big factories and cities. But the new technologies are changing all of that. Now it is possible to have a small company integrated into global value chains, there is fragmentation of production, with customization of products, while urbanization is not as attractive. The old welfare state was very much organized consistent with that old method of production in which not only the state insured the existence of workers, but companies themselves also guaranteed jobs and pensions. Before you normally moved from informal work into the formal sector and became an employee for long periods, and this is now also being reversed.  The old welfare state is still working for old big companies, but it is not working for young people that face a very different economy and don’t have that security of benefits.  This does not mean that the welfare state should be discarded as all the surveys show that people like the welfare state and want less inequality. It will be necessary to extend the security to new forms of labor which are virtually informal, but also to make the formal sector more flexible.

Lider: Where do you see small, open economies like Croatia’s in all of this? Can they reap certain benefits from such a global environment and the associated trade tensions?

HT: Sometimes they can. You saw this with the sanctions on Russia or the counter sanctions in Russia on agricultural products with other countries stepping in, which can also happen now with bilateral tariffs coming from the US. In the short run, itis possible for others to benefit, but whether there is a huge opportunity for Croatia, I am not sure, since it’s part of the European Union, as it is affected by the same kind of measures as other EU members.  In the longer run, this is not the way to think about it. This is not a win or lose situation. Everyone loses in the end that way. Small, open economies can have short-term gains, but over the long term they also lose because they are trading with countries that are no longer as integrated, which brings us to the report I’ve mentioned. We worked on this kind of analysis for Brexit with scenarios for winners and losers, but ultimately in the longer run almost all countries lose if the United Kingdom is less integrated than it used to be. In Croatia and other European countries, we have observed over the past few years that they have very successfully changed their growth model by moving away from the public and domestic sectors toward exports. This is true of many Central European countries, where lots of capital inflows and remittances played a major role until recently, but which have moved toward exports and competition on the international market.

Lider: You say that there are no winners and losers, but many countries in Central and Southeastern Europe are, for example, experiencing problems with workforce outflows, which is very difficult to resolve.

HT: True, this is a problem now. There are several consequences to integration, which we see in many countries, but it’s not true that they can’t be reversed. There are examples, such as India, in which, thanks to changes in the domestic economy, we suddenly see return of migrants because there are more opportunities now. We always believe that there are advantages to creating opportunities for work abroad, because when people come back, even if it’s temporarily, they bring money and knowledge. Moreover, this situation underscores the need for investment in the type of knowledge being sought outside, of which a part remains at home since not everyone goes abroad to find work. The ultimate result should be that you learn from the opportunities abroad, you bring knowledge back home, you bring industries back home, you receive investments from the diaspora and thereby become economically attractive. This does not happen overnight. You have the examples of the diasporas which are starting high tech sectors in Armenia, Georgia and Bulgaria. I repeat, you also have to think again about the counterfactual – you would have had a high number of highly-educated people who would not be able to leave and are not able to find jobs in the country, which would have been worse than finding a job in another country.

Lider: How will new technologies influence the appearance of the near future?

HT: We don’t believe that jobs will disappear, as many have thought throughout history when there was some technological breakthrough. New technologies will create new demand and different jobs, the need for different skills. The impact on productivity will be less important than the changes that will happen in how we work, produce and do commerce. Various types of working relationships are completely different, which means that policies that we have developed in the past no longer apply. This is a gradual process, so many policy makers think they still have enough time, which is not true, because the younger generations are already living in this new system of working relationships and production.

Lider: Where is Europe in the application of new technologies? One gets the impression that it is lagging behind the United States and the Far East.

HT: Two years ago, we wrote a report on digital dividends, and the conclusion was that Europe is different from the rest of the world because of the greater influence of governments in the regulation of markets and people are more risk averse. This is reflected, for example, in the unwillingness to use cards on the internet. Another result of this is better internet access in Europe in comparison to the rest of the world, which is better distributed and cheaper, but at the same time Europe is lagging in e-commerce and in the number of high-technology companies which are mainly American and Chinese. The situation has two sides, in some matters Europe is ahead, and in some it is really falling behind, but in the recent past it has been attempting to keep pace and I am optimistic.