Romania and the Lisbon Agenda

- EU accession and economic competitiveness -

November 2004

Group of Applied Economics – GEA

Romanian Center for Economic Policies - CEROPE

This report has been prepared by a joint team of the Group of Applied Economics (GEA) and the Romanian Center for Economic Policies (CEROPE), at the initiative and with the support of the Romanian Ministry of Foreign Affairs. This is a revised and broadened version of the GEA-SOREC Spring 2004 Report “Romania: An Assessment of the Lisbon Scorecard”.

Authors: Daniel Daianu (coordinator),

Amalia Fugaru, Valentin Lazea, Bianca Pauna, Dragos Pislaru, Gheorghe Oprescu, Liviu Voinea

Acknowledgements:

The authors would like to thank Mr. Marius Hirte and the Inter-ministerial Group focused on the Lisbon Agenda for the support and feedback in documenting sections of this report.

Group of Applied Economics (GEA)

34 Clucerului St., Sector 1

Bucharest 011366, Romania

Tel: +40 31 402 2675, +40 31 402 2676

Fax: +40 21 222 5109

Email: office@gea.org.ro

Website: www.gea.org.ro

Romanian Center for Economic Policies (CEROPE)

6 Natiunile Unite Blvd., Entrance 2, Suites 32-33

Sector 5, Bucharest, Romania

Tel: +40 21 335 8970, +40 21 335 8971

Fax: +40 21 336 1594

E-mail: office@cerope.ro

Website: www.cerope.ro

Contents

Executive summary. 4

1. Introduction - Romania and the Lisbon process. 6

2. Sustainable growth and sound macroeconomic policies – 2005-2010. 9

2.1.1 The real economy. 9

2.1.2 Quality of public finances - Fiscal and budgetary policy outlook. 10

2.1.3 Monetary policy outlook. 11

2.1.4 External equilibrium.. 13

3. Competitiveness and innovation. 15

3.1 Preparing for the internal market 15

3.1.1 Enhancing competition and reducing subsidies to industry. 15

3.1.2 Completing the liberalization process. 19

3.2 Better regulation and more favourable business environment 25

3.3 RDI and the path to competitiveness. 28

4. Employment and social inclusion. 37

4.1 Addressing structural and long-term unemployment 37

4.2 Providing more and better jobs. 39

4.3 Enhancing social cohesion through reforming the pension system.. 41

4.4 Free movement of workers and the impact of migration. 43

5. Environmental sustainability. 45

5.1 Climate change. 45

5.2 Nature and biodiversity. 47

5.3 Resource management, environment and health. 48

6. CONCLUSIONS. 50

ANNEX: Monitoring Romania’s Progress – The Structural Indicators of the Lisbon Strategy. 56

Executive summary

The Lisbon agenda may seem a luxury for Romania as we speak. The structural foundations of the economy are not yet very strong, the external equilibrium is mainly secured by foreign remittances, the financial intermediation is insufficiently developed, agricultural activities are far from being efficient as a whole, competition policy has not yet dealt effectively with state aids, and the liberalization of utility prices is far from being completed. Under these circumstances, the effort to move towards a knowledge based economy when we haven’t yet consolidated the market economy itself is a daring endeavour. Nevertheless, this effort needs to be undertaken: first, because the Lisbon agenda ranks very high on the list of priorities of the club which we will join in two years time, the EU; and second, because a knowledge based economy is Romania’s chance to add more value to its products and services in the medium and long run. While it is not compulsory, the Lisbon agenda is complementary to the needed evolution of the Romanian economy, and it encompasses most areas of public policy.

But the Lisbon agenda is very complex, and its priorities can be differently interpreted by each country: while EU is more concerned with social cohesion, job creation and support for R&D, Romania has still to deal with job destruction (through restructuring), disinflation, and improving business environment. Technology assimilation is more important for Romania, in the short run, than technology creation – simply because, irrespective of how much one wishes, development stages can not be overleaped so fast. Confirming the current status of the Romanian economy, knowledge diffusion indicators (including the extent of the information society) are progressing faster, while many knowledge creation indicators are still underperforming.

This report acknowledges the progress made in specific areas of the Lisbon agenda, and it also provides a number of policy recommendations in order to improve Romania’s capacity to adapt to the Lisbon agenda. The progress should primarily be judged domestically, since we are not even close to the current EU 25 performances in most regards of the Lisbon agenda, and since the priorities within the Lisbon agenda can be interpreted differently on a country by country basis.

Tentative policy recommendations are included in the sections of this report, as it follows.

Fiscal and budgetary policy: a consistent reform of public expenditure is needed to improve their prioritization and to redirect them towards areas that strengthen the country’s human capital, infrastructure and administrative capacity. Multi-annual budget programming is a must.

Monetary policy: in view of the expected appreciation of the domestic currency, and the lack of the asymmetric shocks adapters such as the labour mobility, the participation in the ERM-2 mechanism (preliminary stage of euro adoption) should not be targeted earlier than 2010.

Competition and liberalization policy: 1. State aid should be redirected toward horizontal objectives, in particular towards R&D aid; 2. The competition authorities should be given more power and enhanced independence. A vigorous competition policy would also avoid the market power abuse in the case of privatized utilities – a problem which otherwise runs the risk of keeping users captive.

R&D policy: 1. An independent advisory body should be created to fill in the current gap between the strategic and executive levels in the Romanian innovation system. Such an advisory boy exists in all EU core countries, where it has contributed to the development and implementation of a coherent RDI strategy; 2. Venture capital for innovative firms needs to be encouraged, and the government could provide a co-financing for a venture capital fund aimed at supporting innovative firms; 3. Business R&D expenditures need to be supported by indirect financial measures, which are allowed by EU regulations. Fiscal incentives could be linked to the share of R&D expenditures in turnover or the share of R&D employees in total employees, or the number of patents registered each year.

Employment and social policy: 1. The non-wage components for labour costs should be reduced, especially for low skilled jobs; 2. Hiring and firing costs should be reduced; 3. encourage lifelong learning; 4. Re-examination of the Labour Code

Environmental policy: strengthen the institutional capacity needed to raise funds and to administer the implementation of environmental projects.

The Lisbon agenda may seem a luxury for the Romanian economy, indeed, for the latter still shows structural risks and vulnerabilities. But it should not be treated as such. The eventual fulfilment of the Lisbon agenda would, among other factors, strengthen the foundations of the economy and diminish risks, because it would place Romania on a different stage of economic development – from a factor intensive economy to an innovation intensive economy. Meanwhile, Romania has to consolidate its market economy, and to create a friendly business environment, which should foster research, development and innovation.

1. Introduction - Romania and the Lisbon process

The Lisbon Agenda is much talked about lately. Wim Kok team’s Report[1] criticizes heavily policies in many of the EU member countries – policies which are inappropriate in order to deal with the goals of the Agenda. But these goals remain, fundamentally, valid; they reflect an increased awareness at EU level that traditional policies have started to fail providing results in the new economic context given by the globalisation challenges and the impact of new information and communication technologies. Moreover the Agenda is a reaction to the relative worsening of the EU competitiveness in comparison with the US, Japan, at a time of rapid economic ascendancy of China and other Asian economies. Last but not least, the Lisbon goals are in fact the expression of the centripetal attitudes and forces within the EU, which are worried about the possible dilution and stalemate of the “deepening” side of the European integration process.

As Wim Kok’s Report suggests, the central goal set a Lisbon in 2000, to transform the EU into the most competitive, knowledge-based economy in ten years time has already proved to be overambitious. Other reports of the European Commission or prepared by independent experts have shown that the overall performance of member states is relatively disappointing. This is why a revised Lisbon Agenda is to be adopted.

It should be said however that there is a great diversity in terms of policy effectiveness among the EU countries. While some member states may be considered overachievers (e.g. the Nordic countries), several others are considerably lagging behind. Part of the answer for such developments may be found in the mix between market-oriented reforms and public policy, but there is no miraculous formula that can be applied in order to reach the perfect policy balance. Nonetheless, there is general agreement that the Lisbon principles of investing in research and human capital, of promoting innovation, of consolidating the internal market etc. are important guidelines for increasing the European economic prosperity.

At the current level of development of Romanian economy the urge for structural reforms tends to shadow the more subtle, whilst equally important, issue of developing knowledge-based oriented sectors of the economy. While EU is currently most concerned with social cohesion, job creation and priority to research and innovation, this seems less applicable to Romania in the short-run, where restructuring (incl. job destruction), wage limitation, control of inflation and improving the business environment are top priorities. Romania, as a candidate country, is guided primarily by the Copenhagen criteria aiming at “establishing a functioning market economy and having the capacity to withstand competitive pressure and market forces within the Union”. While integration into the single market without a market economy is not possible, lack of emphasis to preparing the capacity to withstand EU competitive pressures would hinder Romania’s position in the longer run.

Moreover, for accession countries, which embark on catching up trajectories, technology assimilation (diffusion) is much more important for productivity gains and, further, for high economic growth rates. Recent decades’ spectacular evolution of Asian economies, and of Ireland in Europe, confirm the above statement. The same could be said, though in a more qualified manner, about Spain and Portugal. Romania may benefit a lot by setting high goals, but only if such effort would be reinforced by clever public policy, which would confine market flexibility with effective regulations, development of basic infrastructure and adequate investment in human capital.

The targets set by the Lisbon and subsequent European councils are not compulsory in the sense that failure to comply with them does not attract direct negative consequences of an administrative nature. Romania’s date for EU accession (2007) is not threatened by the Lisbon targets, be those revised. Yet, Romania’s coherent development within an enlarged EU may be at risk, in the medium and long run.

Summarizing the policy actions pending to the Lisbon Agenda, two arguments can be highlighted; this enumeration is, however, not exhaustive.

• The investment in education, technology transfer, research and development, and innovation are main complements to macro-economic stability; in a transition economy, like Romania, they may represent the pillars for achieving long-lasting, sustainable economic growth in the future, for reducing economic gaps.

Over the last decade, Romania has experienced a rather turbulent macroeconomic history, with episodes of recession (1990-1992; 1997-1999), recovery (1993-1996) and growth (2000-2004). Disinflation has made substantial progress, but inflation is still high; unemployment is low compared to other economies in the region, but this owes, on the one hand, to hidden unemployment in the state sector and in subsistence agriculture and, on the other hand, to emigration of a large part of the working population. The budget deficit is within Stability Pact’s limits, but the quasi-fiscal deficit is higher.

Table 1: Key macroeconomic indicators

	1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004*
GDP real growth	1.5	3.9	7.1	3.9	-6.6	-5.4	-3.2	1.6	5.3	4.9	4.9	7.5
Inflation Dec/Dec	295	61.7	27.8	57	151	40.6	51.4	40.7	30.3	17.8	14.1	9.6
Unemployment	10.4	10.9	9.5	6.6	8.8	10.3	11.5	10.5	8.6	8.1	7.6	7
Gross fixed capital formation, % GDP	17.9	20.3	21.4	23.0	21.2	18.2	17.7	18.9	20.5	21.1	23.5	24
Current account deficit/GDP	4.5	1.4	5	7.2	6.7	7.5	3.8	3.7	5.5	3.4	5.6	6
Budget deficit/GDP	2.6	4.2	4.1	5	3.6	2.8	2.5	3.6	3.1	2.5	2.4	1.6
Total medium and long term foreign debt/GDP	12.7	15.1	15.4	20	22.4	24.4	24.6	25.5	30.2	30.2	30.2	31

Source: adapted from NBR statistics

* forecast

How can the Lisbon process contribute to macroeconomic stability in Romania? First, it could help to reduce the structural trade deficit (and the current account deficit) over the longer run. Domestic research and innovation helps increasing the local content of domestic production, therefore diminishing the need for imported technology and equipments; it would also help increase value added in domestic output, in export-oriented activities. Second, better access to education and knowledge can help increasing saving and investing behaviour (as opposed to simple consumerism), on the one hand, and, on the other hand, supports a dynamic life as an employee (increases employees’ mobility). Third, active employment policies and social inclusion address the unemployment challenge. Fourth, support for start-ups can only improve the business climate and spur gross domestic capital formation.

• The investment in research and development, and innovation in particular, are key to changing Romania’s current development paradigm.

This report quotes various studies describing the current situation in Romania: technology is mainly imported, not locally created; foreign capital firms are promoters of R&D in Romania, in the form of technology transfer; but this technology transfer is nevertheless used for less value added products and the technology imported is in many cases not one of last generation by international standards; export products compete on price, not on innovation. E.g., Caceres et all (2002), by using the unit value of products as proxy for quality, found that only 18% of Romania’s exports were embedding high technology (which is the lowest ratio in the region). A piece of good news is that this that ratio has nevertheless almost doubled as against a decade ago.

This is the second independent report assessing Romania’s economic performance by using Lisbon Agenda benchmarks. The first one, prepared in March 2004, provided a scorecard based on the brief evaluation of the main objectives set at Lisbon. The present study has a different approach, trying to focus more in-depth on Romania’s competitiveness challenge; it suggests possible policy venues to increase the convergence with EU standards. The timing of producing this second report is not random, as similar efforts have been carried by several other member states in order to provide inputs for the 2005 Mid-term Review of the Lisbon Agenda.

The following parts of the report will focus on issues related to sustainable growth, competitiveness and innovation, employment and social inclusion, and environment sustainability.

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[1] Former Dutch Prime Minister Wim Kok was mandated by the March 2004 European Council to lead a high level expert group in order to provide an independent review of the progress achieved in the implementation of the Lisbon strategy. The Report, entitled “Facing the challenge – the Lisbon Strategy for Growth and Employment”, issued on November 1, 2004, will serve as an important input for the preparation of the Mid-Term Review, which will take place during the 2005 Spring European Council;