Innovation needed to re-start CEE integration into Europe – Eerste report

The global financial crisis has put a brake on the integration of central and eastern European economies into the European Union, but growth drivers remain intact and innovation is needed to re-start the process, according to a report from Eerste Group.

The special report, “Convergence 2.0“, warns that over the next decade CEE will have to move from a classical catching up by imitation, to a knowledge-based system with more value added and more diversified exports.

Since the fall of communism Central and Eastern Europe has become “a textbook example of economic convergence” through integration into the EU.

“Pure cost competitiveness is not enough when countries are approaching the technological frontier; CEE countries will need to increase productivity of capital and labour by their own means and this makes investments in education and R&D crucial,” explains Birgit Niessner, chief analyst of CEE Macro Research at Erste Group.

In the Eerste CEE universe, the Czech Republic, Slovakia and Poland are seen as frontrunners in terms of competitiveness and knowledge, with Hungary falling behind them. Romania and Serbia are “on their way” but can still exploit more efficiency reserves before becoming innovating economies, the report said.

Croatia must become more competitive to preserve its relatively high income level, whereas Turkey has yet to move towards a knowledge economy.

The countries in the region have used their relative cost advantage to modernize their industries with foreign technologies. High stocks of foreign direct investment and a high share of exports to GDP are testimony to this, and have survived the financial crisis well.

The report noted that the “crisis year” 2008 constituted a break in the accumulation of FDI stock, but until 2011 the FDI stock had stabilized in all countries.

Another aspect underpinning CEE growth is excellence in exports. By exports’ share of GDP, differences within the CEE region become obvious. The most developed markets in the region were able to raise their share of exports in the crisis years.

Poland, Croatia and Romania sit in the middle range, partly due to the size of the markets (larger countries tend to export less), but also to non-competitive structures. However, their performance is still superior to the Southern European countries.

The report concludes that EU integration “a factor of paramount importance” in shaping the economic catch-up of the region. The question now is how to reform the integration growth model.

“…the challenge is to move from efficiency to innovation as drivers of competitiveness,” says Niesser. “The key to further catching up will be to replace the knowledge import with innovative products generated in CEE countries. Competition, high-quality tertiary education and the availability of venture capital finance will gain in importance.”

How much time do the CEE countries have to close the gap? Both actual and potential output growth rates have diminished in most European countries, but they are now forecast to recover to higher levels in CEE countries, with the exception of Hungary.

“This implies that in the short to medium term CEE countries will again embark on their path of catching up with the technological frontier. However, as soon as gaps in technology and human capital are closed, productivity growth will slow down and the deficits in home-grown innovation will become relevant,” concludes the report.


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