A revamped industrial policy is essential for the Central and Eastern European EU members (EU-CEE), if they are to escape the so-called "middle-income trap”, says a new report from the Vienna Institute for International Economic Studies (wiiw). 

Having served as an "extended workbench" for Western firms by hosting labour-intensive production, the EU-CEE nations must now pivot toward innovation to maintain economic momentum, according to wiiw. 

The report is a follow-up to an earlier study, published in 2021 for the Friedrich-Ebert-Stiftung, which found the region – comprising Poland, Czechia, Slovakia, Hungary, Slovenia, Croatia, Romania, Bulgaria, Estonia, Latvia and Lithuania – has made significant strides in catching up with Western Europe since the early 2000s. 

However, this growth model is nearing its limits, the new report reveals, and thus a new industry policy is needed. 

“This is … illustrated by the recently published report by former European Central Bank president Mario Draghi on the future of European competitiveness,” said Zuzana Zavarská, economist at wiiw and co-author of the study. “In it, Draghi rightly calls for a European industrial policy and massive investment in key technologies.”

Lagging behind in innovation

One of the key challenges facing EU-CEE countries is insufficient investment in research and development (R&D). While R&D expenditure is slowly rising, particularly in Poland, Czechia and Croatia, the region remains far behind the EU target of spending 3% of GDP on R&D. “Above all, they are spending nowhere near enough money on research and development, which impairs their ability to innovate,” Zavarská added.

Only Slovenia and Czechia currently exceed 2% of GDP R&D expenditure, with other nations like Slovakia, Bulgaria, Latvia and Romania spending less than 1%. Although some countries export medium- to high-tech products, much of this is driven by foreign multinational companies, and domestic firms struggle to benefit from advanced technological expertise.

Areas for improvement

The report highlights shortcomings in education systems across the region, with poor quality and chronic underfunding affecting graduates' ability to contribute to innovation. Additionally, there is significant room for improvement in green technologies, a key area where the EU-CEE countries are falling behind global trends.

Despite these challenges, there have been notable advances in digitalisation, with several innovative companies emerging in digital sectors. However, the study notes that these are often isolated examples, not yet fully integrated into broader innovation ecosystems.

Role models

In the face of these challenges, the wiiw report identifies Ireland and Singapore as role models for the region. Both countries, which once relied heavily on foreign direct investment (FDI), have shifted towards fostering domestic innovation through strategic industrial policy. "Ireland's 'innovation by invitation' approach has been highly effective," said Zavarská. Ireland has leveraged FDI to build clusters in industries like microelectronics, creating more local value through increased R&D activity.

A key factor in both Ireland and Singapore's success has been a focus on aligning education systems with industrial needs. Zavarská pointed out that both nations have made substantial investments in vocational training and higher education, particularly in science, technology, engineering, and mathematics (STEM) fields.

Policy recommendations

To replicate these successes, wiiw’s report recommends a comprehensive rethinking of industrial strategies across the EU-CEE region. The report advocates for the creation of national agencies to coordinate innovation efforts, better utilization of EU funds, and targeted incentives for R&D.

"A long-term innovation strategy, alongside efforts to build industrial clusters in promising sectors, will be key for these countries to remain competitive," the report concludes. Additionally, governments are encouraged to facilitate stronger cooperation between universities, research institutions, and industry players to accelerate technological advancement.

The report further calls for enhanced immigration policies to attract highly skilled specialists and for improvements in financing conditions for start-ups and innovative enterprises. Ultimately, the study underscores the need for a coordinated, Europe-wide approach to industrial policy, with significant public investment to ensure the EU-CEE region can break free from its current economic constraints.