BUCHAREST, January 17, 2013—The EU11* region is set to expand by about 1 percent annually in 2012 and 2013. That is significantly slower than in 2011, says the World Bank’s latest EU11 Regular Economic Report.
“The recession in the Euro area continues to dampen EU11 economic performance,” said Gallina Vincelette, World Bank Senior Economist and lead author of the report. “Economic growth in 2012 is now expected to be weaker than predictions of six months ago, averaging below 1 percent. We do, still, expect a modest rebound to 1.3 percent in 2013. With heightened uncertainty, even this modest growth assumes that policies adopted in the Euro area are implemented successfully to avoid severe deterioration in international financial market conditions.”
To protect and accelerate the growth momentum, the report recommends pursuing decisive economic policies on two fronts. First, a prudent macro-policy stance should continue in order to bolster the confidence of financial markets. Second, the medium-term economic growth potential of the EU11 can only be realized if structural barriers to economic activity are removed.
“Both product and labor market reforms are crucial for enhancing the productivity and competitiveness of the EU11,” said Yvonne Tsikata, World Bank Director for Poverty Reduction and Economic Management, Europe and Central Asia Region. “Simplifying business regulation, strengthening the efficiency of delivery of public services, and protecting minority shareholders against misuse of corporate assets for personal gain are among areas where some EU11 countries could pursue reforms to build up the private sector, making it easier to attract investment and do business.”
The Report also recommends providing incentives for labor mobility, making public finances more sustainable, adapting social security systems to demographic developments, and harmonizing regulation across borders. These measures will help mitigate demographic threats and produce sizable returns in income convergence with the rest of the EU.
The modest growth in the EU11 in 2012 was supported by several factors. First, the ability of the EU11 to diversify markets and increase the share of exports to non-EU markets helped spur favorable trade results. Second, foreign direct investment (FDI) inflows remained stable, keeping the EU11 among the attractive destinations to invest. Third, EU11 financial sector confidence has started to show gains, supported by the continuous efforts of EU11 regulators to safeguard the stability of the financial system. Fourth, in the second half of 2012, the EU11 countries accessed financial markets at record low prices due to improved domestic conditions, as well as the somewhat calmer financial markets.
Moreover, against the backdrop of slowing growth across the region, EU11 governments continued their fiscal retrenchment in 2012. The EU11 fiscal deficits went down across the region, reaching an expected 3.2 percent of GDP in 2012. The EU11 fiscal consolidation efforts helped contain the increases in public debt-to-GDP ratios and, despite tight budget envelopes, most EU11 governments delivered their ambitious public investment programs.
However, in an environment of slowing economic activity, the labor markets remained slack. Unemployment rates hovered around those recorded in the midst of the global financial crisis of 2008, with sluggish employment growth and long-term unemployment on the rise. In Croatia and Bulgaria, unemployment rates are now above the rates from the global financial crisis, while Estonia, Latvia, and Lithuania recorded significant declines in unemployment supported by a strong rebound in growth. The near-term labor market outlook remains unfavorable with unemployment decelerating only in the medium-term.
According to the report, credit growth remains constrained. The legacy of nonperforming loans (NPLs) is contributing to the low credit growth in the EU11. Growing NPLs still burden some EU11 countries, whereas a number of countries, including Slovakia and Latvia, achieved some successes due to loan resolution efforts.
The EU11 should continue to remain an attractive FDI destination, the report says, especially if progress in improving the business environment continues. Poland, Slovakia, and Bulgaria experienced the largest gains in FDI in 2012 compared to 2011.
The “Special Topic” section of this edition of the EU11 report explores the issue of the economic growth implications of an aging European Union. According to the report, the current and projected low fertility levels for Europe imply that the region will go through an unprecedented process of population aging, causing dramatic changes in the age structure of European societies. In fact, in the forthcoming two decades, the old-age dependency ratio in the EU11 region is expected to increase at a higher speed than in the EU17. Moreover, labor force participation rates in EU11 already lag behind those in the rest of the EU, with particularly large differences for females without tertiary education. This indicates that from a labor supply perspective, the EU11 faces greater demographic challenges from aging than the rest of the EU. If current trends continue, the number of persons in the labor market is projected to decline by over 35 percent by 2050 in EU11.
The report’s empirical findings suggest that if present demographic trends remain unchanged, the EU11 is likely to experience a notable reduction in income per capita growth, and thus in the speed of income convergence to the rest of the EU. However, increasing labor productivity and labor force participation rates, as well as improving the skill level of the labor force in the EU11, appear to be powerful vehicles in aging societies for fostering economic growth and further convergence in the EU.
The EU11 Regular Economic Report (EU11 RER) is a semiannual publication of the Poverty Reduction and Economic Management Department of the World Bank’s Europe and Central Asia Region. It monitors macroeconomic and reform developments in the EU11 countries, and provides in-depth analyses of key policy issues.
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* EU11 is a group of countries which include 10 European Union (EU) member states – Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic, and Slovenia – and one forthcoming member, Croatia.