CEE Economies Could Return to Fast Growth: Report
December 19, 2013
Central and Eastern European countries have the potential to return to their pre-crisis economic growth rates—but they need to update their growth model, according to a report by management consulting firm McKinsey.
To return to their pre-crisis growth rates, the CEE economies need to pursue three growth thrusts, the report says: expanding and upgrading exports; raising productivity in lagging domestic sectors; and restoring flows of foreign direct investment and increasing domestic saving rates to fund investment. The new model’s success would also require additional reforms and other broad-based “enablers” in the CEE economies, according to McKinsey.
The report, A New Dawn: Reigniting Growth in Central and Eastern Europe, considers eight nations —Bulgaria, Croatia, the Czech Republic, Hungary, Poland, Romania, Slovakia, and Slovenia, all of them EU member states. They vary greatly in terms of land mass, population, urbanization, and stage of economic development. Yet they have many things in common, including geography, culture, history—and their past growth model.
Central and Eastern Europe was one of the fastest-growing regions before the financial crisis, with GDP expanding at an average annual rate of 4.6 percent from 2000 to 2008, the report says. Since the financial crisis the CEE region—like other parts of the world—has struggled to reignite growth. However, the region’s great underlying strengths, such as its educated yet affordable work force, a stable macroeconomic environment, and a strategic location, remain intact, according to McKinsey.
The initiatives outlined in the report are expected to help the CEE economies pursue sustainable, investment-led, and export-oriented growth. Investment in fixed capital would rise by 1.9 percent a year and total factor productivity growth would average 2.9 percent, putting the region on a path to pre-crisis levels of GDP growth of 4.6 percent. In a business-as-usual scenario, capital investment rates return to pre-crisis rates, total factor productivity growth reverts to its long-term average, and the effects of an aging work force are fully felt. This scenario leads to a 2.8 percent annual growth rate for CEE economies through 2025.
A new economic model is needed, the report says, because the global recession exposed certain weaknesses in the growth strategy that CEE economies followed before the crisis. These include very high consumption (about 80 percent of GDP from 2005 to 2008 vs. 50 percent in China), which was enabled by high levels of borrowing. The region was dependent on foreign direct investment, which fell by approximately 75 percent during the crisis and has only partly recovered. Trade was overly concentrated on Western European markets and in a few categories such as automotive, according to the report. And despite strong FDI flows, investments in machinery and technology were modest in many sectors.
The CEE economies have demonstrated their commitment to growth to improve the lives of their citizens, according to McKinsey. They undertook sweeping reforms in the 1990s to open their economies to investment and trade. They made difficult decisions to raise productivity, which led to rising wealth. The crisis and the slow global recovery have interrupted this progress, but pursuing this new growth model could put the CEE economies back on a path to faster growth and rising per capita GDP while helping counter the looming effects of aging populations.
To bolster growth, the CEE economies will also need to build the foundations for sustainable growth, including investment in infrastructure, urbanization, education, and innovation as well as regulatory and institutional reforms, the report says.