The latest data on Bulgaria's GDP show that economic growth has remained robust against the EU-wide backdrop. The expansion reached 4.2% year-on-year in non-adjusted terms in the second quarter, crossing the 4% mark for the first time since the 2009 crisis. Bulgaria's growth has consistently remained above the EU-average since Q4 2014, with the real rate already double the EU expansion.
Within the EU, Bulgaria's growth rate in Q2 2017 puts the country at the forehead in terms of year-on-year economic expansion, with only Malta (6.4%), Romania (5.9%) and Estonia (5.7%) outperforming it in the period.
The question is, how long Bulgaria could sustain such a growth rate and if there is possibility for even faster expansion of the economy.
What drives the GDP growth?
Production-wise, the main drivers of Bulgaria's economic upturn in Q2 are the construction and real estate sectors, which grow at 7% and 8% year-on-year, respectively. As a matter of fact, the 7% growth rate of the construction industry is the highest after the 2009 crisis and reflects renewed interest in real estate investment. The latter, in turn, has been spurred by close-to-zero interest rates on bank deposits and rapidly growing incomes of the population. The steep rise of real estate prices, particularly in the bigger cities and for high-class estate, has already spurred speculation about a new real estate bubble that is currently being blown in the Bulgarian economy.
Apart from these sectors, finance is also growing at above-average rates. This is hardly a surprise, as this industry traditionally picks up in tune with real estate and construction upturns. This was the case in the pre-crisis period (up to 2008) and there are signs that this pattern of growth is starting to replicate again. Also, the ICT sector, which has been one of the engines of post-crisis recovery, continues to grow at a rapid pace (+4.3% in Q2). The other growth engine in the last few years - outsourcing of business services - disappoints in Q2 as it grows by just 2.3% year-on-year.
On the demand side, both household consumption (+4.9%) and exports (6.3%) drive economic growth, while investment expansion, even if already in positive territory, remains modest (+2.9%).
Hitting the ceiling?
Overall, Bulgaria's economic growth, albeit robust in comparative terms, has been moving in a narrow band between 3% and 4% roughly for almost 3 years now. This suggests that the economy is already operating at its potential with the main impediment to higher growth being human capital (or rather, the shortage thereof).
The same conclusion is arrived at in the latest IMF's regional outlook and the regular forecasts of the European Commission. According to these, Bulgaria is either slightly short of or operating at its full potential. Analysts at the IMF and the EC are unanimous that the economy's potential has shrunk significantly after the 2009 recession on unfavorable demographic trends and insufficient capital inflows.
Breaking the ceiling
With the above in mind, an increase of the growth potential of the Bulgarian economy can be sought in two directions: increase of the labor force and development of new technologies and capital formation.
This can be achieved either via luring economically inactive population into the labor force or via attracting foreign workers. The regular labor force survey of the National Statistical Institute shows that there are roughly 200,000 people who are currently economically inactive but would like to start a job, if one is available. Half of them are discouraged workers. If we assume that these 200,000 people are the upper bound of extra workforce that can be tapped, this means that the labor force can be increased by no less than 5%.
As regards the second route - attracting foreign labor - this is already happening spontaneously in the tourism sector and specifically in some seaside resorts where one can come across workers from Ukraine, Georgia and Moldova. Here, the upper limit of potential newcomers to the local labor market is much higher, even if one assumes that Bulgaria can rely on labor migrants only from countries which are close to Bulgaria in terms of language, culture and education.
Bulgaria is among the EU laggards in terms of R&D development and investment, so it would better focus on this option rather than only hoping to attract new workers. Capital investment continues to disappoint even though it moved into positive territory in early 2017. FDI have fallen significantly after the 2009 recession, averaging 1.2-1.3 bn euro in the past few years and hitting a new low in 2016.
Bulgaria can surely become more attractive to foreign investors and low labor costs should not be relied on much longer. Labor costs are already picking up rapidly on labor shortage and the resulting double-digit growth of wages that is likely to keep accelerating. Authorities should rather undertake long-awaited reforms to strengthen the rule of law and property rights protection, introduce faster and cheaper administrative procedures, fight corruption and ensure the independence of the judiciary. However, all these are major institutional changes that require strong political will and take years to bear fruit.
The above-mentioned measures on the labor market seem more achievable in the short to medium run. For instance, imports of labor force from the former USSR countries, Macedonia, Serbia, Bosnia and Herzegovina and other countries can be facilitated with little effort on the part of the administration. The sooner the thinking on such measures starts, the faster the Bulgarian economy will boost its growth potential and start expanding at rates above 3%-4%. Conversely, the country will remain a long-term laggard that never manages to catch up with its richer EU partners.
Desislava Nikolova, Chief Economist, Institute for Market Economics