Competitiveness of Bulgaria’s Economy and the Challenges of Real and Nominal Convergence

1. “Competitiveness of the South Eastern European Countries and Challenges on the Road to EU” Competitiveness of Bulgaria’s Economy and the Challenges of Real and Nominal Convergence Grigor Stoevsky Economic Research and Forecasting Directorate, Bulgarian National Bank Skopje, 30 May 2008

2. Outline • Competitiveness and convergence • Theoretical grounds • Aspects of competitiveness related to productivity and efficiency • Price and cost competitiveness • The links between real and nominal convergence • The Bulgarian experience • Productivity and efficiency indicators • The longer term perspective • Driving forces and interpretation • Challenges of real and nominal convergence • Conclusion

3. Competitiveness and Convergence Competitiveness and Convergence: Theoretical Grounds (1) • Many definitions of competitiveness: • Global Competitiveness Report 2007-2008: “We define competitiveness as the set of institutions, policies, and factors that determine the level of productivity of a country. The level of productivity, in turn, sets the sustainable level of prosperity that can be earned by an economy.” (p.3) • Hence, in catching-up economies higher productivity ensures higher income levels, which in turn stimulate more investment and productivity • Ireland’s National Competitiveness Council, Annual Competitiveness Report 2007: “Competitiveness refers to the ability of firms to compete in markets. Ireland’s national competitiveness refers to the ability of the enterprise base in Ireland to compete in international markets.” (p.8) • Many factors, hence indicators: • Productivity (labour and total factor), efficiency • Price and cost developments • Export performance • But improving the competitive position of the country can be hampered by other factors, e.g. deficiencies in institutions and the business environment

4. Competitiveness and Convergence Competitiveness and Convergence: Theoretical Grounds (2) • Competitiveness, convergence and integration • Maintaining a sustainable convergence path  maintaining and improving the competitive position of the economy • Real convergence is a long process requiring sustained productivity gains and efficiency improvements • Cost-based advantages (based on low wages and input costs) are easily exhausted in the process of nominal convergence • Trade and financial integration accelerates nominal and real convergence

5. Competitiveness and Convergence Aspects of competitiveness related to productivity and efficiency (1) • The main competitiveness factors are labour productivity and factor efficiency, which depend on: • Physical and human capital • TFP • Energy intensity • Sectoral productivity developments: • Productivity in non-tradable sectors is also important • Competitive advantage • Unique and hard to imitate • More immune to price shocks • Based on innovations (escaping price competition trap) and technology spillovers

6. Competitiveness and Convergence

7. Aspects of competitiveness related to productivity and efficiency (2) Labour productivity: Most of the new member states (NMS) maintain labour productivity growth rate differential vis-à-vis the euro area A process of capital deepening and efficiency gains Unit labour costs (ULC) developments: In nominal terms ULC are steadily increasing in all NMS No clear pattern in real terms Competitiveness and Convergence 7

8. Competitiveness and Convergence

9. Competitiveness and Convergence Price and cost competitiveness • In a monetary union other adjustment mechanisms are crucial: • Labor market flexibility • Labor costs flexibility • Working time flexibility • Labor mobility (inter-sectoral and geographical) • Product market efficiency • Competition enhancing policy (measured by level of competition, market power) • Easy entry, exit and deregulation • Competitiveness usually measured on international level by real effective exchange rate (REER) developments • But, REER exhibits trend appreciation for a catching-up economy

10. Competitiveness and Convergence

11. Competitiveness and Convergence

12. Competitiveness and Convergence The links between real and nominal convergence • The impact of real convergence on inflation takes place through: • The Balassa-Samuelson effect (supply side effects based on intersectoral productivity growth differentials) • Higher demand for non-tradable goods and services relative to tradable goods driven by increases in income levels (demand side effects) => change in relative prices and higher inflation • Restructuring of the consumption basket (towards higher weight of services and lower weight of food) contributes towards lower inflation volatility • Increasing trade openness (pushing up tradable goods prices through the law on one price, but it also has a dampening effect on inflation through stronger competitive pressures and lower mark-ups) • Declining energy intensity

13. The Bulgarian experience Key Developments in the Bulgarian Economy • Competitiveness: productivity and efficiency • Real sector • Labour market • Energy efficiency • External sector • Survey-based measures of competitiveness • Convergence in productivity: the longer term perspective • Driving forces of the convergence process • Interpretation of some of the key indicators

14. The Bulgarian experience Key Indicators • Recent and likely short-to-medium term developments v.s. long-term trends • Measuring competitiveness • Macro data – indirect evidence • Sectoral and firm-level data – better but not readily available

15. The Bulgarian experience Key Indicators – the Real Sector (1)

16. The Bulgarian experience Key Indicators – the Real Sector (2)

17. The Bulgarian experience Key Indicators – Labour Market (1)

18. The Bulgarian experience Key Indicators – Labour Market (2)

19. The Bulgarian experience Key Indicators – Energy Efficiency

20. The Bulgarian experience Key Indicators – the External Sector (1)

21. The Bulgarian experience Key Indicators – the External Sector (2)

22. The Bulgarian experience Key Indicators – External Sector (3)

23. The Bulgarian experience Key Indicators – External Sector (4)

24. Key Indicators – External Sector (5) The Bulgarian experience 24

25. Key Indicators – External Sector (6) The Bulgarian experience 25

26. Other Indicators of Competitiveness: Survey-based measures

27. The Bulgarian experience Convergence in productivity: the longer term perspective (1)

28. The Bulgarian experience Convergence in productivity: the longer term perspective (2)

29. The Bulgarian experience Driving Forces of Catching-up • Domestic investment - financed by foreign (FDI) and domestic sources • Investment spurred by: • Macroeconomic stability and predictable environment • EU membership => positive profit (income) prospects => optimism • External position = increasing foreign liabilities (both FDI and debt) => sustainability issues (solvency and liquidity) • The investment demand contribution to import growth is complemented by consumption demand (reflecting income growth)

30. The Bulgarian experience Interpretation of Some of the Key Indicators • Some “headline” indicators = a reason for concern? • Current account deficit increases • Deterioration of the net IIP • Wage growth and inflation • REER appreciation • Some “bottom line” indicators • Balance of payments surplus • Steadily increasing FDI flows and central bank’s reserves • Steady productivity and GDP growth, allowing income convergence and increased welfare of the population

31. Challenges of real and nominal convergence Challenges of Real and Nominal Convergence (1) Real convergence challenge: ensure sustainable path for productivity and income growth: • Institutional arrangement, stable political and macroeconomic environment • The right policies, conducive to growth: • Fiscal and income policies • Monetary policy • Structural reforms: • Promote competition and flexibility in product, labour and capital markets • Business environment – basic infrastructure, knowledge economy pillars, rule of law, intellectual property rights, etc.

32. Challenges of real and nominal convergence Challenges of Real and Nominal Convergence (2) • The nominal convergence process is spurred by deepening integration into the Single European Market with liberalized current and capital accounts, and an increasing domestic income level • The impact of real convergence on inflation complicates the meeting of the nominal convergence criterion on inflation • Factors influencing the effect of the real convergence process on inflation dynamics: • The initial level of both prices and income • The speed of adjustment/catching-up – interestingly – the better policies the government pursues and the better environment it secures, the higher the adjustment speed, hence faster convergence (higher inflation) • Flexibility of product, labour and capital markets

33. Challenges of real and nominal convergence Challenges of Real and Nominal Convergence (3)

34. Challenges of real and nominal convergence Challenges of Real and Nominal Convergence (4) Policy measures: • Short-to-medium term • Decrease vulnerabilities and guarantee sustainability • Improve efficiency of public institutions and the general business environment • Longer term • Address the problems of ageing population • Provide the right incentives for a transition to a knowledge-based economy

35. Conclusion • Real convergence crucially depends on the competitive position of the economy • Real and nominal convergence are closely related, hence: • Increasing prices, wages and real exchange rates are to be expected • Competitiveness is a broad concept => variety of indicators, which may point at different directions => need proper interpretation • Our assessment of the developments in the Bulgarian economy is that the country improves its competitive position

36. Appendix 36

37. 37

38. 38

39. 39

40. 40

41. 41

42. 42