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Restarting Growth in Central and Eastern Europe: Drivers and Barriers

Arnold Schuh © WU Wien

The outbreak of the Covid-19 pandemic in early 2020 stopped a formidable 5-year growth period and pushed the economies of the CEE region into recession. With a projected decline in GDP for the region of about 6%, they will still do better than the Eurozone countries with an 8.3% fall in economic output. The forecast for the rebound are around +5% what means that the region will be back to 2019 levels in 2022 at the earliest.

To assess the impact of the pandemic on the future economic development of the CEE region, the analysis of pre-crisis trends in the business environment is a good starting point. There are six structural challenges that should be on the radar of Western multinationals operating in EU-CEE11: labor shortage and demographic decline, tendencies towards nationalist-populist policies, the decline in institutional quality, the transition from a low-cost economic model to an innovation-driven economy, a changing competitive landscape and the exposure to EU politics. Seen through the lens of the Covid-19 crisis, not many changes in the directions of those trends are expected, the pandemic is rather reinforcing them.

Regarding the labor market, the postponement of the labor shortage brings only short relief. Expanding businesses might it now have easier to find the candidates with the skills they urgently need. With the economic recovery, demand for sought-after skills will pick up again. At the same time, the pandemic will not stop the dramatic decline in working-age population in the region reaching up to 40% and more until 2075 in the Baltics, Bulgaria, Poland and Romania. Increased automation, return migration and migration in general as well as higher labor force participation rates may alleviate the situation in the medium-term.

The accelerated adoption of digital solutions in all areas of society and economy will be a game changer. The current digitalization boom will facilitate the transition from a low-cost economic model to an innovation-driven economy that is necessary to keep and enhance the living standard. An improved digital infrastructure provides foreign multinationals more options for upgrading their local operations. These may include efforts to advance Industry 4.0 in manufacturing, to drive further business process outsourcing to CEE or to team up with innovative start-ups in the region.

As in the past, another outstanding driver of this economic transformation and contributor to the current economic recovery are EU transfers. Main beneficiaries of the EU Recovery and Resilience Facility with € 310 bn. of grants are Croatia and Bulgaria. The former one will receive grants from 2021 to 2023 representing 11% of its GDP 2019, the latter one grants of nearly 10% to mitigate the economic and social impact of the coronavirus pandemic. These grants are just a part of the next EU long-term budget 2021-27 and the "NextGenerationEU" funds summing up to € 1.8 trillion. Besides the recovery, the focus of the funding will be research, innovation, digitalization, green technologies and the healthcare sector.

The other expected developments are rather threatening for incumbent Western multinationals. Regarding the competitive landscape, I expect a further diversification and intensification of competition. The 50% share of old EU-15 in the imports to the region will further decline at the expense of imports from the EU-CEE11 countries themselves and China. Governments will heavily support local businesses to stay in business or gain market share. The fast growing e-commerce sector lowers the entry barriers for newcomers. And the foreseeable industry consolidation in the wake of the economic downturn provides many market entry opportunities for new competitors too.

In addition, foreign firms will face a stronger and more intervening state, more protectionism and nationalism as well as increasing corruption. In the last months, we have seen a concentration of power in the hands of governments and their expanded influence on the economy. This happens in a region where many countries perform poorly in institutional quality, i.e. a concept that captures rule of law, control of corruption and regulatory quality. Now billions of Euro from the state and the EU's recovery funds are flooding the economy to fight the economic effects of the crisis and to strengthen the healthcare sector. This mix of huge inflows of money, power concentration, cronyism, and pervasive corruption does not bode well for the future development of the institutional quality in CEE as already some medical equipment sourcing scandals in the last months showed. This is unfortunate as institutional quality and economic development reinforce each other over the long-term, particularly in the knowledge economy. Legal insecurity, lack of transparency in public procurement and high levels of corruption will depress investment climate and deter potential investors.

What does this all mean for the management of Western multinational firms in CEE? First, they will have to pay more attention to the economic and political affairs in the individual countries and the region as a whole to be better prepared for the upcoming tensions and potential opportunities in the post-pandemic times. Second, they cannot rely on market strategies alone in such a politicized environment. They have to consider the more comprehensive use of political strategies in addition to market-oriented ones to protect their local businesses.

Continue reading and find out more about Austria as a springboard to CEE.

If you want to learn more about the economic recovery in CEE, please attend the Virtual Grow East Congress 2020 where academics and practitioners share their lessons from the crisis so far and discuss the role of human capital and innovative local firms for restarting growth in CEE.

Virtual Grow East Congress 2020:
Restarting growth in CEE: Drivers & barriers

27 November 2020, 9:30-13:00 (CET)
Program & registration: http://www.groweast.eu

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