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Bulgaria's Growth Calculus



An earlier post on the poor economic prospects in Bulgaria, accompanied by four policy recommendations, invited a flurry of comments. Some focused on the need to improve the business environment by cutting red tape and corruption in the bureaucracy. Others commented on the significant Bulgarian emigration to other European economies due to poor economic prospects at home. Still others questioned whether Bulgaria could ever enjoy the type of growth rates seen before the euro area crisis. Some asked whether the country has entered a decade of low investment in productive activity, high unemployment, and increasing public debt.

The latter prospect is most troubling, as it is the main reason why many young Bulgarians are forced to leave the country in search of job opportunities. Fuelled by a global boom in trade and investment, and by a regional boom in real estate and financial services, Bulgaria grew by an average of 5.6 percent a year between 2001 and 2008. Since then, it has averaged below 1 percent annual growth, and the prospects for the near future remain bleak.

I have argued that the main policy to increase the growth rate should be additional investment in infrastructure. With interest rates on sovereign bonds close to zero, and the new focus on quantitative easing by the European Central Bank, cheap money is likely to be around for a few years. There is also idle labor in the construction sector due to the pre-2009 investment boom in real estate and tourism. A significant share of the European Union's funds slated for Bulgaria—some €16 billion for the next seven years—can also be used for infrastructure investment.

The growth calculus is simple. If the government wants to reach an average growth rate of 5 percent a year, it needs to add 4 percentage points of growth on top of overall GDP of about €41 billion—or about €1.6 billion in annual growth. Recent work by Professor Yuriy Gorodnichenko at the University of California at Berkeley suggests that during recessions the multiplier on basic infrastructure is around 3—in other words, every euro invested in infrastructure yields an additional 3.5 euros in output. This is because better infrastructure feeds into other sectors of productive activity like transport, tourism, real estate development, and commerce.

Let's take this multiplier at face value. To generate growth of 5 percent a year, all else being equal, the government would have to invest an additional €400 million a year in infrastructure on top of the investment that has been made in previous years. This doesn't seem to be a daunting number. Importantly, however, this multiplier was calculated using US data. Waste or corruption in infrastructure projects is probably higher in Bulgaria than in the United States, reducing the multiplier effect. How much higher is difficult to say. Assuming arbitrarily that 30 percent of investment gets wasted, the necessary additional investment increases from €400 million to €600 million a year. Still manageable.

Finally, the government has to choose wisely where to invest. Here the economics literature is suggestive too. Studies find that investment in military infrastructure has a negligible multiplier effect (in some studies, a negative effect); investment in real estate (for example, housing, stadiums, and ministry buildings) has a small multiplier effect of 0.2 to 0.3; investment in schools, hospitals, and university infrastructure has a multiplier of 2 to 3; while investment in roads, ports, and airports typically has a multiplier of 4 to 6. The mixture of these investment choices is subject to politics, not just pure economics. Still, growth calculus provides a useful guide.

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