Who is competitive and rich?
For Central and Eastern Europe, the crisis has not only meant austerity and slowing growth, but also some doubts about the sustainability of its growth model. Was it all simply an economic boom driven by capital inflows and over-consumption, where, behind the high headline growth figures, economies did not invest and become more productive? Looking at actual growth figures, it looks like economic convergence is taking a break.
First, we dig deep into the characteristics of the CEE growth model, which is essentially an industrial one. CEE countries have used the re-integration of Europe to their own economic benefit and foreign investors have discovered the region as a place in which to invest. And they did so in more and more sophisticated branches of the economy, which brought enormous productivity gains. Productivity levels are still lower than in Western European countries, but this is compensated for by low labor costs. 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 success and have survived the financial crisis well.
So the recipe for success is intact, but pure cost competitiveness is not enough when countries are approaching the technological frontier. The key to further catching up will be to replace the importing of knowledge by innovative and new products generated in the countries. And this is only possible with highly educated people and a significant increase in expenditure on R&D. The aim is to become a knowledge economy which relies on knowledge as the key engine of economic growth. Investing in education and innovation can help CEE countries to restart the convergence machine in difficult times and at the same time prepare the way for joining the high-tech league of countries.
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.
Finally, we ask how CEE will fare in terms of growth of potential output, i.e. whether the catching-up story will continue. Major forecasts say that CEE will maintain its growth advantage over Western peers in the short- and long-run.