EU REGULAR ECONOMIC REPORT 10 PART 1 A Path to Inclusive Growth in the EU amid Inflation and Fiscal Constraints EU REGULAR ECONOMIC REPORT 10 PART 1 A Path to Inclusive Growth in the EU amid Inflation and Fiscal Constraints The data presented in this report is as of November 1, 2024. © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank Group with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Cover design and typesetting: Piotr Ruczynski, London, United Kingdom, prucz.co.uk Contents 7 Acknowledgements 9 Abbreviations 9 Regional Groupings 11 Executive Summary 15 Chapter 1 Recent Macroeconomic Developments 16 After a sharp slowdown in 2023, the EU economy has shown signs of improvement in 2024 17 After a historic tightening cycle, inflation is inching toward target 22 Fiscal consolidation has stalled, highlighting the importance of the revised EU fiscal framework 27 Chapter 2 RecentLabor Market, Poverty, and Inclusion Trends 28 From struggle to stability: The resilience of the EU labor market to the COVID-19 crisis and Russian Federation’s invasion of Ukraine 38 Poverty and inclusion trends: Significant progress but some challenges going forward 49 Chapter 3 The EU outlook remains weak in the near term, and downside risks continue to dominate 50 The EU economy is expected to pick up, albeit from weak levels of activity 51 Risks to the EU outlook remain tiltedto the downside 57 Policy challenges 61 References 64 Methodology for estimating direct welfare impacts Annex A  of food inflation 65 Annex B  Estimating the cost of Roma exclusion Boxes 20 BOX 1.1  The diverging paths of 52 BOX 3.1  Global outlook productivity growth in the EU and the US 56 BOX 3.2  Avoiding the risk of missing 24 BOX 1.2  The reformed EU fiscal framework opportunities of RRF 35 BOX 2.1  The economic benefits of Roma 60 BOX 3.3  Recent social protection reforms inclusion in Romania, Bulgaria, Poland and Croatia 43 BOX 2.2  Simulating the distributional impact of rising food prices Figures 12 FIGURE ES.1  Recent developments in the 29 FIGURE 2.3  Impact of the pandemic and EU Ukraine conflict on employment, most 16 FIGURE 1.1  Contributions to EU Growth affected sectors 17 FIGURE 1.2  Growth is rebounding in the 30 FIGURE 2.4  Less-educated workers face EU, albeit unevenly significant challenges 18 FIGURE 1.3  EU headline inflation rate, 30 FIGURE 2.5  Inequality in employment broken down by contributors trends has been increasing over time 18 FIGURE 1.4  EU inflation by region 31 FIGURE 2.6  Regional disparities persist in 19 FIGURE 1.5  Euro area headline (HICP) and employment recovery among less educated core inflation workers 20 FIGURE B1.1.1  GDP per hour worked in 31 FIGURE 2.7  Polarization of job USD (index: 1995 = 100) opportunities and unequal employment 21 FIGURE 1.6  Current account positions recovery 22 FIGURE 1.7  Fiscal balance evolution in EU 32 FIGURE 2.8  Female full-time workers: subregions recovery surpassing pre-pandemic levels since 2021 22 FIGURE 1.8  Number of countries with fiscal deficits above 3 percent of GDP, by EU 32 FIGURE 2.9  Young workers faced COVID-19 subregion job losses but rebounded stronger 23 FIGURE 1.9  Fiscal rigidity 2019 – 2023 32 FIGURE 2.10  Surging vacancies tighten EU 23 FIGURE 1.10  Underperforming fiscal labor market in the post-pandemic period, revenues and elevated expenditures with slightly loosening labor market conditions recently 24 FIGURE 1.11  Public debt-to-GDP ratio decreased across the board but remain 33 FIGURE 2.11  Despite a tight labor market, elevated real wages declined mostly due to inflation 25 FIGURE 1.12  EU income convergence 33 FIGURE 2.12  Real wages have recovered in displays signs of accelerating Central and Eastern Europe 25 FIGURE B1.2.1  Fiscal adjustments under 37 FIGURE B2.1.1  Projected numbers of the reformed EU fiscal framework working-age Roma in the Labor Force, 28 FIGURE 2.1  EU’s labor market has shown Bulgaria, Baseline vs. Policy Scenarios resilience to multiple shocks (2022-2030) 29 FIGURE 2.2  EU’s sectoral employment 38 FIGURE 2.13  Poverty and Vulnerability dynamics post-shocks have decreased substantially in the EU 38 FIGURE 2.14  The evolution of poverty 44 FIGURE 2.22  Income inequality is shows unconditional convergence across expected to increase in the absence of the EU government measures 39 FIGURE 2.15 The EU has witnessed a 45 FIGURE 2.23  Household income marked reduction in inequality is expected to fall along the welfare 39 FIGURE 2.16 Most EU countries witnessed distribution substantial income growth among the less 46 FIGURE 2.24  Account ownership has well-off increased significantly, yet disparities 40 FIGURE 2.17  Most individuals in Bulgaria, persist Croatia, Poland, and Romania are at the 46 FIGURE 2.25  Borrowing has increased, lower end of the EU’s income distribution, though it remains low, and the gaps have but there have been steady improvements widened over time 47 FIGURE 2.26  The less well-off worry 41 FIGURE 2.18  Food and energy prices have that they will not be able to access basic experienced a significant cumulative rise services in recent years 50 FIGURE 3.1  Euro area output gap 42 FIGURE 2.19  Food inflation can affect the estimates less well-off relatively more 53 FIGURE B3.1.1  Global Indicators 42 FIGURE 2.20  Many poor households are vulnerable to shocks as they are unable to 54 FIGURE 3.2  Geopolitical impacts on face unexpected expenses shipping costs 43 FIGURE 2.21  Food inflation could lead to 55 FIGURE 3.3  Global trade policy significant increases in poverty uncertainty and increasing distortions Tables 64 TABLE A.A.1  Assumption of price 65 TABLE A.B.1  Roma population according elasticities by income deciles to different sources 7 Acknowledgements Part 1 of this report was led and produced by Collette Mari Wheeler and Monica Robayo-Abril, with sup- port from the following core team: Andrei Silviu Dospinescu; Ehab Tawfik; Leonardo Lucchetti, Lukas Delgado Prieto; Matija Laco; and Emilija Timmis. Additional contributions were provided by Franz Ulrich Ruch, Kersten Kevin Stamm, Kaltrina Temaj, and Bart Marco Wilbrink. Managerial guidance and direction were provided by Anna Akhalkatsi (Country Director, EU Member States), Asad Alam (Regional Director, Europe and Central Asia), Jasmin Chakeri (Practice Manager, Economic Policy Global Practice, Europe and Central Asia), Reena Badiani- Magnusson (Program Leader, EU Member States) and Ambar Narayan (Practice Manager, Poverty and Equity Global Practice). Anna Fruttero, Angella Montfaucon and Natasha Rovo served as peer reviews for the report. Marcello Arrigo edited the report. 9 Abbreviations EA Euro Area ICT Information and communication ECB European Central Bank technologies ESI Economic Sentiment Indicator IRA Inflation Reduction Act EU European Union OIS Overnight Index Swap FDI Foreign Direct Investment PMI Purchasing Managers’ Index FDP Forcibly Displaced Persons REER Real effective exchange rate GDP Gross Domestic Product RER Regular Economic Report GFC Global Financial Crisis RFF EU Recovery and Resilience Facility GVCs Global Value Chains SOE State Owned Enterprises HICP Harmonized Index of Consumer Prices TFP Total Factor Productivity Regional Groupings Central and Southeast Europe (CEE): Southern Europe (SE): Bulgaria (BG), Croatia (HR), Czech Republic (CZ), Cyprus (CY), Greece (EL), Italy (IT), Malta (MT), Hungary (HU), Poland (PL), Romania (RO), Portugal (PT), Spain (ES) Slovak Republic (SK), Slovenia (SI) Western Europe (WE): Northern Europe (NE): Austria (AT), Belgium (BE), France (FR), Denmark (DK), Estonia (EE), Finland (FI), Germany (DE), Ireland (IE), Luxembourg (LU), Latvia (LV), Lithuania (LT), Sweden (SE) Netherlands (NL) 11 Executive Summary Following an unprecedented tightening cycle that avoided both deep recession and widespread job losses, the EU economy seems poised for a “soft landing,” with inflation edging closer to target. Growth in the EU slowed as expected in 2023, averaging a modest 0.4 percent amid an unprecedented decline in trade. Employment now shows tentative signs of recovery in 2024, but with key divergences across sec- tors, regions, and socioeconomic groups of the EU (Figure ES.1, panel a). Trade volumes contracted last year, marking the first such decline outside of an annual growth downturn, in part reflecting a slow- down in export growth amid a loss of export competitiveness due to elevated energy prices. Over the course of 2024, headline inflation (HICP) in the EU has continued its gradual deceleration, recording 2.8 percent year-on-year (y/y) growth in July, down from an average of 6.4 percent in 2023. Falling inflation, coupled with slow but still positive nominal wage growth, has reversed the real wage decline, bolster- ing consumer purchasing power. Yet risks remain, as the effects of monetary tightening may not have fully filtered through to households and businesses. Despite easing inflation, historically high prices continue to strain Europe’s poorest, many of whom are still recovering from the COVID-19 crisis. This ongoing pressure, coupled with tighter fiscal space, may limit support for vulnerable groups moving forward. By September 2024, consumer prices in Bulgaria, Croatia, Poland, and Romania had surged more than 24 percent since September 2021, driven largely by a stag- gering more than 35 percent rise in food prices. This escalation has eroded real wages, exacerbating pov- erty and food insecurity in the region. The burden has fallen disproportionally on the poor, who spend a larger share of their income on food. In Romania and Poland, the poorest decile of the population allo- cates as much as 51 percent and 38 percent of their expenditure to food, respectively, leaving them particu- larly vulnerable to price hikes. The disparity in spending patterns highlights the regressive impact of food price inflation, which poses a significant threat to the welfare of low-income households across the bloc. Employment remains a cornerstone of poverty alleviation, yet many groups — particularly the less skilled and blue-collar workers — are struggling to recover from multiple recent shocks. Job growth and rising labor incomes, particularly for those at the lower end of the income distribution, contributed to approximately 44 percent of the total poverty reduction observed between 2016 and 2022. However, pro- gress remains uneven. Less educated and blue-collar workers have yet to see their incomes recover from recent economic shocks (Figure ES.1, panel c). While labor markets across the EU have shown resilience, with overall employment rebounding, certain sectors and demographics continue to struggle. The dis- parities in employment recovery underscore the need for targeted policies to support the most vulner- able groups and ensure broader economic inclusion. Across the four Central and Eastern European economies (4CEEs) analyzed more closely in this re- port — Bulgaria, Croatia, Poland, and Romania — the cost-of-living crisis and shifting employment pat- terns have compounded the burden on households in the bottom 40 percent of the income distribution (B40). Since 2019, employment in industries such as mining, quarrying, manufacturing, and agricul- ture — where many lower-income individuals work — has steadily declined, narrowing job opportunities for those with limited education or sector-skills specifically aligned with these sectors. Meanwhile, ris- ing food prices are expected to worsen poverty and income inequality, particularly in rural areas. Simu- lations suggest that a 20 percent rise in food prices could temporarily increase the Gini index in Bulgaria and Croatia by 0.75 and 0.34 points, respectively, and short-term increases in poverty rates (Figure ES.1, panel d). The regressive impact of food inflation is stark: the poorest decile could see welfare reductions 12  |  A Path to Inclusive Growth in the EU of up to 10.3 percent, compared to just 2.6 percent for the richest. Combined with sectoral job losses, these pressures underscore the urgency of policies to mitigate inflationary shocks while creating better em- ployment opportunities for vulnerable workers. Fiscal consolidation in the EU, after stalling in 2023 and 2024, is poised to gain momentum under the bloc’s revamped Economic Governance Framework (EGF). However, striking a balance between fiscal sustainability and inclusive growth remains a challenge, particularly against a backdrop of geopoliti- cal and social pressures that continue to weigh on governments — many of which faced multi-level elec- tions in 2024. The reactivation of the Excessive Deficit Procedure alongside the EGF is expected to test pol- icymakers’ ability to navigate fiscal consolidation pressures without depressing already-weak growth. While the new framework emphasizes investment and growth, meeting fiscal consolidation targets will require tangible measures on both expenditure and revenue fronts. Multiple pressures persist on the expenditure side, driven by rising defense spending, climate change impacts, and the green transition. Part 2 of this report explores the opportunities and policy challenges for the 4CEEs as they seek to navi- gate the shifting EU policy landscape and tap into trade opportunities arising from the green transition. FIGURE ES.1  Recent developments in the EU a. Growth in EU subregions b. European Central Bank (ECB) policy rate change 1.0 5 0.8 4 Percent, q/q sa 0.6 3 Percent 0.4 2 0.2 1 0.0 −0.2 0 EU WE NE SE CEE 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 Months since start of tightening cycle 2023 Q3 2023 Q4 2024 Q1 2024 Q2 2024 Q3 11/1999 12/2005 04/2011 07/2022 c. Employment growth index (2019Q3=100) by education d. Simulated poverty rates, pre-shock vs post-shock food level, EU27 inflation scenarios, $6.85 poverty line (2017 PPP) 120 16 115 14 12 110 10 Poverty rate 105 8 100 6 95 4 90 2 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 2022Q3 2022Q4 2023Q1 2023Q2 2023Q3 2023Q4 2024Q1 2024Q2 0 BG HR PL RO Lower Secondary and below Pre-shock Post-shock (20%) Upper Secondary Tertiary Post-shock (30%) Post-shock (40%) Chapter 1 Recent Macroeconomic Developments 16  |  A Path to Inclusive Growth in the EU After a sharp slowdown in 2023, the EU economy has shown signs of improvement in 2024 Growth in the EU decelerated as expected in 2023, accompanied by an unprecedented decline in trade. In line with previous World Bank projections,1 overall GDP growth in the EU slowed down to 0.4 percent in 2023, reflecting tight credit conditions, dwindling exports, and elevated energy prices. Economic per- formance was especially weak in some large EU member states, such as Germany, with negative spill- overs on bloc-wide activity. Trade volumes declined in 2023 for the first time outside of a year of eco- nomic recession, in part reflecting a slowdown in export growth amid a loss of export competitiveness due to elevated energy prices. However, as imports declined — especially for energy — the impact of net exports on growth remained positive. On the domestic demand side, private consumption growth slowed sharply amid still-high inflation, and investment weakened against a background of subdued business confidence and tight financial conditions. Growth appears to have bottomed out, with activity levels showing signs of firming in 2024, but with key differences across sectors. After some weakness in 2023, services activity indicators suggest improve- ment in the first half of 2024, with activity supported by relatively robust labor markets. The Purchasing Managers’ Index (PMI) for services suggests continued sectoral strength in the near term, with the Paris Olympics likely providing a temporary boost in the third quarter. However, this improvement has been somewhat offset by weaker-than-expected industrial activity, especially in manufacturing, as reflected in the sector’s PMI. Goods trade in the first half of 2024 was also disappointing, with the contraction (in year-on-year terms) that started in September 2022 continuing into 2024, and forward-looking indica- tors pointing to sustained weakness. FIGURE 1.1  Contributions to EU Growth a. By country grouping b. By expenditure component 2.5 2.5 10 Percentage point contribution 8 2.0 2.0 6 Percent, q/q sa Percent 1.5 1.5 4 2 1.0 1.0 0 0.5 0.5 −2 0.0 0.0 −4 2024 Q1 2024 Q2 2024 Q3 2022 2023 2023 Q3 2023 Q4 −0.5 −0.5 2021 Q1 2021 Q2 2022 Q1 2022 Q2 2022 Q3 2022 Q4 2023 Q1 2023 Q2 2024 Q1 2024 Q2 2024 Q3 2021 Q3 2021 Q4 2023 Q3 2023 Q4 Annual growth Quarterly growth, q/q sa Growth Private consumption EU growth Euro area (RHS) Government consumption GFCF Other EU (RHS) Inventories Exports Imports Source: Eurostat. Note: Quarterly growth seasonally and working day adjusted. Over the first three quarters of 2024, the strength of the recovery was uneven across EU member states. Although most EU economies experienced growth in the first three quarters of 2024, its pace was sub- dued and its volatility higher in Northern Europe (NE) and Western Europe (WE) (Figure 1.2), owing in 1 World Bank 2023a; World Bank 2024a. Recent Macroeconomic Developments  |  17 part to the earlier loss in export competitiveness due to the energy price shock. In contrast, Central and Eastern European and Southern European countries experienced the most robust recovery, driven by strong domestic demand and enhanced investment due to the positive impact of the Recovery and Resilience Facility (RRF). Growth in Central and Eastern Europe has also been significantly higher than the EU average. This suggests a revitalized convergence, with countries such as Romania, Poland, and Croatia exhibiting higher growth potential than their longer-tenured EU counterparts. FIGURE 1.2  Growth is rebounding in the EU, albeit unevenly a. Percent of economies expanding in q/q terms in EU b. Growth in EU subregions subregions 1.0 100 90 0.8 80 70 0.6 Percent, q/q sa 60 Percent 50 0.4 40 30 0.2 20 10 0.0 0 2022 Q1 2022 Q2 2022 Q3 2022 Q4 2023 Q1 2023 Q2 2023 Q3 2023 Q4 2024 Q1 2024 Q2 2024 Q3 −0.2 EU WE NE SE CEE 2023 Q3 2023 Q4 2024 Q1 EU27 WE NE SE CEE 2024 Q2 2024 Q3 Source: Eurostat and WB calculations Note: Panel b shows GDP-weighted growth. World Bank Q3 growth estimates for Belgium, Greece, Croatia, Cyprus, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, Finland. Oxford Economics Q3 growth estimates for Denmark, Bulgaria, Poland, and Romania. While indicators of business and consumer confidence in the EU have seen an uptick, as growth revived in early 2024 and inflation rates decline, they remain below long-term averages. Consumer confidence is on an upward trend, but spending remains tempered due to persistently high real interest rates and diminished purchasing power caused by inflation. This prudence is evident in the rising trend of savings intentions, indicating households’ desire to rebuild their financial safety nets. Business confidence has seen a modest uptick, but to a lesser degree than consumer confidence, with persisting sectoral dispar- ities. The PMIs for construction and industry have remained below the 50 mark since mid-2022. Softer demand for durable goods is impacting essential manufacturing sectors such as machinery and equip- ment. Although demand for residential housing is weakening, infrastructure projects, supported by the Recovery and Resilience Facility, are providing support to the construction sector. After a historic tightening cycle, inflation is inching toward target Over the course of 2024 headline inflation (HICP) in the EU has continued its gradual deceleration, stand- ing at 2.1 percent y/y in September versus an average of 6.4 percent in 2023 (Figure 1.3). This decline stems from dissipating energy and food shocks, tight monetary policy, and fading supply-chain pres- sures. EU headline inflation is projected to decline further over 2025, although core inflation is set to 18  |  A Path to Inclusive Growth in the EU FIGURE 1.3  EU headline inflation rate, broken down by contributors 12 10 8 Percent, y/y 6 4 2 0 −2 07/2024 07/2023 07/2020 07/2021 07/2022 10/2020 10/2022 10/2023 01/2024 02/2024 03/2024 04/2024 05/2024 06/2024 09/2024 10/2021 08/2024 01/2020 04/2020 08/2020 12/2020 02/2021 12/2022 02/2020 03/2023 05/2023 06/2023 09/2023 03/2020 05/2020 06/2020 09/2020 11/2020 01/2021 03/2021 04/2021 05/2021 06/2021 08/2021 09/2021 01/2022 08/2022 04/2023 12/2023 11/2021 12/2021 02/2022 03/2022 04/2022 05/2022 06/2022 09/2022 11/2022 01/2023 02/2023 08/2023 11/2023 Headline inflation Food Energy Core Source: Eurostat and WB staff calculations. remain somewhat elevated, owing to catch-up wage growth and robust demand for services in the con- text of a tight labor market — with the unemployment rate standing at a historic low of 6 percent of the labor force. Nevertheless, inflation remains elevated in certain regions, particularly in CEE (Figure 1.4). FIGURE 1.4  EU inflation by region a. EU headline inflation by region b. EU core inflation by region 18 18 16 16 14 14 12 12 Percent, y/y Percent, y/y 10 10 8 8 6 6 4 4 2 2 0 0 −2 −2 01/2020 05/2020 09/2020 01/2021 05/2021 09/2021 01/2022 05/2022 09/2022 01/2023 05/2023 09/2023 01/2024 05/2024 09/2024 01/2020 05/2020 09/2020 01/2021 05/2021 09/2021 01/2022 05/2022 09/2022 01/2023 05/2023 09/2023 01/2024 05/2024 09/2024 EU WE NE SE CEE EU WE NE SE CEE Source: Eurostat and WB calculations based on country weights. In the euro area, headline inflation decelerated in 2024, sitting within the ECB’s medium-term target in October at 2 percent y/y. This decline, at a time when the euro area has returned to quarterly growth, has opened the door to successive 25 bps cuts to the ECB’s deposit facility rate in July, September, and October, bringing it down to 3.25 percent and with further gradual reductions expected over the com- ing quarters. The ECB is allowing its Asset Purchase Programme (APP) portfolio to decline at a meas- ured and predictable pace by no longer reinvesting the principal payments from maturing securities; has started to reduce its holdings of Pandemic Emergency Purchase Programme (PEPP) securities by, on average, EUR 7.5 billion per month in the second half of 2024; and has seen banks repay funds borrowed under targeted longer-term refinancing operations. Thus, the size of the ECB’s balance sheet continues to shrink from its peak in 2022. Recent Macroeconomic Developments  |  19 With inflation converging toward its target after a historic tightening cycle, the euro area seems poised for a “soft landing.” The latest ECB forecasts expect HICP inflation for the euro area to decelerate to 1.9 per- cent as of 2026, in a context of continued real GDP growth.2 Nevertheless, the ECB would need to remain vig- ilant and not declare victory over high inflation too soon, as the last mile of the disinflation process may FIGURE 1.5  Euro area headline (HICP) prove more difficult than anticipated. In particular, and core inflation core inflation has somewhat surprised on the up- 12 side, coming in at 2.7 percent y/y in September (Fig- 10 ure 1.5). This is largely explained by stubbornly high services inflation which, largely as a result of solid 8 Percent, y/y catch-up wage growth, stood at 4.2 percent in August, substantially above its long-term historical average. 6 4 Nominal wage growth is showing tentative signs of slowing down from its Q1 peak, with further normal- 2 ization of wages expected over the coming quarters. 0 This hinges on the assumption that nominal wage 01/2022 04/2022 07/2022 10/2022 01/2023 04/2023 07/2023 10/2023 01/2024 04/2024 07/2024 10/2024 growth is partially absorbed in unit profits to buff- er the pass-through to consumer prices. However, the risk remains that wage pressures prove more Headline Core potent, as firms remain well-positioned to largely pass higher labor costs onto consumers. The con- Source: Eurostat and ECB. tinued risk of a wage-price spiral is evident in Bel- gium, for example, where core inflation is above the euro-area average and wages are indexed to inflation; and in the Netherlands and Germany, where nominal wage growth is relatively strong, with a lagged re- sponse due to negotiated wage-agreement outcomes in a tight labor market with a relatively high vacancy rate. If wage pressures prove more stubborn than anticipated, the disinflationary process could be slower. On the other hand, monetary tightening may not have been fully passed through to households and businesses yet, which would limit future demand. Delays in pass-through may have increased compared with previous tightening cycles, especially since deposit rates for households have not increased propor- tionally to policy rates, and mortgages have longer fixed-rate terms.3 Such transmission lags could lead to a stronger cooling of future demand than currently anticipated, despite preliminary reductions to pol- icy rates. This implies that risks around the path of inflation remain two-sided, with the additional pos- sibility that labor markets and price pressures cool in a more pronounced manner than currently pro- jected. Therefore, maintaining a relatively restrictive stance for too long risks otherwise avoidable harm. This also suggests that the fiscal stance should be such that it does not add to domestic price pressures, and fiscal authorities act with restraint with regard to discretionary fiscal support. Thanks to higher interest rates, the profitability of European banks markedly improved in 2023 and remained high as of mid-2024. The most important driver of bank profitability was rising net-inter- est income, reflecting a significant widening of net-interest rate margins. In addition, increases in net fee and commission income and in trading income contributed to offsetting a rise in operating costs. Asset quality in the banking system is high, but pockets of vulnerability remain, especially in commer- cial real estate and SME loans. 2 ECB (2024), September 2024 Macroeconomic Projections (https://www.ecb.europa.eu/press/projections/html/index. en.html#:~:text=September%202024,-At%20a%20glance&text=Inflation%20is%20projected%20to%20increase,feeds%20 through%20to%20consumer%20prices.) 3 ECB, 2024; IMF, 2024 20  |  A Path to Inclusive Growth in the EU Although lending interest rates have started to drop, bank lending has so far failed to rebound, due to further tightening of credit standards and lower demand. In the euro area, credit growth remains sub- dued amid weak demand, linked primarily to the cost of borrowing. In the 4CEEs, household demand for housing loans has picked up (especially in Bulgaria) and interest in consumer loans has increased, due to broad improvement in the financial position of households and demand for financing for the pur- chase of durable goods. Growth in credit to non-financial corporations was somewhat muted, with low demand for working-capital loans and moderate growth in investment loans. The latter are expected to pick up, because of the projected increase in capital expenditure associated with the energy transition and releasing the access to EU funds. The financing pattern of non-financial corporations relying strongly on trade credit for financing their activity in some countries (e.g., Romania, Bulgaria) generates vulner- abilities. Even though trade credit can help firms manage cash flows over the short term, especially dur- ing periods of tight financial conditions, it is generally costlier and riskier compared to bank financing. BOX 1.1  The diverging paths of productivity growth in the EU and the US In recent years, there have been growing concerns about the competitiveness of the EU economy, espe- cially vis-à-vis the US. In part, these were exacerbated by the pandemic and the spillovers from the Russian Federation’s invasion of Ukraine.a While the drivers of this trend are complex, several aspects are worth highlighting. First, when the US economy emerged from the pandemic, it was about 9 percent larger in real terms than pre-pandemic, while the EU economy was 4 percent larger. There is emerging evidence that since the pan- demic, the US has experienced significantly stronger labor productivity growth than EU countries, which may in part be attributable to differences in policy responses to the pandemic. For instance, the European response had a stronger focus on within-industry labor retention, while the US focused more on income support with stronger labor reallocation incentives.b Moreover, the EU lacks the degree of capital market integration that can channel savings towards productive investment to the same degree as in the US. Structurally smaller house- hold exposure to equity markets in the EU relative to the US has precluded European households from reap- ing the wealth benefits of recently bullish markets. Finally, the latest global monetary tightening cycle, which saw interest rates rise sharply, likely dampened household balance sheets more severely in Europe than in the US, as a market preference for fixed-rate mortgages helped shield American households. FIGURE B1.1.1  GDP per hour worked in USD Second, spillovers from the Russian Federation’s (index: 1995 = 100) invasion of Ukraine, especially through high energy prices, caused a strong deterioration of the EU’s 160 terms of trade, affecting the competitiveness of energy-intensive industries. Notably, while energy 150 prices in the EU have fallen considerably from their late-2022 peaks, electricity and industrial gas prices 140 are still substantially higher than in the US and China. Beyond recent shocks, however, EU competitive- 130 ness had already been under pressure for decades. GDP per hour worked in US$ terms grew substan- 120 tially less in the EU than in the US between 1995 and 2022 (Figure B1.1.1), and the EU-US productivity gap 110 predates the global financial crisis.c Potential causes of weaker productivity growth in Europe include: rel- 100 atively rigid labor markets, more limited access to finance, the structure of EU firms, the EU’s industrial 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 composition, the regulatory environment, more lim- ited creation and adoption of disruptive digital tech- US EU nology, and the EU’s de facto market fragmentation. Source: OECD Recent Macroeconomic Developments  |  21 Reigniting productivity growth is key to promoting the EU’s competitiveness and raising its standards of liv- ing. A comprehensive package of structural reforms is needed to restore productivity growth in Europe.n It is important that policymakers carefully weigh trade-offs and act with restraint in promoting strategic autonomy and protectionist measures that may harm longer-term prospects. The recent report on the Future of European Competitiveness identifies three key challenges.d First, EU companies face weaker foreign demand, as well as rising competitive pressure from non-European companies. In this regard, EU R&D investment lags substan- tially behind other advanced economies, there has been a notable decline of European firms represented in the Fortune 500, and only four of the world’s top-50 tech companies by market capitalization are European. Second, energy prices in the EU remain high, and need to be contained in a structural manner without compro- mising, delaying, or disincentivizing the green transition. Third, the EU’s high degree of trade openness leaves it exposed to the risk of further deglobalization and to the effects of trade policy interventions by its competitors. a. Lopez-Garcia and Sforzi, 2021; Strauss et. Al, 2024; Schnabel, 2024; Li and Noureldin, 2024. b. ECB, 2024; FED, 2024; World Bank, 2023. c. van Ark, O’Mahony, and Timmer, 2008; Bergeaud, 2024. d. Draghi, M., 2024. The Future of European Competitiveness Part A: A competitiveness strategy for Europe, European Commission. Belgium. The EU’s current account position improved in 2023 and over the first half of 2024, primarily due to im- port contraction. The fall in import prices, including both energy and non-energy commodities, sup- ported an improvement in the goods trade balance, with Northern Europe and Western Europe recording the largest average gains (Figure 1.6). The goods trade balance remains negative in Southern Europe and Central and Eastern Europe, but the deficit reduced substantially in 2023 relative to 2022, and dropped further in 2024H1; the same regions show a considerable surplus in services trade, above pre-pandem- ic averages, driven by growing exports in the tourism sector. While primary income positions have re- mained stable, they were the principal contributors to the current account deficits in CEE in 2023, large- ly due to investment income dynamics. FIGURE 1.6  Current account positions 8 6 4 2 Percent of GDP 0 −2 −4 −6 −8 −10 −12 EU27 2011–19 WE 2011–19 NE 2011–19 SE 2011–19 CEE 2011–19 EU27 2008–10 WE 2008–10 NE 2008–10 SE 2008–10 CEE 2008–10 EU27 2000–07 WE 2000–07 NE 2000–07 SE 2000–07 CEE 2000–07 EU28 2024 H1 WE 2024 H1 NE 2024 H1 SE 2024 H1 CEE 2024 H1 EU27 2020 EU27 2022 WE 2023 EU27 2021 EU27 2023 WE 2020 WE 2021 WE 2022 NE 2020 NE 2021 NE 2022 NE 2023 SE 2020 SE 2021 SE 2022 SE 2023 CEE 2020 CEE 2021 CEE 2022 CEE 2023 EU27 WE NE SE CEE Current account Goods Services Primary income Secondary income Source: Eurostat and WB calculations Note: Weighted by euro chain-linked volumes GDP 22  |  A Path to Inclusive Growth in the EU Fiscal consolidation has stalled, highlighting the importance of the revised EU fiscal framework Fiscal consolidation stalled in 2023, leading to an increase in the number of EU countries at risk of en- tering the Excessive Deficit Procedure (EDP), including several major economies within the Eurozone. Weakened economic activity impacted tax collection, while the prevailing high-interest rate environ- ment has partially offset the withdrawal of pandemic-related spending measures and the reduced fiscal impact of lower energy inflation. On average, the CEE region reported the largest deficits in 2023, having historically enacted some of the most procyclical fiscal policies in the EU. CEE also faces the most signif- icant risk under the EDP, with 5 out of 8 countries experiencing fiscal deficits above 3 percent of GDP (Fig- ure 1.8). The fiscal position continued to show signs of deterioration in the first half of 2024, with more than half of the countries in Western Europe (WE) and Southern Europe (SE) experiencing a worsening of the fiscal deficit compared to the second half of 2023. FIGURE 1.7  Fiscal balance evolution in EU FIGURE 1.8  Number of countries with fiscal subregions deficits above 3 percent of GDP, by EU 2 subregion 26 24 0 22 20 −2 18 Percentage of GDP 16 −4 14 12 10 −6 8 6 −8 4 2 −10 0 2019 2020 2021 2022 2023 2019 2020 2021 2022 2023 EU27 WE NE SE CEE EU27 WE NE SE CEE Source: Eurostat, World Bank calculations Source: Eurostat, World Bank calculations Note: Unweighted average across countries Note: Unweighted average across countries High fiscal rigidity highlights challenges to expenditure-driven fiscal consolidation. Over the past two decades, the average share of highly rigid expenditures (compensation of employees, social transfers, and interest payments) in total public spending in the EU27 has hovered around 71 percent (Figure 1.9). While fiscal rigidity decreased to 67 percent in 2021, the reduction was driven by a growth in spending on non-rigid components, such as subsidies and intermediate consumption. As of 2023, Central and Eastern Europe and Northern Europe recorded the lowest levels of fiscal rigidity in the EU, reflecting the increasing contribution of capital spending to total expenditure — thanks in large part to substan- tial investments under the RRF. Conversely, Western Europe reported the highest levels of fiscal rigidity, which can be attributed to a larger share of spending on social transfers and weaker public investment. A sustainable reduction in fiscal rigidity over the medium term must be accompanied by revenue and other expenditure efficiency measures, to minimize the risk of reducing the fiscal deficit through exces- sive cuts to public investment. Recent Macroeconomic Developments  |  23 FIGURE 1.9  Fiscal rigidity 2019 – 2023 a. Highly rigid expenditure items b. Contributions to change in general government expenditure 72 7 6 5 70 government expenditure 4 Percentage of general Percent 3 68 2 1 66 0 −1 −2 64 EU27 2019 EU27 2023 WE 2019 WE 2023 NE 2023 SE 2019 CEE 2019 NE 2019 SE 2023 CEE 2023 62 EU27 WE NE SE CEE 2000–07 2008–10 2011–19 2020 2021 2022 2023 Capital expenditures Social transfers Intermediate consumption Compensation of employees Interest EU27 WE NE SE CEE Subsidies Other Total Source: Eurostat, World Bank calculations Note: Unweighted average across countries; Social transfers include social benefits other than social transfers in kind and Social transfers in kind — purchased market production. Fiscal revenues underperformed in 2023, while expenditure levels remained elevated compared with pre-pandemic figures. Revenues from indirect taxes, as a percentage of GDP, decreased on average in 2023, reflecting the impact of lower energy prices, falling imports, and weakened economic activity. The most pronounced decreases were observed in Southern Europe, particularly in the countries experienc- ing the steepest drop in economic growth. Social contributions benefited from an improving labor mar- ket, while rising wages helped curb the decline in direct tax revenues. EU funds bolstered public invest- ments, which saw an uptick in 26 out of 27 EU member states. Additionally, interest expenditure rose in an environment of high interest rates and increasing nominal debt, with the highest interest expendi- ture-to-GDP ratios registered in Southern Europe and Central and Eastern Europe. FIGURE 1.10  Underperforming fiscal revenues and elevated expenditures 50 10 40 8 30 6 20 4 Percent of GDP Percent of GDP 10 2 0 0 −10 −2 −20 −4 −30 −6 −40 −8 −50 −10 −60 −12 EU27 2011–19 WE 2011–19 NE 2011–19 SE 2011–19 CEE 2011–19 EU27 2008–10 WE 2008–10 SE 2008–10 NE 2008–10 CEE 2008–10 EU27 2000–07 WE 2000–07 NE 2000–07 SE 2000–07 CEE 2000–07 EU27 2020 EU27 2021 EU27 2022 EU27 2023 WE 2021 WE 2023 WE 2020 WE 2022 NE 2020 NE 2021 NE 2022 NE 2023 SE 2021 SE 2020 SE 2022 SE 2023 CEE 2020 CEE 2021 CEE 2022 CEE 2023 EU27 WE NE SE CEE Direct taxes Indirect taxes Capital taxes Social contributions Other revenues Current expenditure Capital expenditure Fiscal balance (right scale) Source: Eurostat, World Bank calculations Note: Unweighted average across countries 24  |  A Path to Inclusive Growth in the EU The public debt-to-GDP ratio continued to fall in 2023 but remains, on average, above pre-pandemic lev- els, pointing to significant vulnerabilities. High nominal GDP has mitigated some of the effects of ele- vated interest rates and persistently high primary deficits, supporting a 1.7 percentage point average decrease in the public debt-to-GDP ratio. However, the ratio remains above pre-pandemic levels in 19 of the 27 EU member states, with the smallest average adjustments observed in Central and Eastern Europe. Debt ratios are still above 60 percent in 13 member states, and exceed 100 percent in five of them, pre- dominantly in Southern Europe. Public debt-to-GDP ratios are showing weak signs of trend reversal in 2024Q2, with 17 out of the 27 EU member states reporting a decrease. FIGURE 1.11  Public debt-to-GDP ratio decreased across the board but remain elevated 140 120 100 Percent of GDP 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 EU WE NE SE CEE Source: Eurostat, World Bank calculations Note: Unweighted average across countries BOX 1.2  The reformed EU fiscal framework The reformed EU fiscal framework aims to create a robust and adaptable system to handle future economic challenges by emphasizing simplicity, transparency, national ownership, and effective enforcement. It seeks to ensure fiscal sustainability while promoting sustainable and inclusive growth across the EU. National medium-term fiscal structural plans are central to the framework, strengthening national ownership by inte- grating reform and investment policies within a common EU framework. The new fiscal framework includes the possibility for member states to extend the adjustment period from four to seven years, by committing to growth-enhancing reforms and investments. Enforcement is strengthened by the requirement for annual progress reports and a control account to monitor deviations.a The reformed EU fiscal rules, which came into effect in April 2024, represent a significant shift from the previous framework. Under the new framework, the focus has shifted from strict numerical targets to a more nuanced approach that emphasizes debt sustainability. This is achieved through country-specific debt sus- tainability analyses (DSAs) and the establishment of a single operational target based on public expenditure. This target is designed to ensure that, barring any new budgetary measures, a member state’s debt ratio will be either on a downward trajectory or maintained at prudent levels below 60 percent of GDP over the medium term. The new rules also introduce additional safeguards for countries with higher levels of debt or deficit. These include requirements for a minimum yearly reduction in the debt ratio, and improvements in the structural pri- mary balance. The aim is to prevent backloading (whereby adjustments are postponed to later years), and to ensure that countries with structural deficits make consistent efforts to improve their fiscal positions. To foster stronger national ownership, member states are now required to design medium-term fiscal structural plans that outline their fiscal targets, reforms, and investments. These plans are assessed by the Recent Macroeconomic Developments  |  25 European Commission and endorsed by the Council, FIGURE B1.2.1  Fiscal adjustments under the ensuring that they align with common EU criteria. The reformed EU fiscal framework integration of fiscal, reform, and investment objec- 0.8 tives into a single medium-term plan is expected to streamline the process and enhance the effectiveness 0.6 Avg. annual fiscal adj., of national strategies, while promoting sustainable Percent of GDP debt reduction, fostering a green, digital and resilient 0.4 economy and enhancing the EU’s competitiveness. Countries in Central and Eastern Europe will face the 0.2 most significant requirements for fiscal adjustment. The requirements will be particularly demanding for 0 countries with a high current primary deficit, such as those in the CEE region, although in most such coun- −0.2 EU27 WE NE SE CEE tries the public debt-to-GDP ratio stands below 60 per- cent (in comparison, Southern Europe has, on average, 4 year adj. 7 year adj. higher debt ratios). Conversely, countries that maintain a Source: World Bank calculations based on Darvas, Z., L. primary balance surplus can adjust more gradually if they Welslau and J. Zettelmeyer (2024) ‘The implications of the Eu- commit to implementing specific investment and reform ropean Union’s new fiscal rules’, Policy Brief 10/2024, Bruegel measures that support fiscal sustainability and growth. Note: Unweighted average across countries a. European Commission, https://economy-finance.ec.europa.eu/document/download/0aaf8190-b9fe-46b2-9dac- 912b98bef0da_en?filename=ip295_en_0.pdf. Income convergence across the EU has accelerated, but primarily because of underwhelming per-cap- ita-income growth in some of the major high-income member states (Figure 1.12). The pace of catch-up, measured by the gap in GDP-per-capita growth between the EU average and the 16 member states with lower-than-average income levels, has accelerated after the pandemic, from an average of 1.1 percentage points during 2015 – 2019 to 2.5 percentage points during 2021 – 2023. In 2023, the convergence trend ac- celerated, with 15 out of the 16 lower-income member states recording higher per-capita-income growth than the EU average. However, within-country divergence increased after the pandemic, as inflationary pressures hit poorer households harder (see next section). FIGURE 1.12  EU income convergence displays signs of accelerating 115 110 Coefficient of variation (2003=100) 105 ence ntry diverg Within-cou 100 95 90 Converg ence b etween the EU countrie 85 s 80 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022e 2023e Source: World Bank calculations using Eurostat Note: Computations based on Real GDP per capita in PPS for the EU27 countries Chapter 2 Recent Labor Market, Poverty, and Inclusion Trends 28  |  A Path to Inclusive Growth in the EU From struggle to stability: The resilience of the EU labor market to the COVID-19 crisis and Russian Federation’s invasion of Ukraine The EU’s labor markets have shown remarkable resilience in the face of challenges posed by the COV- ID-19 pandemic and the energy and cost-of-living crisis resulting from the Russian Federation’s in- vasion of Ukraine. Despite a significant decline in labor force participation and employment during the pandemic, there was a robust rebound in employment afterward (Figure 2.1). Swift and substan- tial policy measures, enacted at both the EU and FIGURE 2.1  EU’s labor market has shown national levels, have mitigated the impact of the resilience to multiple shocks pandemic on unemployment, despite the unprec- Changes in labor force participation, employment, and edented economic contraction. Russia’s invasion unemployment rates, EU27, 2019Q3 – 2024Q2 of Ukraine and the associated energy and cost of living crisis seem to have had relatively limited 2019 Q3–2020 Q2: COVID shock short- and medium-term impacts on labor mar- ket indicators. Compared to the third quarter of 2020 Q2–2022 Q2: Post COVID recovery 2019, both employment and labor force participa- tion rates have increased by 2.7 and 2.3 percentage 2022 Q2–2023 Q1: points (pp), respectively, while the unemployment 3Q after Russian invasion rate has seen a slight decline of about 0.5 pp. This 2023 Q1–2024 Q2: showcases the resilience of the EU’s labor markets Rest of 2023 to 2024 Q2 and underscores the adaptability of its workforce. Varying labor market trends have been observed −3 −2 −1 0 1 2 3 4 across EU subregions during this period, with the Percentage point labor force participation rate growing most rapid- Labor Force Participation rate ly in WE and CEE, followed by SE, while growth re- Employment rate mains sluggish in NE. Unemployment rate Source: World Bank calculation based on Eurostat (lfsi_emp_q and une_rt_q), 2019Q3 – 2024Q2. While employment across most sectors has re- Note: Participation and employment rates are calculated bounded, recent shocks continue to cast a shad- for individuals aged 15 to 64, while unemployment rates are ow over some sectors, notably manufacturing, ag- determined for individuals aged 20 to 64. These figures are riculture, and administrative services. Since 2019, derived from the seasonally adjusted Labor Force Survey series. nearly all major industries have seen increases in employment levels (Figure 2.2). However, the employment rebound has not been homogeneous, with a noticeable reallocation of employment across sectors. Some sectors have substantially surpassed their pre-pandemic levels; for instance, information and communication, utilities and real estate activities, experienced notable growth in employment from the third quarter of 2019 to the second quarter of 2024, with increases of about 28.4, 20.3 and 13.9 percent, respectively. On the other hand, the agricultural sec- tor witnessed a decline of approximately 19.9 percent in employment during the same period, followed by service activities (5.8 percent) and manufacturing (2.7 percent) (Figure 2.3). Some of these trends are indicative of longer-term structural shifts toward non-routine cognitive tasks, expansion in globally in- novative sectors requiring skill-intensive labor, and the acceleration of these trends during the COVID-19 pandemic, which was a time of increased digital investment.4 For example, the decline in agricultural employment predates the pandemic, partly due to the consistent growth of the services sector, which has created more job opportunities outside of rural areas. 4 Eurofound, 2022. RecentLabor Market, Poverty, and Inclusion Trends  |  29 FIGURE 2.2  EU’s sectoral employment dynamics post-shocks Employment growth by sector, EU27, 2019 Q3 – 2024 Q2 Information And Communication Electricity, Gas, Steam And Air Conditioning Supply Real Estate Activities Professional, Scientific And Technical Activities Education Human Health And Social Work Activities Arts, Entertainment And Recreation Other Service Activities Financial And Insurance Activities Public Administration And Defence; Compulsory Social Security Construction Water Supply; Sewerage, Waste Management And Remediation Activities Transportation And Storage Wholesale And Retail Trade; Repair Of Motor Vehicles And Motorcycles Accommodation And Food Service Activities Manufacturing Administrative And Support Service Activities Agriculture, Forestry And Fishing −20 −10 0 10 20 30 Percent Source: World Bank calculation based on Eurostat (lfsq_egan22d), 2019 Q3 – 2024 Q2. Note: Total employment series are calculated for individuals aged 15 to 64, derived from the unadjusted Labor Force Survey series. Adjusted series by sectors of economic activity are not available. FIGURE 2.3  Impact of the pandemic and Ukraine conflict on employment, most affected sectors Employment growth by sector and subperiod, EU27 2019 Q3–2020 Q2: COVID shock 2020 Q2–2022 Q2: Post COVID recovery 2022 Q2–2023 Q1: 3Q after Russian invasion 2023 Q1–2024 Q2: Rest of 2023 to 2024 Q2 −24 −20 −16 −12 −8 −4 0 4 8 12 16 20 Percent Accommodation and Food Service Activities Administrative and Support Service Activities Agriculture, Forestry and Fishing Manufacturing Wholesale and Retail Trade; Repair of Motor Vehiclesand Motorcycles Source: World Bank calculation based on Eurostat (lfsq_egan22d), 2019 Q3 – 2024 Q2. Note: Total employment series are calculated for individuals aged 15 to 64, derived from the unadjusted Labor Force Survey series. Adjusted series by sectors of economic activity are not available. The overall improvement of key labor market indicators masks a starkly uneven path of recovery for specific subgroups, with employment gains concentrated among highly educated workers. Uneducated individuals emerged as the most vulnerable group, experiencing the steepest decline in employment dur- ing the pandemic, and after some recovery, their employment levels dropped again following the Russian Federation’s invasion of Ukraine, extending their struggle for stability (Figure 2.4). In fact, after the two shocks, they are still grappling to reach the employment levels seen prior to the pandemic (Figure 2.5). This underscores the profound and enduring impact of these shocks on the most vulnerable segments of 30  |  A Path to Inclusive Growth in the EU the workforce. Conversely, high-skilled employment has demonstrated remarkable resilience, remaining robust in the face of adversity. This divergent trajectory in employment recovery has had a profound con- sequence: the widening of the employment gap among workers with varying educational backgrounds. FIGURE 2.4  Less-educated workers face FIGURE 2.5  Inequality in employment trends significant challenges has been increasing over time Employment growth by education, EU27, 2019 Q3 – 2024 Q2 Employment growth index (2019Q3=100) by education level, EU27 120 2019 Q3–2020 Q2: COVID shock 115 2020 Q2–2022 Q2: 110 Post COVID recovery 105 2022 Q2–2023 Q1: 3Q after Russian invasion 100 2023 Q1–2024 Q2: 95 Rest of 2023 to 2024 Q2 90 −8 −6 −4 −2 0 2 4 6 8 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 2022Q3 2022Q4 2023Q1 2023Q2 2023Q3 2023Q4 2024Q1 2024Q2 Percent Lower Secondary and below Upper Secondary Lower Secondary and below Tertiary Upper Secondary Tertiary Source: World Bank calculation based on Eurostat (lfsi_educ_q), Source: World Bank calculation based on Eurostat (lfsi_educ_q), 2019Q3 – 2024Q2. 2019Q3 – 2024Q2. Note: Total employment series are calculated for individuals Note: Total employment series are calculated for individuals aged 15 to 64, derived from the seasonally adjusted Labor Force aged 15 to 64, derived from the seasonally adjusted Labor Force Survey series. “Lower secondary” refers to less than primary, Survey series. “Lower secondary” refers to less than primary, primary, and lower secondary education; “upper secondary” primary, and lower secondary education; “upper secondary” comprises upper secondary and post-secondary non-tertiary comprises upper secondary and post-secondary non-tertiary education; while “tertiary” denotes tertiary education. education; while “tertiary” denotes tertiary education. The pace of employment recovery for less educated workers shows significant variation across subre- gions, with NE approaching full recovery. The substantial decline in employment experienced by the less educated was not uniform across regions (Figure 2.6). In NE, despite a sharp downturn during the COVID- 19 pandemic, the employment levels for workers with primary education in Q2 of 2024 were around 2 percent lower than pre-crisis levels. That is not the case in other regions, where such workers still grap- ple with employment levels more than 5 percent below their pre-crisis levels. This discrepancy under- scores the acute vulnerability faced by this group in certain regions. Employment levels for blue-collar workers, irrespective of their skill level, have yet to rebound to pre- pandemic levels, in contrast to a full recovery among white-collar workers — suggesting a polariza- tion in employment growth. Heterogeneity also exists across skill levels.5 Low-skill blue-collar workers faced the most significant employment decline during the pandemic, and while they have seen notable improvements during the recovery, their employment rates still lag behind pre-pandemic levels (Figure 2.7). Additionally, high-skill blue-collar workers experienced employment declines with minimal gains during the recovery period. Conversely, white-collar workers (especially those highly skilled have not only regained pre-pandemic employment levels but even surpassed them. One of the key contributors to 5 Obtaining reliable and detailed data on skills presents challenges, as a comprehensive measure of skills should encompass basic education and training. To address this, we use ISCO data on occupations, a common practice for the EU, sourced from Eurostat. This classification aggregates occupation categories from the ISCO 88 classification into four groups: White-collar high-skilled; White-collar low-skilled; Blue-collar high-skilled, and Blue-collar low-skilled. RecentLabor Market, Poverty, and Inclusion Trends  |  31 job polarization is the increased technological change in response to the pandemic6 that may dispropor- tionately impact middle-skill workers (Autor & Dorn, 2013), who are often high-skill blue-collar workers. FIGURE 2.6  Regional disparities persist in FIGURE 2.7  Polarization of job opportunities employment recovery among less educated and unequal employment recovery workers Employment growth index (2019Q3=100), by occupation, EU27 Employment growth index (2019Q3=100) by subregion, workers 112 with lower secondary and below 102 108 100 104 98 100 96 96 94 92 92 88 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 2022Q3 2022Q4 2023Q1 2023Q2 2023Q3 2023Q4 2024Q1 2024Q2 90 88 Low-skill blue collar High-skill blue collar 86 Low-skill white collar High-skill white collar 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 2022Q3 2022Q4 2023Q1 2023Q2 2023Q3 2023Q4 2024Q1 2024Q2 Source: Eurostat (lfsq_egais), 2019Q3 – 2024Q2. Note: Total employment series are calculated for individuals aged 15 to 64, derived from the unadjusted Labor Force Survey series. Low-skill blue collars (ISCO codes 8 and 9) include WE NE SE CEE plant and machine operators and assemblers and elementary occupations; High-skill blue collars (ISCO codes 6 and 7) Source: World Bank calculation based on Eurostat (lfsi_educ_q), include skilled agricultural and fishery workers and craft and 2019Q3 – 2024Q2. related trades workers; Low-skill white collars (ISCO codes 4 Note: Total employment series are calculated for individuals and 5) include clerks and service workers and shop and market aged 15 to 64, derived from the seasonally adjusted Labor sales workers; High-skill white collars (ISCO codes 1,2 and 3) Force Survey series. “Lower secondary” refers to less than include legislators, senior officials and managers, professionals primary, primary, and lower secondary education. Germany is and technicians and associate professionals. The figure excluded due to a lack of data for 2020. excludes employment in the armed forces and non-responses. The employment landscape has undergone a heterogeneous evolution in response to the challenges posed by recent shocks, particularly the youth. The pandemic impact was stark and widespread, with both full-time and part-time employment experiencing substantial declines across genders (Figure 2.8). However, in 2021 signs of recovery emerged. This recovery was particularly pronounced for female full- time workers, who bounced back and consistently surpassed pre-pandemic employment levels since 2021, with levels around 6 percent higher in the second quarter of 2024. In contrast, part-time employ- ment took longer to recover for women, with recent data showing a return to pre-COVID levels. One demo- graphic group that faced significant challenges during the pandemic was young workers aged 15 – 24 (Figure 2.9). They experienced a sharp decline in employment opportunities of about 10 percent dur- ing COVID-19. This is a particular concern as it is more likely that young labor market entrants will carry long-lasting scars of recessions due to disrupted career development. For instance, on average, workers entering the labor market in a recession experience an initial reduction in their earnings of about 10 to 15 percentage points.7 Despite these initial setbacks, there has been a notable resurgence in employment among this group, with current levels surpassing those recorded before the pandemic. 6 Eurofound, 2022. 7 Wachter, T. V., 2020. 32  |  A Path to Inclusive Growth in the EU FIGURE 2.8  Female full-time workers: recovery FIGURE 2.9  Young workers faced COVID-19 job surpassing pre-pandemic levels since 2021 losses but rebounded stronger Employment growth index by type of employment and gender Employment growth index by age and gender (2019 Q3=100), (2019 Q3=100), EU 27, 2019 Q3 – 2024 Q2 EU 27, 2019 Q3 – 2024 Q2 106 120 116 104 112 102 108 100 104 100 98 96 96 92 94 88 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 2022Q3 2022Q4 2023Q1 2023Q2 2023Q3 2023Q4 2024Q1 2024Q2 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 2022Q3 2022Q4 2023Q1 2023Q2 2023Q3 2023Q4 2024Q1 2024Q2 Part-time female Full-time female Young Female Old Female Part-time male Full-time male Young Male Old Male Source: World Bank calculation based on Eurostat (lfsq_epgais), Source: World Bank calculation based on Eurostat (lfsi_empq), 2019 Q3 – 2024 Q2. 2019 Q3 – 2024 Q2. Note: Total employment series are calculated for individuals Note: Total employment series are calculated for individuals aged 15 to 64, derived from the unadjusted Labor Force Survey aged 15 to 24 (young) and 55 to 64 (old), derived from the series. No adjusted series are available for any type of job. seasonally adjusted Labor Force Survey series. Surging vacancies tighten the EU labor market in the post-pandemic period, but more recently, labor market conditions have loosened. In the post-COVID recovery phase, the uptick in job openings sup- ported by the removal of pandemic containment measures and the reopening of economic activity cre- ated a more challenging landscape for businesses seeking to fill positions despite the concurrent rise in labor force participation rates. Job vacancies surged across the EU27 and various European subregions, while the number of unemployed individuals remained relatively stable. This led to a tightening of the labor market, with more firms willing to hire workers out of a declining unemployment pool (Figure 2.10). FIGURE 2.10  Surging vacancies tighten EU labor market in the post-pandemic period, with slightly loosening labor market conditions recently Labor market tightness, 2019 Q3 – 2024 Q2, EU27 and subregions 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 2022Q3 2022Q4 2023Q1 2023Q2 2023Q3 2023Q4 2024Q1 2024Q2 EU WE NE SE CEE Source: World Bank calculation based on Eurostat (jvs_q_nace2 and une_rt_q), 2019Q3 – 2024Q2. Note: Labor market tightness is calculated as the ratio of job vacancies in the service, industry, and construction sectors to unemployed individuals aged 20 to 64, excluding the primary sector, international organizations, and household activities. These figures are derived from seasonally adjusted LFS data, ensuring consistency despite time series breaks, with data unavailable for Italy and Estonia. RecentLabor Market, Poverty, and Inclusion Trends  |  33 Consequently, firms have found themselves compelled to offer higher wages to attract workers, particularly in WE, where the tightening of the labor market was most pronounced. Labor market tightness has slightly decline recently, likely due to the economic slowdown after the Russian Federation’s invasion of Ukraine. However, it remains well above pre-pandemic levels in most regions (i.e. WE and SE) likely due to sus- tained labor demand from firms rather than lower labor supply from the population or labor mismatches.8 With easing inflation and sustained nominal wage increases, the real wages — after a sustained de- cline — are showing signs of improvement. While nominal hourly labor costs have steadily risen across most EU countries (leading to a roughly 19 percent increase in real wages since 2019 Q3), the purchasing power of wages has eroded due to the rapid inflationary pressures (i.e., real wages decreased by nearly 21 percent as a result of higher prices), particularly evident since the third quarter of 2021. Consequently, real wages have dropped by over 2 percent since the beginning of the pandemic.9 Recent developments indicate that real wages have recovered over the past year as inflationary pressures have eased (Figure 2.11). Several EU countries have observed annual growth in real wages since 2019. Nevertheless, real wag- es in most Western and Southern European countries continue to lag their 2019 levels (Figure 2.12). In contrast, in Northern Europe real wages are slightly above, and in Central and Eastern Europe there is robust real wage growth, consistent with their tighter labor markets after the pandemic. Furthermore, statutory minimum wages have undergone a substantial increase between 2019 and 2024, averaging a remarkable 28 percent real increase across the bloc on average. This upward adjustment has contributed FIGURE 2.11  Despite a tight labor market, real FIGURE 2.12  Real wages have recovered in wages declined mostly due to inflation Central and Eastern Europe Real wage growth index (2019 Q3=100), 2019 Q3 – 2024 Q2, EU27 Percentage change in prices and nominal and real labor costs, 2019 Q3 – 2024 Q2, EU27 and subregions 125 60 120 50 115 Percentage points 40 110 30 105 20 100 10 95 0 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1 2021Q2 2021Q3 2021Q4 2022Q1 2022Q2 2022Q3 2022Q4 2023Q1 2023Q2 2023Q3 2023Q4 2024Q1 2024Q2 −10 WE CEE SE NE EU 27 Nominal Labor Costs HICP Nominal labor costs changes Price changes Real Labor Costs Real labor costs changes Source: World Bank calculation based on Eurostat (lc_lci_r2_q Source: World Bank calculation based on Eurostat (lc_lci_r2_q and prc_hicp_midx), 2019Q3 – 2024Q2. and prc_hicp_midx), 2019Q3 – 2024Q2. Note: Real labor costs are derived by deflating the labor cost Note: Real labor costs are derived by deflating the labor cost index with the HICP index, which represents a consumer basket index with the HICP index, which represents a consumer basket typical of the entire EU. Labor costs encompass wages and typical of the entire EU. Labor costs encompass wages and salaries across the services, industries, and construction sectors. salaries across the services, industries, and construction sectors. 8 European Commission, 2023. 9 The changes in real wages result from changes in both nominal wages and prices. To discern the impact of these factors in- dividually, we calculate the Shapley value of the marginal contribution of each component to the change in real wages. In other words, we alter nominal wages while keeping prices constant and then adjust prices while holding nominal wag- es steady. When nominal wages change, maintaining prices at a constant level, there is a 19 percent increase in real wag- es. Conversely, adjusting prices while keeping nominal wages unchanged leads to a 21 percent reduction in real wages. The combined effect yields a net change of approximately -2 percent in real wages since 2019 Q3. 34  |  A Path to Inclusive Growth in the EU to stronger wage growth among lower-paid workers. Considering the significant role inflation has played in the evolution of real wages, the escalation of prices has emerged as a pressing issue, especially for vulnerable households. As such, the following section delves deeper into the distributional impact of rising prices, with a particular focus on food inflation. In 2022, the working poor (B40)10 in four Central and Eastern European economies (4CEEs) were pre- dominantly concentrated in a few key sectors. In all four countries, around one-fifth of the employed poor worked in the mining, quarrying, manufacturing, electricity, gas, and water sector. The wholesale and retail trade sector also employed a substantial portion of the B40, with 18 percent in Bulgaria, 16 per- cent in Croatia, 12 percent in Poland, and 14 percent in Romania. Agriculture, forestry, and fishing were prominent sectors, especially in Poland (24 percent) and Romania (38 percent). The construction sector also had a notable share of B40 workers, in Bulgaria (14 percent), Croatia (10 percent), Poland (8 percent), and Romania (12 percent). Additionally, accommodation and food service and transportation and stor- age were important sectors for B40 employment across these countries, albeit with varying shares. The second part of this report explores the manufacturing opportunities in the green value chains, show- casing the importance of export-related jobs in Romania, Bulgaria, Croatia and Poland. Employment trends since 2019 across 4CEEs show a consistent decline in key sectors where the poor work, namely the mining and quarrying, manufacturing, and agriculture sectors. Quarterly data from 2019Q3 to 2024Q2 shows that during this period, mining employment fell sharply in Bulgaria (-62.5 percent) and declined across all countries except Croatia, which had no initial employment data. Manufacturing declined moderately, particularly in Bulgaria (-13.8 percent) and Romania (-5.6 percent). Agriculture experienced significant reductions, especially in Romania (-49.8 percent) and Bulgaria (-26.3 percent). In contrast, the wholesale and retail trade sector displayed mixed results, with employment decreasing in Poland (-2.6 percent) but increasing in Bulgaria (1.9 percent), Croatia (2.8 percent) and Romania (4.6 percent). Despite employment losses in the sectors where the poor (B40) are overrepresented, real wages in these sectors continue to rise. Using nominal labor costs adjusted for inflation as a measure of real wages, they have increased across specific sectors. For example, from 2019Q3 to 2024Q2, manufacturing real wages grew from 8.9 percent in Poland to 33.2 percent in Bulgaria. In the wholesale and retail trade sec- tor, they ranged from 8.6 percent in Poland to 38.1 percent in Bulgaria. In the construction sector, they ranged from 7.8 percent in Poland to 42.3 percent in Bulgaria. This growth is driven by several factors, like tighter labor markets and stronger firm demand, which have pushed wages upward. Furthermore, labor costs can be inflated by the negative employment growth of low-educated workers, that result in relatively more high-educated employees and a higher average cost per worker, leading to an increase in the labor cost index without widespread wage growth. Even though there are no official estimates to adequately capture dynamics of labor market indicators and labor income among the Roma population, unofficial estimates indicate that access to the labor market remains low.11 The 2021 Household Budget Survey for Romania and the 2021 National Survey on Income and Living Conditions for Bulgaria reveal significant labor market disparities between Roma and non-Roma populations. In Romania, there are large gaps in labor force participations between Roma and their non-Roma counterparts, particularly among the group with secondary education or more 10 Working poor refers to workers living in households with incomes at the bottom 40 percent of the income distribution. 11 Ethnicity identifiers are not common in household surveys. In Bulgaria, while ethnicity information is collected for the Survey of Income and Living Conditions (SILC), this information is not collected in labor force survey (LFS) data. Therefore, we rely on the latest SILC to construct labor income and key labor market indicators, though comparability with official esti- mates from LFS are not possible. In Romania, there is no formal ethnicity identifier in the HBS, but Roma is one of the catego- ries in the nationality question. RecentLabor Market, Poverty, and Inclusion Trends  |  35 (around 12 percentage points). If participating in the labor market, they are less likely to be employed, with unemployment gaps oscillating around 13 percentage points. When employed, the monthly labor income of a Roma individual age 25 – 64 with primary or less education is only 60 percent the income of the non-Roma counterpart. In Bulgaria, the outcomes are similarly stark, with labor force participa- tion gaps of 7 percentage points among those in working-age with secondary or more education, and employment gaps of around 10 percentage points. Estimates from FRA 2021 also suggest large differences in labor market outcomes among these two groups. The exclusion of Roma in the EU and enlargement countries is a complex issue rooted in socio-economic factors, discrimination, and ineffective poli- cies. Despite EU efforts to address Roma marginalization through frameworks and integration strate- gies, implementation has been challenging.12 Due to limited access to high-quality data13, research on Roma inclusion to support evidence-based policies remains scarce, and reliable data on Roma-focused programs are needed.14 The current societal benefits resulting from the inclusion of the Roma community could be substan- tial in the EU. Investing in the education, skills, and meaningful integration of the young and expand- ing Roma populace can yield significant economic advantages, especially in aging countries like those in the EU. Ensuring Roma inclusion entails enabling them to access equal social and economic pros- pects as the broader population. This encompasses not only ensuring that both male and female Roma attain comparable levels of education as the general population but also facilitating their access to equivalent economic opportunities. Attaining complete Roma inclusion would lead to heightened labor productivity, increased tax revenue, and ultimately reduced social protection expenditures for Roma households. Presently, Roma exclusion can translate into lost earnings within EU countries (see Box 2.1 for Details). BOX 2.1  The economic benefits of Roma inclusion Roma inclusion is important from the standpoint of social justice and human rights, but also from an eco- nomic perspective. It is crucial to emphasize the economic rationale for supporting social inclusion, highlight- ing the notion that failing to undertake efforts to foster inclusion is ultimately more costly.a The current soci- etal expenses resulting from Roma exclusion can be considerable, encompassing implications like diminished productivity growth, reduced fiscal revenue, and heightened social assistance spending. The exclusion of the Roma workforce from the labor market can translate to significant losses in productivity, as shown by evidence from other countries. Prior World Bank research examined the overall economic bene- fits of social inclusion experienced by the Roma population in Serbia. The findings indicated that if the Roma population of working age were to attain the same employment rates and labor earnings as the general pop- ulation, the potential gains from higher productivity alone could vary from €314 million to €1.28 billion annu- ally, representing approximately 0.9 percent to 3.5 percent of Serbia’s gross domestic product (GDP) in 2017.b Furthermore, Roma exclusion results in fiscal losses, including reduced tax revenues and increased social assistance expenditure. Enhancing equal labor market opportunities can generate fiscal savings by increas- ing tax revenue and reducing social assistance spending. These gains would be seen in higher social contribu- tions, income tax payments, and corporate tax revenues due to higher productivity. Additionally, there would be savings through reduced social protection payments for working-age individuals, excluding pensions. For 12 Iusmen, 2018. 13 Ethnicity is typically excluded from nationally representative household surveys, and administrative data are rarely dis- aggregated by ethnicity. Additionally, Roma individuals may not wish to self-identify as Roma, leading to undercounting in census data and under sampling in household surveys. 14 Robayo-Abril and Millan, 2019. 36  |  A Path to Inclusive Growth in the EU Serbia, previous evidence suggests potential fiscal benefits ranging from €78.1 million to €317.0 million (equiv- alent to 0.5 percent to 2.1 percent of government expenditure in 2017) resulting from increased tax revenue and reduced social assistance spending.c Quantifying the overall economic benefits of Roma inclusion is challenging. This difficulty arises from the uncertainties in estimating the size of the Roma population, which can vary significantly between official Census figures and unofficial estimates, such as those from the Council of Europe and others. Additionally, household surveys often lack ethnicity identifiers, making it harder to gather accurate data. Furthermore, eco- nomic models rely on various assumptions, and the parameters used for the Roma population may differ sub- stantially from those used for the general population. We focus on modeling one key aspect: how increasing the educational attainment and labor force partic- ipation rates of the working-age Roma in Bulgaria and Romania from 2022 to 2030 can help mitigate the decline in their labor force, ultimately benefiting the overall labor force in these countries. The overall labor force decline is driven by adverse demographic trends, such as population aging and outmigration. A shrink- ing working-age populations and labor force in these countries is a major concern; as more individuals reach retirement age, there are fewer working-age people available to fill jobs. This can lead to a shortage of skilled workers, economic slowdown, increased pressure on social security systems, and ultimately hinder economic growth. We chose these countries given the larger shares of Roma population and the availability of some ethnicity identifiers in the household surveys. Our approach relies on information on labor market outcomes from the available household surveys, population estimates from various sources (Census 2021, households surveys and Council of Europe), and UN Population projections (See Annex B for details). The baseline and policy scenarios are described below. • Baseline: This scenario assumes that the Roma will maintain the same low educational attainment and labor force participation rates currently observed, with no additional inclusion efforts from 2022 to 2030. As a result of a shrinking working-age population, the size of the labor force among the Roma is project- ed to decline, consistent with UN population projections (see Figure B2.1.1, panel a). • Scenario 1: This scenario assumes higher labor force participation rates among the Roma based on age and education, without adjusting their educational attainment levels. Specifically, it anticipates a year- ly increase of 1.6 percentage points in LFP among working-age (25 – 64) Roma across all education levels from 2021 to 2030. This increase helps stabilize the labor force, compensating for reduced growth in the working-age population (see Figure B2.1.1, panel b). • Scenario 2: In this scenario, we assume that the Roma have higher human capital, resulting in an in- creased share of Roma in the high-skill group. However, their labor force participation rates remain un- changed. More educated Roma are likely to engage more in the labor market, which could lead to a higher proportion of educated individuals within the labor force. Despite this, the overall labor force still declines due to an aging population; however, a larger share of the remaining labor force is more educat- ed and, therefore, more productive (see Figure B2.1.1, panel c). • Scenario 3: This scenario combines elements from Scenarios 1 and 2, assuming both higher human cap- ital and increased labor force participation rates among the Roma. In this scenario, labor force participa- tion increases sufficiently to offset the decline in the working-age population, while also increasing the proportion of better-educated individuals within the Roma labor force. This scenario is the most benefi- cial for counteracting adverse demographic trends, as it results in a larger, more educated Roma work- force, ultimately translating to higher productivity (see Figure B2.1.1, panel d). Similar results are obtained in Romania. These estimates suggest that implementing policies to enhance both educational attainment and labor force participation among the Roma could yield significant benefits. By focusing on inclusion efforts, not only can the decline in the Roma labor force be mitigated, but the overall productivity and economic contri- butions of this group can also be substantially improved. RecentLabor Market, Poverty, and Inclusion Trends  |  37 FIGURE B2.1.1  Projected numbers of working-age Roma in the Labor Force, Bulgaria, Baseline vs. Policy Scenarios (2022-2030) a. Baseline: No increase in LFP and human capital among b.Scenario 1: Increasing LFP among Roma Roma 300 300 in the labor force, thousands 250 Working age Roma (25–64) in the labor force, thousands Working age Roma (25–64) 250 200 200 150 150 100 100 50 50 0 0 2022 2023 2024 2025 2026 2027 2028 2029 2030 2022 2023 2024 2025 2026 2027 2028 2029 2030 c. Scenario 2: Assume higher human capital stocks among d. Scenario 3: Assume higher human capital stock and Roma labor force participation among Roma 300 300 in the labor force, thousands in the labor force, thousands Working age Roma (25–64) Working age Roma (25–64) 250 250 200 200 150 150 100 100 50 50 0 0 2022 2023 2024 2025 2026 2027 2028 2029 2030 2022 2023 2024 2025 2026 2027 2028 2029 2030 Low-skill High-skill Source: Own estimates based on Bulgaria, 2021 National SILC (2020 Income year). Low-skill is defined as having a primary education or less, while high-skill is defined as having a secondary education or more. Addressing the rising expenses associated with pensions, healthcare, and long-term care necessitates an expansion of the active population. Leveraging the Roma population, characterized by a high birthrate, can aid in replenishing the working-age demographic. However, this is contingent on providing sufficient opportu- nities for Roma to acquire human, physical, and social capital, and to participate in the labor market. Presently, the disparities between the Roma and the general population are substantial, necessitating a comprehen- sive effort to bridge these gaps. a. Robayo-Abril, M & Natalia Millan, 2019. “Breaking the Cycle of Roma Exclusion in the Western Balkans,” World Bank Publications—Reports 31393, The World Bank Group. b. World Bank, 2015. “Roma in Serbia, A Generation of Opportunities: The Economic and Fiscal Benefits of Roma Inclusion in the Western Balkans.” Background paper, World Bank, Washington, DC. c. World Bank (2015). 38  |  A Path to Inclusive Growth in the EU Poverty and inclusion trends: Significant progress but some challenges going forward The EU has made significant strides in poverty reduction. The poverty rate, defined as the percentage of the population living on less than $6.85/day in 2017 PPP, has halved from approximately 4 percent in 2009 to less than 2 percent in 2022,15 and more than 7 million people have been lifted out of poverty (Figure 2.13). Reflecting this remarkable achievement, the share of those vulnerable to economic shocks (orange area) and potentially falling into poverty16 has decreased significantly from about 10 percent to less than 5 percent of the population. Moreover, the percentage of the population considered middle- or upper-class17 has notably increased over these years (gray area). Similar positive trends have been observed in the anchored AROP (at-risk-of-poverty) measure (fixed in 2019), with poverty rates decreas- ing from around 21.5 percent to 14.1 percent across the region during the same period.18 Countries that initially had higher levels of absolute poverty tend to experience faster poverty reduction. From 2009 to 2022, several EU countries, notably Lithuania, Latvia, and Estonia, experienced a strong reduc- tion in absolute poverty (Figure 2.14). The decrease in poverty is positively associated with their initial pover- ty levels. This pattern of unconditional poverty convergence indicates that poorer EU members are catching up with wealthier ones. This means that over time, as economic growth occurs, lower-income countries tend to catch up with higher-income countries in terms of poverty levels, regardless of other influencing factors, and the pattern is partly related to the GDP per capita convergence mentioned in section 1. However, the rate FIGURE 2.13  Poverty and Vulnerability have FIGURE 2.14  The evolution of poverty shows decreased substantially in the EU unconditional convergence across the EU Evolution of economic classes, EU27, 2009 – 2022 Poverty rate change between 2009 and 2022 and initial poverty rate in 2009 100 1.0 Percent of the population 80 FI Poverty Change (2009-2022), Percent 0.5 EL SK 60 SE AT HU PT 0.0 SI LU NL ES 40 FR IT BE MT DK −0.5 CZ 20 EE BG 0 −1.0 HR PL 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 RO −1.5 IE LT LV Income > US$14/day Income Between US$6.85/day and US$14/day −2.0 −3 −2 −1 0 1 2 3 4 Income < US$6.85/day Log Initial Poverty Rate ($6.85/day), 2009 Source: World Bank calculation based on EU-SILC 2010 – 2023. Note: The figure excludes Germany, for which microdata is not Source: World Bank calculation based on EU-SILC 2010 and available. Netherlands is also excluded in 2022, as microdata was 2023. not available. We define those at risk of falling into poverty as Note: We use the 6.85 USD 2017 PPP poverty line to compare by those whose incomes are between US$6.85/day and US$14/day.  periods and across countries. 15 2022 refers to the income reference year based on the 2023 EUSILC-survey year. No more recent estimates are available. 16 Vulnerability to poverty is defined as those living with US$6.85–$14 per day in 2017 purchasing power parity prices. This is an operational measure developed by the World Bank. 17 Identifying a middle class is challenging within a country and even more so in a global or regional context. Different approaches give rise to wildly differing estimates and understandings of the middle class. Therefore, we do not distinguish between the mid- dle and upper classes. There is underreporting of income at the top and under coverage of richer households in household surveys. 18 The anchored AROP for the EU excludes Germany, for which microdata is not available. RecentLabor Market, Poverty, and Inclusion Trends  |  39 of convergence is not uniform. Countries like Romania (RO) and Latvia (LV), which had higher initial poverty rates, show the most significant reductions in poverty. In contrast, Bulgaria, despite starting from high pov- erty levels in 2009, has made slightly less progress in reducing poverty compared to other EU countries with similar initial income levels. Considering the differentiated impacts of the war in Ukraine across countries, regions, and population subgroups, it is essential to continue monitoring convergence dynamics over time. EU member states have also witnessed inclusive FIGURE 2.15  The EU has witnessed a marked growth, leading to a substantial reduction in ine- reduction in inequality quality across the region. Over the span of thirteen Evolution of income inequality, EU27, 2009 – 2022 years, from 2009 to 2022, the Gini index exhibited 38 a notable decline, from approximately 36.7 to less 37 than 32.1 (Figure 2.15). This positive trend in pov- 36 erty and inequality reduction has been driven by 35 Gini index an increase in the income of the less well-off. Eco- 34 nomic growth has been slightly pro-poor, with in- 33 come for the bottom 40 percent of the population 32 on the income distribution growing at an annual- 31 ized rate of over 3.3 percent between 2016 and 2022 30 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 on average (Figure 2.16). This growth outpaced the average population’s income growth by approxi- Source: World Bank calculation based on EU-SILC 2010 – 2023. mately 0.3 percentage points on average over the Note: The figure presents the Gini index (adult equivalent) of same period. This trend towards more equitable in- disposable income for the EU27, excluding Germany. The 2022 come growth, with faster increases among the less estimate also excludes Netherlands. A Gini index equal to zero means perfect equality, while a Gini index equal to 100 means well-off, has been observed across most EU member complete inequality. states, contributing significantly to poverty reduc- tion. Some countries, such as Bulgaria, Romania, Ireland and Spain have achieved large, shared pros- perity premiums.19 Moreover, the prosperity gap, defined as the average factor by which incomes must be multiplied to attain a prosperity standard of $25, has decreased in most EU countries. In particular, Bulgaria and Romania have experienced notable reductions, with Bulgaria’s prosperity gap dropping from 3 in 2015 to 1.4 in 2022, while Romania’s dropped from 3.9 to 1.7 in the same period. FIGURE 2.16  Most EU countries witnessed substantial income growth among the less well-off Annualized growth in income per capita for the bottom 40 percent and the overall population (percent), EU27, 2016 – 2022 14 12 10 8 Percent 6 4 2 0 −2 RO BG LT HR PL HU LV EL IE SI CY ES PT EE IT BE CZ LU MT AT FI DK SE FR SK Growth B40 Mean growth Source: World Bank calculation based on EU-SILC 2017 and 2023. Note: “Growth B40” represents the average annualized growth of per capita income for the bottom 40 percent, while “Mean growth” represents the average annualized growth rate of per capita income for the entire population. The figure excludes Germany, for which microdata is not available. 19 The Shared Prosperity Premium is defined as the difference between the annual income growth of the bottom 40 percent and the mean income growth of a country. 40  |  A Path to Inclusive Growth in the EU Expanding employment opportunities and rising labor income have significantly contributed to pov- erty reduction in recent years, but almost one-tenth of all workers across the EU27 remain at-risk-of- poverty. As in most economies, labor is the most important income source for European households. Labor earnings constituted a primary income source for the poor that year, with approximately one- third of the lowest quintile’s income stemming from labor incomes. Job opportunities and earnings saw considerable growth, particularly among those at the bottom of the income distribution, contributing to approximately 44 percent, on average, of the observed poverty reduction between 2016 and 2021 using the anchored AROP line of 2019. Despite these advancements, labor-market challenges remain, prompting a deeper exploration of labor-market dynamics. In the 2022 income year, 8.3 percent of all EU-27 workers aged 18 – 64 lived in households that were at risk of poverty.20 Since 2009, Bulgaria, Croatia, Poland, and Romania have significantly reduced the proportion of their population that sits at the lower levels of the EU’s income distribution, although substan- tial gaps persist. Following their integration into the EU, most of the population of these countries fell into the EU’s bottom 40 percent by income: the proportion stood at 96 percent of the population in Romania, 87 percent in Bulgaria, 75 percent in Poland, and 72 percent in Croatia (Figure 2.17). By 2022, these countries had improved their economic conditions, with the proportion of individuals living at the bottom of the EU’s income distribu- FIGURE 2.17  Most individuals in Bulgaria, tion ranging from 45 percent in Poland to 76 per- Croatia, Poland, and Romania are at the lower cent in Romania. Despite these advances, further end of the EU’s income distribution, but there efforts are required to overcome persistent spa- have been steady improvements over time tial disparities within the EU and foster economic Share of the population of each country in the EU’s bottom 40 convergence throughout the EU. 100 Going forward, the sectoral shifts in employment 90 and the cost-of-living crisis could have adversely impacted the bottom 40 percent of households 80 (B40) in four Central and Eastern European economies (4CEEs). As shown in section 2.1, since Percent 70 2019, there has been a steady decline in employ- ment within key sectors such as mining, quarry- 60 ing, manufacturing, and agriculture, where many lower-income individuals work, limiting job 50 opportunities for the B40, particularly for those with lower education or skills relevant to these 40 industries. Additionally, inflation is expected to 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 disproportionately affect poorer households, as their spending primarily focuses on essentials like BG HR PL RO food and utilities, which experienced some of the Source: World Bank calculation based on EU-SILC 2010 and 2023. steepest price increases. Note: The figure provides a relative comparison over time of the proportion of individuals (adult equivalent) in each country who After the economic rebound in 2021, the escalation are among the bottom 40 percent of the population in 26 EU countries (EU27 excluding Germany). of food prices has emerged as a pressing concern for households in the region, particularly those on lower incomes. In recent years, there has been a notable uptick in inflation, leading to a detrimen- tal effect on real wages. By September 2024, consumer prices in the four countries considered in this analysis — namely Bulgaria, Croatia, Poland, and Romania — had surged by over 24 percent compared 20 Source: Eurostat, https://ec.europa.eu/eurostat/databrowser/view/ilc_iw01/default/table?lang=en RecentLabor Market, Poverty, and Inclusion Trends  |  41 to before the inflation crisis in September 2021 (Figure 2.18). This steep price rise can primarily be attrib- uted to the rapid inflation in food prices during the same period, resulting in an increase of more than 35 percent in these four EU countries. The escalation in food prices is expected to have worsened pov- erty and compromised food security.21 FIGURE 2.18  Food and energy prices have experienced a significant cumulative rise in recent years Evolution of prices (index), January 2019 – September 2024 a. Bulgaria b. Croatia 200 200 180 180 160 160 2015 = 100 2015 = 100 140 140 120 120 100 100 80 80 01/2019 05/2019 09/2019 01/2020 05/2020 09/2020 01/2021 05/2021 09/2021 01/2022 05/2022 09/2022 01/2023 05/2023 09/2023 01/2024 05/2024 09/2024 01/2019 05/2019 09/2019 01/2020 05/2020 09/2020 01/2021 05/2021 09/2021 01/2022 05/2022 09/2022 01/2023 05/2023 09/2023 01/2024 05/2024 09/2024 c. Poland d. Romania 200 200 180 180 160 160 2015 = 100 2015 = 100 140 140 120 120 100 100 80 80 01/2019 05/2019 09/2019 01/2020 05/2020 09/2020 01/2021 05/2021 09/2021 01/2022 05/2022 09/2022 01/2023 05/2023 09/2023 01/2024 05/2024 09/2024 01/2019 05/2019 09/2019 01/2020 05/2020 09/2020 01/2021 05/2021 09/2021 01/2022 05/2022 09/2022 01/2023 05/2023 09/2023 01/2024 05/2024 09/2024 HICP index: Total Food Energy Source: Eurostat (prc_hicp_midx), 2019 M1 – 2024 M9. “Food” includes food and non-alcoholic beverages, and energy includes electricity, gas and other fuels. Despite the recent reduction in food inflation, it remains a critical issue for the poor, as current price levels are still historically high. The poor, already struggling to recover from the economic fallout of the COVID-19 crisis, were hit again by the inflationary shock, creating a chain of setbacks that hinder a return to pre-pandemic conditions. Going forward, the poor may continue to face challenges in managing high cost of living costs, compounded by the likelihood of tighter fiscal space, which could further constrain social assistance programs and limit support for vulnerable populations. Households’ vulnerability to higher prices depends not only on price increases but also on income and consumption patterns. Given that the harmonized index of consumer prices (HICP) monitors the expens- es associated with a representative basket of goods, the index provides a reasonable estimate of the infla- tion experienced by an average household. As such, overall inflation and food inflation may not accurate- ly mirror the inflation experienced by the less well-off, as their spending habits diverge from those of the 21 Energy prices have also risen significantly in recent years, especially in Poland and Romania. The distributional effects of these higher energy prices have already been analyzed in the previous EU RER (https://www.worldbank.org/en/region/eca/ publication/eurer#:~:text=The%20EU%20Regular%20Economic%20Report,countries%20(EU%2DCEE)). Consequently, this analysis now shifts its focus to the poverty and distributional impact of higher food prices in these four countries. 42  |  A Path to Inclusive Growth in the EU average household. The less well-off spend a larger share on food, which creates a challenge to cope with higher prices. For instance, in Romania, the first decile allocates approximately 51 percent of its expendi- ture to food, whereas in Poland, it is around 38 percent (Figure 2.19). In contrast, those in the top decile in these countries spend only about 25 and 13 percent FIGURE 2.19  Food inflation can affect the less of their overall expenditure on food items, respec- well-off relatively more tively. Consequently, it is foreseeable that the poor- Household consumption expenditure on food and nonalcoholic est decile would consistently experience higher food beverages (percent consumption) inflation rates compared to the average population 60 and the wealthiest decile. This implies that food in- Percentage of consumption 50 flation has the potential to result in more significant 40 welfare losses for low-income individuals, render- expenditure 30 ing them more vulnerable to these types of shocks. 20 Given that a substantial portion of their income is 10 allocated to essentials, the less well-off have lim- 0 ited flexibility to navigate through food price hikes. BG HR PL RO Households confront the significant task of safe- Lowest decile Top decile guarding themselves against sudden price fluc- Source: World Bank calculations using harmonized HBS data. Note: Years are: Bulgaria 2019, Croatia 2017, Poland 2019, and tuations that could deeply affect their financial Romania 2019. stability. In Romania and Croatia, over 40 percent of survey participants expressed their inability to manage unforeseen expenses in 2022 — the highest share among EU countries (Figure 2.20). In Poland, approximately 30 percent struggled significantly. The situation was more severe for those on lower in- comes. In Romania and Croatia, roughly 80 percent of individuals earning less than 60 percent of the median equivalized income found themselves ill-prepared to handle unexpected financial burdens, while in Poland, the corresponding percentage exceeds 45 percent. FIGURE 2.20  Many poor households are vulnerable to shocks as they are unable to face unexpected expenses Economic strain, inability to face unexpected financial expenses, 2022 100 Percentage of the population 80 60 40 20 0 RO HR LV EL BG CY LT ES IE HU DE IT FR EE PT PL SK SI FI BE SE DK AT LU CZ MT NL Total Below 60% of median equivalised income Source: Eurostat (ILC_MDES04), 2022. The impact of rising food prices disproportionately affects the less well-off.22 According to microsimu- lation findings (see Box 2.2 for details), the direct short-term consequence of food price inflation is wel- fare reduction across all four countries. A hypothetical food price hike of approximately 20 percent (a 22 The simulations are not direct observations, but rather estimates representing our best assessment of the potential pover- ty and distributional impacts of rising food prices. These figures should be viewed as best estimate of what might have oc- curred under specific assumptions, and several channels of transmission cannot be modeled (see Box 2.2 for details). RecentLabor Market, Poverty, and Inclusion Trends  |  43 baseline scenario) is anticipated to result in a short-term increase in poverty rates — measured at the upper-middle-income poverty line of $6.85/day in 2017 PPP terms — of 0.25 pp in Poland and 1.4 pp in Romania (Figure 2.21). The increases in poverty rates become even more pronounced with hypothetical food price increases of 30 and 40 percent. In the former scenario, poverty rates increase range from by 1.7 pp. in Bulgaria to and 2 pp. in Romania. In the latter scenario, these rates climb from 2.4 pp. to 3.5 pp. in both countries, respectively. FIGURE 2.21  Food inflation could lead to significant increases in poverty Simulated poverty rates, pre-shock vs post-shock food inflation scenarios, $6.85 poverty line (2017 PPP) BG HR PL RO 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Poverty rate Pre-shock Post-shock (20%) Post-shock (30%) Post-shock (40%) Source: World Bank staff simulations based on HBS-2019 and EUSILC-2020 for Bulgaria and Romania, while for Poland is based on HBS and EUSILC of 2019 and for Croatia is based on HBS-2017 and EUSILC-2020 surveys. Note: Welfare is estimated in U.S. dollars using 2017 PPPs in all countries. “Pre-shock” refers to poverty rates before food prices increase, and “Post-shock” refers to a simulated poverty rates after food price increases of 20 percent, 30 percent, and 40 percent. The figure does not assume government support. BOX 2.2  Simulating the distributional impact of rising food prices This section examines the welfare implications of escalating food prices and explores potential government responses. To assess the distributional effects of higher food costs, this analysis relies on the most recent rounds of household surveys conducted in Bulgaria, Croatia, Poland, and Romania, specifically the Household Budget Surveys and EU-SILC. This data enables an examination of food expenditure patterns across differ- ent demographic and income groups. The analysis evaluates changes in the overall consumer surplus in response to increases in food prices.a As such, the results of these simulations should be interpreted as short-term marginal welfare impacts.b Recognizing that some households can adjust their food consumption in response to price fluctuations, we consider a price elasticity of food demand of –0.25 for households above the third decile of the income distri- bution, and of zero for households below the third decile.c Additionally, the simulations can be further refined to account for any government transfers received by households.d Given the data limitations, it is not possible to take into account within-country spatial variation in prices, which could be an additional source of distributional impacts. Unfortunately, there are no subnational Consumer Price Indexes (CPIs) in the four EU countries considered. Subnational data, especially for food CPIs, would be valuable for a more granular understanding of regional disparities and convergence in eco- nomic conditions. The simulations account only for the consumption impact of rising food prices, overlooking households’ role as food producers. This provides a partial picture of the overall effects, as it does not capture the potential benefits some households might experience through increased income from food production. Consequently, the analysis may underestimate the positive impact higher food prices could have on pro- ducer-consumer households. 44  |  A Path to Inclusive Growth in the EU Furthermore, the simulations do not account for any behavioral changes, and capture first-order effects, meaning the direct, immediate impacts without factoring in any secondary or adaptive responses that might occur over time. This means we do not model how consumers might adjust their spending patterns by substituting towards other goods in response to rising food prices. This limitation restricts the analysis to the direct effects of price increases without considering how individuals or households might adapt to mitigate these adverse welfare impacts. Annex A presents more details on the methodology. a. Deaton, A. ‘Rice prices and income distribution in Thailand: A non-parametric analysis’, Economic Journal, Vol. 99, (1989) pp. 1–37. b. Ferreira, F., A. Fruttero, P. Leite, and L. Lucchetti. 2013. “Rising Food Prices and Household Welfare: Evidence from Brazil in 2008.” Journal of Agricultural Economics. 64 (1), 151-176. c. Freund, Caroline, and Christine Wallich. 1996. “The welfare effects of raising household energy prices in Poland.” The Energy Journal, Vol. 17, No 1, pp. 53-77. d. Ferreira et al., 2013. Rising food prices exacerbate income inequality. Certain demographic groups are simulated to expe- rience more significant impacts from rising food prices. For instance, in Poland, Croatia, and Romania, rural households are particularly vulnerable to this shock.23 A 20 percent rise in food prices is project- ed to temporarily increase the Gini index by 0.75 FIGURE 2.22  Income inequality is expected and 0.34 in Bulgaria and Croatia, respectively (Fig- to increase in the absence of government ure 2.22).24 Income inequality increases even fur- measures ther with food price increases of 30 percent and 40 Simulated changes in income inequality—measured by the Gini percent. The increase in inequality is the result of index—due to food inflation an asymmetric impact on welfare across the entire 1.6 income distribution. On average, welfare impacts 1.4 are notable, ranging from a 4.4 percent decline in 1.2 Poland to a 7.5 percent decline in Romania (Figure 2.23).25 However, these impacts exhibit a regres- Gini change 1.0 0.8 sive pattern in all countries, with welfare reduc- 0.6 tions ranging from approximately 10.3 to 7.7 per- 0.4 cent in the poorest decile and from about 5 to 2.6 percent in the top decile. 0.2 0.0 BG HR PL RO Existing social transfer programs could alleviate the negative welfare impact of economic shocks. Post-shock (20%) Post-shock (30%) Simulations show that the adverse effects of higher Post-shock (40%) food prices on the extreme poor (those in the first Source: World Bank staff simulations based on HBS-2019 and EUSILC-2020 for Bulgaria and Romania, while for Poland is decile) can be partially mitigated through govern- based on HBS and EUSILC of 2019 and for Croatia is based on ment interventions. For instance, increasing the HBS-2017 and EUSILC-2020 surveys Guaranteed minimum income (GMI) benefit trans- Note: Welfare is estimated in U.S. dollars using 2017 PPPs in all countries. “Post-shock” refers to a simulated increase fers serves as a coping measure to mitigate the in inequality rates after food price increases of 20 percent, income reduction experienced by the less well- 30 percent, and 40 percent. The figure does not assume government support. off (Figure 2.23). However, since these transfers 23 However, simulations do not consider households as food producers, which may lead to an overestimation of the rural impact. 24 The Gini index is a statistical measure of inequality that ranges from 0 to 100, where higher values represent a higher degree of equality. 25 The price change incidence curve (Ferreira et al. 2012) depicts the percentage reduction in income at each percentile of the income distribution and is equivalent to the growth incidence curve developed by Ravallion and Chen. 2003. ‘Measuring pro-poor growth’, Economics Letters, Vol. 78 (pp. 93–99.). RecentLabor Market, Poverty, and Inclusion Trends  |  45 predominantly target individuals with lower incomes, most of the mitigating impact occurs within the first decile of the income distribution in most countries, with limited benefits for the other income groups. Most of the new poor that result from higher food prices would not be covered by these pro- grams. As such, increasing benefits for existing beneficiaries would effectively bolster their income but leave a significant portion of the population without protection. Expanding the coverage to assist the newly impoverished could effectively contain the rise in poverty rates. However, it is not always simple to expand coverage, as it may also potentially contribute to increased inequality among those in pover- ty. Section 3 provides a further discussion on the role of the social protection systems in tackling poli- cy challenges going forward. FIGURE 2.23  Household income is expected to fall along the welfare distribution Percentage reduction in income at each decile of the income distribution from food price shock and increase in GMI 6 4 2 0 Percent −2 −4 −6 −8 −10 −12 BG 1 BG 2 BG 3 BG 4 BG 5 BG 6 BG 7 BG 8 BG 9 BG 10 HR 1 HR 2 HR 3 HR 4 HR 5 HR 6 HR 7 HR 8 HR 9 HR 10 PL 1 PL 2 PL 3 PL 4 PL 5 PL 6 PL 7 PL 8 PL 9 PL 10 RO 1 RO 2 RO 3 RO 4 RO 5 RO 6 RO 7 RO 8 RO 9 RO 10 BG HR PL RO Deciles of welfare distribution Food Shock (20%) Increasing GMI Source: World Bank simulations based on most recent surveys. Note: Welfare is estimated in U.S. dollars using 2017 PPPs. The figure shows the simulated welfare percentage changes after the food price increases. “Food Shock (20 percent)” refers to a simulated impact after a food price increase of 20 percent, while “Increasing GMI” refers to the impact after expanding GMI benefits by 50 percent. For GMI identification, the variable “social exclusion not elsewhere classified” from the EU-SILC is used. Financial inclusion can also help alleviate the impact of unexpected shocks. Access to financial ser- vices allows individuals and businesses to save money securely, send and receive payments, and access investment opportunities. It promotes the inclusion of different groups, such as women and rural pop- ulations, and empowers low-income individuals by providing tools to manage their finances and invest in education, healthcare, and small businesses, thereby improving their livelihoods. Financial inclu- sion also helps low-income families manage risks and shocks, such as medical emergencies, natural disasters, and/or higher prices. In the European countries considered, the share of individuals with a financial account has steadily increased between 2011 and 2021, although the less well-off still face substantially lower ownership rates. Before the rise in inflation, account ownership rates for the poorest 40 percent ranged from 57 percent in Romania to 94 percent in Poland in 2021 (Figure 2.24). A large share of Roma does not have a bank account,26 contributing to their vulnerability. Despite the improvement in ownership rates since 2011, the gap with the richest 60 percent has decreased in Poland along, among the countries considered. Moreover, access to accounts in Croatia, Poland, and especially Bulgaria and Romania, is much lower than in the Euro area. Expanding the access (and use) of financial services to the less well-off may be a relevant tool to tackle the unequal distributional impacts of shocks. 26 FRA, 2022. 46  |  A Path to Inclusive Growth in the EU FIGURE 2.24  Account ownership has increased significantly, yet disparities persist Ownership of Account or use of mobile-money service provider for in selected EU countries, 2011 – 2021 100 Percentage of respondents 80 60 40 20 0 BG 2011 BG 2014 BG 2017 BG 2021 HR 2011 HR 2014 HR 2017 HR 2021 PL 2011 PL 2014 PL 2017 PL 2021 RO 2011 RO 2014 RO 2017 RO 2021 EU 2011 EU 2014 EU 2017 EU 2021 BG HR PL RO Euro Area Bottom 40% Top 60% Source: Global Findex Database. More recent data is not available. Note: This figure shows the percentage of respondents who report having an account (either individually or jointly) at a bank or another type of financial institution, or who report personally using a mobile money service in the past year. The less well-off borrow relatively less from financial institutions, and the gap has increased over time. Loans can help individuals smooth consumption, particularly during challenging economic times. How- ever, borrowing rates remain low, especially among the less well-off. In 2021, the loan rates for the poor- est 40 percent ranged from less than 15 percent in Romania to almost 30 percent in Poland, while for the richest 60 percent of the population, the rates ranged from about 22 percent in Bulgaria to about 40 per- cent in Croatia. Moreover, the gap in borrowing rates between these groups has been increasing over time, even in the Euro area (Figure 2.25). FIGURE 2.25  Borrowing has increased, though it remains low, and the gaps have widened Respondents who report borrowing any money or using credit card in selected EU countries, 2011 – 2021 100 Percentage of respondents 80 60 40 20 0 BG 2011 BG 2014 BG 2017 BG 2021 HR 2011 HR 2014 HR 2017 HR 2021 PL 2011 PL 2014 PL 2017 PL 2021 RO 2011 RO 2014 RO 2017 RO 2021 EU 2011 EU 2014 EU 2017 EU 2021 BG HR PL RO Euro Area Bottom 40% Top 60% Source: Global Findex Database. More recent data is not available. Note: This figure shows the percentage of respondents who report borrowing any money from a bank or another type of financial institution or using a credit card in the past year. Lack of access to financial instruments can hinder poor households’ ability to cope with unexpected shocks and overcome hardships, affecting their investment opportunities. In 2021, over 37 percent of the poorest individuals in Bulgaria, Croatia, Poland, and Romania were worried about not being able to pay RecentLabor Market, Poverty, and Inclusion Trends  |  47 for medical costs in case of a serious illness or accident. Similarly, more than 20 percent were concerned about being unable to pay education fees in Poland and Bulgaria. Moreover, the gap between the poorest and the richest 60 percent was substantial and higher than in the Euro area in most cases (Figure 2.26). FIGURE 2.26  The less well-off worry that they will not be able to access basic services a. Verry worried about not being able to pay school fees or fees b. Verry worried about not being able to pay for medical costs for education, selected EU countries, 2011 – 2021 in case of a serious illness or accident, selected EU countries, 2011 – 2021 70 70 60 60 50 50 40 Percent 40 Percent 30 30 20 20 10 10 0 BG HR PL RO Euro area 0 BG HR PL RO Euro area Bottom 40% Top 60% Bottom 40% Top 60% Note: This figure shows the percentage of respondents who report having an account (either individually or jointly) at a bank Note: This figure shows the percentage of respondents who or another type of financial institution, or who report personally report borrowing any money from a bank or another type of using a mobile money service in the past year. financial institution or using a credit card in the past year. Source: Global Findex Database. Chapter 3 The EU outlook remains weak in the near term, and downside risks continue to dominate 50  |  A Path to Inclusive Growth in the EU The EU economy is expected to pick up, albeit from weak levels of activity After a sharp slowdown in 2023, a consumption-led recovery remains in the baseline, supported by real disposable income growth and tight labor markets, accompanied by a gradual loosening of finan- cial conditions. Growth is forecast to firm only slightly in 2024, to 0.7 percent,27 supported by an ongoing recovery in real incomes but dampened by still-subdued investment, particularly for housing, and export growth. As a result, manufacturing activity is anticipated to remain weak in the near term. Consumer spending is expected to edge higher in 2024, as inflation declines and wages continue to rise, albeit at a more moderate pace than before. Having said that, the European Central Bank (ECB) forecasts the over- all contribution of household consumption to the outlook to be a bit weaker than earlier projected. This is explained by somewhat weaker incoming data as well as recent survey data pointing to still subdued consumer confidence and stubborn household savings intentions. Savings remain above pre-pandemic levels given the absence of notable dissaving of pandemic-induced savings, with a large share of the savings accumulated by the richest households in illiquid assets.28 As headwinds from earlier shocks fade, growth is anticipated to outpace that of potential output — which should help close the negative output gap — with the pickup driven in large part by private consump- tion. Growth is forecast to pick up in 2025, to 1.4 percent, as the recovery in export and investment growth gathers pace, with the latter benefiting from lower policy rates and the absorption of EU funds but still constrained by elevated political uncertainty. Export growth is anticipated to improve alongside global trade (though not without risks)29, but to remain somewhat subdued by historical standards amid slight euro appreciation and lingering competitiveness issues. Nevertheless, private consumption is expect- ed to underpin the strengthening in growth as it continues to benefit from a resilient labor market and, eventually, from firming consumer confidence as FIGURE 3.1  Euro area output gap estimates real wages catch up, albeit at a slower pace than 2 before. In 2026, economic activity is projected to expand at a relatively stable pace of 1.3 percent, 1 slightly above potential growth estimates as reforms Percent of potential output 0 under the EU’s NextGenerationEU plan start to bear −1 fruit, with growth benefiting from rising green and −2 digital investments. Private consumption is set to remain an important driver of growth as house- −3 hold spending and savings continue to normalize. −4 Over the near term, the cyclical pick-up in growth, −5 which is anticipated to outpace that of underlying potential growth, should help narrow the negative −6 output gap (Figure 3.1).30 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 The negative impact of earlier monetary policy 90 percent 60 percent 30 percent Output gap tightening is anticipated to gradually ease over the Source: Kilic Celik, Kose, Ohnsorge, and Ruch (2023). Based on forecast horizon. The impact of the monetary policy the multivariate filter model of Kilic Celik et al. (2023). tightening that took place between December 2021 27 Euro area growth is subject to further revisions, and will be re-estimated for the World Bank’s January 2025 edition of Global Economic Prospects. 28 ECB 2023. 29 World Bank 2024. 30 Kilic Celik, Kose, Ohnsorge, and Ruch (2023). The EU outlook remains weak in the near term, and downside risks continue to dominate  |  51 and September 2023 continues to feed through to the real economy, affecting the growth outlook — par- ticularly for 2024. Although the ECB has started to cut its policy rates — first in June and then again in Sep- tember of 2024 — the impact of these cuts will feed through the economy gradually, with credit conditions only materially loosening later in the forecast horizon given the lag in monetary policy transmission. In addition to the end of the monetary tightening cycle, fiscal policy is assumed to be slightly less of a drag on growth than under previous projections. The fiscal stance (measured as the change in the cyclically adjusted primary balance) is expected to be in slightly expansionary territory over the fore- cast horizon despite the withdrawal of a large part of energy and inflation support measures, on account of slower than previously projected consolidation. However, the fiscal assumptions underlying ECB and European Commission forecasts are surrounded by considerable uncertainty pending the announce- ment of 2025 budget plans (DBPs) in most euro area countries and the implementation of the revised economic governance framework. The baseline only takes into account planned and announced fiscal policy measures and fiscal plans. While needed from the fiscal and debt sustainability perspective, a further fiscal tightening under the EGF — especially for countries in Excessive Deficit Procedures (EDPs) –presents a downside risk to baseline growth in the short term. The disinflation process is anticipated to continue, with inflation reaching the target by the end of 2025, albeit at a slower pace than before amid sustained pressure on core inflation. Overall, the ECB projects average annual headline (HICP) inflation to slow from 5.4 percent in 2023 to 2.5 percent in 2024, 2.2 percent in 2025, and 1.9 percent in 2025. However, core inflation has been revised up marginally for both 2024 and 2025, to 2.9 percent in 2024, 2.3 percent in 2025, and 2.0 percent in 2026. Core inflation has been somewhat more persistent than expected, owing in part to stubbornly high services inflation. Nevertheless, the ECB expects a gradual slowing in core inflation over the forecast horizon, with wage growth and other cost pressures easing. Profit growth has declined notably and is assumed to partially buffer the pass-through of labor costs to prices, especially this year. Nominal wage growth has started to decline from elevated levels by a bit more even than anticipated, as the impacts from inflation compen- sation pressures due to a tight labor market fade. Labor cost pressures are expected to moderate along- side an improvement in labor productivity. Despite the projected pickup in labor projectivity growth, the level of productivity per person employed is anticipated to remain below the 2000 – 19 average over the next few years31. Still, the envisioned improvement to labor productivity growth could be curbed by structural factors, including the gradual reallocation of economic activity towards the services sector, the cost of the green transition, lingering impacts from the energy price shock, slower-than-expected adoption of new technologies, and a worsening of demographic trends. Risks to the EU outlook remain tilted to the downside Globally, risks to the outlook have become somewhat more balanced, given the continued resilience of the global economy to high financing costs but remain tilted to the downside amid heightened uncer- tainty (Box 3.1). Worsening conflicts or escalating geopolitical tensions could have adverse impacts on global growth through commodity markets, trade, and financial linkages. Further trade fragmentation amid resurgent inward-looking policies carries the risk of additional disruptions to trade networks, supply chains, and economic activity. Conflict-related disruptions to oil supply from the Middle East could result in sizable oil price increases — in a more severe scenario, this could stall progress on global 31 ECB 2024. 52  |  A Path to Inclusive Growth in the EU disinflation this year. Globally, trade policy uncertainty has risen to levels higher than those in other years with major elections since 2000. Among new trade-distorting policies, the use of subsidies has risen sharply since the pandemic. Advanced-economy interest rates are expected to remain well above 2000 – 19 average levels. Persistent core inflation in these economies could see interest rates remain higher for longer, substantially lowering global growth in 2025 by forestalling anticipated monetary eas- ing and tightening financial conditions. BOX 3.1  Global outlook Global growth is expected to remain steady in 2024. According to the June 2024 edition of the Global Economic Prospects, global growth is projected to hold steady at 2.6 percent in 2024, despite flaring geopo- litical tensions and elevated financing costs, before edging up to 2.7 percent in 2025 – 26 alongside modest expansions in trade and investment. Following several years of overlapping negative shocks, the forecasts indicate signs of a stabilizing global economy. By historical standards, however, the global outlook remains subdued; growth in both advanced economies and EMDEs is expected to grow at a slower pace over the fore- cast horizon compared to the decade before the pandemic. High-frequency indicators point to firming global activity, although with increasing divergence across sec- tors. The global composite Purchasing Managers’ Index (PMI) has remained in expansionary territory since October 2023, with a pickup in services activity offsetting a further decline in the manufacturing sub-index. The gap between global services and manufacturing outturns by August 2024, was the largest in over a year. The weakening in manufacturing activity has been broad based, with PMIs in China, United States and the Euro area in contractionary territory for most of the year. Global headline consumer inflation decelerated at 3.5 percent in 2024 and is expected to continue easing (in line with average inflation targets), amid softening core inflation and modest decline in commodity prices. Latest incoming data point to global median head- line inflation continuing its downward trajectory, easing at 3.4 percent (y/y) in August 2024. Global trade is projected to pick up after pronounced weakness last year. Global trade is expected to expand by 2.5 percent in 2024, and 2.4 percent in 2025, after nearly stalling in 2023. By historical standards, however, global trade growth in 2020 – 24 is set to register as the slowest half decade of growth since the 1990s. Global goods trade has shown signs of recovery in 2024, after a sharp contraction in 2023, with volumes increasing by 1.8 percent (y/y) in June, driven by strengthening growth in emerging market and developing economies that offset the continued contraction in most advanced economies. Services trade growth continued to mod- erate in 2024, after increasing by 9 percent in 2023, reflecting a slowdown in travel services. Despite a sharp increase in maritime transit and freight rates amid the ongoing disruptions in the Panama and Suez Canals, these elevated rates have not significantly increased supply chain pressures or global delivery times, partly due to the frontloading of imports into the United States in anticipation of potential global trade disruptions. Nevertheless, the number of implemented trade policy interventions restricting trade remains five times higher than the 2010 – 19 average, although slightly lower than in 2023, weighing on global trade.  Global financial conditions have generally eased since 2023. By mid-2024, the United States began reduc- ing policy rates amid softening labor markets and easing inflation. Market expectations for U.S. policy rates for 2025 – 26 have been revised down significantly since June, narrowing the divergence in economic activity with other advanced economies. Reflecting these developments, the U.S. dollar in September has depreciated by 5 percent since June, which has alleviated some pressure for EMDE currencies. Risk appetite remains robust in advanced economies and EMDEs with strong credit ratings, while financial stress concerns remain acute in about 40 percent of EMDEs with weak credit rating or in high debt distress. In China, risk appetite remains subdued amid weak domestic demand and a sluggish recovery in the property sector.  Global commodity prices have continued to ease in 2024, reflecting improving supply conditions and softer-than-anticipated global industrial activity. Brent crude oil prices have fluctuated this year, surpass- ing US$90/bbl in April in the context of escalating tensions in the Middle East, but have declined to US$73/bbl by September, as slowing economic activity and reduced oil consumption in China, combined with softening U.S. growth, put downward pressure on prices. In response to declining oil prices, OPEC+ members recently announced a delay to the planned unwinding of voluntary cuts for at least two months. The price of European The EU outlook remains weak in the near term, and downside risks continue to dominate  |  53 natural gas has declined by 25 percent compared to last year, averaging $10/mmbtu so far this year, reflecting robust production, mild winter weather, and elevated inventories. However, recent data points to a pick-up in prices by 20 percent (m/m) in August, highest level this year, reflecting some supply disruptions and concerns about further gas flow disruptions from Russia through Ukraine. Agriculture prices have remained broadly sta- ble so far in 2024, reflecting robust global supply and record high production for some grains. Metal prices have also remained somewhat stable as weaker commodity demand for real estate in China is offset by firm- ing global industrial demand. However, gold prices reached another record high in August, at nearly US$ 2,500 per ounce, due to strong demand from central banks and heightened geopolitical tensions.  FIGURE B3.1.1  Global Indicators a. Global growth b. Goods trade growth 4 10 8 6 3 4 Percent 2 Percent 2 0 −2 −4 1 −6 01/2023 02/2023 03/2023 04/2023 05/2023 06/2023 07/2023 08/2023 09/2023 10/2023 11/2023 12/2023 01/2024 02/2024 03/2024 04/2024 05/2024 06/2024 0 2010–14 2024–26 2015–19 2020–23 1990–94 1995–99 2000–04 2005–09 World Advanced economies EMDEs c. Global PMI d. Global manufacturing PMI and oil prices 54 54 140 53 130 Index, 100 = May 2022 Index, 50+ = expansion Index, 50+ = expansion 50 52 120 51 110 46 50 100 49 90 42 48 80 38 47 70 46 60 05/2022 05/2022 08/2022 11/2022 02/2023 05/2023 08/2023 11/2023 02/2024 05/2024 08/2024 34 01/2022 03/2022 05/2022 07/2022 09/2022 11/2022 01/2023 03/2023 05/2023 07/2023 09/2023 11/2023 01/2024 03/2024 05/2024 07/2024 09/2024 Global manufacturing PMI Suppliers' delivery times New export orders Oil (right scale) Copper (right scale) Sources: Bloomberg; CME; CPB Netherlands Bureau of Economic Analysis; Federal Reserve Bank of St. Louis; Haver Analytics; World Bank.  Notes: Panel a: GDP aggregates calculated using real U.S. dollar GDP weights at average 2010 – 19 prices and market exchange rates. Panel b: Panel shows year-on-year percentage change of goods trade volumes. Last observation is February 2024. Panel c: Readings above (below) 50 indicate expansion (contraction). Last observation is April 2024. Panel d: Monthly average oil prices indexed to May 2022 = 100, except for last observation which is the month-to-date average until April 15th, 2024. Last PMI observation is April 2024. The EU outlook remains subject to considerable downside risks, many of which stem from external fac- tors and could compound lingering weakness in longer-term drivers of growth. The materialization of a number of risks — including an escalation of armed conflict and broader geopolitical risks, greater trade fragmentation and trade policy uncertainty, and tighter than expected credit conditions — could exac- erbate the ongoing adverse impacts on growth. 54  |  A Path to Inclusive Growth in the EU The EU economy remains exposed to the risk of worsening armed conflict and geopolitical tensions, continuing to put pressure on prices. Risks related to armed conflict have increased sharply given the ongoing conflict in the Middle East, attacks on vessels in the Red Sea, a marked deterioration in security conditions in parts of Sub-Saharan Africa, and Russia’s ongoing invasion of Ukraine. Since a fraction of goods to and from the EU transit the Red Sea, further disruptions could lift manufacturing PPI and core goods CPI by a peak impact of 3.7 percentage points and 1.1 percentage points — this would translate into a 0.3 percentage point increase in headline inflation and a 0.4 percentage point increase for core inflation (Figure 3.2, panel a).32 The EU economy could also face negative spillovers from adverse effects on global commodity markets (Figure 3.2, panel b). If the conflict in the Middle East intensifies, it could trigger disruptions to the global supply of oil and cause large commodity price spikes, potentially undermining efforts to bring inflation back to target in EU economies. Furthermore, uncertainty around the evolution of Russia’s invasion of Ukraine poses continued risks to commodity markets — including for oil products and grains — and regional security. Moreover, some of the challenges posed by conflicts could be com- pounded in the longer term by wider geopolitical tensions, which could result in commodity, finance, trade, and labor markets becoming increasingly segmented into regional blocs. Historically, periods of heightened geopolitical risks have been associated with large adverse effects on economic activity.33 FIGURE 3.2  Geopolitical impacts on shipping costs a. Eurozone: Estimated Impacts from Shipping Costs b. Brent oil prices under conflict-related oil supply disruption scenarios Industrial import 110 prices (non-EA) Domestic PPI 100 (excl. construction & energy) 90 US$/bbl CPI: Non-energy 80 industrial goods 70 0 2 4 6 8 10 12 14 16 18 20 Peak percentage point increase 60 in annual inflation rate 2021 2022 2023 2024 Full model ensemble average Historical Baseline Baseline Range of model estimates Moderate disruption More severe disruption Sources: Oxford Economics and WB Global Economic Prospects (June 2024). Chart b. The blue dashed line indicates baseline forecasts for the price of Brent oil, expressed as annual average. Orange and red lines depict outcomes under moderate and more severe conflict-related disruptions to oil supply, occurring in mid-2024. The EU economy, which is already facing a protracted period of weakness in trade and manufacturing, could be impacted by further trade fragmentation. A further proliferation of trade restrictions presents a substantial downside risk to EU growth prospects, especially given the bloc’s openness to global trade, fi- nancial, and investment flows. Historically, global supply chains have facilitated technological diffusion, enabling rapid economic convergence and poverty reduction.34 Following Russia’s invasion of Ukraine, trade and FDI flows between countries in geopolitically distant blocs have already declined considerably compared to flows between more closely aligned countries.35 Moreover, policies aimed at reducing de- pendence on specific suppliers do not necessarily achieve diversification, as these policies could lead to stronger indirect linkages as trade is diverted via other countries, resulting in more complex and less effi- cient supply chains.36 Reconfiguring supply chains is costly and can result in welfare losses as firms devote 32 Oxford Economics 2024. 33 Caldara and Iacoviello 2022. 34 World Bank 2020. 35 Blanga-Gubbay and Rubínová 2023; Gopinath et al. 2024. 36 Freund et al. 2023. The EU outlook remains weak in the near term, and downside risks continue to dominate  |  55 resources to search for alternative suppliers.37 At the same time, decarbonization may give rise to grow- ing market demand for specific technologies, providing opportunities. Part 2 of this report explores some of this potential from the individual member states perspective, taking the regional policy shifts as given. Heightened trade policy uncertainty and a further weakening of the multilateral trading system — both of which may follow from escalating trade-restrictive measures — could also have adverse effects on EU growth. In the near term, increased trade policy uncertainty could slow business investment.38 In the longer term, less efficient supply chains could decrease returns on capital, posing headwinds for produc- tivity growth — which is already relatively weak in the EU compared to other advanced economies, namely the United States. Over time, multinationals may elect to near-shore by outsourcing some manufactur- ing processes to nearby countries — even if such decisions would otherwise not be optimal — because of declining expectations that trade tensions will be resolved.39 While such developments may reflect stra- tegic considerations, there is a risk they also embed norms that erode benefits from globalization — such as the depth and efficiency of global markets — and slow the dissemination of beneficial technologies. Political uncertainty — both abroad and domestically — could also negatively impact trade and thus EU growth prospects. Growing public support for more inward-looking policies and an increasingly divided political landscape pose additional risks in the context of the large number of elections scheduled for this year. Globally, countries holding parliamentary or general elections in 2024 account for about 60 percent of global GDP. Indeed, trade policy uncertainty has reached an unusually high level relative to previous years of major elections around the world since 2000. Election outcomes could lean toward greater pro- tectionism, such as increased tariffs and subsidies, which could hinder trade and FDI. This would exacer- bate emerging trends. For instance, the number of trade-distorting policies at the global level has already tripled compared to the pre-pandemic period. Among these policies, the use of subsidies has surpassed contingent trade-protective measures as governments have become more interventionist in pursuing industrial policy objectives. These policies can lead to inefficiencies through increased fragmentation of production processes and idle capacity, as well as by encouraging the entry of inefficient firms.40 FIGURE 3.3  Global trade policy uncertainty and increasing distortions a. Global trade policy uncertainty in years with major expansion b. Trade-distorting policy measures affecting goods trade 80 2,500 policy measures Number of new 2,000 60 1,500 1,000 Index 40 500 0 20 2012–14 2017–19 2022–24 Subsidies (excl. export subsidies) 0 Contingent trade-protective measures 2000 2004 2012 2024 Other Source: a. Caldara et al. (2020); World Bank.b. GTA (database); World Bank. Note: Chart a. shows the average trade policy uncertainty index in the first five months of each year in which elections were held in countries cumulatively representing more than 30 percent of global GDP. Last observation is May 2024. Chart b. shows implemented interventions that discriminate against foreign commercial interests. Contingent trade-protective measures include trade defense instruments such as safeguard investigations and anti-circumvention, antidumping, and countervailing measures. Subsidies cover state loans, financial grants, loan guaran- tees, production subsidies, and other forms of state support, excluding export subsidies. Adjusted data (for reporting lags) as of May 30, 2024. 37 Grossman, Helpman, and Redding 2024. 38 Caldara et al. 2019, 2020. 39 Alessandria et al. 2024. 40 Barwick, Kalouptsidi, and Zahur 2024; Bown 2023. 56  |  A Path to Inclusive Growth in the EU In the EU, headline inflation continues to ease toward central bank targets, but interest rates remain restrictive and a number of external shocks, as outlined above, could disrupt the ongoing disinflation process. Given that EU inflation is projected to steadily moderate over the forecast horizon, central banks are assumed to gradually ease monetary policies in the remainder of 2024 and 2025 to prevent real inter- est rates from becoming unduly restrictive. Even so, policy rates in 2025- 26, especially in the euro area, are expected to remain markedly elevated compared to recent decades, at more than the 2000 – 19 aver- age. Moreover, if inflationary pressures endure for longer than envisaged, policy rate cuts may be fewer or postponed, leaving monetary conditions tighter than in market-derived expectations and baseline forecasts. Higher-for-longer interest rates, alongside a higher path for inflation (if unmatched by nom- inal wage growth), would reduce real incomes and dent consumer spending in the EU. If short-term interest rates are higher than anticipated, bond yields would likely rise, exerting an additional drag on activity. Reduced risk appetite, which could accompany an inflation-driven shift in rate expectations, would tighten financial conditions further. For EU countries outside of the euro area, inflationary pres- sures arising from potential currency depreciations could prompt more restrictive monetary policies than assumed in the baseline, trigger capital outflows, and derail nascent recoveries.41 BOX 3.2  Avoiding the risk of missing opportunities of RRF The EU economy entered the COVID-19 pandemic following a decade of growth disappointments, reflect- ing damage from various crises and structural headwinds. Long-term growth expectations were repeatedly downgraded in the wake of the global financial crisis (GFC) and the euro area debt crisis.a By 2019, ten-year- ahead forecasts for EU growth fell to 1.4 percent—well below the 2 percent annual average over 2002 – 07 and broadly in line with the weakness that followed the GFC over 2010 – 19. Growth prospects also deteriorated alongside a slowdown in the fundamental drivers of long-term growth, including investment, labor produc- tivity growth, improvements in education and health, and working-age population growth.b The EU MS have a chance to limit the potential impact of fiscal consolidation on growth — and avoid another decade of growth disappointments — by maximizing the use and impact of the RRF. Despite the adverse impact of multiple overlapping shocks in recent years on near-term growth prospects, substantial EU invest- ments and reforms under NGEU and national RRPs held the promise of lifting potential output growth (EU RER 8). NGEU is the EU’s €800 billion (5 percent of EU 2022 GDP) temporary recovery instrument to support the economic recovery from the coronavirus pandemic and build a greener, more digital and more resilient future. The centerpiece of NGEU is the Recovery and Resilience Facility (RRF), which is an instrument of grants and loans to support reforms and investments totaling €723 billion at 2022 prices (4.5 percent of EU 2022 GDP). Climate and digitalization objectives are featured prominently, with at least 37 percent of the expend- iture allocated to climate objectives and 20 percent of total investment allocated to digital transformation. NGEU, through a package of reform milestones and investments, is anticipated to spur investment projects across several sectors, including construction and power generation. As estimated by EU RER 8, the combined impact of reforms under a package of structural and NGEU reforms could meaningfully boost—in some cases double—the potential growth and foster inclusion, in the four selected countries on which the analysis focused.c Successfully implemented reforms that offset the drag from a shrinking labor supply, support an inclusive recovery by improving the quality of human capi- tal, strengthen institutional quality, and aim for ambitious green and digital investment targets are estimated to be able to boost average potential growth over 2022 – 30. Assuming the range structural and NGEU reforms are enacted—thus improving investment and TFP growth, lifting human capital, and offsetting some of the drags from adverse demographic trends—potential growth estimates for the euro area could reach 1.4 per- cent over 2022 – 30, versus about the 1 – 1.2 percent without such reforms; this would represent an improve- ment relative to the 2010s, where potential growth was estimated at about 0.9 percent. In the four EU coun- tries—Bulgaria, Croatia, Poland, and Romania—the combined reform package was estimated in EU RER 8 to raise potential growth to 4.6 percent in Bulgaria (versus 2.3 percent baseline), 3.2 percent in Croatia (versus 41 Arteta, Kamin, and Ruch (2022). The EU outlook remains weak in the near term, and downside risks continue to dominate  |  57 1.7 percent), 4 percent in Poland (versus 2.8 percent), and 5.2 percent in Romania (versus 3.7 percent). At these rates, potential growth would about double from the baseline in Bulgaria and Croatia and would outpace growth during the EU accession period of 2002 – 07 in Poland and Romania.d However, many EU member states have experienced reform delays, which could represent a missed oppor- tunity in terms of lifting long-run growth, and leave resources on the table at the time of critical fiscal con- solidation needs. The RRF entered into force in February 2021 and is available for member states to access until end of 2026, which means they have only about two more years left to achieve the milestones/targets needed to gain access to these funds. After a slower-than-expected start, absorption of RRF grants is expected to increase over 2024 – 25. For the EU as a whole, absorption of RRF grants is set to reach 0.4 percent of GDP in 2024 (from 0.3 percent in 2023) and to 0.5 percent of GDP in 2025 (European Commission Forecast: Spring 2024). Although reform progress has been made in some areas—including improvements in justice vis-a-vis speedier legal trials (Italy), narrowing school drop-out and tertiary educational attainment gaps (Italy) with euro area, investments in education (Spain, Portugal), and workforce participation (Greece)—other reforms have stalled somewhat more broadly, including those related to digitalization (especially of public services, especially in economies with ICT staff shortages), the sustainability of public pension systems, labor force participation, and tax reforms. Additionally, the outcomes related to some NGEU legislation have not materi- alized yet, in part related to partial implementation and slow execution. In many economies, PISA scores have not materially improved, overall and female labor force participation rates have continued to lag the euro area average, labor matching has remained a challenge as indicated by the vacancy-to-unemployment rate ratio, and competition indicators, such as the Control Risk business environment score, have not budged. a. Kose, Ohnsorge, and Sugawara (2021). b. Dieppe (2020). c. The Oxford Economics’ Global Economic Model is a global semi-structural macroeconomic projection model (here Oxford Economics 2023). The model comprises a system of error-correction equations that determine the rate of convergence of various economic indicators to their respective theory-motivated equilibrium levels and includes detailed specifications for almost 90 countries. Please refer to EU RER 8 Part 2 for additional details. d. However, since EU RER 8, which did not incorporate the full impact of Russia’s invasion of Ukraine, baseline estimates have been re-estimated. In Bulgaria, potential growth has remained broadly in line with earlier estimates, averaging 2.3 percent over 2022 – 30. In Croatia, potential growth has been lifted from 1.7 percent to 2.9 percent, in part reflecting improvements on the supply side, especially as related to the labor market, and euro area membership. In Poland, potential growth has edged down from an estimated 2.8 percent to 2.4 percent, reflecting initial delays to NGEU reforms and pronounced spillovers from the invasion. In Romania, the estimate for potential growth has also been revised down from 3.7 percent to 2.4 percent, partly reflecting a reassessment of TFP growth. Policy challenges The implementation of the revised Economic Governance Framework will test policymakers’ ability to balance fiscal and growth sustainability trade-offs. The implementation of the EGF, together with the resumed EDP, is expected to lean on intensive dialogue between the member states and the EC, and between the technical experts and politicians. While the new framework aims to ensure focus on invest- ment and growth, the fiscal consolidation targets will require concrete expenditure and revenue meas- ures. Multiple pressures from the expenditures side remain, including from additional defense spend- ing — that again add short-term fiscal pressure but could boost long-term EU GDP growth; to climate change, that presents major fiscal challenges, with more frequent extreme weather events imposing financial burdens on governments. In this context, managing the green transition remains critical with both public and private green investment essential for transitioning to a sustainable economy. Although the transition may increase fiscal costs, carbon-pricing mechanisms, like carbon taxes, could help off- set expenses by generating much-needed revenue. 42 Policy uncertainty is expected to decline with the 42 Please see the EU RER 7: Green Fiscal Policies for some options. 58  |  A Path to Inclusive Growth in the EU multi-level 2024 EU elections increasingly behind, hopefully allowing for a renewed focus on the sus- tainable and inclusive -growth friendly revenue agenda. Despite declining headline inflation in 2024, domestic price pressures remain strong, particularly in the services sector, cautioning against monetary policy unwinding too quickly. Additional pressures arise from wages, as the pass-through of higher wages into producer prices is typically stronger in the services sector. Real wages have also yet to fully recover in some EU countries to the levels seen prior to the pandemic.43 Delays in digital and green transitions may reduce labor productivity, further limiting firms’ ability to absorb rising unit labor costs. Additional pressure may arise from growing interest rate divergence, potentially pushing EUR/US$ closer to parity and adding to inflationary pressures. However, the euro is less weak on a trade-weighted basis.44 In the EU, several countries introduced in-kind support measures, like food vouchers, to address increas- ing food prices, as well as tax and non-tax measures, such as reduced VAT rates or price caps, to manage energy and food inflation. For instance, in June 2022, the Romanian government launched the “Support for Romania” program to help offset increased food costs. This program includes distributing food vouch- ers available initially from June to December 2022 and subsequently extended throughout 2023.45 In Bulgaria, the monthly ceiling for (voluntary) food vouchers for employees — which are exempted from income tax and social security contributions — have been increased more than two times, from BGN 80 previously to BGN 200 per month (per employee) effective start-2022, as an anti-crisis measure. This has incentivized an increasing number of employers to start offering such vouchers as a fringe benefit to their employees. In Bulgaria, amendments to the Corporate Tax Law (Article 209a), approved by the National Assembly, introduced electronic meal vouchers beginning January 1, 2024.46 Moreover, the governments also implemented several measures to support households and firms from energy inflation, including tax relief and non-tax measures like subsidies, VAT reductions and exemptions and energy price caps (World Bank, 2024). To address rising energy and food prices, the Croatian government introduced price caps on electricity and gas in 2021, followed by expanded measures in 2023, including a reduced VAT on energy products, lower fuel excise duties, and increased social benefits for disadvantaged groups. An export ban on natural gas was also implemented to secure domestic supply.47 Although largely untar- geted and with a significant fiscal cost (about 1.5 percent of GDP in 2023), these interventions helped pro- tect households’ incomes. Most measures are set to phase out by 2024. Household resilience to rising energy and food prices largely depends on the effectiveness of the pol- icy response. By offsetting some costs, policies like food vouchers or price caps can in principle help households maintain a basic standard of living without sacrificing other essential needs. However, some measures are more effective than others mitigate the immediate impact of inflation on households. In Romania and Croatia, although preferential VAT rates tend to reduce poverty, they are not well targeted towards poor households overall, and wealthier individuals benefit considerably from them. Given their size, the implicit energy subsidies implemented in 2022 in Romania help alleviate poverty by enhancing the population’s purchasing power; however, wealthier individuals benefit considerably, as shown by 43 ECB 2024. 44 ING 2024. 45 The program targets vulnerable groups, including pensioners and individuals with moderate to severe disabilities whose net monthly income is below a specified threshold, as well as families with two or more children, single-parent households below an income threshold, guaranteed minimum income recipients, and homeless individuals, according to existing legis- lation. 46 These tax- and contribution-free vouchers are redeemable at a network of approved merchants. Since January 1, 2024, em- ployers can issue these meal vouchers electronically, either as physical cards or virtual tools, due to an amendment to the Corporate Tax Law (Article 209a), approved by the National Assembly, introduced electronic meal vouchers beginning January 1, 2024. 47 See 2023 Country Report — Croatia- https://economy-finance.ec.europa.eu/system/files/2023-05/HR_SWD_2023_611_en.pdf The EU outlook remains weak in the near term, and downside risks continue to dominate  |  59 their low progressivity.48 In Bulgaria, long-standing electricity subsidies are less progressive but larger than all direct transfers. Therefore, they reduce poverty but contribute minimally to inequality reduc- tion.49 The effectiveness of food vouchers has not been evaluated in the recent fiscal incidence analy- sis conducted in both countries, due to the difficulty of assigning a monetary value to this in-kind food assistance. International evidence on cash vs. in-kind transfers for food assistance shows mixed results. While cash transfers are often favored, many beneficiaries — especially food-insecure households and those in high-price areas — prefer in-kind aid, which protects against price volatility.50 Studies also indi- cate that cash recipients maintain nutritious diets without misusing funds, suggesting limited need for in-kind aid. However, cash and in-kind transfers impact local economies differently: in-kind transfers tend to reduce food prices, benefiting consumers, whereas cash transfers can raise prices, which may reduce their overall value, especially in remote areas.51 Effective social safety nets are also vital for protecting low-income households from food inflation, par- ticularly in the short term. Our policy simulations in section 2.2 show that expanding the benefit gen- erosity of well-targeted social assistance programs helps to offset income losses among lower-income groups. Well-targeted programs such as food vouchers or cash transfers, which directly address immedi- ate needs, tend to be more effective than universal measures because they direct resources to those who need them most. When designing these policies, it is important to consider fiscal constraints, focusing on cost-efficient and adequate support. Targeted interventions help reduce fiscal strain while provid- ing substantial aid to the most vulnerable populations. By prioritizing vulnerable groups and practic- ing fiscal discipline, governments can protect low-income households from the negative impacts of ris- ing food prices without exceeding their budgets. The effectiveness of the policy measures also depends on how social protection systems and the tax system adjust benefits and tax thresholds to reflect inflation. Social protection systems with irregular or infrequent updates to benefit levels or eligibility thresholds often struggle to provide timely support during inflation spikes, leaving households without adequate adjustments. Similarly, the tax system not always adjust to reflect that change in real income due to price rises. Inflation can unintentionally alter taxes when tax system parameters are set in fixed nominal terms without adjusting for inflation. The lack of indexation and lack of adjustment of the parameters in the tax system can worsen the impact of high prices, making regular and responsive indexation crucial for maintaining purchasing power and meeting essential needs. Some countries have recently implemented good examples of social protec- tion reforms, but there is still scope for improvement (Box 3.3). Implementing effective social safety nets and well-targeted policy responses are crucial for helping low- income households manage rising food and energy costs amid inflationary pressures. Countries across the EU have adopted a range of policy measures, such as food vouchers, price caps, and VAT reductions, to alleviate these pressures. However, the long-term success of these measures depends on careful bal- ancing of fiscal constraints, targeted assistance, and regular adjustments in social protection systems. Ensuring that tax and benefit systems adjust to inflation can help maintain households’ purchasing power and mitigate the unintended effects of rising costs. By learning from current policies and incor- porating evidence-based practices, EU member states can continue to refine their approaches, protect- ing the most vulnerable populations and supporting sustainable economic resilience. 48 Romania CEQ, forthcoming. 49 Robayo and Cabrera, 2024. 50 Hirvonen & Hoddinott, 2020; Gadenne et al., 2021. 51 Cunha, 2014. 60  |  A Path to Inclusive Growth in the EU BOX 3.3  Recent social protection reforms in Romania, Bulgaria, Poland and Croatia Romania has implemented significant reforms to the GMI program, aimed at enhancing social protection and reducing poverty. The new regulations introduced the Minimum Inclusion Income Program (VMI) with sin- gle eligibility criteria and an increased Social Reference Indicator (SRI) for indexation. This reform had effects on benefits such as support allowances for families with children, guaranteed minimum income (GMI), and unemployment benefits. In 2022, state allowances increased following the SRI adjustment and starting in 2023 they have been provided as fixed nominal amounts. These changes reflect Romania’s commitment to improving its social safety net amid ongoing economic challenges, yet the broader coverage reduces pro- gressivity. The implementation of the Minimum Inclusion Income Program (VMI) and adjustments to the Social Reference Index (SRI) are expected to enhance the progressivity of child benefits and contribute to greater poverty reduction.a However, despite introducing the Social Reference Indicator (SRI) in 2008 to index ben- efits, the country has not consistently adjusted benefits with inflation. Certain benefits have been subject to ad-hoc changes, leading to imbalances in benefit values and reduced effectiveness. Bulgaria expanded social support and updated the indexation of benefits in recent years. Before 2022, the social assistance scheme had limited coverage and was not adjusted for inflation, minimizing its impact on poverty reduction. In 2022, a reform aimed to expand social support by increasing the income threshold to 30 percent of the relative poverty line and adjusting for age, health, and social status. Benefits are now indexed to the relative poverty line, aligning with median income changes. However, restrictive eligibility thresholds compared to a Bulgarian food basket suggest the need for further improvements, such as anchoring pro- grams to an absolute poverty line or basic consumption basket, to enhance the effectiveness of guaranteed minimum income and indexed benefits.b Poland faces ongoing challenges in enhancing the equity and efficiency of its social protection system. Poland, along with 13 other EU countries, updates its minimum income thresholds intermittently, whereas 10 countries have automatic indexation to keep pace with inflation. Current rules only require review every three years, potentially leaving thresholds stagnant during rapid inflation, limiting support for households. Despite a range of benefits, the focus on non-means-tested cash benefits has limited redistributive effects and cov- erage gaps for the working poor. Minimum-income programs, for instance, reached only half of those in legal poverty in 2021, with fragmentation and overlaps across numerous family benefits. Poland must address cov- erage gaps to improve equity by expanding targeting capacity, possibly through a social registry.c Croatia is aiming to increase the adequacy and transparency of social benefits under the Croatian Recovery and Resilience Plan. This reform aims to enhance the adequacy and transparency of social benefits for the most vulnerable groups, thereby reducing inequalities. Key aspects include merging existing benefits into a single, streamlined program to improve coverage and fairness while reducing administrative burdens. This initiative is part of the National Plan against Poverty and Social Exclusion 2021 – 2027, which targets a reduc- tion in the at-risk-of-poverty rate to below 15 percent and seeks to improve the living conditions of those fac- ing severe material deprivation. The reform will involve changes to the legal framework, including the newly adopted Social Welfare Act. By the end of 2024, the plan includes increasing the guaranteed minimum ben- efit, integrating it fully with other social benefits, enhancing evaluation and monitoring effectiveness, and introducing indexation for future benefits.d These measures are designed to support vulnerable groups more effectively and reduce poverty. a. Romania CEQ, forthcoming. b. Robayo and Cabrera, 2024. c. 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The World Bank: Washington, DC. http://hdl.handle.net/10986/41134 64  |  A Path to Inclusive Growth in the EU ANNEX A Methodology for estimating direct welfare impacts of food inflation Direct Welfare Impacts To estimate the welfare impact of relative changes in food and energy prices, following Freund and Wallich (1995), we adjust the welfare aggregate to account for the loss in purchasing power (PPP loss) because households spend a larger share of the total expenditure on food and energy. Following the methodology used by Freund and Wallich (1995) and the Balancing Act (2013), the impact of the change in prices on the share of consumer surplus as a percentage of total household expenditures can be cal- culated as: ∆CS/E = (S0 (P1 − P0) / P0) (ε + ε (P1 − P0) / P0 +1) (1) where S0 is the initial budget share before the price change, ε is the price elasticity of demand, and P1 and P0 represent the initial and final relative prices. TABLE A.A.1  Assumption of price elasticities We implement this approach using the available by income deciles household budget surveys and EU-SILC surveys in the 4 EU countries. First, we estimate the food and Income deciles Price elasticity of food and energy energy shares using the country’s household budg- 1 – 3 0 et surveys (HBS) by dividing and imputing them for each household in the EU-SILC by assuming a one- 4 – 10 -0.25 to-one relationship between consumption and in- come deciles. To do so, we assume the same share across households in the same decile. Then, we estimate the change in consumer surplus for each house- hold in the EU-SILC using (1), given the estimated shares, (b) a range of price elasticities (decile depend- ent), and (3) the relative food and energy prices from Eurostat Harmonized Indices of Consumer Prices (HICP) over the period 2019 – 2022. Finally, we use the PPP losses to estimate one counterfactual income distribution for the observed change in food prices and another for the observed change in energy prices. Some caveats apply. It is important to note that this approach would not explicitly account for house- holds’ ability to be both producers and consumers of food. It also does not incorporate indirect and gen- eral equilibrium effects. Lucchetti, Robayo-Abril, & Delgado-Prieto, L. (forthcoming) provide more details on the methodology. 65 ANNEX B Estimating the cost of Roma exclusion The methodology for estimating the cost of Roma exclusion is outlined below. Step 1: Obtain Roma population estimates for Romania and Bulgaria from the 2021 Population Census data. These estimates differ from the Council of Europe’s unofficial estimates due to underreporting in the Census. Even though there are no recent reliable estimates of the size of the Roma population in Romania and Bulgaria, official estimates suggest that this ethnic minority may represent between 3 and 4.1 percent of the population, respectively, in 2021. Despite these official figures, Council of Europe estimates suggest a much larger Roma population for both countries, with average estimates at 10.2 percent of Bulgaria’s population and 9.2 percent of Romania’s population. These differences are because Census data allows for ethnic self-identification, but there is likely significant underreporting of individuals of Roma ethnicity. The 2011 and 2021 Census data for Bulgaria and Romania also reveal a decline in both the total popula- tion and the Roma population compared to 2011. In Bulgaria, the total population dropped from 7.36 mil- lion in 2011 to 6.52 million in 2021, with the Roma population decreasing from 325,343 to 266,720, repre- senting a slight decrease from 4.4 percent to 4.1 percent of the total population. Similarly, Romania saw its population shrink from 20.12 million in 2011 to 19.05 million in 2021, with the Roma population fall- ing from 619,007 to 569,500, accounting for 3.0 percent of the total in 2021, down from 3.1 percent in 2011. TABLE A.B.1  Roma population according to different sources Roma population estimate based Roma population estimate based on Censuses on Council of Europe (2012) estimate based on estimate based on Average estimate population (2021 population (2011 Total population Total population Official national Official national total population percent of total percent of total statistics (2021 statistics (2011 as a percent of Census (2021) Census (2011) Census data) Census data) Census data) Census data) Maximum Minimum estimate estimate estimate Average Country 10.2 Bulgaria 7,364,570 6,519,789 325,343 266,720 4.4 4.1 700,000 800,000 750,000 percent 9.2 Romania 20,121,641 19,053,815 619,007 569,500 3.1 3.0 1,200,000 2,500,000 1,850,000 percent Step 2: Estimate the total Roma population, overall, and by age cohorts and educational attainment using household surveys (2021 HBS for Romania and 2021 SILC for Bulgaria) since this detailed informa- tion is unavailable in the Census. Age groups are 0 – 25, 25 – 64, and 65+, with educational attainment categorized as low (primary or less) and high (secondary or more). Step 3: Estimate labor force participation rates by age, education, and ethnicity from the 2021 household surveys. Use these rates to estimate the labor force stock among working-age (25 – 64) Roma by educa- tional attainment. Step 4: Estimate employment rates for the working-age Roma (25 – 64) by age and education, then esti- mate the corresponding employment stock. 66  |  A Path to Inclusive Growth in the EU Step 5: Project future labor force stocks for 2022 – 2030 using UN Population growth rates by age. Since population projections by ethnicity are unavailable, repeat Steps 2 and 3, assuming the same labor force participation and employment rates by group. Step 6: Calculate net flows, which represent changes in the number of people entering and leaving the labor force by age and ethnicity between consecutive years. Scenario analysis: • Baseline: Assume the same educational attainment and labor force participation rates among Roma population in 2022 – 2030 as in 2021 (no further improvements in additional Roma inclusion). • Scenario 1: Assume higher human capital stock among Roma with unchanged labor force participa- tion rates. • Scenario 2: Assume higher labor force participation rates among Roma by age and education, adjust- ing for educational attainment. • Scenario 3: Combine Scenarios 1 and 2, assuming both higher human capital and labor force par- ticipation rates.