CEE countries’ GDP has risen to levels never before enjoyed, yet the validity of their growth models built on low cost labour is being brought into question; critical challenges of demographics, migration and digital disruption loom ahead. The region as a whole has made huge strides and ranks 38th worldwide in terms of prosperity, although it lags behind when it comes to economic openness, finds the CEE Prosperity Report produced by the Legatum Institute together with Erste Group. Three distinct prosperity zones are emerging in CEE, depending on the respective countries’ competitive strengths. At the same time, all CEE countries are challenged to rethink their strategies to ensure that future prosperity is sustainable. Whatever path they follow, rule of law, government integrity and performance and an engaged citizenry are going to be critical to success.

“Being at a crossroads means asking a couple of tough questions: What kind of future do you envision? And how do you start planning for it today? As a bank, we would add a third one: Where will the financing you need to build this future going to come from? CEE countries have come a long way and at Erste we’ve witnessed that progress first-hand. But as they enter a new phase, with challenges that are very different from before, they need to start thinking of themselves differently: as players on a bigger, global stage who compete for higher value-adding businesses, skilled talent and smart capital. Each of these is a serious task in itself. 

We welcome the second edition of the Legatum Institute CEE report as an opportunity to keep the ball rolling on these strategic conversations. And we will do our share to make sure CEE countries, their businesses and people have access to the diversified capital they need to step up their game in this new era,” says Andreas Treichl, CEO Erste Group.

Also commenting on the findings of the report, the Legatum Institute’s Senior Fellow James Sproule said: 

“This report has shone a spotlight on the challenges and opportunities facing a region in transition. Our findings tell a compelling story of an economic model built on comparatively low cost labour under terminal pressure. 
“Looking to the next stages of economic growth requires businesses to be further integrated in the wider European and Global supply chains, but also to be far more entrepreneurial. This can be achieved through the creation of new ventures, or the facilitation of entrepreneurialism within existing businesses.”

If it were a single country, Central and Eastern Europe would, according to the Legatum Institute Prosperity Index, be comparable to Chile, South Korea and Israel. Breaking this overall ranking down into its constituent parts: for economic openness, Central and Eastern Europe is ranked 44th, due in part to the fact it was judged to have a weak business environment. The region overall scores poorly in labour market flexibility, ease of resolving redundancy, perceptions of the value of hard work and being a good place to start a business. In terms of an inclusive society; Central and Eastern Europe is ranked 36th – comparatively strong in safety and security, but weak in social capital. The countries of Central and Eastern Europe scored just above their overall rank in terms of empowered people – ranked 37th - comparatively strong in education, but weaker in health. 

Three different zones of prosperity have emerged – the Baltic ‘entrepreneurial sea’, the central “industrial hinterlands”, and a southeast “food hub”

The report also shows what that future is beginning to look like, with three distinct zones of prosperity emerging: the Baltic ‘entrepreneurial sea’, the central “industrial hinterlands” adjacent to Germany and Austria, and a south east “food hub”. Each area has different advantages and challenges, and each will likely follow a distinctly different path in future. What underpins all successful paths is effective governance which stops corruption; property rights that facilitate investment and a competitive landscape that promotes the best ideas. 

1) The Entrepreneurial Sea

The three Baltic States are amongst the most entrepreneurial in all of Europe. While much of Europe languishes in the bottom quartile of global entrepreneurial activity, the Baltic nations have shown that high degrees of social provision can be successfully combined with significant degrees of entrepreneurial business agility and large doses of radicalism.

The Baltic countries are catching up with the central Industrial Hinterlands levels of prosperity. Progress in future depends upon maintaining their present levels of economic and social agility. 

2) The Industrial Hinterlands 

The parts of CEE that have successfully integrated into the EU – Czechia, Slovakia, Slovenia, as well as parts of southern Poland and northern Hungary – are at the core of what is denoted the “Industrial Hinterlands” in the report. These have effectively become become the near-source home for German and other Europeans engineering and manufacturing. 

The strategic bet on vehicle production has worked very well, leading to a rapid rise in prosperity; but there is a growing need for industrial and economic diversity, as well as a wider variety of investment partners.  Moreover, the middle-income trap looms, where wage rises run ahead of productivity increases, resulting in firms and indeed industries becoming increasingly uncompetitive. The way out of the trap, and one that is well appreciated by the Czech Republic’s government amongst others, is to encourage productivity increases. Sitting alongside this challenge is the fact that the global automotive industry could well face significant challenges in the years ahead, such as the potential ban on internal combustion engine vehicles in China.

3) The South East Food Hub

The population or South Eastern Europe is less prosperous, less urban and less productive than in the rest of Central and Eastern Europe. The region has the potential to be a major agricultural resource for the whole of the EU, although it has to be recognised this has to be a long-term ambition. 

Encouraging and enabling migration to urban centres will help both productivity and prosperity. Key to achieving this is raising the capital intensity in the countryside, while raising the productivity of human capital in urban centres. The key policies proposed are: support for farm integration to increase the size of holdings and generate scale economies in production, and migration of labour surpluses to the cities to foster greater prosperity in both urban and rural parts of the economy. The greater development of urban centres across the region should be a priority, along with how local industry might use their strength as a food hub to move up the value chain of food processing.   

To foster further prosperity, the countries of Central and Eastern Europe must look beyond existing partners and technologies to either integrate or invent, or best of all, do both.

The economic model built on comparatively low cost labour is coming under terminal pressure. This model was the right one in the immediate post-Communist world, but rising wages and wage expectations and the longer-term difficulty of having productivity match wage increases means the “middle income trap” becomes an ever more prevalent challenge. Looking to the next stages of economic growth requires businesses to be further integrated in the wider European and Global supply chains, but also to be far more entrepreneurial. This can be achieved through the creation of new ventures, or the facilitation of entrepreneurialism within existing businesses. 
Prosperity has to be home grown, depending on a range of competitive small and medium businesses 

Fostering growth beyond that generated by foreign direct investments is a key priority. But in practice, most people work for small and medium enterprises, and too many of these firms are not internationally competitive. A burden of bureaucracy makes growth difficult and working within the shadow economy too tempting. At the same time, larger firms are not greatly affected by the Governance issues because they have developed mechanisms to cope with bureaucracy and negotiate exemptions; such an approach is a serious hindrance to fostering widespread prosperity.

The digital and information age puts “creative adaptation” at the heart of business and government transformation

The digital and information revolution means that the pace and scope of change seen over the past thirty years is likely to continue. The countries of the Baltic ‘Entrepreneurial Sea’ rank on average 29th in the world for broadband connections, whereas the ‘Industrial Hinterlands’ rank at 36th, with South Eastern Europe coming in at 49th. Finding the necessary investment for the digital challenge is primarily going to come from ‘creative adaptation’, existing companies using their cash flows to access capital and enable new business ventures to be built. Bringing about this adaptation is a challenge, and one that will be met much more effectively and readily embraced if the opportunities created are to be open to all. 

Read the report here.