The GDP per capita of Moldova and other non-EU countries in the Central, Eastern and South-Eastern European region is at the level of the United States in the 50s of the 20th century, and fundamental reforms are needed to reduce this gap - IMF.
This was stated by the Director of the IMF's European Department, Alfred Kammer, speaking at the international conference on regional and global finance, organized by the Bank of Slovenia and the International Monetary Fund in the Slovenian city of Portorož. According to him, in general, Europe has withstood the test of double crises. Despite the 2020 pandemic and the energy shock caused by Russia's invasion of Ukraine in 2022, unemployment is at record lows, banks are sound and the IMF forecasts an economic recovery and inflation returning to target. Alfred Kammer noted that in the Central, Eastern and South-Eastern Europe (CESEE) countries this resilience is due to two decades of sustained growth. Growth based on integration into European value chains was often financed by foreign direct investment. This model has paid off. Over the past two decades, real economic growth has averaged 4%. Bank financing dominated, supplemented by equity financing and foreign direct investment. The Director of the IMF's European Department noted two important caveats. “First, investment overall has been too low to close the capital stock gap with other advanced economies. Secondly, the world has changed: the model of the past will not meet the challenges of the future,” he emphasized. Alfred Kammer drew attention to the fact that, despite progress in the CESEE countries, the transition to higher income levels has slowed down, and the gap with the world leader, the United States, remains huge. Those outside the EU have the US per capita income of the mid-1950s, before the wall separating East and West Berlin had even been built. Those CESEE residents who are part of the EU have per capita incomes as in the US in 1986, shortly before the fall of the Berlin Wall. In other words, the per capita income gap with the US was 45% in 2023. According to the Director of the IMF's European Department, the income gap between CESEE countries and the US is related to capital and technology. Two-thirds of the gap is attributable to total factor productivity, with the remainder reflecting lower levels of capital stock. And this is where the old growth model began to fail. Total factor productivity growth is slowing and the capital stock gap has stopped narrowing. Productivity shortfalls extend across all sectors. The share of high-productivity sectors of CESEE in total output (5%) is about 1/3 of the rest of the EU. Both regions lag far behind the United States (44%). In contrast, the share of low productivity in CESEE countries is much higher than in other countries. To improve productivity, we need to get more large companies closer to the productivity frontier. This means investing in technologies that will allow low-productivity firms to catch up, developing new technologies that will allow average-productivity firms to become high-productivity firms, and promoting the growth of new, high-productivity firms. However, there are also new obstacles. The first is weaker global medium-term growth prospects, which imply weaker external demand. This does not bode well for the prospects for foreign direct investment, which has already declined since the global financial crisis. Second, economic fragmentation is growing. This casts another shadow on the old growth model. As Alfred Kammer has noted, there is no guarantee that existing value chains will remain as relevant as in the past. Changing trade patterns and structural shifts, such as artificial intelligence and climate change, require a reallocation of resources between sectors and greater investment, including in intangible assets. The director of the IMF's European Department believes that a new growth model needs a financial system that supports innovation and adaptation. At a later stage in the development of firms, financing is needed to scale up inventions. A well-developed financial system takes into account these various business risks and provides a range of financing options throughout the life cycle of the firm. It meets the needs of new and existing firms as they modernize or expand; and this allows firms to grow as they explore markets. Such a financial system also ensures that investors find attractive options for their risk appetite and return, and capital is efficiently channeled into productive capacity. Based on expected growth, capital should flow to CESEE companies as expected returns are significantly higher than in developed European countries. According to EIB research, more and more firms in CESEE are experiencing financial difficulties compared to the EU (9.1% versus 6.1%). Leading innovative firms tend to be even more constrained. And fewer firms in CESEE are happy with relying on internal funding (17% vs. 25%). As a result, 30% of companies believe they have not invested enough. And the amount of funding does not contribute to the introduction of advanced technologies. This system is bank-based and tends to favor conservative lending – not least because of the reasonably regulated nature of the banking business. This banking system primarily supports investment in machinery and equipment rather than in intangible assets. According to recent studies, this is a determining factor holding back the rankings of CESEE countries in their readiness to adopt advanced technologies. According to Alfred Kammer, raising capital stock to the level at which advanced European economies stood in 2000 (which goes hand in hand with productivity growth), especially in terms of intangible capital, could more than double incomes in CESEE countries. He also gave advice on how to improve the financial system, eliminate gaps holding back financing, including by developing intermediation, increasing deposits and the size of capital markets, increasing the role of insurance and pension funds, increasing the use of venture capital, etc. Alfred Kammer explained that for the CESEE financial system to support a new growth model adapted to the changing global context, obstacles must be overcome. According to him, firstly, the distribution of household savings is too conservative. More and more households are holding cash, and for every euro held by households in bank deposits, about 1 euro is held in equity or investment funds. In the US, the corresponding value of stocks and investment funds is almost 4 times this value. This ensures higher profits. Second, the role of institutional investors should increase as a means of attracting domestic savings and as a source of risk capital. Third, individual small and fragmented capital markets in Europe, with a greater home-country investor bias, imply higher financing costs in CESEE. Overcoming these obstacles will pave the way for expanding the reach of the banking sector, increasing the importance of capital markets and expanding funding opportunities. At the national level, the expansion of bank lending can be accelerated by: promoting competition through adequate regulation and supervision to reduce financing costs for firms; improving the security system and bankruptcy procedures to reduce the risks associated with bank lending; strengthening trust in financial institutions through transparent provision of information to expand the deposit base. The director of the IMF's European Department noted that improving financial literacy could help change preferences from cash to income-generating assets. Strengthened regulation and supervision, better protection of property rights and the development of an institutional investor base, including through second pillar pension systems, will help stimulate demand for market-based instruments. Large capital markets also support the growth of venture capital by improving exit opportunities for start-up firms. In his opinion, harmonization of insolvency and taxation regimes is necessary; better and more standardized public information on listed companies that is easily accessible, centralized supervision and general deposit insurance. This will reduce institutional investors' country bias, encourage cross-border activity, create deeper pools of capital and improve the efficiency of capital allocation. “Simply put: the border should not matter. Deeper capital pools in the EU mean that fast-growing firms seeking capital do not have to turn to the US. Yes, this may come with some risks, but we have learned to monitor and prepare for those risks. After all, for an entrepreneur who wants to prosper, the biggest risk is not to take it,” said Alfred Kammer.// 21.05.2024 — InfoMarket
