Romania’s Tiger Economy Is Running Out of Fuel

Romania rightfully earned the “tiger economy” moniker over the past decade with its robust economic growth. Few outside the country, however, appreciate just how impressive its performance has been. Yet Romania’s forward momentum now threatens to stall, as it has for so many other countries before. The fuel that powered Romania to middle-income status will not advance it to the top league of high-income nations. In short, Romania’s great middle-income achievement now threatens to become a trap rather than a stage in its continuing development. Part of the problem is Romania’s spending on education and research and development—the lowest by percentage of gross domestic product in the entire European Union.

In the early post-communist 1990s, Romania struggled to reach even half of Serbia’s paltry per capita GDP. The past 20 years, however, have witnessed a remarkable surge. Granted, Romania started from a very low base these past two decades, but growth nonetheless was strong.

How strong? In the past two decades, Romania has recorded the European Union’s largest percentage change in income growth. Other states seeing substantial per capita income gains over this period include Poland and the Baltic states, all posting increases ranging from 83 per cent in Latvia to 85 per cent in Estonia, 91 per cent in Poland, and 93 per cent in Lithuania. Yet all these countries were surpassed by Romania, which achieved 134 per cent income growth over the same period.

Some argue that Romania’s great leap forward is unremarkable given the low level from which it began. They assume Romania still sits well below Poland and the Baltic states on income. But Romania has come further than they think. Yes, Poland remains the leading post-communist European economy on the score of per capita GDP at purchasing power parity. Its sophisticated economy, with companies beginning to perform advanced headquarters functions, produces high-level profits—so much so that Poland’s per capita GDP at purchasing power parity reached Japan’s level this year. Romania is not there yet, but it nips at the heels of the Baltic states on income. This year, Romania passed Latvia on per capita GDP at purchasing power parity and sits only $1,000 a year from catching and surpassing Estonia.

The ceiling looms

Economies plateau when they exhaust their economic development models and cannot find their way to more productive systems. Middle-income traps result from the inability to progress to the next levels of economic development.

What got Romania here—middle income—will not get it there—high income. Romania’s economy contains a mixture of basic outputs, such as substantial raw timber exports and agriculture, alongside parts manufacturing and assembly, but also sophisticated engineering and industrial research. Romania’s strong human capital has also contributed to the emergence of thriving digital-economy centres in Bucharest, Cluj-Napoca and Timișoara. Nature endowed Romania with timber, arable land, energy resources and ores. EU funding then helped develop these assets through infrastructure investment, while foreign capital fuelled manufacturing. All these “development machines” functioned too well and too fast to prompt reflection on the developmental steps required once they reached their ceilings. Romanian enterprises must now create high-value-added headquarter functions if the country is to escape its middle-income trap—and that means significantly increased investment in R&D by both private and public sectors.

Romania sits dead last in the EU as a percentage of GDP spent on R&D. Not only does it occupy the bottom of the EU barrel on this score, but its expenditures have barely budged over the past decade, remaining abysmally below 0.5 per cent of GDP. By contrast, Sweden, the EU’s R&D leader, invests seven times more—3.5 per cent of its GDP. Romania’s R&D expenditure is low even compared to other post-communist EU states such as Slovenia, Estonia and the Czech Republic, all posting rates near 2 per cent of GDP.

Time for tough choices

Romania cannot expect continued forward movement on income with the lowest levels of R&D investment in the entire EU. Low taxes, impressive natural endowments, solid human capital and locations attractive to western European industry seeking to offshore production under cost pressures from China will not propel Romania to high-income status. At minimum, the missing ingredient to break through the glass ceiling of its middle-income trap is R&D. Research and development costs money, which means raising revenues to pay for it. Getting there requires tough decisions on tax policy that can fuel Romania’s economy with essential investment in innovation.

If the truism holds that “you can’t spend your way to riches,” even more true from a development perspective is “you can’t cut your way to prosperity.” It is past time for Romania to begin making serious investments in R&D if it hopes to escape its middle-income trap. Romania’s notoriously low spending on education and research must be reversed if further prosperity is to be achieved. Should Romania fail to make those investments, it could find itself stuck—much as Latvia has discovered this past decade. Refusing to increase R&D spending, Latvia has dropped further behind its bigger-spending Baltic neighbours and is being left behind in the middle-income trap. Romania would do well to heed that cautionary tale.