Romania, with year on year GDP growth at 8.8%, is currently the fastest growing economy in the EU. It is beginning to resemble the period before the financial crisis of 2008, where Romania was known as a “tiger” economy due to the growth rates it produced regularly, as high as 8 or 9%. Nevertheless, despite this exceptional performance, there are still some fundamental structural issues which have the potential to undermine the future of the Romanian economy.
What’s Driving the Growth?
The IT services sector, as well as manufacturing in areas such as electronics and car production, are where Romania exhibits a comparative advantage over other countries in the region. Foreign direct investment is also a main driver behind this, with net inflows at around 3% of yearly GDP in 2016.
In fact, renowned multinational Phillip Morris began the construction of a new factory worth half a billion euros just outside Bucharest. Nevertheless, there has also been a consumption boom helped by the growing middle class, as well as the low-interest rate environment. With consumption expenditure forming around 70% of aggregate demand, this has an even more significant impact on GDP than countries such as the UK.
There have been concerns that this consumption boom may be artificially buoying the economy, however, the interest rate of 1.75% has been relatively higher than many economies during the last couple of years, so the National Bank of Romania still has some room for manoeuvre.
The head of the National Bank of Romania, Mugur Isarescu, nevertheless stated that “the period with very low-interest rates is over, and not only in Romania”. The inflationary pressures of this consumption are clearly being seen, due to the increase in inflation to 3.2% in December.
Concerns about salary rises in the public sector may account for the fact that most of this rise has been in the last few months. However, the central bank is yet to make a move on interest rates, therefore the demand side conditions still remain favourable for expansion.
Another serious weakness is infrastructure, especially in terms of transport. Romania only has around 750km of motorways currently functioning, which is another area where it is lagging among the last in Europe.
The transport minister promised in February 2017 that there would be 90km added over the year, but only around 15 materialised. Embezzlement of EU funds and wasted money on “feasibility studies” have been some of the major factors hindering the development of Romanian roads.
This area of the economy is the epitome of how political negligence and corruption can lead to such astounding underperformance. Nevertheless, even though the plan of action for Romania to correct this area of weakness is quite straightforward, there are other issues that will be much more complex to tackle.
Like quite a few Eastern European countries, Romania is experiencing a declining population, but for Romania this issue is compounded by both significant emigration in conjunction with a low birth rate. In fact, the current population of 19.7m has almost reached the level of 1966.
This emigration is one of the biggest obstacles for Romanian GDP growth in the long term, with the “brain drain” already becoming a serious problem in areas such as healthcare, where around a third of hospital positions are unfilled. However, it is not just this sector, but the whole economy where wages are still a long way behind.
According to data from the Romanian National Institute of Statistics, gross average wages have hardly moved from the 3300 RON (£650) level for the whole of 2017. This is why the benefits of growth must quickly translate into an improvement in living standards otherwise this exodus will continue.
However, not only is the population declining due to emigration, it is also ageing significantly, with the dependency ratio expected to more than double by 2050, from 21.7% to 49.6%. Not only will this put immense fiscal pressure on the government in terms of state pensions, but it also means that Romania will lose some of the competitiveness it has in attracting FDI, as there will be further upward pressure on labour costs, on top of the wage growth from rising national income.
Recent moves by the Romanian government to cut pension contributions for private pension schemes to 3.75% is not a sustainable way of addressing this fiscal pressure, as it will hurt investment and growth by disrupting a system which had reached significant improvements.
Although pushing harder on pro-natalist policies could help, the distributional concerns with this GDP growth are actually underlying both issues. The inadequate level of incomes is not only a major factor behind the emigration but is not helping the birth rate either. An indicator of this is a study from the ONS, from 2014, which shows that the average number of children per female for Romanian mothers in the UK, is 2.93, compared to just 1.25 back home.
Short vs Long-term
There are also other key issues with the labour market in Romania. The labour force participation rate of around 53% is significantly below the EU average of almost 58%. This means that even though Romania has a relatively low unemployment rate at 4.9%, it is still not fully utilising its human capital. Not only that, but Romania has the highest proportion of workers in agriculture out of the whole EU.
Although these factors can be seen as a sign of a lack of development in the Romanian economy, if the government approaches tackling the issue of social mobility more effectively, this could be seen as an advantage. This is because it could provide some spare capacity for Romania to sustain its growth in the long term, by providing some room for a transition to the manufacturing and service sectors in spite of the declining population.
Although all the main indicators point towards a booming economy, there are still some large structural issues, especially concerning the labour market and infrastructure, which will be challenging to tackle for any future governments, as in some of these areas Romania is right at the tail end of the EU.
Despite all the political tensions and corruption problems Romania is facing even today, even if these are eliminated from the equation, there will still need to be extensive reforms and a thorough approach to reverse these longer-term weaknesses. If these issues are not addressed, it will be difficult for Romania to fully reclaim its status as the “tiger” economy of Europe.