CESEE Region Still Has Enormous Growth Potential

“CEE growth drivers intact but innovation is needed to start convergence 2.0” Erste Group says.

Since the fall of communism Central and Eastern Europe has become a textbook example of economic convergence through integration into the EU. However, the financial crisis has put a brake on this process. Erste Group’s special report “Convergence 2.0” published today finds that growth drivers are intact, but over the next decade CEE will have to move from a classical catching up by imitation to a knowledge-based system with more value added and more diversified exports. “Pure cost competitiveness is not enough when countries are approaching the technological frontier; CEE countries will need to increase productivity of capital and labour by their own means and this makes investments in education and R&D crucial,” explains Birgit Niessner, Chief Analyst of CEE Macro Research at Erste Group.

“Among our sample of CEE countries, the Czech Republic, Slovakia and Poland are the frontrunners in terms of competitiveness and knowledge, with Hungary falling behind this group of countries. Romania and Serbia are on their way, but can still exploit more efficiency reserves before becoming innovating economies. Croatia must become more competitive to preserve its relatively high income level, whereas Turkey still has to move towards a knowledge economy.” Erste Group says.

FDI stock stable at high level, exports still strong but CEE must go beyond the low cost play
CEE countries have used the re-integration of Europe to their own economic benefit and foreign investors have discovered the region as a place to invest in. The countries of the region have thus used their relative cost advantage to modernize their industry with foreign technologies. High stocks of FDI and a high share of exports to GDP are testimony to this and have survived the financial crisis well. The crisis year 2008 constituted a break in the accumulation of the FDI stock, but until 2011, the FDI stock stabilized in all countries. Hungary’s FDI stock has seen the most negative development: From a peak of 75% of GDP in 2009, it came down by more than 10 percentage points in only two years. Last but not least, another specialty of growth in CEE is excellence in exports. Looking at export’s share of GDP, differences within the CEE region become obvious: starting at already high levels, the CEE-3 countries were able to raise their share of exports in the crisis years. Poland, Croatia and Romania can be found in the middle range, which is partly due to the size of the markets (larger countries tend to export less), but also to non-competitive structures. However, their performance is still superior to the Southern European countries.

So the EU integration has been a success and a factor of paramount importance in the shaping of the economic catch up of the CEE region. The question now is how to reform the integration model of growth. “To use the terminology of the World Economic Forum (WEF) the challenge is to move from efficiency to innovation as drivers of competitiveness. The key to further catching up will be to replace the import of knowledge by innovative and new products generated in CEE countries. Competition, high-quality tertiary education and the availability of venture capital finance will gain in importance,” says Niessner.

The level of tertiary education in CEE is quite diverse, but for most of them it oscillates around 20% of for people aged 30 to 34 and is thus far from the EU target (40%) and the level needed for a labor force engaged in highly innovative sectors.