Croatia Should Build on Strengths of Europe’s Growth Model While Pursuing Reforms, Says World Bank Report

June 5, 2012

Europe’s ‘convergence machine’ has helped hundreds of millions prosper

ZAGREB, June 5, 2012 – In the last decades, Europe has followed the golden rule of growth, which looks at how much people have to work, save and invest today so that future generations could be at least as well off as they were. This European growth model has been an engine for economic convergence and has delivered prosperity to hundreds of millions of people on the continent. Croatia has also benefited from economic convergence with Europe. However, faced with adverse debt dynamics and unfavorable demographic trends, many Europeans are calling for a ‘new growth model’. They are asking if there is a need for a new growth model. And if so, what should the new growth model look like? These are some of the questions addressed in the recent World Bank report “Golden Growth: Restoring the Lustre of the European Economic Model”*, presented today in Zagreb.

The report looks at long-term growth in Europe, paying special attention to the last two decades, and identifies what needs to be done to assure continued prosperity in the decades ahead. It assesses the six principal components of the European growth model: trade, finance, enterprise, innovation, labor, and government.

According to Indermit Gill, World Bank Chief Economist for Europe and Central Asia and one of the lead authors of the report ‘most countries in Europe are doing well in trade and finance, many in enterprise and innovation, but few are doing well in labor and government. So Europe needs many changes to make governments and labor markets work better, fewer changes to foster innovation and productivity growth in enterprises, and fewer changes still to reform finance and trade. Stalled productivity, declining populations, and unsustainable fiscal imbalances have made many changes urgent. Croatia follows the same trend and should focus its efforts in making the government and the labor markets more efficient.’

Today’s presentation of the report brought together more than a hundred participants, including high level government officials, private sector representatives, think tanks, opinion makers, academia, diplomatic community and NGOs. The discussion focused on how to revitalize the European growth model, through three sets of recommendations: (i) restarting the convergence machine that has allowed poorer countries become high income economies; (ii) rebuilding “brand Europe” that has helped the region, with one-tenth of the world’s population, account for a third of the global economic output; and (iii) reassessing what it takes to remain the world's lifestyle superpower, with the highest quality of life on the planet.

Restarting the European “convergence machine”
Between 1950 and 1973, Western European incomes converged towards those in the United States. Then, until the early 1990s, the incomes of more than 100 million people in the poorer southern periphery—Greece, southern Italy, Portugal, and Spain—converged to those of advanced Europe.  Starting with the first association agreements with Hungary and Poland in 1994, another 100 million in Central and Eastern Europe were absorbed into the European Union.   Another 100 million in the candidate countries in Southeastern Europe are now benefiting from the same aspirations and similar institutions that have helped almost half a billion people achieve the highest standards of living.

“One can say without exaggeration that Europe invented a ‘convergence machine’, taking in poor countries and helping them become high income economies,” said Indermit Gill, World Bank Chief Economist for Europe and Central Asia “In East Asia and Latin America people worry about a ‘middle income trap’, because few countries have quickly grown from low to high income. Those that have done so during the last few decades were either fortunate—like the handful which found oil—or ferocious, like the East Asian tigers. But in Europe, more than a dozen poorer countries have reached high income. Croatia is one of them. To do well in Europe, they just needed to be disciplined. This is what makes economic growth in Europe unique.  Because trade and financial integration is an intrinsic feature of Europe’s integrated economy, it should not be difficult to restart the convergence machine.”

Rebuilding brand “Europe”
Europe is known for its combination of engineering and design. With few exceptions, every part of Europe has seen a growth in employment, productivity, and exports.   But during the last decade, two growing shortfalls in productivity are threatening Europe’s global economic influence.   The first is that since the mid-1990s, labor productivity in Europe’s leading economies has fallen relative to the United States and Japan. The productivity gap between advanced Europe and the United States today is more than twice what it was in the mid-1990s.  The second is that enterprises in southern Europe have become less productive.  To be competitive, productivity should have grown by about 3-4 percent each year during the 2000s. Instead, it fell by about 1 percent each year.

According to the report, preserving Europe’s global brand will be somewhat more difficult than restarting convergence, but still well within the continent’s reach.  Trade and finance have to be made even more durable so that the continent becomes a single economy. Governments in southern and Eastern Europe will have to improve the business climate, and the larger continental countries must give their enterprises more economic freedom if they are to compete with North America and East Asia. They must also learn from the US to better harness scientific discovery for commercial use and make their universities magnets for the best and brightest.

Remaining the lifestyle superpower
Europe has provided its citizens more income security and a better work-life balance. With real incomes a quarter short of that of the United States, Europe became a “lifestyle superpower”, with arguably the highest quality of life in human history.

Superpowers spend a lot to project their influence and protect their way of life,” said Indermit Gill. “Europe spends more on social protection—pensions, unemployment insurance, and social welfare—than the rest of the world combined. European governments spend about 10 percent of GDP more than counterparts in other parts of the world and almost all of the difference is social protection.  For many countries in Europe, this has become unaffordable. Combined with demographic pressures and weakened work incentives, this fiscal burden is now a drag on growth.”

According to the report, Europe will need to make big changes in how it organizes labor and government. Large and inefficient governments slow economic growth, and Europe’s governments will have to become more efficient or become smaller. A 10 percentage point increase in government size leads to a reduction in annual growth by 0.6 to 0.9 percentage points, or about a third of the long-term growth rate of advanced European economies. While fiscal consolidation and reduction of public debt should be the top priority during the next decade, controlling the healthcare and social security expenses related to aging will remain the policy imperative over the next 20 years.

With a rapidly aging population and falling fertility and without changes in employment, immigration, and pension policies, Europe will lose about one million workers each year for the next five decades and Europe’s labor force is projected to shrink from 325 million to 275 million. At the same time, Europeans have been reducing how much they work.  Today, Americans work an extra month compared with the Dutch, French, Germans, and Swedes, and work noticeably longer than less well-off Greeks, Spaniards, Hungarians, and Poles. Men in Poland, Turkey, Hungary, and France retire more than 8 years earlier than in the mid-1960s.  By 2007, French men expected to draw pensions for 15 more years than they did in 1965, Polish and Turkish men more than a dozen. This puts enormous pressure on public finances, already strained by the costs of servicing large public debt.

Europe will have to work on many fronts to deal with impending labor shortages: increasing the competition for jobs, improving labor mobility, fixing how work and welfare are facilitated, and rethinking immigration policies.  These changes will need a new social consensus.

* The report covers 45 countries: 27 EU member states, 4 EFTA countries (Iceland, Lichtenstein, Norway, and Switzerland), 8 EU Candidate and Potential Candidate Countries (Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, Serbia, and Turkey), and 6 Eastern Partnership Countries (Armenia, Azerbaijan, Belarus, Georgia, Moldova, and Ukraine). The analysis draws on good practice both in and outside Europe. In 16 policy areas ranging from crisis-proofing banks to immigration policy to public pensions and greening growth, the report summarizes the experience of countries both in Europe (such as Czech Republic, Finland, Germany, Ireland, Slovak Republic, Sweden, and the United Kingdom) and from around the world (including Canada, Republic of Korea, New Zealand, Singapore, and the United States).


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