Warsaw, September 27, 2007

World Bank EU8+2 Regular Economic Report

Main Report

Main messages

Growth continues despite recent international disturbances.

Sustained efforts are needed to address on going challenges relating to CADs, inflation and fiscal consolidation.

• GDP growth has been strong

• Slowed slightly in 2Q

0

2

4

6

8

10

12

14

16

CZ EE HU LV LT PL SK SI BG RO

3Q 06 4Q 06 1Q 07

2Q 07 2006

GDP growth rates (% yoy)

• Consumption is strong in the Baltic States, Slovakia, and Romania, and is driven by strong wage growth.

• Investment is strong in Poland, Slovenia and Bulgaria.

-5

0

5

10

15

20

25

30

35

40

4Q 0

6

1Q 0

7

2Q 0

7

4Q 0

6

1Q 0

7

2Q 0

7

4Q 0

6

1Q 0

7

2Q 0

7

4Q 0

6

1Q 0

7

2Q 0

7

4Q 0

6

1Q 0

7

2Q 0

7

4Q 0

6

1Q 0

7

2Q 0

7

4Q 0

6

1Q 0

7

2Q 0

7

4Q 0

6

1Q 0

7

2Q 0

7

4Q 0

6

1Q 0

7

2Q 0

7

4Q 0

6

1Q 0

7

2Q 0

7

CZ EE HU LV LT PL SK SI BG RO

Consumption

Gross Fixed Investment

GDP

Consumption, Investment and GDP growth, yoy, %

Both residential and civil engineering. Especially strong in Baltics, Bulgaria and

Romania. Increasingly important to overall growth. Now being constrained by labor shortages. Baltic real estate boom may be ending.

Construction has been booming

External market conditions have changed significantly

Global slowdown started in 2Q Shock from US mortgage and housing market

developments. Global reprising of risk and retreat from risky

assets. Represents a test of vulnerabilities of EU8+2 now

more integrated into world economy. Potential further surprises and slowdown in US.

Two channels of communication of external shocks to EU8+2

Trade Financial markets

2.1

2.3

2.4

1.7

1.53.2

1.52.25.6

2.0

0%

20%

40%

60%

80%

100%

2004

2005

2006

Jan-

May

07

2004

2005

2006

Jan-

May

07

2004

2005

2006

Jan-

May

07

2004

2005

2006

Jan-

May

07

2004

2005

2006

Jan-

May

07

2004

2005

2006

Jan-

May

07

2004

2005

2006

Jan-

May

07

2004

2005

2006

Jan-

May

07

2004

2005

2006

Jan-

May

07

2004

2005

2006

Jan-

May

07

EU15 NMS Russia USA RoW

CZ EE HU LV LT PL SI SK BG RO

Geographical destination of exports of the EU8+2, structure in %

EU8+2 exports to US are small US slow down would have to be much bigger and pull

down RoW growth to have greater impact on EU8+2 via the trade channel

Financial vulnerabilities stem from need to finance CADs…..

-15

-10

-5

0

5

10

2006

1Q 0

7

2Q 0

7

2006

1Q 0

7

2Q 0

7

2006

1Q 0

7

2Q 0

7

2006

1Q 0

7

2Q 0

7

2006

1Q 0

7

2Q 0

7

CZ HU PL SK SI

Trade in goods, net Trade in services, netIncome, net Current transfers, netCurrent account balance

CAD as % of GDP

….some of which are large and rising

-30

-25

-20

-15

-10

-5

0

5

10

2006

1Q 0

7

2Q 0

7

2006

1Q 0

7

2Q 0

7

2006

1Q 0

7

2Q 0

7

2006

1Q 0

7

2Q 0

7

2006

1Q 0

7

2Q 0

7

EE LV LT BG RO

Trade in goods, net Trade in services, netIncome, net Current transfers, netCurrent account balance

CAD as % of GDP

The type of finance matters

FDI is the most secure and covers 100% of the CADs of Czech Republic and Poland, in 90% in Bulgaria and 2/3 in Slovakia and Romania.

Hungary relies more on portfolio investment. Baltics rely on borrowing, largely through

banks. In Latvia the rate of borrowing is unsustainable.

Evidence of trouble?

Bond spreads Equity markets Currencies

Bond spreads up, but not much…

0

500

1000

1500

2000

Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07

EMBI+ spread

EMBI+ LatAm spreadEMBI+ Asia spread

EMBI+ Europe spread

…and less in EU8+2 than in other emerging markets

0

50

100

150

200

250

300

Jan-07 Apr-07 Jul-07

EMBI+ spreadEMBI+ Russia spreadEMBI+ LatAm spreadEMBI+ Asia spreadEMBI+ Europe spread

Some stock markets are actually up

Stock market indices

80

85

90

95

100

105

110

115

2-Jul 17-Jul 1-Aug 16-Aug 31-Aug

PL

CZ

HU

BG

RO

SK

80

85

90

95

100

105

110

115

120

2-Jul 17-Jul 1-Aug 16-Aug 31-Aug

EE

LT

LV

SI

in Visegrad countries, BG and RO Baltic countries and Slovenia

Currencies are mixedExchange rates vs. Euro

Czech koruna

26

27

28

29

30

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Slovak koruna

323334

35363738

3940

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Romanian leu

3

3.2

3.4

3.6

3.8

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Polish zloty

3.5

3.6

3.7

3.8

3.9

4

4.1

4.2

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Hungarian forint

240

250

260

270

280

290

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

EU8+2 have weathered this storm so far, but things could get worse

There remains a large block of US mortgages to rollover. Further credit crunch could evolve despite Fed and ECB

actions

0

2

4

6

8

10

12

0 10 20 30 40 50 60

2006

2005

2004

2003

months after origination

Sub-prime 60 day delinquencies by mortgage vintage year, adjustable rate mortgages, in percent of payments due

Fundamental medium term challenges remain

• Ensure that CADs do not grow unsustainably• Ensure that inflationary forces remain

controlled• Continued efforts towards fiscal consolidation• Address overheating in Latvia

Inflationary pressures are mounting

0

2

4

6

8

10

Jan-

05

Apr

-05

Jul-0

5

Oct

-05

Jan-

06

Apr

-06

Jul-0

6

Oct

-06

Jan-

07

Apr

-07

Jul-0

7

CZ HUPL SK

0

2

4

6

8

10

Jan-

05

Apr

-05

Jul-0

5

Oct

-05

Jan-

06

Apr

-06

Jul-0

6

Oct

-06

Jan-

07

Apr

-07

Jul-0

7

BG RO

Overall HICP

Some of the pressure is from volatile food and energy.

But there are sustained pressures from wages which are growing faster than productivity in most countries.

0

2

4

6

8

10

12

Jan

-05

Apr

-05

Jul

-05

Oct

-05

Jan

-06

Apr

-06

Jul

-06

Oc

t-0

6

Jan

-07

Ap

r-07

Jul-0

7

LV SILT EE

Overall HICP

Further efforts are needed towards fiscal consolidation

Fiscal outcomes this year will be better than planned in most countries because of strong revenue performance.

Hungary, Estonia, Poland, Slovakia and Latvia are making some consolidation efforts.

Bulgaria and Romania could make greater consolidation efforts.

Cyclically adjusted balances are high in Bulgaria and Estonia.

Latvia is struggling to implement fiscal stabilization plan

Next year’s budget plans are not fully clear but indications are that many countries will cut tax rates and increase expenditures, especially social expenditures.

There may be fiscal loosening in Estonia, Bulgaria and Poland.

Fiscal 2008

Thank you for your attention

http://www.worldbank.org/eca/eu10rer

From the Shortage of Jobs to the Shortage of Skills

Recent Labor Market Developments in EU8+2

Countries

World Bank EU8+2 Regular Economic Report

Special Topic

Main questions

What have been the main changes in the EU8+2 labor markets since the EU accession?

What are the emerging challenges? How can they be addressed?

Main LM Developments in EU8+21. Substantial improvement in labor market conditions over a

short period of time A strong growth in domestic labor demand is the main factor behind the

improvement

2. But labor resources are still underutilized Low employment rates among certain groups Long-term unemployment Low-productivity employment

3. Still labor and skills shortages have emerged and may become an impediment to further growth

4. Challenge of mobilizing effective labor supply Workers who have incentives to seek employment, and skills that

enable them to take available jobs

Outline

1. Labor market conditions have improved

2. Labor remains underutlized

3. Skills shortages: an emerging challenge

4. How to mobilize labor supply to address

skills shortages

Employment outcomes have improved

More people of working age are employed and less are unemployed

50

55

60

65

70

75

CZ EE HU LV LT PL SK SI BG RO HR EU15

2000 2006 Lisbon Goal

Change in employment rates 2000-2006 (15-64)

thanks to a growth in labor demand

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

CZ EE HU LV LT PL SK SI BG RO

1Q 05 1Q 06 1Q 07

Vacancy rates in EU8+2

Why labor demand picked up? EU accession and access to new markets Global economic prosperity But most importantly the responsiveness of employment to

growth has significantly increased All EU8+2 countries experienced periods of “jobless growth” The increase in the “employment content” of growth reflects successful

enterprise restructuring Move from “defensive” to “strategic” firm restructuring:

Initially firms were restructuring by shedding off redundant labor, and using productivity gains to meet increasing demand

Productivity growth has made EU8+2 firms more competitive Which allowed them to expand and gain market shares They need to hire additional workers to meet increasing demand and

sustain growth

Other factors have played a negligible role

Three main suspects: Labor market flexibility

No major reforms and no improvement => cannot explain the fall in unemployment

Out-migration It is not the hard core unemployed who migrate Out-migration cannot account for job creation and employment growth The fall in unemployment was associated with strong employment

growth Active Labor Market Programs

Limited impact Tend to redistribute jobs rather than create new ones Cannot account for the increase in employment

Strict EPL has not hampered improvement in employment outcomes

0

10

20

30

40

50

60

70

CZ PL HU SK BG LT HR RO SI EE LV

2003 2006

Rigidity of Employment Index

Labor remains underutlized

many people of working age do not contribute to output growth

YouthHungary, Lithuania, Bulgaria

Older workersPoland, Slovakia, Hungary

Long-term unemployedSlovakia, Croatia, Romania

Subsistence farmersRomania, Bulgaria, Poland

Youth in EU8+2 do not combine education with work

0

10

20

30

40

50

60

70

Bul

garia

Slo

vaki

a

Cze

ch R

epub

lic

Hun

gary

Por

tuga

l

Latv

ia

Luxe

mbo

urg

Lith

uani

a

Cyp

rus

Est

onia

Gre

ece

Mal

ta

Aus

tria

Rom

ania

Italy

Ger

man

y

Pol

and

Bel

gium

Spa

in

Fra

nce

Slo

veni

a

Uni

ted

Kin

gdom

Fin

land

Sw

eden

Den

mar

k

Net

herla

nds

EU 25 Average

Share of 15-24 in part-time employment, 2006

Early retirement is a particular problem in aging societies

52 54 56 58 60 62 64 66

PL

SI

HU

HR

SK

BG

CZ

RO

LV

LT

EE

OfficialMedian

Official and Actual (Median) Retirement Age in EU8+2, 2005 (Men)

As a result many older workers are out of the labor force

Workers Aged 55-64Employment/Population Ratio

2006

0

10

20

30

40

50

60

70

EE LV LT EU15 CZ HR RO BG HU SK SI PL

%

Lisbon target

High shares of LTU point to structural unemployment

0

10

20

30

40

50

60

70

80

Sw

eden

Cyp

rus

Den

mar

kS

pain

Uni

ted

Kin

gdom

Fin

land

Aus

tria

Luxe

mbo

urg

Irel

and

Latv

iaM

alta

Fra

nce

Net

herla

nds

Lith

uani

a

Hun

gary

Est

onia

Slo

veni

a

Italy

Por

tuga

l

Bel

gium

Cze

ch R

epub

lic

Gre

ece

Bul

garia

Pol

and

Ger

man

yR

oman

ia

Cro

atia

Slo

vaki

a

EU 25 Average

Share of long-term unemployment in total unemployment, 2006

Many workers are employed in low-productivity agriculture

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

RO BG PL HR LT LV SI EE HU CZ EU15 SK

Employment in Agriculture Employment in Industry Employment in Services

Share of employment by sector, 2006

Skills shortages

Shortages of skilled labor have become employers main concern

0 10 20 30 40 50 60

Slovakia

Slovenia

Croatia

Estonia

Poland

Romania

Bulgaria

Hungary

Lithuania

Czech

Latvia

Expanding f irms

Non-expanding f irms

EU8+2 averageAll f irms

Percentage of firms that report worker skills as an important obstacle to firm operation and growth, 2005

Poland: hiring a worker with required skills is increasingly difficult

1.8 3.05.3

10.1 10.7 10.712.7

13

11

7

21

2-31-2

0

2

4

6

8

10

12

14

4Q 05 1Q 06 2Q 06 3Q 06 4Q 06 1Q 07 2Q 07

number of enterprises (%)rank of obstacle

Enterprises reporting hiring difficulties in an open survey on key obstacles to growth (in %) and the rank of this obstacle

Filling vacancy for a skilled worker can take a long time even if unemployment is high

0 2 4 6 8

RO

BG

PL

CZ

SI

HU

LT

CR

EE

LV

SK

EU8+2 and

HR average

Time needed to fill a vacancy for a skilled worker 2005 (in weeks)

because of the skills mismatch: excess supply of low-skilled labor

-20

-15

-10

-5

0

5

10

15

20

25

30

CZ EE HU LV LT PL SK SI BG RO EU15

Primary and low er secondary

Upper secondary and post-secondaryTertiary

“Excess Supply” of Labor by Educational Attainment, 2006

Skill shortages have given rise to wage pressures and to growing ULC

(Example: construction)

-10

0

10

20

30

40

1Q 0

3

2Q 0

33Q

03

4Q 0

3

1Q 0

42Q

04

3Q 0

4

4Q 0

41Q

05

2Q 0

5

3Q 0

54Q

05

1Q 0

6

2Q 0

63Q

06

4Q 0

6

PL EESK LT

Unit labor costs in construction, 4Q moving average, yoy %

How to mobilize labor supply?

The big shift Until recently low employment/population ratios

in EU8+2 were due to insufficient labor demand Now they are they reflect supply side constraints There are labor shortages despite a large pool of

working age population which out of the labor force but able to work

The policy priority has shifted from fostering job creation to mobilizing effective labor supply

Otherwise labor shortages may hinder economic growth

EU8+2 need to mobilize labor supply to sustain economic growth

Three main ways of achieving this: Improving labor supply incentives through

reforming social security systems Improving worker skills by making the

educational system more responsive to labor market needs

Opening labor markets to foreign workers to import labor with required skills

Thank you for your attention

http://www.worldbank.org/eca/eu10rer