Expert: Belarus will fare much better if transition to high income happens; and it passes via market

Ivailo Izvorski, Practice Manager, Macroeconomics and Fiscal Policy Global Practice made a presentation at Kastrychnitski Economic Forum in Minsk. We publish the full text of his presentation.

Belarus is undergoing two transitions.  One, as a country that we at the World Bank classify as "upper middle income" - that is, with income per capita of about $4,000-13,000 - is the transition to high income. This is a feat that has been accomplished by only about two dozen counties since the 1950s, half of which have done so during the last twenty-five years.

The other is the transition to a market economy.  Belarus began this transition nearly twenty five years ago, as did the rest of Eastern Europe and the countries of the former Soviet Union. This transition has been halting and today, there are just a couple of countries in this region that do not fare better than Belarus on the criteria measuring progress to market that the EBRD tracks. The children of Belarus are likely to be much better off in a decade or so than their parents today if the transition to high income is accomplished. But that transition passes through the market.  Let me clarify.

Many of you have probably heard the term "middle-income trap." This term was coined by Indermit Gill and Homi Kharas in their book East Asian Renaissance (2007). The book looked at the astonishing transformation of East Asia after the 1997 Asian financial crisis. On the heels of Japan, Singapore, Hong Kong (china), Taiwan (China) and South Korea becoming high-income during the last several decades, the book examined how government policies need to adjust to enable this transition. Rather than an inevitable threat of getting stuck in middle income for some unexplained reason, the authors argued that it is a policy trap makers need to overcome. Why has this been so challenging for some? Typically, as wages rise and competitiveness in producing goods intensive on low cost labor is eroded, businesses need to create higher paying jobs that produce goods and services more intensive in highly skilled labor and innovation. Without the proper skills, a more entrepreneurial streak and increased propensity to take risk, these better paying jobs will not be created and popular expectations of sustained improvements of living standards clash with the economic reality.

As an example, China, Bulgaria, Belarus, and Peru are countries with per-capita GDP of about $7500 and moving to high income is the next stage of their development. For China, the transition to high income is an absolutely essential concern for the authorities, as they and the World Bank analyzed in depth in China 2030.  Peru´s stunning progress over the last decade reflects the intention of the authorities to go for high income in a generation, as documented in a recently published work by my colleague Katia Vostroknutova. For Bulgaria, the poorest EU member, the move is of equal concern and my colleague Doerte Doemeland explored the imperative in Productivity in Bulgaria.

There is little doubt that the transition to high income is of great significance for Belarus. That is why I would like to briefly go through the areas that Gill and Kharas examined in their book.  They remain relevant today. 

One area is trade. For small economies, there is no prosperity without integration into the world economy.  For economies transitioning to high income, that integration these days includes companies being part of regional or global value chains.  The breakup of production into tasks enables companies to graduate from specialization in, say, the production of complete tractors, to a specialization in tractor engines, transmissions, or software. Poland, Belarus’s neighbor, became Europe’s growth miracle, thanks in part to its integration into these GVCs.

Another is innovation. As the advantage of low cost labor is eroded, can companies move from imitating to innovating? How does it happen? Does it require government support and if so, what kind? What are the linkages between higher education and businesses?

A third one is finance. Achieving high income depends crucially on moving from a bank-dominated financial system, often with substantial role for the government in directing lending  to one where banks are properly regulated and managed, and further to one with more innovative – venture - finance that helps support start-ups.

Another one are livable cities - cities that bring together companies and individuals without the slums and traffic jams we are accustomed to see in many a developing country.

Cohesion and inequality is another one. How do we ensure that the fruits of economic success are shared broadly without stifling the innovation that often comes from attempts to enforce "equality"?

Further down the list, but by no means less important than the others, is the ability of countries to ensure accountability, control over corruption and curb state capture.

Many countries are grappling with these issues. While some find it challenging to advance in a particular area because of domestic politics, state capture, or improper sequencing of structural reforms, at times the stumbling block is the incomplete transition to a market economy.  It is helpful to recall what the key attributes of a market economy are.

The first is markets and prices. Prices provide signals to producers, workers, entrepreneurs, and governments.  All of the high-income countries have well-functioning product markets, decently working labor markets, and reasonable financial markets that are capable to channel savings to the most productive uses.  Regulation of prices in high income countries is minimal and typically limited to prices for utilities and natural monopolies.  There is a minimum wage in many countries, or a floor for the price for labor, but great care is taken that setting such a prices does not distort the labor market.  And since the 1970s, there is no high income county that regulates market interest rates. 

The other is the high degree of economic freedom for individuals and firms to engage in productive activity, create new businesses that generate employment, production and new ideas, close unprofitable ventures without the stigma of failure (yet without the expectation that fraud by connected interests is allowed).

And the third is a more optimal government footprint.  For simplicity´s sake, governments affect economic activity through three channels. One is fiscal policy: revenues, spending, guarantees, both explicit and implicit. The second one is government regulation. And the third one is direct government intervention in the economy through setting targets, plans, and through state owned enterprises.  In many countries, it is possible that governments are both too small and too large and Belarus could learn from this experience.  Often, governments spend too much without clear measures of efficiency and effectiveness and on the wrong areas. Just as often, genuine social protection or unemployment insurance to permit labor markets to function well is missing.  Regulation is often burdensome - take, for example, the number of payments a business needs to settle their tax obligations. In Belarus it takes 7 payments, lower than the 8 in Estonia and the 11 in OECD.  

In summary, avoiding the policy trap and moving to high income depends crucially on progress in developing the institutions and policies of a market economy. That is, high income passes through the market. Only a market economy provides clear price signals to individuals, companies and the government; a high degree of economic freedom; and a more optimal government footprint through transparent and efficient fiscal policy, limited and well-targeted regulation; and a small government role in the productive economy. 

The text of the presentation was originally published at World Bank