Leonardo Badea (BNR): Economic structure, growth dynamics, and the strategic channeling of investments: a regional perspective

In recent years, amid the many challenges to economic policies generated by the direct and indirect effects of overlapping crises, one of the main concerns has been related to maintaining economic growth, in order to lessen the negative impact on society as a whole and to facilitate the fast as possible adaptation to the new conditions. For governments and decision-makers, both at national, and regional or global levels, economic growth is a priority derived from the need to support employment, stabilize markets, and maintain or advance the well-being of the population.

An important component of the economic support programs is the stimulation of investments. They are necessary during periods of normal operation of the economy for the improvement of productivity and the continuous incorporation of technological progress into productive processes. Given the sharpening of long-term vulnerabilities that most economies currently face (e.g. the climate crisis, the demographic evolution), as well as emerging geo-political tensions affecting international trade and traditional value-added chains, the role of investments becomes crucial.

In order to invest efficiently, however, it is necessary, among other things, to have as clear a picture as possible, both of the current structure of the economy (contributions to the formation of GDP) and of the sources of growth.

I. Contribution to GDP

The factors that contribute to GDP, as we well know, may be approached from multiple perspectives, each with specific relevance. Figure 1 below shows the share of the main categories of uses (therefore, on the demand side), both for Romania and for the four countries in the region with which we often compare ourselves and with which we are in cordial competition on the international markets for attracting investments and increasing exports. The figures are presented in billions of euros at current prices, and the vertical scale has the same range of values ​​for all component graphs, to provide a perspective on the differences in the size of the economies of the five countries.

A first observation is that Romania occupies a middle position in the regional ranking from the perspective of the contribution of investments (gross capital formation) to GDP formation. Thus, in the period 2019 – 2022, in Romania, the investments had a share in GDP of about 24% – 27%, higher than Poland and Bulgaria, but significantly lower than Hungary (28% – 34%) or the Czech Republic (28% – 32%).

At the same time, Romania and Bulgaria were the countries in the region where net exports had the least favorable contribution to GDP formation over the entire 12-year period included in the graphs in Figure 1. In the case of Romania, net exports had a negative contribution during the entire mentioned interval, a situation that has intensified since 2018 and that only improved during the last year, according to the provisional data available for now only for the first three quarters of 2023.

To add more details to the picture above, it is important to bear in mind that, at the level of the European Union (27 states) and the Eurozone (20 states), the share of gross capital formation in GDP was in the mentioned time interval between 23% and 25%, and that of net exports between 2% and 4%.

Corroborating the mentioned data, we notice that Romania is still slightly above the European average from the perspective of investments contribution to GDP formation, although we are not among the countries where they have high levels (as is the case, in our region, of Hungary and the Czech Republic). On the aggregate demand side, from the data above, much more visible is the structural problem (well-known and discussed for a long time) that we have on the net exports side. The difference between their positive contribution of 2% – 4% to GDP, on average at the European level, and a negative one of about -4% to -7% as recorded in the case of Romania from 2019 to 2022, is closely related to the significantly higher share of consumption in our case (about 79% – 80%) compared to the European economy as a whole (about 73% – 74%).

Considering the important role, the similarities but also the differences revealed in the above data regarding the contribution of investments to the formation of GDP, it is interesting to observe their composition by sectors, grouped according to the Statistical classification of economic activities in the European Community (NACE) used at the European level since 1970. In Figure 2 below, as in the previous figure, the values ​​represent billions of euros in current prices, which allows observing not only the structure, but also the nominal size of the respective investments categories. The regional analysis highlights at least four relevant differences between Romania and neighboring countries:

• as a nominal value, investments in industry were lower in the case of Romania compared to the Czech Republic, in each of the last five years, and even compared to Hungary in 2022, although both mentioned economies have a smaller size (especially Hungary, also expressed in billions of euros current prices) and at the same time a higher share of investments in GDP;
• Romania compensated marginally by somewhat more important investments in agriculture and partly in IT&C where it surpassed Hungary, but is significantly below the value of those in the Czech Republic;
• the nominal value of investments made in the construction sector is significantly higher in Romania compared to the Czech Republic and Hungary, even taking into account the relative sizes of the three economies. At the same time, the nominal value of investments made in the real estate transaction sector is comparable in Romania to the Czech Republic and higher than Hungary;
• regarding services on the whole grouped under the categories trade, transport, storage, auto-motorcycle repairs, hotels and restaurants, Romania ranked above Hungary, but was significantly surpassed by the Czech Republic in 2021 and 2022, the most recent years for which there are complete data.

Correlating the above, a lower value of investments in industry can be observed in Romania compared to the Czech Republic and Hungary, but significantly higher in the construction sector, and respectively, only marginally higher in the agricultural sector. In terms of the real estate and IT&C transactions sector we surpass Hungary (an economy significantly smaller than ours), but we are on the same level or even surpassed by the Czech Republic (an economy only marginally smaller in size, but where, overall, investments have a greater weight). Grouped for the categories of trade services, transport, storage, auto-motorcycle repairs, hotels and restaurants, we have also been overtaken here by the Czech Republic in the last two years.

Figure 2: Structure by activity sector of gross capital formation (billions of euros, current prices)

From the perspective of the unfavorable contribution of net exports to GDP formation that I referred to in the comments on the previous figure, it is worth noting that investments in some important sectors of activity that contribute to the supply of goods and services that can be traded internationally and that, implicitly, may substitute imports (”tradables”), are lower in Romania than in the Czech Republic (and in some cases even than Hungary). Even if investments in the constructions sector have their role and contribute (in the case of infrastructure constructions) to the development of the economy and to reduce existing gaps, still, Romania should not lag behind the region from the perspective of investments in the productive sectors.

As economists, we are all aware of the driving role that housing and commercial building constructions, as well as real estate transactions, have on the economy and production as a whole. However, I think that through the mix of policies, they should not be allowed to have an indirect effect of diminishing (”crowding out”) investments in the development and increasing the competitiveness of the supply of mobile goods and internationally tradable services. In Romania, we have a structural problem on the supply side that leads to an external imbalance, and this cannot be improved if productive investments are not stimulated to be placed in the foreground through the balance of economic policies.

I believe that the above idea is supported by a series of observations that can be formulated following the analysis of Figure 3 below which presents for the year 2022 the contribution (expressed as a percentage) to the gross added value (the most important component of GDP on the supply side) of the same sectors of activity.

• A first remark is that, in 2022, the shares of contributions to gross value added (GVA) by sector do not differ much within the countries of the region, nor by comparison with European averages. There are variations, but they are within the limit of 2 – 5 percentage points;
• In the case of the constructions and IT&C sectors, the contribution to GVA is higher in Romania, both compared to the region and at the European level. However, the differences are about 1-2 percentage points. Therefore, the investments in this sector, higher compared to the region, do not seem to produce a significant favorable differentiation for Romania, from the perspective of the contribution to GVA.
• Even in the case of the sector of real estate transactions, the larger investments made in Romania do not seem to bring a favorable differentiation in relation to the region for the time being, the weight of this sector in GVA being lower compared to the Czech Republic, Bulgaria, and Hungary, as well as in relation to the European average.
• The contribution of the industry to GVA is higher compared to the EU and Eurozone average, in Romania, as well as in Bulgaria, the Czech Republic, and Poland, countries that outrank us from this perspective. In Hungary, the situation is very close to ours.
  • On the one hand, this observation contradicts, once again, some less informed opinions according to which the Romanian industry would be in a much more unfavorable position compared to what is happening in Europe. We see that, in fact, in Romania the industry has a greater contribution to the economy than the European average.
  • On the other hand, connecting with the ideas formulated above based on Figures 2 and 3, it is not surprising that, unfortunately, the lower investments in industry in Romania compared to our neighbors correspond to a somewhat smaller contribution to GVA, in relative terms.
• Romania ranks better compared to the European average and to most of its neighbors (except for Poland) in terms of the aggregate contribution to the GVA of large groups of services such as trade, transport, storage, auto-motorcycle repairs, hotels and restaurants.
• Finally yet importantly, the contribution of agriculture, forestry, and fishing activities is among the highest in the region and significantly above the European average.

II. Contribution to economic growth

After devoting the first part of this short analysis to studying the structure of the economy, both from the perspective of demand and supply, attempting a correspondence with the weight of investments and their allocation by types of activities, we will add to this picture, in what follows, a series of observations on contributions to economic growth.

The study of the structure of economic growth and the factors that contribute to it is relevant because some fields and categories of activities may have important weights in the formation of GDP, but a much smaller contribution to its annual growth.

As we mentioned in the very motivation of this analysis, maintaining economic growth is an important concern for governments and decision-makers, especially in the current context at the regional and global level, and investments have an important role.

For Romania, Figure 4 below shows that, in each year from 2014-2022, net exports had a negative impact on economic growth. The most important driver of growth was private consumption, most often seconded by investments and government consumption.

Looking at the medium to long term, for the entire period included in the graph, a high level of volatility can be observed, both of the overall growth structure and of each individual component. An important part is justified by the effects of the successive crises and the natural cyclicality of the mechanisms of the market economy. However, a more consistent mix of economic and structural policies that consistently aims for long-term objectives, set by consensus beyond the normal political cycle in any democracy, and targeted at reducing known persistent vulnerabilities could reduce volatility.

Because all economists, regardless of ideology, recognize investments as beneficial, the policy mix must continue to support their contribution to GDP and annual growth. Provisional data for the first three quarters of 2023 show a significant slowdown in the main driver of our economy, consumption. Rising nominal incomes and falling inflation lead to favorable dynamics of real disposable income, which I believe will support the recovery of consumption to some extent during 2024. The increased contribution of investments has counteracted the negative effect of the reduction in consumption on the annual growth of GDP in 2023. In the absence of financing through European programs, but also of the support granted through national programs, this would not have happened. We therefore have very conclusive proof of the benefits of European integration and the alignment of national programs with the Union’s medium and long-term strategies. Nevertheless, we must continue to build on this result, because in the long term, our economy needs a more balanced and, if possible, slightly less volatile structure of economic growth.

A regional comparison (Figure 5) shows that in 2022, for most of our neighbors and for the EU as a whole, investments contributed significantly to growth. For us and our Bulgarian neighbors, this contribution was all the more important since, as we previously observed, exports acted in a negative direction, which did not happen for the others.

In the context where many of the crises are acting simultaneously on most economies in the Union, the favorable contribution to economic growth in the first three quarters of 2023 that net exports had may not be able to be sustained at the same level in the following quarters. In addition, we are going through a difficult period for international trade for multiple reasons: increasing protectionist accents in many countries, intensifying geopolitical tensions, tendencies to partially replace the architecture of international economic cooperation with one based on economic blocs and regionalization.

Along with the recovery of consumption, it is important that investments continue to contribute to the growth of the economy. Ideally, this should be associated with a structural adjustment of domestic supply, so that it is not accompanied by a revival of imports and a re-inflammation of trade and current account imbalances. From a realistic perspective, the performance and positive contribution of investments in the first three quarters of 2023 cannot be further maintained at the same level by inertia alone. Some signals from the public space indicate a possible slowdown in 2024. That is why a consistent effort, coordinated and aligned with long-term national and European strategies, is necessary to prevent the situation in which investments, if not further supported by appropriate policies, would significantly decelerate.

From the perspective of the contribution of resource categories to GDP growth (Figure 6), in recent years Romania’s economy has been based predominantly on services and less on industry, a situation that is correlated with the overall picture at the European level and which we also find in some of the countries in our region (Figure 7).

The overlapping crises, the numerous international blockades, and the volatility of the raw materials markets led to the situation where the contribution of the industry to the economic growth was predominantly negative in the case of Romania in the period 2019-2022, as well as in the first three quarters of 2023.

As in the case of contributions on the demand side, Romania also needs a more balanced and stable structure of contributions to growth on the supply side. Structural policies must aim at the revitalization of industry and agriculture, without neglecting the engine represented by services, which has so far proved robust. We therefore need to support the dynamics of the components that have traditionally represented new engines of growth, but at the same time ensure that additional engines also work and can take the leading role, depending on the cyclicality of internal and external conditions.

III. Conclusions

The short analysis above tries to highlight three aspects that I consider important for economic policy decisions in the current period.

The first is that, observing the structure of contributions to the formation of GDP and its annual growth, we must find ways to support all the engines of the economy, as we need a more balanced structure of their contribution, so as to reduce the volatility observed in recent years. Cyclical development is a normality of market economies, and disruptions introduced by external shocks are likely to continue in the years to come. However, by improving the balance of the contributions of the sectors on both the demand and the supply side, we act to reduce the amplitudes of the cycles and to increase the resistance to exogenous shocks.

The second aspect is that the slowdown in consumption in the first three quarters of 2023 was partially offset by the favorable contribution of net exports (for the first time in about 10 years) and to an important extent by investment. Although beneficial and gratifying, the contribution of net exports may not be able to be maintained in the coming period, because there are important transformations at the global level that for the time being act with great force in an unfavorable direction to international exchanges (geopolitical tensions, the re-amplification of protectionism, economic slowdown in Europe and in China, etc.). Therefore, we must continue to count on the return of consumption. At the same time, investments are necessary to adapt the economy to the new conditions and to implement the accelerated technological advance of recent years. Moreover, important funding programs at European level support them. So we have very strong motivations to make all the necessary efforts so that, after the very good performance of investments in the first three quarters of last year, they do not slow down significantly in 2024.

The third aspect is that investments must still be channeled through public policies to those areas where their utility for our economy and society is as high as possible, and their economic efficiency is maximized. The data presented above shows that, unfortunately, so far this has not happened every time. Comparisons within the region and at the European level show that an important part of the investments in the Romanian economy are oriented towards sectors that do not contribute enough to added value and growth or that do not lead to the production of tradable goods and services, so that we have a long-term improvement in the trade balance and current account deficit. Constructions play a very important role in the economy of any country, and for us infrastructure construction is crucial because it helps reduce the large gaps we have, reduce transport costs, pollution, travel times, and increase the accessibility of our products and services for external partners. But perhaps we should find a better balance between investment in residential real estate constructions and real estate transactions on the one hand, and those in industry on the other.

It is essential to recognize the role of all factors in adding value and growing the economy. What matters a lot, however, is the optimal mix, adapted to natural conditions, the characteristics of the local and regional economy, human resources and the training capacity of the workforce, access to technology and technological goods, major long-term trends at the international level, etc. Such a complex system will never be easy to optimize. However, we can study constantly how our neighbors and partners in the region and in the European Union act, as well as any other partner whose experience and results we can draw inspiration from.

Investments, in particular, hold a unique and vital position in this dynamic. As a component of demand, investment stimulates economic activity by providing capital for new businesses and expanding existing businesses. This leads to job creation, increased productivity and consequently higher income levels, which further fuel consumer spending. On the supply side, investment is essential because it expands an economy’s productive capacity while increasing its efficiency and competitiveness. This dual role of investment acts as a catalyst for sustainable economic growth, demonstrating its critical importance in the formation and growth of GDP.

Furthermore, the impact of investments extends beyond immediate economic parameters. Investments in education and healthcare, for example, contribute to the development of human capital, which is essential for economic growth and long-term stability. Such strategic investments ensure that the workforce is skilled, healthy, and able to adapt to new technologies and global market demands.

In short, while all components of supply and demand have their role in shaping GDP, investments stand out for their ability to stimulate both immediate economic activity and long-term sustainable growth. Romania is now in a very favorable position to continue investments, including through the European funding it benefits from. It is important to maintain the effort, but also to always remain attentive to optimizing their orientation towards those areas whose development helps us the most in the long term (e.g. infrastructure, industry, agriculture, and services).

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