The new EU member states of Central and Southeast Europe have made “enormous progress” during the three decades of transition, but are being held back by the quality of their institutions. Tackling this will help determine whether the region can shift to a model of innovation-led growth, says European Bank for Reconstruction and Development (EBRD) chief economist Beata Javorcik in an interview with bne IntelliNews. 

An anniversary of significance — the 30th anniversary of the fall of the Berlin Wall is on Saturday, November 9 — is inevitably a time for reflection on the progress made since that date, seen as the most decisive single moment in the ending of the Cold War to an end, and to also look ahead to what still needs to be achieved. 

Asked whether the transition period could be said to be “over” for some or all of the former Eastern Bloc countries, Javorcik said that while an “enormous amount” has been achieved, the transition “is definitely not over, and the frontier is not standing still so it’s a moving target”. 

“It’s not full convergence — perhaps it would have been unrealistic to expect full convergence within 30 years — but enormous progress has been made,” Javorcik tells bne IntelliNews. “Nine Central European countries are now officially classed as high income countries by the World Bank; they have reached about two-thirds of the income level of the OECD countries.” 

On top of the economic catch-up, Javorcik points to other factors indicating progress such as individual satisfaction with life. The EBRD examined this in a survey published in its annual Transition Report in 2016, finding that respondents from Central European and Baltic countries reported similar levels of satisfaction to their peers in West European countries such as Germany and Italy. 

Going beyond the statistics, Javorcik recommends looking at the younger generation. “Look at college students in CEE: they feel they are no different from their colleagues in the West — they watch the same films, listen to the same music, they dress the same way, they can travel and they take all this for granted. For them it seems that the world has always been this way,” says Javorcik. “For me that’s the best kind of progress.” 

Moving forward together

The performance of the economies that emerged from socialism in 1989-1990 has diverged over the last three decades, with the first wave of EU accession states that joined the bloc in 2004 still somewhat ahead of Bulgaria and Romania, which joined two years later in 2007. But the differences among these countries today are not so large as those between Central Europe and the former socialist countries to their east. 

The Central European countries were helped by their strong skill bases that helped them attract investment from the beginning of the transition period: “One thing these countries have going for them is a good endowment of skills, that was one of the good legacies of central planning.” This helped the development of the IT and outsourcing sectors, as well as specialisation in areas like automotive where the region was historically strong. 

Another positive legacy was gender equality including in tech and sciences; the gender differential in Central Europe tends to be smaller than in the West for example when it comes to maths and science students, and studies have also shown a larger share of women in the ICT and high-tech industries in Central than Western Europe. 

Over time, Central Europe has become more than a low wage destination, even though wages, while rising rapidly, still lag behind those in Western Europe. “We observe the movement up the value chain. If you were to compare productivity at a Volkswagen factory in Slovakia or Hungary and Germany you wouldn’t see substantial differences … Central European countries are creating high skilled jobs, replacing medium skilled jobs so there is some development in a positive direction.” 

EU accession was the other critically important factor for Central Europe as it “locked in the reforms”, says Javorcik. “Essentially for countries offered the prospect of EU accession, this prospect provided an anchor … tied the hands of policymakers because no matter which party was in power there was wide-ranging support for joining the EU, so no government could afford to change course. Locking in reforms was enormously important and I think that’s what really made the difference.”

And the benefits didn’t end with accession. Once the Central European countries got into the EU, structural and cohesion funds helped greatly with infrastructure development. 

The governance gap

But while there has been an economic catch-up, Javorcik points out that the gap between transition countries and advanced economies still remains quite large when it comes to institutions such as control of corruption, rule of law, quality of regulation and effectiveness of governments, and improvement in these areas has stalled.

This has serious practical implications: “If half of the governance gap with the G7 countries was closed, income convergence would be brought forward by almost a generation,” says Javorcik. 

“The governance gap matters very much because the early sources of growth have already been tapped, the low-hanging fruit has been reaped so now it becomes harder to grow. If these countries want to grow now they need to focus more on innovation-led growth, and for this kind of growth institutions matter very much,” says Javorcik. “They need this new source of growth because wages are increasing and their competitiveness as locations with relatively cheaper labour force is being eroded.”

The challenges ahead

Looking ahead, Central Europe faces two major challenges: handling demographic decline, and climate change and the transition to a low carbon economy. 

It’s no surprise that demographics is one of the big concerns for the future. On top of the slowdown in population growth typically seen as countries get richer, CEE has seen huge outflows of people, with countries losing substantial numbers of their populations. While some countries dealt with tightening labour markets by inviting labour migrants in particular from Ukraine, demography remains a challenge not just in terms of finding enough workers but because, for example, of the questions it raises about the sustainability of the pension systems 

“Another way of dealing with the challenge of the tight labour market is to respond with automation, moving up the value added chain to better, more sophisticated, higher paying jobs,” says Javorcik. There are some signs this is happening already, with the opening of R&D centres in the region, and the creation of higher skilled jobs. 

However, Javorcik adds, “moving to better paid, higher value add jobs is not trivial and this brings us back to the challenge of improving governance.” To really achieve innovation-led growth, “countries in the region have to address the governance deficit.”

Going green

The second big challenge ahead is the transition to a green economy. “This will happen,” says Javorcik. “The pressures will increase because climate change is becoming more and more apparent and we will need to take action.”

She acknowledges this will be more difficult for CEE countries than their western peers because high pollution is a legacy from central planning: “Even though they have made progress, on average these countries are 20% more polluting per unit of output than comparable emerging markets”. Poland in particular faces a heavy challenge due to its “addiction to coal”; Poland’s energy intensity is nearly twice the EU average. 

While the EBRD and other international financial institutions active in the region are stepping up their investments into the green economy, government action will most likely be the decisive factor in pushing companies towards green investment. The EBRD’s 2019 Transition Report due to be published later this month is set to include a survey in which around 60% of companies responding said that green investments were not a priority. “What emerges is there is very limited awareness of the need to undertake green investment, to think ahead,” says Javorcik. “Not surprisingly firms are more likely to undertake green investments if they are forced by regulation.” 

And this is not just a technical challenge; as Javorcik point out, thousands of jobs are heavily dependent on polluting industries, and energy intensive industries tend to be geographically concentrated. This means governments will need to think carefully about how to help people that will be negatively affected by the shift to a low carbon economy as jobs are lost in some traditional industries — even while there are clear benefits ahead in the reduction of air pollution and the creation of sunrise industries.