Labour shortages driving economic growth?

10 November 2016

At today’s press conference, Vasily Astrov presented the new wiiw forecast for 22 countries of Central, East and Southeast Europe. A summary.

In most of the countries from Central, East and Southeast Europe (CESEE), the current virtuous circle of rising consumption and incomes is expected to continue at least in the near  term,  accompanied  by  solid  GDP  growth  to  the  tune  of  some  3%  p.a.  Ongoing labour-market improvements and rising wages will continue to be the main growth driver throughout the region; they will be complemented by a recovery in fixed investments as new EU funds become available. The economies of Russia, other CIS countries (except Belarus) and the Ukraine are expected to bottom out, as the negative shocks of the past two  years  have  already  been  largely  absorbed.  Turkey  is  heading  for  a  ‘soft  landing’. These are the main findings of the newly released medium-term macroeconomic forecast by the Vienna Institute for International Economic Studies (wiiw).

Despite  the  sluggish  external  environment,  economic  growth  remains  fairly  strong  in  the majority  of  CESEE  countries;  the  economic  dynamics  in  almost  half  of  those  countries  have intensified over the current year compared to 2015. Growth in the EU Member States from Central and Eastern Europe (EU-CEE) has declined only modestly over the current year, mostly on account of temporary investment weaknesses. It remains 1.5 pp higher on average than in the euro area. In
Turkey, economic dynamics were also very solid up until mid-2016, albeit accompanied by signs of ‘overheating’, while the CIS countries are experiencing a ‘bottoming out’.

Table: GDP growth, wiiw forecast for 2016-2018

wiiw forecast, November 2016

The main driver of growth throughout the CESEE region continues to be private consumption, underpinned  by  sharply  rising  wages  and  incomes  as  well  as  decreasing  unemployment.  The tightening of labour markets and the rising labour shortages are partly a consequence of sizeable outward migration over the past years, which has had a cumulative negative effect on labour supply. A number of countries have also introduced higher minimum wages, sometimes as part of a more general  fiscal  relaxation  package.  Inflationary  pressures  in  most  CESEE  countries  –  with  the exception of the CIS countries and Turkey – are almost non-existent, as solid wage growth has been largely offset by marked gains in labour productivity and a profit squeeze.

The expansion of fixed investments, which were an important pillar of GDP growth in 2015, has largely run out of steam this year. In the EU-CEE region, the main reason for this lies in a temporary  drop  in  EU  transfers  that,  in  previous  years,  used  to  be  an  important  source  of investments.  EU  funds  disbursed  under  the  previous  2007-2013  Multiannual  Financial  Framework (MFF) were absorbed in 2015 at the latest, whereas attracting new funds under the recently adopted 2014-2020 MFF will take time. At the same time, disregarding the ‘EU transfers effect’, the underlying dynamics of investments remain strong.

The  export  dynamics  in  many  CESEE  countries  have  been  better  than  those  of  imports, resulting in a positive contribution of net exports to GDP growth. In most EU-CEE countries and Serbia,  this  is  largely  a  reflection  of  their  ever-strengthening  export  base  and  further  gains  in competitiveness.  However,  in  the  CIS  countries  it  is  entirely  due  to  the  weakness  of  domestic demand which is still depressed following strong currency depreciations over the past two years.

Credit  expansion  in  the  CESEE  region  remains  rather  modest:  no  country,  with  the  possible exception  of  Slovakia,  is  currently  experiencing  a  credit  boom.  Other  factors  tend  to  be  more important determinants of the demand for loans than interest rates, which in many CESEE countries are  rather  low.  Going  forward,  this  reduces  the  risk  of  ‘boom-and-bust’  developments  that  have characterised the trajectories of a number of CESEE countries in the run-up to and during the global
financial crisis.

Domestic  demand  in  many  CESEE  economies  is  supported  by  fiscal  policy  relaxation, particularly in Romania and Ukraine. One reason for this may have been a decline in government borrowing costs. Furthermore, the general disenchantment with the practical results of ‘expansionary austerity’ pursued in the past has played a role as well. At the same time, in most Western Balkan countries and in the CIS, the fiscal stance tends to be either neutral or restrictive – and in the case of the CIS countries it is essentially pro-cyclical.

The  impact  of  the  forthcoming  Brexit  on  CESEE  economies  should  be  contained  by  those countries’ relatively low trade exposure to the UK economy. In the EU-CEE region, some 1.6% of GDP is accounted for by final demand from the UK, and that share is even lower in other CESEE countries. At the same time, from 2019 onwards the EU-CEE region potentially faces the prospects of much lower (by up to 20%) EU transfers once the UK – the second largest net contributor country to the EU budget after Germany – leaves the bloc. The migration flows from the EU-CEE region to the UK could fall by nearly half compared to the past two years even without any changes to the migration regime, as the UK will become less of a magnet for migrants.