Opinion by Leonardo Badea, First Deputy Governor at the National Bank of Romania (BNR)
In the last two decades, Romania has recorded a sustained pace of economic growth, boosted by the European integration process, the structural reforms implemented before and after accession, as well as access to the single market and European Union funds.
Fast growth and high imbalances. CEE countries (including Romania) have grown rapidly in recent decades, but this growth has been accompanied by certain imbalances (particularly in our situation).
Similar developments have also occurred in other Central and Eastern European economies, which we often use for comparison due to their similar levels of economic development and shared experience transitioning from command to market economies. It is therefore justified to state that integration into the European Union has played an essential role in the rapid economic progress observed in Romania, Poland, the Czech Republic, Hungary, and Bulgaria. Among these, our country stood out for a faster pace of convergence, managing to recover the significant gap it had 20 years ago compared to Hungary and Poland, from the perspective of GDP/capita adjusted to purchasing power parity.
However, especially in recent years, even before the onset of the period of overlapping crises, in Romania, the higher economic growth rate than that recorded, on average, by other states in the region was accompanied by imbalances. The effects of the COVID-19 pandemic and the war in Ukraine were and remain important for all economies in the region, but Romania entered this period of economic turbulence already having a significantly higher level of imbalances, and these subsequently intensified. Regional comparisons are significantly unfavorable for our economy in terms of the magnitude and persistence of the fiscal deficit and the current account deficit, as well as from the perspective of the growth rate of public debt. Especially in 2024, dominated in social terms by political and electoral events, these economic problems have become increasingly acute.
Large imbalances require a serious analysis of the growth model
In this context, the concern for adjusting Romania’s economic growth model is fully justified, both with a view to returning to a sustainable trajectory, which would limit the emergence of imbalances in the medium term, and from the perspective – broader but equally important – of avoiding the middle-income trap. The strategy to overcome the difficult economic situation we currently face must tackle both of these aspects.
The challenge is all the greater as the adjustment must be carried out against a backdrop of unfavorable general conditions: international trade and partner economies are affected by significant geopolitical tensions, as well as the threat of increased trade tariffs, and the local economy is going through a sharp slowdown.
Even if the solution is not obvious, it is certain that a healthy economic model can no longer be built on consumption expansion uncorrelated with productivity, on directing investments towards low value-added activities, or on weak performance in the collection of fiscal revenues.
A structured approach to this dual problem formulated earlier requires the phased discussion of the two key questions.
- How can Romania achieve sustainable growth, while limiting the buildup of macroeconomic imbalances?
In principle, the idea of equilibrium in the economy refers to a situation in which it functions efficiently, does not generate negative externalities, and there is no large discrepancy between demand and supply. In such a complex mechanism, however, this is difficult to maintain naturally for long periods of time. The emergence of imbalances is natural, the important thing is that they do not persist and do not increase beyond certain thresholds, which also vary depending on the context.
John Maynard Keynes introduced, as early as the early 20th century, the basic idea of the theory of economic disequilibrium: that prices do not adjust quickly enough to automatically restore the balance between supply and demand. As a result, markets can function inefficiently, leading to price instability and slow adjustments in traded quantities.
On this conceptual foundation, the theory of disequilibrium was later extended and formalized. An essential contribution belongs to Barro and Grossman (1971), who proposed a rigorous analytical framework for studying simultaneous disequilibria in several markets, in which monetary and fiscal policies have real effects, precisely because prices do not adjust instantaneously.
This approach is part of the so-called Old Keynesian models, which later inspired the explicit introduction of rigidities and frictions in modern macroeconomic models. Recent works, such as that of Nobel Prize winner Thomas Sargent (2023), and those of renowned economists Roger Farmer (2008) and Robert Barro (2025), provide a detailed presentation of this family of models.
Moreover, the dynamic stochastic general equilibrium (DSGE) models widely used today, both in economic research and in economic policy formulation, adopt elements of disequilibrium theory by introducing nominal and real frictions. Thus, disequilibrium is modeled as the result of incomplete, slow, or costly adjustment mechanisms within a rational equilibrium model.
From an empirical perspective, macroeconomic imbalances are a recurring phenomenon in both developed and emerging economies. However, the frequency, severity, and persistence of these imbalances tend to be considerably higher in developing economies, due to structural vulnerabilities and a lower institutional capacity to respond effectively to shocks.
When imbalances are small in scale and generated by endogenous factors – such as pro-cyclical policies, weak tax collection or structural rigidities – they are manageable through well-calibrated domestic measures.
In contrast, when deficits become large, chronic, and persistent, they tend to be self-perpetuating: the economy and its actors – households, companies, public administration – end up adapting to an environment characterized by permanent fiscal stimulus and policies that tolerate imbalances. Over time, this erodes economic discipline, reduces pressure for efficiency and innovation, and impairs the system’s ability to respond effectively and with credibility to crises.
At the same time, if imbalances manifest themselves against the backdrop of external shocks of a global nature – for example, geopolitical tensions, changes in international financial conditions, or major disruptions to supply chains – or are amplified by them, the adjustment process becomes all the more difficult, and the national authorities’ room for maneuver is substantially restricted.
The previous two paragraphs represent, unfortunately, a fairly accurate X-ray of the current situation of our economy.
Imbalances can also manifest themselves on a punctual basis, in the labor market, in the goods and services market, and the most publicized and occurring with the greatest frequency are those on the financial markets.
- In goods and services markets, a relevant cause for potential imbalances in the current context is represented by trade restrictions between countries or economic blocs. Although they are applied with the aim of correcting a series of dysfunctions, protectionist policies often give rise to other problems with much deeper implications and effects throughout the economy. While aiming to support the development of domestic supply in the medium term, protectionist measures initially harm consumers by leading to higher prices and a decline in the variety and quality of available goods.
Because it most often results in the horizontal expansion of barriers to free trade, in subsequent rounds financial and technological capital flows are affected, as well as innovation, which, in the long term, disrupts economic growth.
The relationship between economic growth and the intensity of international trade relations is cyclical and bidirectional. An expanding economy usually stimulates the growth of imports and exports, contributing to the strengthening of trade interdependencies and, often, to the deepening of diplomatic cooperation. These dynamics can create a virtuous circle in which international trade, in turn, supports economic growth. During economic slowdowns, however, the tendency of many states is to resort to protectionist measures to defend their domestic sectors. Such policies can lead to trade tensions, the fragmentation of global supply chains, and impact the growth pace at international level.
- Macroeconomic imbalances are frequently manifested in the labor market. John Maynard Keynes argued that the labor market does not automatically equilibrate, and labor demand can remain lower than the available supply even in the absence of explicit restrictions, generating involuntary unemployment. Among the causes identified by Keynes are price rigidity, and particularly the inflexibility of nominal wages. Today, we observe in practice that the labor market is affected by a series of factors that accentuate these rigidities: differentiated tax rules, the calibration of the minimum wage that is not adapted to economic conditions, pension and social security schemes that do not function efficiently, etc. All of these factors can contribute to the emergence of persistent imbalances in labor allocation.
The Romanian labor market also exhibits some of the aforementioned rigidities, which fuel structural imbalances and constrain the potential for long-term economic growth.
Thus, although the increase in the minimum wage led to a significant and almost immediate improvement in the living standards of low-income earners, the slower pace of productivity growth created distortions in the incentive structure of certain economic sectors with low added value.
In certain regions or industries, the minimum wage approaches the average wage, thus compressing the differences between skilled and unskilled labor and discouraging investment in vocational training. At the same time, the lack of correlation with the level of domestic supply has caused the surplus demand for household consumption to lead to an increase in imports, worsening the external imbalance and implicitly the latent and indirect pressure on the exchange rate. Over time, in conjunction with a series of exogenous factors, domestic prices and the impact of import prices on inflation have increased simultaneously. Therefore, in the medium term, those initial positive effects of wage increases uncorrelated with productivity were, in the end, naturally and visibly eroded.
In the absence of effective adjustment mechanisms and an institutional capacity for early reaction, such imbalances risk intensifying in the long term, affecting economic growth potential and competitiveness. It is therefore essential that public policies include tools for preventive monitoring and early corrective intervention in the labor market. Among other things, I believe that we need a predictable and transparent formula for updating the minimum wage, based on productivity, inflation, and economic dynamics, differentiated at sectoral level.
- On the financial capital market, as we are currently witnessing, imbalances emerge when investor confidence in a country’s or region’s profit outlook declines, leading to a reduction in productive investment. Over time, this increases inequalities between regions, which impacts the labor market, economic growth, and well-being. In this context, maintaining investment grade-status from the rating agencies is not merely a technical issue of financial perception, but a crucial objective for Romania. It directly influences the cost of external financing of the budget deficit during the adjustment period we are going through, the appetite of foreign investors to develop private businesses in Romania, the stability of the exchange rate, and the state’s capacity to support public investments and the defense effort. Any deterioration in risk perception has the potential to amplify existing imbalances and slow down economic convergence, affecting medium and long-term development prospects.
The emotions, intuitions, and irrational impulses that shape the behavior of economic agents -whether in their consumption and investment decisions or in their confidence in the economy -play a significant role in the dynamics of economic and financial cycles.
Regarding this aspect, Keynes introduced the concept of animal spirits in his 1936 work. Nobel Prize laureates George Akerlof and Robert Shiller explicitly address the concept of animal spirits in their 2009 book, emphasizing that human psychology plays a central role in the real economy and in financial crises. Roger Farmer (2011) explains that this animal spirit phenomenon played a significant role in the collapse of financial markets during the crisis of 2008-2009, leading to a high unemployment rate.
In a speech delivered on November 8, 2013, at the IMF’s annual research conference in honor of Stanley Fischer, the renowned economist Larry Summers reintroduced the concept of “secular stagnation” to describe the situation in which market economies can end up in “inefficient equilibria” (or, more directly, disequilibria) that are long-lasting. Thus, due to a lack of confidence among private investors in the prospects for future growth, the economy could end up in a situation characterized by persistently high unemployment and below potential aggregate output. In this presentation, he suggested that advanced economies could suffer from chronically insufficient aggregate demand, even under very low interest rates, which could lead to slow economic growth and below-target inflation in the long run. This idea has been considered by some influential economists, such as Nobel Prize laureate Paul Krugman, or former IMF chief economist during the financial crisis, Olivier Blanchard, as one of the most important recent contributions to the development of macroeconomic thinking.
- Macroeconomic imbalances can vary in form and intensity, but they also share common features. They can have structural causes – linked, for example, to the model of economic development, the specialization of certain sectors or institutional efficiency – they can be cyclical in nature, generated by inherent fluctuations in economic activity, or they can become chronic, when factors persist over the long term without adequate corrective interventions.
Consequently, imbalances must be analyzed and approached differently, depending on the context and the mechanisms that generate them. However, beyond the particularities, several recurring patterns in their formation and accumulation can be distinguished.
An illustrative example is the case of the so-called “Asian tigers” – such as South Korea, Thailand, or Indonesia – which, in the 1980’s and 1990’s, recorded accelerated economic growth, supported by massive investments and dynamic exports, but accompanied by fragilities that later were the catalyst for the Asian financial crisis of 1997. This demonstrated that rapid growth, in the absence of macroeconomic prudence and institutional consolidation, can amplify instability instead of ensuring continued sustainable development.
Aguiar and Gopinath (2004), in a remarkable work that changed the perspective on the dynamics of business cycles in the case of emerging economies, attribute a crucial role to the current account balance. Thus, large and persistent current account deficits in emerging economies indicate a high dependence on external financing, which makes the economy vulnerable to external shocks and sudden capital withdrawals or “sudden stops”. The accumulation of external imbalances prolongs and aggravates the risk of a financial crisis, because the country must refinance its external debt under conditions of increased uncertainty. Thus, in crisis situations, emerging economies must engage in painful adjustments to reduce the external imbalance.
At the same time, Ricardo Reis (2013) takes a pre- and post-crisis X-ray of the Portuguese economy, to identify the factors behind the poor economic performance recorded in the period 2000-2012. During the mentioned period, the Portuguese economy had a weaker performance than that recorded by the United States economy during the Great Depression, respectively by the Japanese economy in its lost decade. Reis (2013) attributes Portugal’s economic evolution during the mentioned period to the following factors: the appreciation of the real exchange rate, wage increases, the inefficient allocation of capital in the economy, the expansion of the non-export sector („non-tradable”), the decrease in total factor productivity (TFP), massive foreign indebtedness, and the lack of actions to address the problems in the pension sector in a timely manner. As in the case of the economies investigated by Aguiar and Gopinath (2004), the „sudden stop” shock generated by the financial crisis caused serious problems for the Portuguese economy in the context of the vulnerabilities mentioned above.
- When tailored to Romania’s specific context, we observe a good similarity with the case of the Asian tigers, but not only for positive reasons: high economic growth rates in the past associated with the accumulation of major imbalances.
Looking back, from the moment of integration into the European Union until today, the data highlight remarkable progress in terms of real convergence. Gross domestic product per capita, expressed in purchasing power parity (PPP), increased from around 10,800 euros in 2007 to around 31,000 euros in 2024 – a tripling in 17 years. We chose this measure expressed in PPS because it more accurately reflects the real purchasing power of the population, allowing for a relevant comparison with other EU Member States, regardless of differences in prices and living costs.
During the same period, the average GDP per capita in the European Union increased from 24,700 euros to 39,700 euros. Consequently, Romania advanced at a considerably faster pace than the Union average, from only 44% of the EU average in 2007 to approximately 79% in 2024 (which, however, places us only in 18th place among the 27 Member States).
This dynamic confirms the success of the economic convergence process, while also raising questions about the sustainability of the growth model that supported this performance. As international experiences, including in Asia, show, accelerated growth can hide the accumulation of structural imbalances, which only become visible when a shock or crisis occurs.
A useful example for this discussion, but from a different perspective, is that of Bulgaria, which started in 2005 from a level very close to ours but grew at a slower pace, reaching only 66% of the European average in 2024, but without such large imbalances and for as long a period as in the case of Romania. This is evidenced by the conclusions of the most recent convergence reports, published on June 4th by the European Commission and the European Central Bank, which indicate that Bulgaria meets the reference values set by the convergence criteria, thereby being prepared to adopt the euro as of January 1st, 2026.
Needless to say, Bulgaria has a significantly smaller economy and many peculiarities that differentiate it from Romania. At the same time, the lesson it offers is not necessarily about the opportunity to adopt the euro – which I support, in a balanced way, considering both the advantages and the challenges, but which is a topic debated among Romanian economists and which often polarizes. However, its situation shows that, in certain situations, a more moderate growth rate, but accompanied by better macroeconomic balances (which sometimes result even from constraints that may seem quite severe), may be preferable to a rapid expansion that generates persistent vulnerabilities.
Returning to the dynamics of the Romanian economy, two other sub-adjacent questions may be relevant: how intense was the integration into the European Union, and in how many years could the GDP per capita indicator in our country reach the average level of the European Union.
To answer the first question, we resorted to the approach proposed by Robert Lucas in his 2007 paper Trade and the Diffusion of the Industrial Revolution. During the period analyzed, the average annual (logarithmic) growth rate of GDP per capita was approximately 6.21% in Romania, and approximately 2.8% at the European Union level. It is important to note that emerging economies, such as Romania, register not only increases in production, but also adjustments in the price level towards the European Union average. This alignment of prices, reflected in indicators calculated at purchasing power parity, can lead to a growth rate of GDP per capita expressed in purchasing power parity higher than that of real GDP, thus expressing progress both in quantitative terms and in terms of relative prices. From the numerical calibration of the Lucas’s model results an integration parameter of approximately 0.9. This means that Romania assimilates, on average, approximately 90% of the benefits stemming from our membership in the European Union, referring here to technology, productivity, European funds, or foreign direct investment.
If we assume that the convergence parameters favorable to us during the 2007–2024 period will remain constant a challenging and unlikely scenario, given that it would require Romania to sustain the same per capita GDP growth rates as the European Union-then, ceteris paribus, we would need approximately 7.2 years to catch up with the European Union average and completely eliminate the gap.
This is, however, just a counterfactual exercise, because in fact we cannot imagine that as we approach the EU average our annual growth rates could remain consistently over 2.2 times higher than those of the economic block we are part of. This is where the second major challenge for our growth model comes in, which I just mentioned in the first part of the article: how do we avoid the middle-income trap?
- Can the middle-income trap be avoided?
Regarding the risk of falling into the middle-income trap, this concept refers to the situation in which a country that has managed to transition from a low to a middle-income level reaches a point of stagnation, from which it can no longer progress towards the status of a developed economy.
When market economies are at the beginning of their journey – as was the case with Romania and other states in the region that, in the 1990’s, made the transition from authoritarian regimes and fully planned economies – they benefit from a series of advantages that allow for rapid growth. Some capitalize on cheap labor, used intensively in agriculture and industry, others exploit their natural resources and manage to attract significant foreign investment.
As an economy evolves, the initial advantages listed above (useful at an early stage but essentially rudimentary) become insufficient to sustain development and must be replaced by more sophisticated growth foundations, mainly technological and related to human capital quality. Thus, when labor and natural resources become scarcer and more expensive, innovation and the adoption of new technologies are among a handful of remaining solutions for maintaining growth, as they allow further improvement in economic performance by combining fewer or more expensive resources in a more efficient manner.
One of the leading proponents of the debate on the middle-income trap is Indermit Gill, currently the World Bank’s chief economist. He recently delivered a lecture in Romania at a seminar on the topic, emphasizing the urgent need to adapt development models in economies transitioning toward developed-country status. In a 2007 World Bank report, Gill, together with Homi Kharas, highlighted the idea that several Asian economies – despite experiencing periods of accelerated economic growth – subsequently entered a phase of relative stagnation, failing to further sustainably reduce the gap with advanced economies.
The report’s central finding was that without deep structural reforms and a shift from an extensive to an intensive model – based on innovation, education, efficient institutions, and investment in human capital – the convergence process could stall for decades. This analysis is all the more relevant for Romania today, at a time when its economic growth model risks exhausting its traditional resources and has long been in an area of structural vulnerability.
At the same time, in line with the conclusions outlined by Aguiar and Gopinath (2004), being in a favorable phase of the global economic cycle, corroborated with belonging to a “catching-up” process, are not sufficient premises for sustainable economic development in the long term. Moreover, when economic growth is of a high magnitude, it is essential that this favorable evolution of the economy is not accompanied by major imbalances, especially in terms of the current account balance. Otherwise, rapid economic growth, simultaneously a large current account deficit can lead to subsequent painful adjustments for the economy and society as a whole. Today, our country’s economy finds itself in this unfavorable situation identified in the studies conducted by Aguiar and Gopinath (2004), as well as by Reis (2013). Therefore, finding solutions for an adequate reform of the pension system, as well as the efficient allocation of capital in the economy, are essential prerequisites for sustainable economic development.
III. How can these two objectives – sustainable growth and convergence – be harmonized in a coherent development model?
Most relevant examples indicate that achieving long-term growth and convergence—while avoiding an intensification of the natural downturns in economic cycles—requires addressing macroeconomic imbalances, particularly the fiscal deficit, as it also impacts the current account deficit.
The current discussion about budgetary consolidation should not be carried out in isolation, but connected to the medium and long-term development vision. Fiscal consolidation is not an end per se, but an essential condition to restore the credibility of public policies, stimulate productive investments, and support external competitiveness.
In the process of gradually reducing the budget deficit, a balanced effort is essential, combining responsibly reducing public spending with measures to increase tax revenues. The concrete choice of instruments naturally falls to those who assume the responsibility of governance. However, for the adjustment to be legitimate and sustainable, it cannot disproportionately protect only one of the two components of the budget – either spending or revenue. In other words, without a fair sharing of the effort, there can be neither social cohesion nor genuine public support for a correction that is intended to be sustainable.
The rapid convergence in real terms of the Romanian economy was also facilitated by some fiscal policies aimed at stimulating business in certain key economic areas. For example, in some cases, the granting of fiscal incentives has indeed stimulated an efficient allocation of capital to important branches of the economy, such as the IT or agri-food sectors. Today, our country represents an important IT center at a regional level, while on the agricultural side, Romania has become one of the main grain exporters in Europe. So, why didn’t this recipe work in all areas of the economy and why can’t it be expanded and made permanent? The answer is that a stimulus can be effective for putting market economic mechanisms into operation when, for some reason, they are stuck. However, once the convergence process advances, it is recommended to gradually eliminate these incentives so that the economy has the robustness to efficiently allocate resources and adapt to changing conditions. From this perspective, it is useful to study how economic agents perceive these facilities. This question is the subject of intense debate in specialized macroeconomic literature.
In 1974, Robert Barro formulated the principle of “Ricardian equivalence”, after the famous British economist David Ricardo, which states that, when agents anticipate that some tax cuts will be only temporary, and in the future they will be offset by higher taxes (to finance these cuts), saving behavior changes, so that, over the entire period, there is no stimulation of aggregate consumption. On the other hand, when agents are “non-Ricardian”, that is, they do not fully internalize the future tax burden generated by the public debt, temporary tax cuts increase consumption in the short term, because economic agents perceive these cuts as a real gain and do not save to pay higher taxes in the future. At the same time, this mechanism will result in an increase in the budget deficit in the short term, and this is not compensated by additional savings by economic agents, which can lead to an increase in public debt in the long term.
Therefore, in the construction of fiscal policies, it is essential to understand the extent to which economic agents are “non-Ricardian”. The occurrence of fiscal consolidation measures, not anticipated in advance by economic agents, could affect their decisions regarding consumption, saving, and investment, which would further affect capital and activity in the real economic sector. This phenomenon is called “crowding out” in the literature, a term that we have used above. According to Mankiw and Elmendorf (1998), the increase in interest costs related to public debt can affect private capital, leading to crowding out. At the same time, the rapid increase in the cost of interest on public debt may indicate an immediate need for fiscal consolidation. According to the information available in the Ameco database, the cost of interest paid in Romania for public debt increased from a share of 1% of GDP in 2019, to 1.4% in 2022, and to 2.3% in 2024. For 2025 and 2026, Ameco estimates an increase in the cost of interest to 2.6% of GDP in 2025, and 2.8% of GDP in 2026, respectively. Therefore, even in the absence of a significant change in risk perception, when Romania manages to reach the 3% budget deficit target set in the Maastricht agreement, it would probably be used mostly for the cost of interest, which would require that expenditures be maintained approximately at the level of revenues (the primary deficit to be very low).
Source: IMF
According to the IMF (chart above), Romania’s public debt (expressed as a share of GDP) is expected to reach 75.7% in 2030, based on current information. This information outlines an immediate need for fiscal consolidation. However, fiscal consolidation must be designed in a sustainable manner. A key aspect in this regard is the size of fiscal multipliers, making their accurate and plausible estimation critically important. Blanchard and Leigh (2013) highlight that, during the eurozone crisis, the anticipated effects of fiscal consolidation were distorted due to an inaccurate assessment of fiscal multipliers.
At the same time, Sargent et al. (2024) extend the approaches of Barro (1974, 1979) and propose a so-called optimal approach to the management of public debt and budget deficits, in which the level of taxation should be set so that the cost of additional (marginal) taxation of public agents is equal to the marginal benefit resulting from the reduction in taxation. In this sense, the approach proposed by Sargent et al. follows Barro’s principle of “smoothing taxation”. In other words, the approach proposed by Sargent et al. can be viewed as a fiscal rule and a form of policy equity in the field.
At the same time, to paraphrase Nobel laureate Paul Krugman, the fiscal measures required at this moment should not resemble those of Dr. Pangloss—a character in Voltaire’s work known for his excessive optimism—but should instead be grounded appropriately in current economic realities.
The new growth model must incorporate rules that prevent, during periods of broad economic expansion, high budget and current account deficits, as well as a complete decoupling of wage growth from productivity gains and pension growth from wage increases.
Fiscal consolidation must be implemented in a way that avoids economic shocks, relying instead on a well-calibrated set of stimulus measures. To paraphrase renowned economist John Cochrane, the economy is like a nuclear reactor—once it starts up and malfunctions occur, it becomes difficult to stop, and problems can escalate exponentially.
The studies cited above highlight that large current account deficits and inefficient capital allocation are relatively common features of emerging economies that experience highly favorable economic contexts that lead to rapid growth. They conclude that a rapid increase in aggregate demand does not implicitly determine, in the short term, the efficient allocation of capital towards productive branches of the economy. In such situations, one often observes a predominant orientation of capital towards the “non-tradables” sector, attracted by high profitability rates, while the excess aggregate demand materializes in a significant increase in imports and further in trade deficits. We are, therefore, in a trap that was not entirely unforeseeable from the perspective of the specialized literature in the field.
A simple example illustrates Romania’s current situation: although the country is one of the leading cereal exporters in Europe, it still relies heavily on imports of bakery products.
Let’s consider the case of a small business specializing in the sale of bakery products, with most of its goods sourced from imports. Excess demand in the economy drives strong demand for the imported items this shop offers. Even if the business thrives and pays taxes in line with its activity, the money spent on the products ultimately flows out of the country’s economic circuit.
Among many externalities, an important consequence is the fact that the money paid for imported products does not further contribute to increasing the taxable base. On the other hand, if local companies had produced goods that met the requirements (quality, quantity, price, pace and volume of supply) of the retail store, the money would have remained within the country and would have increased the taxable base, ultimately leading to an increase in tax revenues. This is one of the explanations why tax revenues have remained low in Romania, even though we have had years with high economic growth rates, and tax rates have been reduced at certain levels.
As Aguiar and Gopinath (2004) point out, the business cycles of emerging economies differ significantly from those of mature economies. By implication, the criteria by which we consider the optimality of fiscal decisions, for example in terms of taxation, differ in the case of emerging economies in the expansion and convergence phase compared to those in the case of economies that have reached the maturity stage. For example, Mankiw, Weinzierl, and Yagan (2009) point out that, in some areas of taxation, there is significant heterogeneity across OECD countries.
At the same time, Mankiw, Weinzierl, and Yagan (2009) point out that in many countries there are inconsistencies between the practices encountered regarding taxation and what the literature recommends as optimal. Discussions about taxation often invoke the suitability of models that have been successfully implemented in other countries.
The effectiveness of certain tax systems in specific countries does not guarantee that they will achieve the same results elsewhere. The specialized literature recommends that decisions regarding taxation be optimal considering a social criterion. In other words, the specialized literature recommends defining a criterion to be pursued, such as social welfare, so that taxation decisions ensure the maximization of this criterion. At the same time, optimal decisions are investigated differently for each tax. There are two major approaches to the optimality of taxation: a micro approach and a macro approach. The micro approach, proposed by Mirrlees (1971), is characterized by a static environment, while the macro approach, promoted by authors such as Atkinson and Stiglitz (1976), refers to a dynamic environment, in which tax decisions determine effects over time. Finally, it is important to distinguish between an optimal tax environment and the need for fiscal consolidation. In general, fiscal consolidation addresses an immediate need, whereas the development of an optimal framework for fiscal decision-making unfolds over a longer time horizon (an interesting discussion of fiscal consolidation measures and shorter-term optimality can be found in Uribe, 2016).
The difference between the cost of debt and the economic growth rate, found in the specialized literature under the acronym “r-g”, has given rise to important economic debates about the sustainability of public debt and the nuance of the measures that should be adopted. A positive and high level of r-g may indicate problems for the sustainability of public debt. Using a judgment based on a dynamic Laffer curve, Cochrane (2010) emphasizes that the reduction of long-term growth prospects can significantly reduce fiscal space.
Understanding and acknowledging the economic situation we face on this challenging path requires an honest assessment of the current economy. Misperceiving economic realities can lead to serious mistakes with significant consequences, as the trust of private actors—such as the public, businesses, and investors—can be lost quickly and is often difficult and costly to restore in the medium term.
While mystifying economic reality may create short-term illusions, it inevitably results in crises over the long term. Economic truth, however uncomfortable, is fundamental for making rational decisions and maintaining trust in institutions.