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Sunday, 23 November 2014

25 years of transition in Central and Eastern Europe and its impact on the economy

Jonathan Scheele (SEESOX Associate; Senior Member, St Antony's College, Oxford)

On 18 November, Rainer Muenz, Head of Research at Erste Bank, Vienna, gave a seminar, convened jointly by ESC and SEESOX, “On the doorstep between Brussels and Moscow”, looking at the economic prospects for the countries of Central and Eastern Europe – new Member States and candidates. He delivered a master class in clarity and concision, marshalling complex data sets to render his thinking easily accessible to all.

He began by remarking that there was snow on economic expectations – how should we interpret this? His conclusion was far from reassuring. The CEE countries could, pre-crisis, expect their growth differential against western Europe to allow their GDP to converge to the EU average within two to three generations; post-crisis, with a much lower growth differential on current trends, convergence to the EU average will take a lifetime.

While reforms have been significant, CEE countries now face the challenge of transition from low wage comparative advantage to generating the higher value added needed to compensate for wage convergence – moving up the international food chain, in other words. This has yet to happen. And so long as households in the CEE countries need to spend such a high share of their income on basic consumption, they will face constraints on their savings capacity, as well as on their flexibility in times of crisis.

Increased infrastructure and R & D spending is vital to restore the growth differential, but there is a clear correlation between the level of corruption, as shown by the Transparency International index, and the level of absorption of EU funding – the more corrupt the country, the less its capacity to use EU funding.

Huge changes are under way in the CEE countries, with both outward and urban migration, alongside a shrinking and aging population, creating greater inequality within countries, even as average incomes increase – though more slowly now. And it is far from clear that countries in the region are really ready to accommodate the diversity generated by the immigrant flows they will need for future sustainability.

Political tensions with Russia create risks, especially to the small, open economies of many of the CEE countries. These tensions could also prevent Ukraine carrying out the reforms needed to move it in the more liberal direction needed to offer opportunities for its own and neighbours’ SMEs.

One possibility for improving prospects could be strengthening cooperation and integration among the Visegrad 4 (Czech Republic, Hungary, Poland, Slovakia), perhaps enlarged to include Slovenia and Croatia. This could create another “Scandinavia” in Central Europe and help to reshape convergence efforts. But emotional issues remain a problem in such a scenario and can too often triumph over economic rationality, as we see at the moment in the case of Hungary.

Questioned about the Polish “miracle” of being the only country in Europe to maintain growth during the crisis, Muenz ascribed this in part to the size of its economy, making it less vulnerable to developments in its neighbours; Romania had also suffered less than the smaller economies. But he saw this as unrelated to its being outside the Eurozone; for him, being an “out” conferred little advantage, since the solution of competitive devaluation was one of facility and tended to discourage the deeper reform necessary for sustainable growth (as in the case of Hungary). The only advantage was not having to face domestic political criticism when, as in the case of Slovakia, solidarity with Greece during the Eurozone crisis meant support for a country with twice its own per capita GDP.

Altogether a stimulating event, even if one didn’t come out of it feeling overly optimistic for the future of the region.

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