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Beata Javorcik - Chief Economist at the European Bank for Reconstruction and Development, PhD in Economics from London School of Economics, Professor of International Economics at the University of Oxford, Graduate of the Warsaw School of Economics, Research Fellow at the Centre for Economic Policy Research (CEPR). Javorcik is a leading expert in the field of international trade and investment, her research is published in top academic journals and has received prestigious awards.
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Hoshimov: Hello everybody, this is “Hoshimov's Economics” and I'm Bekhzod Hoshimov. Today our guest is Beata Javorcik. She is professor of Economics at the University of Oxford and a chief economist at European Bank of Reconstruction and Development. Welcome, Beata.
Javorcik: Thank you. Pleasure to be joining you.
Hoshimov: Beata has been studying questions of international trade, integration, foreign direct investments for a long time as an academic, and so we'll talk a little bit about her research as it connects to these issues. So my first question would be very broad. How important is international trade for economic development and growth?
Javorcik: Incredibly important is the short answer, and that's for several reasons. I think the main one is that trade gives countries access to foreign knowledge, foreign knowledge that is embodied in capital goods and in inputs. And many academic articles and many years of study have been devoted to documenting the benefits of trade liberalization and it has been shown that they come particularly from access to inputs at cheaper prices. So trade liberalization stimulates productivity growth through competition that's brought about by imports, but also through access to knowledge and new technologies embodied in imported inputs.
Hoshimov: When you say inputs, the definition seems to be quite important, right? One of the ways that people in say Computer Science departments joke, they say that “programmers are machines that turn coffee into code”. And so when we talk about inputs, some countries think that taxing inputs is not a good idea, but taxing what they call “final goods” is a good idea. I mean import taxes. In that sense, how do we know what is the input to how do economists think about it?
Javorcik: There are many ways of answering this question, and there are many ways of running trade policy. I think most economists would say that rather than explicitly focusing and trying to guess which tariffs should be lowered and which tariffs should be kept high, it would be more advisable to lower tariffs across the board simply because you want to benefit also from the competition that's brought about by international trade. In a sense that if you protect domestic industries, they have little incentive to improve themselves, right? Many countries have tried to pursue import substitution strategies and Uzbekistan for a while also has been inward looking when it comes to its approach to industrial policy. But broadly international experience shows that that's not the most effective way of pursuing a growth strategy. Moreover, what we know from international experience is that if there is a lot of differentiation in the tariff structure, there is an incentive to bribe and to try to evade import tariffs. So therefore many countries have chosen to have a uniform tariff because that limits the scope for evasion and for corrupt behavior at the border.
Hoshimov: Thank you. One of the questions that has been discussed I would say is that how can countries that are poor or catching up be able to trade with countries that are very sophisticated in their technologies, in their access to capital and so on and so forth. I know economists model it very elegantly with a concept called comparative advantage. Can you give us a little bit of insight on description of a country which is technologically not advanced and the world is just technologically advanced, and why the country that is technologically not advanced if it joins the world trade, it would still be beneficial to that country. I think this is quite a non-trivial thought exercise. So how would you tell us?
Javorcik: Well, I think it's instructive to look at the experience of Mexico or to look at the experience of eastern European countries. In both cases, the ability to export to a much richer neighboring market. So, the US and Canada, in the case of Mexico under NAFTA, North American Free Trade Argument, and to the EU market under a host of association agreements and then by the virtue of being EU members. The experience of these countries has shown that access to a richer market creates an incentive for local companies to improve the quality of products. And that improvement is associated also with a productivity improvement with investment. So in other words, the fact that there is a lucrative opportunity out there, because suddenly you can export to a country that demands high quality, high value added goods creates an incentive for local entrepreneurs to invest in productivity improvements in product improvements, and that helps create better jobs. Moreover, access to a foreign market, particularly a large lucrative market in a rich country, makes a developing country or an emerging market an attractive location for flows of foreign direct investment. And here again in Mexico and in Eastern Europe, we have seen lots of multinationals establishing their presence and using those locations as a base to supply richer countries. They take advantage of cheaper labor costs, but they bring knowledge, they bring new technologies, they bring management skills, and they bring their knowledge of advanced economy markets. And this combination of knowledge brought through FDI, and local lower production cost is a winning combination and allows countries to grow through export-oriented strategy.
Hoshimov: In the last 60 years, the world has liberalized a free movement of capital, which is money and financial resources and of goods. It's easy for us to purchase goods that are made in different parts of the world for quite a good price. But one thing that hasn't been liberalized, I think, is the movement of labor. It's kind of hard to move labor and some of the back of the envelope calculations show that removing barriers to immigration can possibly double the GDP of the world. It seems to be such a lucrative thing. But let me ask you more sort of specific question about Europe. Do you think that removing barriers to immigration can solve many economic problems including fiscal problems that many western European countries are facing and also the questions of growth and demographics? What'd you think of another component of international relation, which is migration?
Javorcik: Well, so the short answer to your question for why we have not seen similar liberalization of labor flows is that it is a politically very difficult issue, right? Now having said that, if you think about the European Union, the European Union has managed to liberalize migration to within the union, we have free movement of labor, free movement of capital, free movement of goods and services. Now, having said that, one of the reasons why Brexit happened was dissatisfaction of the British public with large inflows of people from, particularly from Eastern Europe, and this large influx of people put in the opinion of locals, pressure on services, created congestion and so on and so forth. Liberalizing migration is difficult because there are also issues that are not related to economics. Going from a country that is homogenous in terms of its population composition to a country that is a multicultural multi-religious country is a big step and that brings complications with it. There is also a concern often about the pressure on public services and therefore countries have been rather careful when it comes to managing migration. There is actually a very interesting report that has recently been published by the World Bank, a “World development report” which discusses in detail the issue of migration and essentially it splits migration flows into several types. There is what most people consider very desirable migration, which is inflow of highly skilled specialists who benefit the country through their skills who contribute to the society. Then there is the flow of refugees to which most advanced economies are open on moral grounds, right? It's the right thing to do. What is problematic, particularly politically, is irregular migration of individuals with lower skills. And the problematic component is particularly the fact that often this migration is not managed through a process, but rather there are people arriving in ways that are illegal and that creates a feeling that the host country is losing control over the process. Now many countries are realizing that when they go through demographic transition, meaning when their population growth slows down, they will be facing a challenge when it comes to sustainability of pensions. So they are realizing that they need inflows of migrants, however they would want to manage the process to give comfort to their citizens. So in summary, I think we are going to see more and more openness to migration as the societies age and as they need to worry about sustainability of pensions. But the challenge is to make this process, to have some control of this process and avoid irregular flows. And these irregular flows are not in the interest of either descending countries or the receiving countries. So some cooperation between the two sides, more cooperation will be needed.
Hoshimov: I see. One of the reasons I was bringing up this issue is that in the papers that you have written, you were talking about the knowledge transfer that happens when a foreign company establish a firm in one of the countries, and there's now also the papers in labor economics where they argue that when people migrate, there's also some sort of knowledge flows that comes in from the more developed place to a less so. There are many interesting channels, speaking of…
Javorcik: Absolutely.
Hoshimov: Yeah. So one of the things I think is quite new in the literature is that… One of the questions that comes to mind when I read this literature on foreign direct investments is that if we think about many priorities of the governments at once and if attracting foreign direct investments are costly, how important that should be from a development point of view where the countries should spend, let's say less and in which areas they should spend more money to attract FDIs. What I'm trying to say is that they have this optimization equation in which they can attract more FDIs, but it's costly. I'm referring to your paper like “The red carpet” paper. And then there is, they have other responsibilities and other things that they should care about. So how important from the policy perspective is for the countries to think about FDIs and maybe to some countries it's worth it and to some countries it's not. How should one think about it?
Javorcik: I would think that it's incredibly useful for an emerging market to attract inflows of FDI. So we mentioned before the knowledge embodied in trade, you mentioned knowledge that's brought by migrants. Foreign direct investment, it's not just capital that flows across borders, it's primarily knowledge that flows across borders. So attracting foreign direct investment, it's a cheap way of upgrading your production structure. Attracting FDI is also a way of creating new pockets of comparative advantage. When we look at international experience that countries that started exporting products they did not export before that to a large extent has been due to multinationals starting those industries or starting those kinds of exports. And finally, in traditional societies, multinationals are also attractive employers for women. So there's also this aspect that is interesting. So now the question is how do you attract FDI? I think the first priority is to get the basics right. So if a country has problems with access to electricity, if corruption is rife and if it is incredibly onerous to register a firm, you are not going to get FDI, no matter how much you start paying in incentives, right? Extractive industries may be somewhat of an exception. So now getting the basics right is important even in its own right because you're doing this not just for foreign firms, but you are helping also local entrepreneurs. So it's something you should do to stimulate growth in the local productive sector. Now when it comes to explicit FDI strategies, I am not a believer in giving handouts in being very generous with incentives with tax holidays. But rather I think that a lot can be achieved through investment promotion that is defined as marketing a country abroad as help providing information to investors, as helping investors navigate the bureaucratic maze and as serving as a channel between foreign investors and the government and advocating on the part of foreign investors. Such a policy works. And you mentioned some of my papers, I've analyzed very detailed data on sectors that were chosen as priority sectors by various countries for inflows in their efforts to attract inflows of foreign direct investment. And what you see very clearly in the data that investment promotion works, that those sectors tend to get more FDI even if you take into account the fact that countries may have various reasons for choosing particular sectors in their targeting efforts. These efforts works in emerging markets. And if you think about investment promotion as a way of lowering the cost of entering your country, then all you need is a world-class or at least a well-functioning investment promotion agency. And that's not an incredibly expensive thing to do. And the best part about it is that if you get it wrong, so if it doesn't work, then you have not actually introduced distortions. You simply don't get FDI and you just wasted a bit of money, the budget of the agency. Now, there is one exception you may want to create, give incentives to first couple projects that are going to make a big splash in the media and that are going to put your country on the global FDI map. I think most people know that Intel invested in Costa Rica. Most people know or may not know that Costa Rica actually did a lot for Intel, including, for instance, designing specific training programs, university programs that would trade workers for Intel. But the enormous publicity the country got was actually something that put it on the global investment map and benefited through marketing of the country.
Hoshimov: Yeah, what I was thinking when I was asking this question is like the counterfactual. So in one way we have, let's say in A country, they invest in investment promotion, they do all this events, they invite investors, they do roadshow of the country, let's say in London. And as you said, investors may decide to come, may decide not to come, and in the worst case scenario, you're bonded by just the cost of operations. But what I was trying to ask is there's things that are fundamentally important for investors like the importance of the courts or the contract enforcement or many, many things like protection of rights of investors and so forth, which are again, very costly and difficult sort of things to do. And it seems like a lot of countries who are in this bandwagon of trying to bring investments, they care more about this, the promotion sort of arm rather than improving the fundamentals. In which case the promotion is not sort of sufficient. I mean, I'm not even sure it's necessary. What do you think? Is it sufficient? Is it necessary the promotion arm to bring investments? Maybe I'm wrong.
Javorcik: It's helpful, but it's helpful only if you get the basics right. Now, in a sense, the first question you asked was about trade-offs, right? And there are trade-offs perhaps not as much in terms of cost as in terms of bureaucratic attention. That's a good way of putting politic bill. And there is a finite number of people working in the government and reforms are costly, they are politically costly. So politicians and authorities have to make trade-offs, right? What they focus on, and there are two ways of thinking about FDI in this context. The first way is to say, well, I'm going to work on the basics. I'm going to fix my courts, I'm going to build the roads and I'm going to simplify the tax regime. And then once I achieve it, I'm going to go out there and will try to attract FDI…
Hoshimov: Or they'll come themselves, maybe you don't have to.
Javorcik: Oh, they'll come themselves. But for them to, there is a lot of competition globally for FDI. And if you think about investment promotion in terms of information provision, it's not something that's incredibly costly.
Hoshimov: Yes, I agree.
Javorcik: You just need an agency that will answer queries from investment. Because think about how investors think about this. You start with a long list of 10 countries and then you send out queries and some countries will not respond. Some countries will give you a sort of rather generic answer, but then there may be a few countries that will give you a really good answer that's tailored to your needs, that includes the information specific to your industry. And those countries are the ones you'll keep on your list and you'll investigate further. So this first interaction with a country that you do remotely by contacting an agency is what creates the first impression. And I think that gives you a lot of bang for the buck. Now, there are lots of consulting firms that can help you with investments in rich countries and advanced economies have a lot of information that's published. But if you are thinking about smaller countries, more remote countries, they are much less known. So that's why you need to lower the cost of obtaining information. But there's another strategy which a country could follow. You may say, well, it's very difficult politically to fix everything, to fix the courts and roads and the tax collection agency. What I'm going to do is I'm going to create this oasis of better investment climate, a special economic zone, and this is going to be the place where firms are not going to be harassed by tax authorities. This is going to be the place where rules will be predictable. And because I can't fix it nationally, I'm going to invite investors there. They are not going to step on the toes of my local companies because I will only invite companies focusing on exports. So that's another way of solving the problem.
Hoshimov: I see. Yeah, very good answer. I agree mostly with what you said because whenever you read any paper or any study or any advice, you have this, I think a lot of people would have this, what is a counterfactual thinking? Okay, if you promote it, what's the counterfactual? And that is a very good answer for it. Now let's switch gears a little bit and talk about some specific industries. And mainly I want to talk about the, how can I say, this idea that is now floating around, they call it new industrial policy. So it used to be the world has played around with the old, I would say the industrial policy 30 years ago. And now people I think like Danny Roderick was again writing about it. And there's again this discussion of it. And I think the reason they brought this topic up, it was because of this geopolitical and sometimes even straight up political issues with supply chains, some critical components being produced in Asia, for example, for the US that was problematic and they were thinking about the politicians were thinking about bringing those industries back. And the same thing happening in Europe, what they call decoupling. The war in Russia. The war that Russia started in Ukraine was also part of this calculation. So what'd you think about this new idea and do you think it is how the world would look like? We talked about the benefits of trade and now people are talking about sort of cost of it, and what's your take on that?
Javorcik: So I'm very worried about decoupling and I'm very skeptical about the benefits of decoupling. In our transition report from last year, we asked the what if question, what would happen if the world were to split into two blocks to trading blocks along the lines of views on the Russian invasion of Ukraine. So essentially all the countries that condemned Russian aggression would be in one trading block and all other countries in another trading block. And then our thought experiment was, what if the trade costs between these two blocks increased by 20%.
Hoshimov: Reasonable.
Javorcik: Yes. And the answer that comes out, which is no surprise to any trade economist, is pretty much everybody would lose. Everybody would register, pretty much every country would register a war for loss and countries that would lose the most, we focused on EBRD countries of operations. So among our countries it would be Morocco and Kazakhstan that would lose the most. So these are economies that have trading links to countries that would find themselves in both blocks. Right now, why am I worried about decoupling? I'm worried about it because I feel that protectionist interests may use the mantra of security, of supplies, national security to introduce protectionism. I'm also worried because we see that now trade policy is driven by political considerations rather than economic interests. And I think this is a huge shift in the mindset. And as we move towards decoupling, fragmentation, French shoring, whatever your favorite term is, there is a real danger that we'll destroy the global trading infrastructure, the legal infrastructure in the form of the World trade organization. So the US China trade war is being fought outside of the WTO, and the organization has been sidelined, and that is going to be quite destabilizing. What the WTO rules have given us is certainty about the limit on tariffs because countries have committed to bind their tariffs, meaning they are not going to increase the tariffs above certain level. Once WTO rules go out of the window, all bets are off. We are likely to see more trading conflict, more trade wars. Moreover, WTO, one of its achievements has been the dispute settlement mechanism. The fact that there was a way for countries to resolve their disputes and smaller countries did not have to worry about being bullied by larger countries. Again, once this is out of the window, it's not going to be beneficial for smaller countries.
Hoshimov: In the light of this, you don't think it's a good idea for the governments to intervene in the developed world to develop what they call strategic industries in the light of problems with supply chains?
Javorcik: So in some cases, intervention may be warranted, but I believe that the European Commission has done a calculation and looked at what percentage of product lines imported by the EU from China are those strategic products. And that was something like 4% of product lines. And so I worry that as we try to think about the supply of critical materials, in the process we are going to increase tariffs across the board and we are going to destroy the global rules of the game. And we are already seeing some of this. So for instance, the US Chips Act is restricting ability of US firms benefiting from subsidies, their ability to sell or export knowledge to China. And China has recently retaliated by introducing export restrictions on two critical raw materials, gallium and germanium, I believe. So we, if we pursue this path towards French shoring, we may see this tit-for-tat retaliation, and it may simply get out of hand before we know it.
Hoshimov: I see. Okay. And let's talk about, so I know that you have written about the combating of import tariffs, and it feels like this topic, which I think this topic is quite important even today in the light of the sanctions that many western countries are imposing on Russia because of the war. And there is media reports almost every day that says Russia found a new way of evading trade. And what I'm thinking, it's not exactly importing evasion of import tariffs per se, but maybe some sort of evasion of export restrictions and so on, because there is some intermediate countries always in that news report. So given your expertise in evasion of import areas, what can we learn about sanctions and how to enforce them better?
Javorcik: So we have actually looked in our department at the question of changes in trade flows between Russia and other parts of the world. So what you see in trade statistics very clearly is a dramatic drop in exports from Europe and the US to Russia. And this drop is particularly pronounced in goods that are subject to sanctions. At the same time, we see an increase in exports from Europe to Central Asian countries and in turn increase in exports from those countries to Russia. And they are particularly enthusiastically exporting goods that are subject to European sanctions. Now, let me just be clear about one thing. Central Asian countries have not signed up for, they have not imposed sanctions themselves. So what we are looking at in this study are exports of goods that are subject to European sanctions. Got it. So this evidence I mentioned is suggestive of sanctions being bypassed. So rather than exporting things directly from Europe to Russia, there is trade that is being intermediated via Central Asia. Now, what types of products are being intermediated? Actually all kinds of products. So it's products that are on the list of functions because of their industrial usage, because of their dual, them being dual technology products or products that could potentially be used for military purposes as well as luxury products because there are also sanctions on luxury products. Now, moreover, you see also some evidence that products that are similar to sanction goods are seeing an increase in such intermediated exports. So to give you an example, an x-ray machine for medical use is not subject to sanctions, but an x-ray machine for industrial use is subject to sanctions. So it seems that in some cases, trading firms are deliberately misclassifying products in order to avoid being seen trading in goods that are subject to sanctions. And product misclassification is one of the favorite methods of traders trying to evade types. Now let me just also qualify what I said. This intermediated trade is small in terms of volume. In terms of volume relative to the trade, to the direct trade that disappeared. So in other words, on average the replacement ratio may be 10%. However, what we see is that in some particular product categories, replacement ratio may be high. Now the sanctions on Russia have also created an opening for other countries that themselves that have not signed up for sanctions to replace trade, right? In international trade, in international economics, we call it trade diversion. So we see that Russia is importing much more than before from Turkey and from China. And often you see, particularly when it comes to imports from China, products that Russia that are subject to European sanctions are now being imported from China. A good example are diesel trucks. European exports of diesel trucks dropped while 360 million of additional imports from China to Russia appeared in the statistics.
Hoshimov: I see. But what do you think, what are the instruments that western countries have to improve the enforcement of sanctions? Do you think they're out of instruments or there are ways they can do to prevent that or to enforce the sanctions more sort of strongly?
Javorcik: So the challenge with export sanctions is the following. While every country wants everyone else to enforce sanctions, you want to be more lenient on your own companies. So there's this free rider problem, as we call it in economics. And we have already seen this during the Cold War because there were export sanctions during the Cold War and there was sanction busting precisely because of the incentives. Now, what could be done? Well, one can try putting pressure on transit countries. The problem with doing that is that new transit countries are going to emerge. So it's always going to be this whack-a-mole game. Another a completely different approach would be to identify producers of the sensitive products and impose on them know your customer regulations. We have such regulations, for instance, when companies use trade finance instruments, banks issuing such trade finance instruments are supposed to know the customers. They are supposed to understand who the end user of a given product that's being transacted is. So that would be a simpler way. So basically enforcing sanctions at the point where products are being produced.
Hoshimov: Okay. Last question about sanctions generally. Do you think that there are other ways other than trade ways in which the west or the countries that support Ukraine's plight can reduce the fiscal capacities of Russian government for military spending? They try to freeze the central banks reserves. They did quite a bit of things, but every time you read in the news they say the new round of sanctions would be imposed. And my question is basically, are there any more instruments that is left in their pocket that they can use? I mean economic sanctions that are out there that weren't used before or haven't been put into the use?
Javorcik: So let me first say that I believe sanctions are working. It's just that it was unrealistic to expect that they would have a huge immediate effect. These sanctions are working through depriving Russia access to knowledge, knowledge through trade knowledge, through foreign direct investment. We've seen many Western firms exiting Russia through lack of scientific cooperation, flows of people and so on and so forth. But these effects are going to be visible in productivity statistics in a few years. So this type of sanctions are not working very fast. Now, to come back to your question, answer it more directly, I would think that rather than trying to come up with new sets of sanctions, it would be useful to think about better enforcement. And we have evidence of sanctions being enforced. So for instance, making payments difficult, processing payments between Russia and the rest of the world is something that is making life difficult for Russia. It's making trade difficult. But of course the challenge is that not every country is on board with enforcing sanctions. And I think this is the biggest challenge. While Europe is not buying oil or natural gas from Russia, there are other buyers, and as long as there are other buyers, there will be funds flowing into the Russian budget. Of course, price caps and all these other mechanism help they have very much because they limit the revenues.
Hoshimov: Yeah, I think they're facing budget deficits this year, as I understand. But you never know. Now the statistics being not quite as reliable as it was. My next question is, in this world landscape, and I know that EBRD produces reports about sort of the global state of affairs in terms of the economy for its member states in particular, what are the unique challenges that emerging and transition economies face in the current economic landscape? I think the report was published in May, right? It was it in May, yes. Yeah.
Javorcik: So the EBRD operates in many countries. So let me contrast two of our regions. So if you think about central Europe and Baltic states, so these are EU member states, they are facing lots of headwinds, right? So high prices of natural gas that prevailed throughout the winter and pretty much until now. The prices drop lowered competitiveness of those countries. Proximity to the war created huge uncertainty which was detrimental to investment, very difficult economic situation in Germany. So Germany has gone through three quarters of GDP decline translated into lower demand for exports from these countries. And inflation that was fueled by globally high agricultural prices and very high prices of natural gas in Europe forced central banks to tighten which further contracted economic activity. Now this contrast very much with the situation in Central Asia, Central Asia and the Caucuses region are,
Hoshimov: Let me interrupt for a second just to give numbers. I think the Baltics are going to grow like point less than half percent and central age is going to grow like 5%. Is that like 10 times the rate?
Javorcik: That's roughly the comparison. Now, of course one needs to keep in mind that Central Asian countries being poorer should be growing somewhat faster, but not an order. That's what I was trying to get at. Yeah, right. So now what we see in Central Asia is inflow Central Asia and Caucuses, right? Inflow of Russian capital creation of companies with Russian capital. We saw also waves of Russians leaving Russia and moving there, many of them brought with them IT companies that they set up. And some of those countries have actually special regimes, tax regimes for Russian IT companies. Now we talked about more limited access of Russia to imports that created import substitution activities. And that meant that Russia labor market has been strong and attracted a lot of migrants. Last year there were 3.5 million new registrations of migrant workers in Russia. 90% of them came from Central Asia.
Now as these migrant workers go to Russia and work to Russia, they send remittances home. My understanding is that remittances flows to Uzbekistan have doubled and that they reach 23% of G D P. That was also helped by strong rub, by strong exchange rates that prevailed for a while. And of course there is the intermediated trade, which we discussed, which may be small for if you think about total Russian imports. But for some of these countries, this intermediated trade is equivalent to several percentage of GDP that also generates revenue through logistics total companies that are serving US intermediaries.
Hoshimov: I see.
Javorcik: And of course, let me just add some Central Asian countries export commodities and we saw high commodity prices and that certainly was helping as well.
Hoshimov: So the outlook is there's a huge range even within EBRD countries, and the range is somewhere around 10 times or something like that. And the reason for the range is not only that there's the different base central age being a lot poorer than Baltics, but also because of the new reality that we'll live in which some countries are facing sanctions and not. You mentioned Germany briefly in your previous answer, and my question is did you expect personally or as an economist that how painless or how little Germany would lose from stopping imports of fossil fuels from Russia? I personally thought the effect on the German economy would be really huge. And I overestimated it. How you thought about it or is it me who was delusional?
Javorcik: I think pretty much all the observers were surprised with how well the German economy has coped. And so of course the mild winter helped, but I think most observers were surprised by how well German industry was able to switch to substitute different fuels. And of course also Germany and other European countries have managed to secure within a very short time alternative sources of natural gas supply. Our ongoing analysis shows that European countries have managed to lower their consumption of natural gas by about 20%. So some of that was due to fuel substitution, some renewables coming online. Some of it was due to savings, to increases inefficiency. And of course some of it was due to lower level of economic activity, but 20% is I think a huge number that nobody expected a year ago.
Hoshimov: This war and sanctions showed us how resilient many economies were and they're much more resilient than many people expected, including people who are running those economies. I think even the German politicians I think were overestimating how bad that would be. And so in this slide I want to ask you a question about role of international organizations such as European Bank for Construction Development, the World Bank, ADB, and so forth. And so a lot of people ask this question, I think quite fairly, saying those organizations are responsible or they should care about economic development. And the question that they ask is what do they do for economic development and economic growth? So how would you respond to that?
Javorcik: So these organizations, including EBRD, do care about economic development and they try to stimulate and support economic development. Now, many people think of the primary role of these organizations as being a source of money. I actually think that the primary role of these organizations is to serve as a commitment device. Reforms are difficult in good times because they require burning through some political capital. Because every reform pretty much creates winners and losers. It involves stepping on somebody's toes, on toes of vested interests. These vested interests often are quite powerful. Often we have the problem that the benefits accrue to the population as a whole. Everybody benefits a little bit, but those who lose tend to lose a lot. They are concentrated so they can block the reform process. So by bringing money, international organizations create an incentive for a country to engage in a reform process. They in a sense demonstrate to the population that they are bringing some good, they support the reformist fractions within the government. And by bringing funds, they allowed them, enabled them to invest to carry through these reforms. And then of course there is the aspect of technical assistance, the aspect of bringing knowledge from other countries, bringing the understanding of what worked in other countries and what has not.
Hoshimov: So one of the questions that is asked, especially in the poorer part of the world, is that international organizations such as EBRD are really keen on what they call ESG, sustainable development, climate change and so forth. And their efforts increase the cost for say, doing business for some people in the developing world, well they want cleaner and better, more sustainable sources of inputs and so forth, which in their opinion creates costs for them. And so can you make a case why organizations such as EBRD should care about the climate change, about the environment and why their policy that is shaped towards that with making world cleaner and better in terms of climate is actually sound economic calculation.
Javorcik: So we care about global public goods. If we support low carbon path in a country or we co-finance wind farms or solar farms, we are directly or indirectly contributing to lower global CO2 emissions. And that means that the planet as a whole is better off. But I would want to make a case for why it's in the interest of individual countries to create access to renewable energy. And the very immediate basic answer is the following. Because of the geopolitical tensions and in the expectations of greater frequency of extreme weather events, firms are rethinking their supply chains. They are reshaping their supply chains. They are trying to build resilience by diversifying the sources of supply. This creates opportunity for many emerging markets to capture a bigger share of the global export market. But what the multinationals are looking for, not just a location where they can produce, they are looking for a location where they can produce in a cleaner way simply because consumers in advanced economies are demanding cleaner products. And because we are moving towards a world with more and more carbon taxation, think about the carbon border adjustment tax in Europe, it hasn't come into force yet. It is planned to start with six sectors, but this is the direction where we are moving. So if you are a multinational firm trying to set up a new supply chain, you are going to be looking for access to renewable energy. So renewable energy is going to be a determinant of comparative advantage for countries that are hoping to export manufactured goods.
Hoshimov: I see. Yeah. Thank you. That's a really kind of a good answer I would say, because a lot of the times, some of the questions I'm asking is that the questions I'm grappling with in my writing and so forth, one question I have to ask you is about what they call now a Polish economic miracle. For many people who observe the transition from sort of former Eastern Bloc to the market economies, Poland seems to be this shining example of how well the reforms went. And then there are countries that are bordering it, be it Ukraine or Russia and so forth that weren't able to do that. And so what is, in your opinion, the reason for this Polish Miracle? I mean even if it's political, even if it's social, it doesn't have to be sort of the econ policy. It could be social or political or philosophical, whatever. So what's your take on that?
Javorcik: So being Polish, I'm very pleased to hear about the Polish economic miracle, but I would think it's actually the economic miracle of the Eastern European EU member states. And the short answer to your question is it happened because the EU accession process created a commitment device. It created an anchor for reforms. So these countries had only to make one decision, do we want to apply for the EU membership? Once the answer was affirmative, the path was predetermined because the list of reforms was given by Brussels. There were authorities, there were people from Brussels checking on the progress of the reforms, and there was a credible threat that the countries would not get in. So essentially you can think about this as the most successful case of conditionality. So the work, the reforms are front loaded. The benefits of EU membership happened at end, though there are some sweeteners along the way, but there was incredible commitment, there was a real price and it anchored the reform and it killed the national debate, and it killed the ability of opposition parties to question the direction because there was a national buy-in on where the reforms were going.
Hoshimov: I see.
Javorcik: And this is something that's incredibly difficult to replicate in a democratic system. Politicians don't look beyond the electoral cycle and therefore they don't have incentives to engage in reforms that pay off in the long run. In countries that are not democratic, the ruling elites often worry about their interest rather than the interest of the country as a whole. Right. So the second best is international financial institutions, multilateral development that's trying to create these anchors for reforms through various programs they offer countries.
Hoshimov: Yeah, that's a really good example. But let me ask about Poland more deeply. I would say there are many countries that became part of the EU, but their growth rates weren't as high as it is in Poland. And so there are theories about Poland having large population or complementarity with the German industry, or there's so many kind of angles you can take. Again, I'm using the term Polish economic miracle because I've seen it, people use it quite a bit. And so I was wondering, is it because it's close to Germany and complementarities, or is it because the population is, there is a theory about population being homogenous and large and quite young in the early nineties. So do you think those theories also kind of have some explanatory power? Again, the EU accession happened to many countries, but some are a lot more successful than others.
Javorcik: So what made policy reforms different was we went through shock therapy. So the fact that you reformed very fast made the reform's hard to reverse, and there was a lot of pain, but the pain was shorter lift than in other countries. So I think that helped. At the same time, Poland was not rushing with privatization. Initially, I think Poland was criticized for that. But with the hindsight, I think it turned out to be not a bad approach. Other factors such as proximity to Germany's certainly helped the fact that Poland is a large market. So inflows again of multinationals helped. But I think all of these things, in my view would be secondary because think about the Baltic states, they did well even though they have small markets.
Hoshimov: I see. Okay. Another point about commitment device. I've written on WTO accession of Uzbekistan and I said the reason we have to go into WTO is not because they will do something for us, it's because it'll force us to commit. It's the tool that would give us this discipline, if you will, to sort of proceed. And I'm happy that you also shared that view that international organizations sometimes help the internal politics to be in line to be able to get it. So before we end, because I'm from Uzbekistan, I cannot ask you about what you think of the reforms. Some observers said that the rate of reforms are slowing down, but overall, if we take a stock of it in the last three to five years, what's your take on that and what do you think we should think about, worry about, care about?
Javorcik: So I think it's incredibly, incredibly happy to see that there is appetite for reforms. I think it's great that Uzbekistan is putting itself on the path, but the proof will be in the pudding in three or five years. Because often the early reforms are easy, and as you continue reforming, you need to undertake deeper changes and they are harder. There are some challenges Uzbekistan is facing, such as sufficient supply of electricity, such as water scarcity, but at the same time it has educated labor force. It is struggling with creating workplaces jobs for fast growing population. But that's also a blessing because that means that there is a labor force one can tap into and turn Uzbekistan into a manufacturing destination. So reforms are not easy, but I would hope that openness to FDI, greater openness to trade, including WTO accession hopefully, and taking into account the needs of the planet using renewable energy as a way of increasing appeal of Uzbekistan as a production destination is something that would be useful. You mentioned there are very few countries in the post-Soviet space that are not members. Azerbaijan. I think it's only a handful.
Hoshimov: Yeah, yeah. I think it's Turkmenistan is not a member and Uzbekistan is not a member.
Javorcik: I think it's maybe Azerbaijan, Belarus and Turkmenistan.
Hoshimov: Yeah. Could be that. Uzbekistan has been trying to get in since 1994, so they started the process almost 30 years ago, which gives me not a lot of optimism, but on the other hand, we got to do it, I guess.
Javorcik: Well, I think it is hard to think about attracting world-class companies without being a WTO member, because WTO membership gives this guarantee of certain trade policy.
Hoshimov: Yeah. Again, I think that a lot of commitment device, even individuals can use. Some people go to gyms that find them if they don't go or something like that, right? It's not that they're interested in going, it's just the commitment makes you more, I would say, disciplined. Professor Javorcik, thank you so much for your time. I really enjoyed the conversation. I can go on, but we have a limited time, so thanks again for agreeing to do that and thanks for your eliminating answers and I hope that our listeners would enjoy our conversation. Thank you.
Javorcik: My pleasure. Thank you very much for having me.