dr Krzysztof RybinskiWarsaw, 31 January 2008

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Comments on the main part of the World Bank

Regular Economic Report EU8+2

  1. As always the World Bank does an excellent job in providing a well written and up to date analysis of the new EU member states. Let me briefly recap the main points.
  2. The level of uncertainty with respect to future economics prospects of EU8+2 countries has increased amid turbulence on the US housing and credit derivatives markets. Having this is mind one should expect robust economic growth in the region in the next two years, with risks to growth remaining slanted to the downside and risk to inflation slanted to the upside.
  3. While wage pressures and credit growth seem to decelerate they remain high. As labor markets are tightening it is unlikely that a more pronounced wage moderation lies ahead. Robust domestic demand growth contributes to large external imbalances, that are expected to remain large in some countries. This makes many new EU members vulnerable to investors sentiment shifts, although in many cases FDI covers large part of the current account deficit.
  4. Wage growth outpacing productivity improvement has led to significant ULC increases in many countries. Costs pressures are aggravated by continued oil prices increases and by rising food prices. One can point to some factors suggesting that food price inflation may last longer than in the case of a typical negative supply shock.
  5. There is very little evidence that strong growth period was used to advance a much needed consolidation of the public finances, with exception of strong consolidation effort in Hungary after a long period of excesses. Fiscal deficits were generally smaller than expected amid higher growth and inflation, but structural deficit reductions were very modest at best. It appears that planned consolidation efforts in 2008 and 2009 are not strong enough to deal with rising inflation and external imbalances risks.
  6. Structural reforms were “erratic”, it is worth noting that Poland is a laggard in the ease of doing business statistic, ranked on 74th place among 178 countries.
  7. In general I fully share the report assessment of the economic and financial conditions in the region. Let me add, however, several remarks and raise few issues.
  8. Available information suggests that there is very limited or no direct exposure of EU8+2 financial institutions to the US subprime market or credit derivative market. Therefore the direct impact of the US turbulence should be nil and economies in the region should experience only the indirect effects of the suprime saga.
  9. Available studies and already collected anecdotal evidence suggest that local banks owned by US or European parent companies may tighten credit conditions and raise the cost of funding for households and corporates. This should positively contribute to a much needed credit growth moderation and may lead to improvement of lending practices, which in some cases departed from prudent standards.
  10. There are two immense challenges for authorities in the region: agflation and wage growth. Rising demand for food in emerging markets, rising demand for agricultural products used for biofuel production and rapidly rising frequency of climate-related catastrophes, all these factors may contributed to prolonged increase of food inflation, often referred to as “agflation” World economy may need few years to adjust properly to these conditions. With high share of food in consumption baskets in the region this will add to overall inflation. Moreover, food products are purchased frequently, so this may lead to high inflation perception, a so-called “cappuccino effect”, which combined with tightening labor markets may lead to sizeable second round effects. Central banks in countries which have independent monetary policy should carefully watch these developments, especially in the context of flat Phillips curves. It remains an open question what is the right approach and how quickly central banks should aim to bring inflation back to the target. However, it is of utmost importance to use central bank communication effectively to reassure households that inflation will be brought back to levels consistent with stable prices. Well designed communication should help anchor inflation expectations at the target.
  11. Wage growth and high ULC growth in almost all analyzed countries is adding to medium term inflation and external imbalances risks, but in the long run may significantly hurt competitiveness of economies in our region. While it seems unlikely that wage demand will go away amid tightening labor markets and outward migration, the proper policy response should focus on advancing structural reforms, that will create right conditions for faster productivity growth. In the medium term productivity growth might accelerate amid sectoral reallocation of labor (for example from low productivity agriculture to higher productivity services or construction). In the longer run, however, countries’ innovation capital has to increase.
  12. It is now clear that relying solely on monetary policy to reduce economic and financial imbalances may be a very costly way of dealing with these problems. There is a need to achieve a better policy-mix in the region with a larger role played by fiscal consolidations and structural reforms. But there is also a need to achieve a proper monetary-regulatory policy mix. Often a regulatory “pre-emptive strike” may reduce the scope for needed policy adjustment that inevitably comes after the period of consumption or investment exuberance. Hence it may reduce the real costs of reducing these imbalances. Each country has to find its own proper monetary-regulatory mix, but a much more forward looking approach in needed.
  13. I would welcome a broadening of the scope of the World Bank Regular Economic Report to include indicators and recommendations that are crucial for long-term growth potential. In my view report should periodically (annually) cover data that are related to intellectual capital of EU8+2 countries. As documented in Radzikowski, Rybinski (2007) there was a large de-convergence in the area of intellectual capital between new and old EU members (not to mention US or Asian NIEs’ benchmarks, where the innovation gap has been rising rapidly), as measuredthe by number of patents, R&D spending, ICT spending, number of publications in refereed and technical journals, readiness to e-administration, share of high-tech goods in exports and many others. While it is important to improve business conditions and advance structural reforms, as recommended in the excellent World Bank report, it is not enough to achieve progress and success in the global knowledge economy. More efforts are needed to create right incentives for the private sector to engage in innovative activity. See Cizkowicz, Rybinski (2007) for a broader discussion on this issue. Let me complement the World Bank team again for preparing this very insightful and timely report.

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[1] Cizkowicz P., Rybinski K (2007). „The Role of Banking and Financial Policies in Promoting Micro, Small and Medium Enterprises“, paper presented at the Bank Indonesia international conference, Bali, 7 December 2007. Paper available also at

[2] Radzikowski M., Rybinski K. (2007) “Achieving Sustainable Growth: Will New Europe Fly or Crawl in the 21st Century Global Knowledge Economy”, in Nadolny A., Schauer T (eds). “The Future of Europe”, Sutainable Development and Economic Growth?”, Vienna 2007. Paper available also at

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