This longform interview with Ivailo Izvorski, World Bank Chief Economist for Europe and Central Asia, was originally published in Croatian in the print edition of the magazine Lider on September 4, 2024.
Some local economists have been warning for a long time that European money is not all-powerful in the context of economic development, especially if it is not invested so as to create the foundations for long-term economic growth on an independent basis. And this independent basis is primarily characterized by private companies’ investments instigated by already realized investments with the money from the European funds. Simply put, without new factories, the European money invested so far will mostly remain dead capital.
The problem of continued growth of investments will become pronounced if private investments do not increase after 2026, which is the deadline for disbursement of funds from the National Recovery and Resilience Program (NRRP), says Ivailo Izvorski, the World Bank's Chief Economist for Europe and Central Asia. With a PhD degree in Economics from the prestigious American Yale University and he joined the World Bank in 2005 as a Senior Economist for Bosnia and Herzegovina in the Poverty Reduction and Economic Management Sector. He has since held several positions at the World Bank. Before joining that institution, he built his career at the International Monetary Fund and the Institute for International Finance. Mr. Izvorski will be a speaker at Lider's conference 'Day of Big Plans', which will take place on September 18 in Zagreb.
Lider: Economic growth in Croatia in recent years has mostly been driven by the influx of money from European funds. Where are the opportunities for continued economic growth after the influx from European funds significantly decreases?
Ivailo Izvorski: Large inflows of EU funds have indeed supported robust growth in Croatia, helping push GDP per capita above 75 percent of the EU average. However, there are also other, even more important factors behind Croatia’s strong economic expansion. Private consumption had a major positive impact on economic growth, supported by favorable labor market developments and large inflows of workers’ remittances. Exports have been strong, especially the tourism industry. Croatia’s innovation performance is also increasing steadily, at a pace higher than the average for the EU. Such trends are likely to continue and support growth and income convergence with the rest of the EU through the end of this decade.
The level of financing from the EU is likely to decline after the current programming period and after resources for the NRRP end in 2026. This means that the country will have to reply much more on private capital to maintain the current level of public investment and will also need to facilitate business investment that has been faltering in recent years. Hence, deeper structural reforms that improve government effectiveness, remove remaining regulatory barriers to the private sector, reduce the role of state in the economy, as well as policies boosting the quality of human capital could help Croatia lift labor productivity, ensuring sustainable high growth and continued income convergence.
L: How do you assess the investments that Croatia has made so far from European funds? How much can they be a foundation for the long-term development of the economy?
II: The EU funds to Croatia are supporting many projects that have a significant potential to boost productivity and growth, improve connectivity, strengthen digital infrastructure, broaden social protection, reduce poverty and inequality, and enhance climate adaptation and mitigation. Croatia has access to about EUR 24.5 billion of EU funds over the next five years, an amount equal to one-third of the country’s 2023 GDP. These funds, together with the reforms planned under Croatia’s NRRP, will continue to support economic growth and income convergence over the medium term. The long-term development impact of these projects will ultimately depend on Croatia’s capacity to bolster private sector investment to build on the foundations these projects establish.
Croatia acceded to the European Union in July 2013, which unlocked access to EU funds that have been one of the highest per capita in the EU. Though the absorption rate of the EU funds has improved substantially, there are still obstacles related to weak administrative capacity and institutional gaps limiting government effectiveness to approve legal instruments, designate competent authorities, and design operational plans. Removing the remaining absorption obstacles could significantly boost the long-term benefits from the EU funds.
L: How much can the reforms implemented as part of the NextGenerationEU plan contribute to a higher rate of economic growth in the eurozone?
II: The Next Generation EU (NGEU) fund, which includes the Recovery and Resilience Facility (RRF), was agreed in 2020 and amounts to about 6 percent of the EU GDP. The fund was created to support the immediate recovery from the pandemic and encourage the implementation of reforms to sustain greener and more resilient growth. The NGEU did help support stronger post-COVID recovery, prevent sizable contraction of public investment, and boost employment. According to the European Commission, EU GDP was 0.4 percentage points higher in 2022 than it would have been in the absence of NGEU, though the impact was much smaller in the eurozone countries compared to other EU member states. The peak GDP effect for the EU is estimated to amount to 1.4 percent by 2026, albeit it is expected to be twice as large in, for example, Poland and Romania compared to France or Germany.
However, the ability of NGEU to sustain permanently higher growth in the future looks less certain. Some of this can be attributed to the economic impact of Russia’s invasion of Ukraine. Further, the additionality of NGEU may be reduced due to the displacement of national public investment - investments that governments had planned -- with NGEU funds, thereby reducing the growth effects from the NGEU. More importantly, the EU funds were designed to encourage complementary reforms of EU’s competitiveness and investment that boost productivity growth. Alas, the NGEU implementation is lagging. By the end of 2023, only a third of the funds were disbursed and several countries are behind their anticipated timeline for completing reforms. This reflects various factors, some that are more positive and speak to the ambition of the NGEU – such as complex reforms that take time to complete correctly - while others are due to slower implementation or disagreements over content that have resulted in delayed payouts to some countries. In addition, rising project costs and changes in governments triggered revisions and renegotiations of the national plans, delaying implementation. As a result, some investments with a potential to boost long-term growth have been delayed or downsized. Low absorption rates also diminish the capacity to invest large amounts of EU funds efficiently, especially for the biggest recipients, as governments try to catch up to achieve near-full disbursement before time runs out.
L: The World Bank forecasts that global economic growth in 2025 and 2026 will be 2.7 percent. This means that the growth of global GDP will be half a percentage point lower compared to the average in the last decade. What is the reason for this, and what are the most significant risks to economic growth in the next three years?
II: Global growth is stabilizing after a series of overlapping crises and is likely to be slightly higher in 2024 than earlier expected. Compared to the decade before the COVID pandemic, however, growth is indeed projected to be half a percentage point lower. This reflects lackluster recovery of global trade and investment and headwinds from the expected tightening of fiscal policies. Investment growth is expected to remain weak because of high borrowing costs, elevated policy uncertainty, and rising geopolitical risks. As labor markets cool, growth of consumption is also likely to moderate. The subdued global outlook also reflects slowing potential growth in many economies amid the enduring impacts of the past shocks.
The risks to economic growth have become more balanced but are still tilted to the downside. These include renewed trade and geopolitical tensions, the resulting fragmentation of value chains, and more volatile commodity prices. Elevated inflation could lead to higher-for-longer interest rates in some economies. There are also potential risks from weaker than now anticipated expansion in key economies and disasters related to climate change.
L: Do you expect the trend of declining inflation in developed economies to continue during 2024 and 2025? Is the target of a two percent annual inflation rate achievable by the end of the decade?
II: Inflation has declined substantially in many countries, and we expect that the disinflation trend will continue this year and next. Despite the decline, inflation is still above target in many advanced economies and in about one-fourth of inflation-targeting EMDEs. Moderating supply disruptions, still tight monetary policy, and continued cooling of labor markets should help bring inflation back to targets. By the end of 2026, we project global inflation to fall to an average rate of 2.8 percent.
L: What developments do you expect in the commodities market over the next three years, especially for commodities important for industrial production?
II: Geopolitical tensions are likely to keep energy prices elevated in the near term, though the partial unwinding of OPEC+ cuts and increasing non-OPEC+ production may help restrain the growth of oil prices. Prices of other industrial commodities, for example metals, are likely to remain above their pre-pandemic levels as increasing global demand related to the clean-energy transition. However, as global supply of many industrial commodities remains tight, further disruptions in supply, could trigger substantial price volatility.
L: Global trade has started to recover. Do you expect a slowdown in growth due to the announced tariffs by the European Union and the United States on imports of Chinese technology?
II: The number of new trade-restricting measures has already increased substantially this decade. The introduction of new restrictions, including tariffs, is likely to escalate further already heightened trade policy-related tensions and may accelerate the shift to more inward-looking policies. As result, growth of global trade -- already weakened by increased trade fragmentation, lackluster global industrial production, wars and conflicts – is likely to slow further, dampening global economic activity.
L: The World Bank forecasts 3.5 percent economic growth for the Western Balkans region (Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, and Serbia) in 2025 and 3.8 percent in 2026. What will be the main drivers of growth?
II: Consumption is expected to be the main driver of growth in the Western Balkans as inflation eases and labor markets remain robust, supporting continued recovery of real wages. Strong exports, including from tourism and information and telecommunication technologies, together with gradually firming external demand, will also provide a boost to growth. Economic expansion will further benefit from infrastructure investment, supported by EU funds and, in some countries, strong construction activity. The downside risks include slower economic growth in the main trading partners, notably Germany.
L: India and the South Asia region are currently the fastest-growing economic areas in the world. Is such a growth rate in India sustainable in the long term, and what are the prerequisites for further strong economic growth in this region?
II: As we show in our South Asia Development Update, output growth in South Asia, projected at just above 6 percent in 2024-25, remains stronger than in other emerging market and developing countries (EMDEs), largely due to strong growth in India. Growth in the rest of the region is picking up but is expected to remain well below pre-pandemic averages. More than in other EMDEs, growth is being driven by the public sector. Over the longer term, stronger job creation could help sustain growth and facilitate climate adaptation.
The region’s labor markets stand out among EMDEs for having declining employment ratios (employment relative to total working-age population) and exceptionally low shares of women in employment. This partly stems from challenging institutional and economic environments that have held back firms’ growth. As working-age population growth is expected to slow, sustaining growth will require increasing employment ratios, especially in the non-agricultural sectors and among women, through measures to remove obstacles to growth for businesses, increase openness to international trade, ease labor market and product market restrictions, build human capital, and strengthen equality of women’s rights. All these policies could also accelerate the structural transformation that lifts labor productivity growth, which has slowed in South Asia to below the EMDE average since the pandemic.
South Asia is highly vulnerable to climate change, threatening sustained growth. With severely constrained fiscal positions limiting the scope for public policies to facilitate climate adaptation, the private sector bear most of the burden of adaptation. Job creation in the non-agricultural sector will help private sector adaptation to climate change.
