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Diversifying for growth

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Ricardo Hausmann, Director, Center for International Development, Harvard University.

Iryna Akimova, Deputy of Verkhovna Rada and Honourable Member, BEST Research Centre.

Panel discusses challenges in building dynamic market economies in EBRD region

Leading economists and academics met at the Economic Panel during the EBRD’s Annual Meeting to discuss the economic challenges ahead in the transition countries. Discussions centred on how best to promote diversification, sustain rapid productivity growth and stimulate innovation.

Panel moderator and EBRD Chief Economist Erik Berglof said it was important to resist the temptation of being content with rapid growth rates across the region. “It is easy to forget the longer-term and conditions for sustainable growth,” he warned. The question is how to maintain past successes and remain internationally competitive.

Ricardo Hausmann, Director of the Center for International Development at Harvard University, provided a thought provoking analysis of factors determining a country’s ability to diversify. For poor countries to grow richer they need to change what they produce; they need to change their competitive advantage. “Countries become what they export,” he said. “Sophistication today determines tomorrow’s competitiveness.”

Using a simple metaphor to explain the process, he compared products to trees in a forest, countries to a collection of firms and firms to monkeys living on trees. If a change occurs in the forest and monkeys cannot stay on their tree, they will try jumping to the nearest tree. Whether they’ll succeed depends on how near the tree is. In other words, whether a change in production is successful depends on the distance between the old and new product. The nearer products are, the more successful the change in production tends to be. Generally, the chemical, electronic and textile industries tend to form clusters within which it is easier for firms to change between goods.

“Where you are positioned in the forest is going to matter,” he said. Most countries in the transition region already have relatively sophisticated export baskets relative to the general level of income, which should help them grow in the future. At the same time there are huge differences in countries’ positions. Many countries in Central Europe, south-eastern Europe and some CIS countries were well positioned for a successful transition process, while others such as Tajikistan or Georgia started from worse positions.

Iryna Akimova, Deputy of Verkhovna Rada (the Ukrainian Parliament) said Ukraine continues to demonstrate strong growth. During 2000-2007 the annual average GDP growth rate was above 7 per cent. This was mainly driven by booming private consumption and investment demand. In order to sustain this in the future, Ukraine needs to strengthen its trade performance on the global market, she stressed.

Ukraine’s export to GDP ratio was 45.3 per cent in 2007 and its import to GDP ratio 50.9 per cent in 2007, compared to an EU-27 average of 39.7 per cent and 39.3 per cent respectively.

Ukraine’s potential is vast, but with export depending heavily on the metal industry, it is very vulnerable to external demand and price movements on the world steel market. Moreover, Ukraine’s export competitiveness is based on facilities which are almost exhausted, such as cheap energy (gas prices doubled in 2006-2008) and labour (real labour costs have increased by 51 per cent).

“Diversification is crucial”, Mrs Akimova stressed. “New opportunities for Ukraine will arise through its integration into the global trading system.”

“Promoting political stability, continuing constitutional reform, a clear division of powers and increased political accountability will be crucial” Mrs Akimova said. “Equally, we need to create macroeconomic stability, a flexibility of the exchange rate, independence of the central bank and a tightening of fiscal policy.” Other important factors will be microeconomic reforms (tax reform and deregulation), increasing private and public investment in human capital and innovative technologies, as well as deeper integration with DFTA and the EU.

Deputy Prime Minister of Serbia Bozidar Djelic, said we witnessed an exceptional phase in the EBRD’s countries of operation. The transition countries were able to exploit the soft spot of globalization. “But we are coming to the end of an era. Nobody is standing still,” he said. China and India are climbing the ladder, overtaking Eastern Europe with a cheaper labour force.

The dividing line between countries able to remain internationally competitive and those lagging behind will be whether you are “in” or “out” of the EU club, he said. Those who are “in” have an unfair advantage to those that aren’t. The recent elections in Serbia showed that people want to belong to the club and “play with the other monkeys”, he emphasised. Playing with the “gorillas” (India and China) will also be important.

“The smaller countries in Europe need to be open” Mr Djelic continued. Forming regional clusters will be vital for them. “In Serbia we are trying to create a new cluster with friends such as Romania […]. The future is bright!”

Ksenia Yudaeva, Chief Economist at Sberbank, said the challenge for a country like Russia is how to get more competitive if you are already rich. While there have been many efforts to diversify Russia’s economy, they don’t have enough impact on the country’s people and government, she maintained.

“In Russia the only monkeys we have are kept in zoos” she said. They don’t get the opportunity to jump between trees; they are locked in cages. If they get out of the zoo they don’t know how to jump, she said picking up Professor Hausmann’s metaphor. Russia has to “parachute” into what rich countries produce. It cannot rely on a cheap labour force and needs to produce something sophisticated. “For this business skills are crucial” she said. “We need to change the culture and mentality of producers”.

One of the biggest challenges is to compete with oil as a source of income and government revenue, she stressed. Diversification efforts come mainly from the Russian private sector, not foreign investors or the Russian government, Mrs Yudaeva said. “A new generation of business leaders is emerging. I am very optimistic for my country. It has changed a lot.”

By Claire Vogt, Communications Advisor
Contact: Office of the Chief Economist

18 May 2008