Growth potential across Central and Eastern Europe has fallen sharply from the levels seen around EU accession, with ageing populations, weak productivity, Chinese competition and slower German industry increasingly testing the region’s economic convergence.
The economic model that transformed Central and Eastern Europe after EU accession is losing momentum, according to the International Monetary Fund, which is warning governments that structural reforms are needed if the region is to continue narrowing the income gap with Western Europe.
Carlos Mulas-Granados, the IMF’s regional representative, said on Tuesday that medium-term growth potential across Central and Eastern Europe had declined to around 2.5 per cent, compared with roughly 5 per cent before countries in the region joined the European Union.
The slowdown does not mean that every economy is stagnating. Poland continues to grow faster than much of Western Europe, while the Czech economy has recovered from recent shocks. The concern is instead about the underlying rate at which these economies can expand once temporary fiscal stimulus, EU funding and post-crisis recoveries are stripped out.
Several of the forces behind the region’s earlier success are becoming weaker.
EU accession opened access to the single market, attracted foreign investment and integrated Poland, Czechia, Slovakia and Hungary deeply into European industrial supply chains. German manufacturers in particular moved production eastwards, taking advantage of lower labour costs, skilled workforces and geographic proximity.
That process generated rapid gains in productivity and incomes. It cannot simply be repeated.
Demographics are one of the most immediate constraints. Working-age populations are shrinking across much of the region while ageing increases spending requirements for pensions, health care and social support.
The IMF’s country assessments illustrate the problem. Its assessment of Poland says demographic pressures are mounting even as labour productivity remains comparatively strong, and calls for higher labour participation, better skills and deeper capital markets.
In Slovakia, the Fund expects growth of only 0.9 per cent this year and says adverse demographics and weaker productivity are weighing on the medium-term outlook. The economy remains particularly exposed to manufacturing and the automotive industry.
The Czech Republic faces a similar structural constraint. The IMF estimates its medium-term potential growth at around 1.8 per cent, with population ageing and modest productivity gains limiting further convergence.
External conditions have also changed.
Germany, the region’s principal industrial partner, has experienced prolonged weakness in manufacturing. Central European producers therefore face softer demand from the market around which many of their supply chains were originally built.
At the same time, China has moved from being primarily a source of imports and components to a direct competitor in sectors where Central Europe has substantial industrial exposure, including cars, batteries, machinery and electrical equipment.
That combination is particularly difficult for economies built around export-oriented manufacturing.
The problem overlaps with the wider European competitiveness debate. EU Today reported in July that only 15.7 per cent of the reforms recommended in Mario Draghi’s competitiveness report had been fully implemented at that stage, with important work still outstanding on capital markets, energy and investment.
For Central Europe, progress on those issues has a direct bearing on growth. Smaller national capital markets make it harder for companies to finance expansion. Fragmented energy systems add to industrial costs, while limited access to venture capital can restrict the development of businesses outside established manufacturing sectors.
There are significant differences between countries. Poland’s larger domestic market gives it more insulation from industrial weakness elsewhere and the IMF expects relatively strong growth. Hungary has faced a different combination of weak investment and fiscal constraints, while Slovakia’s dependence on car production leaves it particularly exposed to changes in the European automotive sector.
EU funding remains an important source of investment across the region, particularly for infrastructure and modernisation. But EU transfers cannot by themselves replace improvements in productivity.
The IMF’s argument is therefore less about an immediate recession than about the end of an unusually favourable period of convergence.
Central Europe entered the EU with lower wages, substantial scope to import Western technology and a powerful incentive for Western European manufacturers to move production eastwards. As those gaps narrow, future growth depends more heavily on innovation, skills, investment and domestic productivity.
The region is still converging with Western Europe. The question raised by the latest IMF warning is how quickly that process can continue once the economic advantages that powered its first two decades of EU membership become less powerful.
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