Economic and Social Improvements conducive to EU Integration

Project Overview | Country Background | The Legacy of Commuism -10 years of severe economic instability | Romania and the European Union | Economic and Social Improvements conducive to EU Integration | Joining the European Union - Pros and Cons |Sources Cited

In the last few years, Romania has significantly improved its economy and human development process, and its imminent acceptance to the European Union in 2007 seems to confirm the fact that the country is slowly but steadily moving in the right direction. Romania was invited to join the North Atlantic Treaty Organization in 2002 and, ever since, the country recorded significant improvements in its attempts to foster economic growth and social development. Many political and economic analysts consider the presidential elections in November 2004 as the beginning of an era full of great prospects for Romania. The new president, Traian Basescu –who is not associated with the old regime—is very popular among intellectuals and the young generation, and was a remarkable minister with an innovative, highly efficient way of finding the best solution to a wide variety of challenges. The Romanian government's objectives are centered around “strengthening the external current account balance, reducing inflation, GDP growth, and preparing the economy for EU accession”[|22]. In recent years, the key stabilization policies implemented by the government (i.e. reduction in the general government budget deficit, strengthening of the finances of state-owned enterprises through energy price adjustments and wage restraint, measures to contain credit growth, strengthening of the judicial system, and decreased corruption), brought significant improvements for the economy [|23].

In order to reduce inflation, the government adopted a re-denomination process that consisted of cutting four zeros from the nominal value of the previous currency. The new currency was introduced on 1 July 2005 [|28]. In addition, the government has also adopted “key monetary and exchange rate policies capable to aim at striking a balance between reducing inflation and maintaining Romania's external competitiveness” [|22]. In 2004 , the Romanian central bank gave more flexibility to the exchange rate, which has caused the national currency to appreciate about 12% against the Euro, which resulted in inflation declining from 14.1% in 2003 to 9% in 2004 [|24]. The government also managed to decrease its consolidated budget deficit from 3.7% in 2000 to 1.2% in 2004. Under the IMF’s guidance, the budget deficit has dropped significantly from earlier levels. In 1999, the budget deficit represented 4.0% of GDP; 3.7% in 2000; 3.5% in 2001; 2.6% in 2002; 2.4% in 2003; and 1.2% in 2004 In order to encourage spending and burrowing, the government significantly decreased interest rates. The reforms taken by the government also resulted in real wages significantly increase (10% in 2004, 13.4% in the first eight months of 2005). Due to increased aggregate demand, increase in real wages and higher energy prices, prices for goods increased by 11.9% in 2004 [|22].

Fiscal reform measures were also implemented. In order to encourage foreign investment, profit tax for businesses was decreased from 25% to 16%. The government expects that the revenue loss caused by these tax cuts should be compensated by “improved tax collection, a broader tax base and a restrictive expenditure policy” [|40]. Also, the government has decreased the requirements for people’s contribution to social public funds ( pensions, health, unemployment), while increasing taxes on luxury goods and that on real estate properties at their real market value. The introduction of the new tax system has also resulted in the budget revenues increasing by 14% over the first four months of 2005 and in the creation of more then 150,000 jobs, which were brought back to real economy from the black market [|21].

In order to increase foreign direct investment in the country the government created in 2002 the Romanian Agency for Foreign Investment (ARIS) [|29], which is responsible for adopting measures that encourage foreign investment in the country. It its attempts to find the most suitable ways to attract investors, ARIS adopted legislation giving foreign investors the same rights and benefits of Romanian citizens. Also, ARIS has taken steps for assuring foreigners that they do not have to fear ownership appropriation by state or expropriation. In addition, legislation was passed saying that there is no limit on foreign share in companies (i.e. a foreign investor can own 100% of a company he establishes in Romania). One of the government’s main objective is to improve its Capital Account by privatizing national companies; in 2004, net inflows of foreign direct investment increased significantly (by 19% when compared to 2003) [|16], mainly due to the privatization of Romania’s national oil company, Petrom, and reached 6.9% of GDP. It is expected that the capital inflows will put upward pressure on the ROL (which appreciated 7.2% against the Euro in the first quarter of 2005). As the Romanian currency (leu) has appreciated against the US dollar and the Euro, investors became more confident that they would achieve economic growth by investing in the country: “Investors are attracted to Romania by the regional market, low costs - labor force, land, production (cheap utilities) - economic and politic stability, as well as by the high quality of the labor force” [|18]. In a report, UNCTAD (United Nations Conference on Trade and Development) shows that more than 50% of the companies that decided to open a business in Easter Europe chose to invest in Poland or Romania [|17]. The Foreign Investors Council considers that does not come as a surprise, as "Romanians are very well educated, skilled and relatively cheap; the market is large - 22 million inhabitants - and has a good geographic location with transport connections towards Europe and central Asia. Moreover, the Government has been striving for many years to create a favorable business environment, which can be seen in the economic growth, diminishing inflation, and political stability." At the end of 2004 Romania attracted approximately $13.7 billion if foreign investment (out of which 6.5% was US direct investment. [|15]. According to the Romanian Agency for Foreign Investment, in the first half of 2005 the level of foreign direct investment has risen by 19% compared to the same period in 2004, mainly due to the introduction of the16% flat tax on personal income and corporate profit (which previously was 25%) and the fact that the country will join the EU in 2007-the accession treaty was signed in April 2005 [|6]. The private sector currently employs over 72% of Romania’s total workforce (from 55% in 2002), which is a reflection that the country has indeed privatized most of its important state owned companies. In the banking system, for example, recent years have brought more stability, mostly due to the fact that a significant number of foreign banks have opened subsidiaries in Romania, any many others are competing in order to buy Romanian banks (i.e. the CEC-Savings Bank), which the government intends to privatize (Government of Romania). The privatization of the Banca Comerciala Romana (Romanian Commericial Bank) has resulted in the government’s share in the banking system decline to 10%. In 2003, there were 38 commercial banks in Romania, 31 of who were owned by foreigners [|8].

Foreign Direct Investment Level (in millions of dollars)

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Some of the benefits of investing in Romania include:[|19]

- Romania is the 2nd largest market in Central and Eastern Europe (following after Poland)

- easy access to former Soviet countries and the Middle East

- skilled labor in technology IT, engineering

- low costs - labor force, land, production (cheap utilities)

- important natural resources (fertile land, gas deposits)

- significant tourism potential (the Carpathian Mountains and the Black Sea)

- future member EU

- member UN and NATO

- free trade agreements with EU, EFTA, and CEFTA countries

The government has also taken measures for fighting corruption [|40] by adopting anti-corruption laws and taking steps for their effective implementation, eliminating all the laws that interfere with the process of free competition in the market, introducing a more effective monitoring of the financial aid given by the state, setting up a better system for detecting corruption phenomena and increasing punishments for those found guilty of corruption. The government also established the Competition Council, which is responsible for preventing the occurrence of anti-competitive practices, while encouraging the creation of a competitive business environment that can benefit the consumers.

In last couple of years unemployment has been significantly reduced, from 10.5 percent in 2000 to 7.8% in the first quarter of 2004 and to 5.6% in the first quarter of 2005[|28]. As a result of the reforms taken by the government, real GDP grew at a fast rate during the last few years, from -3.2% in 1999 to 8.3% in 2004, as seen in the graph below. In 2005, real GDP grew by only 5.3% due to the negative impact of floods and smaller growth in the export sector. The increase in GDP was mainly caused by an increase in the purchasing power of the population, which increased household consumption by 10.8% in 2004 and 11.7% in the first half of 2005 [|28].

Selected Economic Indicators 1998-2004

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As part of the requirements to become EU member, Romania also has to improve its microeconomic system. The country had achieved considerable improvement is the area of micro businesses as currently there are about 15,000 small businesses that were recently developed. Mr. Tariceanu, Romania’s prime minister, declared that currently there are over 110,000 persons in Romania who applied in order to borrow sums that don’t exceed $ 25,000 in order to start various small businesses. It is estimated that more than $100 million will be spent over the next year in order to support the development of these businesses [|22].

In an attempt to encourage the development of a functional democracy, which would be conducive to the country’s acceptance in the European Union, the Romanian government adopted a new Constitution in 2003. The new text “takes a more liberal approach to minority languages, guarantees an independent judiciary, provides better protection of property rights, and allows EU citizens to both buy land in Romania and run in Romanian local elections” [|8]. Also, it drastically limits the ability of the government to pass legislation through emergency ordinances, practice that had often resulted in the Parliament delaying the approval of such bills “for months or sometimes years after they were already in effect” [|8]. The introduction of a comprehensive Anticorruption Law, which states the fact that those found to be corrupt will face severe repercussions, is also a significant step forward towards a true democratization.

In the area of internal market, the government adopted measures promoting the free movement of goods, free movement of persons, freedom to provide service (which allowed financial services to further develop) and free movement of capital. Moreover, the country implemented laws for protecting intellectual and industrial property rights, consumer and health protecti. In line with EU requirements, Romania has also adopted legislation that assures the independence of the central bank and prohibits monetary financing of the public sector by the central bank (with the exception of crisis situations). The government also established the Competition Council, which is responsible for preventing the occurrence of anti-competitive practices, while encouraging the creation of a competitive business environment that can benefit the consumers [|31].

In an effort to match the European Union’s requirements concerning press freedom, the government implemented a new Criminal Code, which gives journalists more liberty of expression. Also, it increased its support for the nonprofit sector, which proved to be crucial in Romania’s democratization. As a result, nowadays there are about 4,000 active nongovernmental organizations (NGOs) —which undertook various public roles, “from election monitoring to social services and civic education” and have a significant influence in public life— and approximately 70,000 registered associations and foundations (Freedom House)[|9].

Romania has also achieved significant improvements in the field of human rights protection (with a special emphasis on the protection of minorities). The government also adopted laws that give the Hungarian minority in Romania (the largest national minority population in Europe) significant more rights than before. Not only were they offered the possibility of pursuing their education in their native language, but Hungarian is now one of the official languages used in administration in areas where Hungarians represent at least 20 percent of the population, [|9]. After the 2004 general elections, the Hungarian minority also gained a significant higher representation in the Government and Parliament and two of the country’s fourteen ministers are of Hungarian origin. The government also adopted a series of measures for child protection and has drastically limited inter-country adoption, measures that are in line with the UN Convention on the rights of the child ([|31].

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[|36] http://www.pwc.com/gx/eng/about/ind/retail/romania%20p.pdf

Concerns regarding Romania's economic development It is expected that in 2006 economic growth will not reach the 2004 or 2005 level. As the country is approaching EU integration, Romanian companies face a significant higher number of competitors. In addition, it is expected that the international climate (a stagnation in economic growth in Western European countries and a rise in Asian economies) is not particularly favorable for the economic development of the country as it will result in countries taking reactionist measures to defend domestic markets. It is thus estimated that the GDP for the year will not exceed 4 percent. This is due to a significant appreciation of the domestic currency, increased competition, rise in energy costs and heavy folds that have affected the country. In addition, it is expected that the trade deficit will grow even more during 2006. Given that the country’s trade deficit has been significantly increasing over the last few years, many policy makers are concerned whether having such a large trade deficit is sustainable. It is questionable whether the National Bank of Romania (NBA) which has adopted inflation targeting, during the second quarter of 2005, will be able to achieve its 5 percent inflation target for 2006, as the NBA does not have full control over the money supply, as “transactions are euro and dollar denominated; interest rate differentials are still high; and the boom of bank credit and capital account liberalization” [|42].