The wrong benchmark for Eastern Europe

The wrong benchmark for Eastern Europe

The wrong benchmark for Eastern Europe

Written by Katinka Barysch, 25 January 2007

The wrong benchmark for Eastern Europe
by Katinka Barysch

In November last year, Anders Aslund, a long-time observer of transition economies, rang the alarm bells over Eastern Europe. In an FT article he talked about “Central Europe’s political malaise” and warned that budget profligacy and reform fatigue would keep the new members from catching up with the West.

The tone was very different at last week’s Euromoney’s East European investment conference in Vienna. Bankers and politicians extolled the virtues of a fast-growing, open and stable region. The tenure of most speeches was: “We may have problems in the East, but on many fronts were are already better than the ‘old’ EU (or at least bits of it)”.

That’s certainly true for growth. In the last five years, the 12 new members recorded an average growth rate of 4.5 per cent, well above the EU-15’s 1.6 per cent. But the comparisons go further. “We are much faster reformers than the West Europeans” beamed one Serbian representative in Vienna. Romanians and Croatians were proud that the World Bank – in its annual ‘Doing business in 2007’ survey – put them into the group of fastest-reforming countries. Only one of the ‘old’ EU countries (France) made it into the list.

Romanians and Bulgarians also stressed that they came far ahead of long-standing EU members Italy and Greece in the World Bank’s overall ranking (which assesses the ease of starting a business, getting a loan, paying taxes and so on). Czechs and Slovenes have less unemployment than France, taxes in Slovakia are lower than in Germany …

Stop! These comparisons may be uplifting for countries that have struggled for more than a decade to join the EU club. But they miss the point. Eastern Europe gains nothing by benchmarking itself against the worst-performing EU-15 countries. This breeds complacency, which is not something that Romania, Poland or even the booming Baltics can afford.

The new members are doing well now. But they are in a rather uncomfortable spot between a high-tech Western Europe and low-cost emerging Asia. When it comes to skills, innovation and flexibility, the new members are miles away from the top EU performers. When it comes to wages, they cannot (and should not) endeavour to compete with China. The average Chinese worker earns $1.60 an hour, according to estimates from the Economist Intelligence Unit, while Chinese productivity has grown by 5 per cent a year over the last half-decade. In Hungary, wages are 5-6 times higher while productivity growth is half that of China. Further east, wages are still lower, but they are rising fast: Romania’s real wage growth exceeds 10 per cent.

China’s current export success rests largely on labour-intensive, mass-manufactured goods and consumer electronics. Most of the ‘old’ EU (perhaps with the exception of Portugal and Greece) has long moved out of the production of T-shirts or television sets, and into sophisticated manufacturing and services that do not directly compete with China. But the new member-states rely on the kind of low value-added goods and consumer electronics that China is specialising in.

There is no need to panic. The East European countries retain many advantages over China: geographical proximity, million of highly skilled, relatively low-cost workers, a business environment that is very similar to that in the ‘old’ EU, and full integration into the EU’s single market.

But competition from China and other emerging economies will force the new member-states to run ever faster just to stand still. They will have to move quickly into higher-value added goods and services. For this, they need vastly better education and training systems, more flexible labour markets and a truly entrepreneur-friendly business environment. In other words, it is Europe’s best performers – Denmark, Sweden, Ireland – that they need to compare themselves too, not the laggards.


Katinka Barysch is chief economist at the Centre for European Reform.

Comments

Added on 30 Jan 2007 at 18:12 by Hungarian voice

If Central European economies were compared to the EU's best performers the picture would be far from rosy.
The political turmoil in the Visegrad countries seems to prove that the prospect of EU accession was basically the one thing uniting these countries' political elites on their way toward modernization. Since accession became a reality, consensus on the ways and means of carrying out reform became in most cases a mere wish.
The need for serious sectoral reforms finds these countries at a time when there is no longer a strong incentive (such as EU membership) that would require or urge political consensus. The political will to carry out reforms in health care, education system, pensions, etc. would need strong governments and constructive opposition forces, who may differ on the means, but not on the ends. All four Visegrad countries political elites seem to be lacking this kind of approach. While adherence to the Maastricht criteria forces fiscal discipline on these countries, in most cases it also provides ground for attacks from the opposition.
So, the question is how long it will take for these countries to realize that EU membership was not the end of a process, but the beginning; and how long it will take for them to modernize their economies, to carry out the much-procrastinated reform in key sectors that will result in making them competitive on a global scale.

Added on 26 Jan 2007 at 15:01 by Baltic

Absolutely agree with the author! Even more, such benchmarking creates political backlash in the most of so called Old European capitals.

If one follows latest articles about new members in the Economist, Le Monde, FAZ and Helsingin Sanomat, then single diagnosis comes out from there, Eastern Europe - political turmoil due to the fledling political culture!

Indeed, political cultures were and are still different, but the very EU membership cleans corrupt administrations, makes the policy debate transparent or to put it another way - it converges the political culture of East and West Europe due to the Europeanization process!

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Written by Simon Tilford, 08 December 2006

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by Simon Tilford


When Claude Trichet, president of the European Central Bank, announced yesterday’s increase in eurozone interest rates, he did not even mention the threat a weaker dollar could pose to the outlook for the eurozone economy. At the current exchange rate between the euro and the dollar, his apparent complacency may be right. In trade weighted terms, the euro has only strengthened very gradually over the last 12 months. However, European policy-makers are being too sanguine about the implication for Europe of a sustained fall in the dollar. As a result, they risk repeating the mistakes of early 2001, when they dismissed the threat posed to the European economy from a weaker dollar.

What has changed since 2001 to make European policy-makers such as Mr Trichet so relaxed about the impact of a fall in the dollar on the European economy? One argument is that the eurozone economy has become less dependent on exports for growth. There are at last signs that the German economy could start growing under its own steam rather than depending on exports for external stimulus. However, it is far from clear that the recovery would remain on track if exports took a big hit.

In fact, the trade dependence of most EU economies has, if anything increased since 2001. For example, German exports as a percentage of GDP have risen rapidly in recent years. The proportion of total exports accounted for by the US may have declined, but that ignores the fact that a sizeable proportion of the growth has been accounted for by rising exports to countries whose currencies are effectively tied to the dollar, notably China.

Another argument is that the reforms made by European economies over the last five years have boosted their competitiveness and left them better able to cope with a weaker dollar. The competitiveness (and profitability) of German industry in particular has certainly improved, with the result that German companies will be relatively better able to cope with a weak dollar than five years ago. The same cannot be said of other eurozone economies. The competitiveness of the Italian and Spanish economies has deteriorated very sharply since 2001.

If the Chinese and the other East Asian central banks were to allow their currencies to rise in response to a fall in the dollar, then the European economy would not have to bear the full cost of adjustment of a decline in the value of the dollar. So far, there is no indication the East Asians intend to allow their currencies to rise against the dollar. In the event of a run on the dollar, European companies are likely to experience a loss of competitiveness not just in the US, but in fast growing Asian markets as well as in third markets, where US and Asian companies will be much more competitive.

In any event, a focus on the direct trade impact risks underestimating the scale of the threat. When measuring the vulnerability of the EU economy to a fall in the dollar and downturn in the US economy direct trade flows are a relatively small part of the story. The importance of the direct trade with the US is far outweighed by indirect links. For example, the sales of British and Dutch-owned companies in the US outweigh exports from the Netherlands to the UK many times over. Even in export-dependent Germany, sales from German-owned companies in the US are five times higher than the value of German export to the US. Declining profits from the US affiliates of European businesses would hit business confidence and investment in Europe hard.

The ECB should not rush to raise interest rates further. Of course, a stronger euro will present benefits as well as impose costs. Import prices will fall, especially those of commodities priced in dollars, such as oil. This will lower inflation pressures in Europe and reduce the likelihood of further interest rate rises. However, the European economy is not as resilient as many are assuming. A rise in the value of the euro to €1.50:$1 or €1.60:$1 – a very plausible assumption – would not just be shrugged off. Indeed, it would in all likelihood put an end to the long-awaited eurozone recovery, which is currently not powerful enough to absorb the shock of a much weaker dollar.

Simon Tilford is head of the business unit at the Centre for European Reform.




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