Central and Eastern Europe (CEE) is facing a historical turning point, as the European Union is in the process of implementing a project of deeper integration in various domains—from energy and public finances to security and foreign policy. For CEE countries, the process of Europeanisation has brought about significant gains, both financial (in terms of economic growth and development) and normative (in terms of the quality of democracy and governance).
However, human rights and rule of law are increasingly being challenged by anti-establishment or Eurosceptic parties in the EU. The nationalist and sovereignist platforms are gaining force. Beyond the posturing of incumbents, such as Viktor Orbán in Hungary, Jarosław Kaczyński in Poland, or more recently, Matteo Salvini in Italy, power is coming under increasing contestation by the Rassemblement National (National Rally) in France, the Freedom Party in Austria and the Alternative für Deutschland (AfD) in Germany.
So, how will the political balance tilt in Central and Eastern Europe (CEE) beyond the European elections? It is unlikely that the nationalist parties will be able to impose a drastic shift in the policy agenda (either in the European Parliament or in the individual nations). Although increasingly loud nationalist and Eurosceptic sentiments are resonating within leading political parties across Europe, the fact remains that integrationist policies have indeed taken effect at a steady pace and will likely continue to do so. With regard to the major threats that Europe is facing nowadays (i.e. migration, security, competitiveness on global markets) there is simply no solution at an exclusively national level—only together can member states prevail.
Still, within CEE there are persistent sentiments of being left behind: from Macron’s two-speed Europe project and the increased perception that Germany shapes Europe, to the persistent developmental divisions, there is mounting pressure for a new approach towards the newer member states in Europe. How will the EU address these sentiments in CEE?
The main offer so far has been based on investing in efforts to overcome the development divide and the feelings of inequality and unfairness that it breeds, with the aim of strengthening resilient pro-European attitudes. While this might be a useful long-term response to short-term outbursts of discontent, any integrationist agenda or political platform (see the recent efforts by the French president Emmanuel Macron and the German chancellor Angela Merkel) at the EU level should be as inclusive as possible towards CEE member states, whose nationalist parties are currently gaining ground. Secondly, CEE member states should seek increased partnership in terms of energy, transport and digital infrastructure, to mention only the most important areas of intervention. In the face of Russian posturing and cyber threats, CEE must seek security through interdependence.
Regional specialisation and factor endowment
The current global economy can be characterised by the term ‘New Economy’, that is, economic growth driven by new, highgrowth industries that are on the cutting edge of technology. While the term ‘new economy’ has been popping up since the early 1990s, there is an argument to be made in favour of current developments.
On the one hand, there has been an increase in the use of disruptive technologies in economic sectors, and innovative solutions for financing are clearly paramount in this overall context. On the other hand, the institutional and regulatory frameworks are increasingly responsive to these new developments, and whether they are adequate or not, it is clearer than ever that there has to be dialogue between the financing sector and European & national regulators in a meaningful, considerate manner. There is no one-size-fits-all economic model for development across Europe; not all the member states have reached the same level of development and convergence.
In CEE for example, Romania and neighbouring countries are good examples of how to move from a low-value economy to a higher value-added economy. Achieving this transition is very important in order to achieve sustainable development. It is also the right recipe to escape the middle-income trap in these countries.
The middle-income trap refers to a situation where the level of wages in a country stagnate as a result of its own economic development; more specifically, when the economic model based on low wages (e.g. manufacturing) changes given a certain increase in wages, but at the same time, the development of new high value-added industries lags behind.
The path to sustainable growth is very much influenced by the availability of factors of production in a given country. For example, Romania benefits from very high-quality human capital (e.g. trained and skilled professionals), but very poor infrastructure.
As such, we see a value increase in human capital-intensive sectors such as ITC, where we no longer see the highest frequency in call–centre-type activities, but rather in high-tech and RDI-intensive activities. In contrast, due to the poor infrastructure, there is slow progress in the industrial sectors reliant on physical activities and logistics. Industrialisation is essentially hampered by the very poor infrastructure. Also, the issue of financing is important for economic agents, particularly SMEs.
In Romania 75% of SMEs are self-funded; furthermore, approximately half of them display no activity, and of those that are active, many do not report profits. Therefore a vicious cycle develops between lack of capitalisation in the start-up segment and the lack of sophistication in developing markets.
Subnational disparities
New division lines are appearing in the European Union, without the historical disparities of development between the member states and regions having necessarily been resolved. The divisions within the different categories of the population both across Europe and within member states are currently just as important as the traditional divides across member states.
Regional divisions are persistent in the EU, and they no longer align to the classical categories of old vs. new member states. The latter are facing challenges of convergence, or catching up, as the European Commission has recently labelled many of them as ‘lagging regions’.
However, although CEE is still struggling with low incomes in some of its regions, high economic growth rates have been recorded across the area as a whole, as opposed to older member states in Southern Europe (i.e. Portugal, Spain, Italy and Greece) whose lagging regions are marked by low economic growth. Many of the EU member states have seen rising regional inequality, as convergence stalled during and since the economic crisis. Social divisions have become increasingly apparent according to various Eurobarometer data from the past decade.
Many of the EU member states have seen rising regional inequality, as convergence stalled during and since the economic crisis.
Social divisions have become increasingly apparent according to various Eurobarometer data from the past decade.
The values and beliefs of European citizens reflect new division lines on top of the persistent socio-economic ones, as social insecurity across Europe has been amplified by the economic crisis in Southern Europe and its strong negative social impact, as well as the current migration crisis. Capital cities are increasingly behaving very differently from rural areas in elections (e.g. Poland, Hungary, Bulgaria, UK, and increasingly Romania, as the latest European elections showed urban voters’ preference for liberal and cosmopolitan platforms to sovereignist and anti-EU rhetoric), according to different alignments of values: as the major cities remain predominantly liberal and cosmopolitan, the rural areas are increasingly turning to traditional or even fundamentalist values.
Economic divisions were meant to be tackled from the very beginning of the cohesion policy and the integration process. Still, economic grievances persist and amplify social and cultural insecurities. According to a recent survey of CEE states, EU membership has made prosperity more achievable for countries in transition, but has also made the consequences of failure more apparent. EU-wide income inequality declined notably prior to 2008, driven by a strong process of income convergence between European countries; but the Great Recession broke this trend and pushed inequalities upwards, both for the EU as a whole and across most countries.
Also, according to recent surveys, both inter- and intra-generational mobility has stagnated or decreased in several member states. Nevertheless, in a number of CEE countries (such as the Czech Republic) citizens still believe they are better off economically than they ever were before. Furthermore, several regions in CEE countries have changed their status from ‘less developed regions’ to ‘developed regions’ over the course of the current multiannual financial frameworks (MFF 2014-2020).
While member states in Central and Eastern Europe (CEE) have showcased steady economic growth over the past years, the area still lags behind its Western counterparts. It now stands at a crossroads, attempting to avoid the ‘middle-income trap’. In order for this region to continue its path to prosperity, it must enhance the competitiveness of its domestic SMEs and push forward in new technologies and innovation.
Drivers of economic development: Romania’s local business environment
In the current context, in which global markets are marked by growing uncertainty, ensuring sources of capital for investments is one of the paramount conditions for achieving and sustaining economic growth and development. For the EU member states, there is the added benefit of accessing EU structural funding for investments, besides the capital markets, national budgets and public-private partnership. Whatever the source of funding might be, it is necessary to identify the specific needs of a given economy, and to prioritise investment projects according to those needs. It is clear that in the case of Romania there is an essential need to develop several priority infrastructure projects. However, it is often difficult to properly understand and address the investment needs from a national, or increasingly a European view-point.
Meanwhile, in a context in which structural funding is mostly directed to projects that provide ‘European added value’, decreasing attention is paid to local needs and opportunities. In a recent paper with George Ștefan, we present an original metric to assess economic activity at the local level: the Local Business Environment Index (LBEI).[i]
In the development of this metric we explored a large set of variables that are disaggregated at municipal level. Following the extant literature on the different drivers of economic development, we proposed four major axes of assessment: entrepreneurship, innovation, investment financing, and support from public authorities.
The highest scores in the 2018 overall ranking of the level of attractiveness of the local business environment went to cities of various sizes: Bucharest, Cluj-Napoca, Timișoara, Alba-Iulia and Sibiu. Each municipality has a different distribution of its specific strengths. Interestingly enough, it is not just the capital city of Bucharest that dominates the different components of the LBEI.
In the case of the sub-index for Innovation for example, the rankings are dominated by Timișoara, Cluj and Sibiu, and not the capital city of Bucharest. In the case of the sub-index for Entrepreneurship, the top-ranking city is Cluj, and not Bucharest. As such, we can see that there are elements (competitive advantages) that define some Romanian cities and lead them to excel in certain areas over others.
The two-tier approach of the EU might shelter Western countries from economic and social risks, but it also fuels tensions with new member states.
These rearrangements in the ranking of Romanian cities in the sub-indexes of our proposed LBEI metric show the extent to which there are specific local and regional economic opportunities and challenges. In the cities that occupy the top positions, the economic growth rate and general development level surpass those of many Western European cities.
It is important to understand the drivers of this economic performance, as this is key to remedying the disparities across the wider EU.
Rethinking CEE: Bridging the divides
It is becoming increasingly obvious that the two-tier approach of the European Union might shelter Western countries from economic and social risks, but it also fuels tensions between old and new member states. Economic development in many of the newer member states has been robust, albeit heavily concentrated in major cities.
As shown in the case of Romania, the economic development of many cities in Central and Eastern Europe depends on the extent to which these are integrated into the larger European market: whether in terms of innovation or access to capital, connectivity remains a central driver. Social integration often comes by way of economic integration. For Central and Eastern Europe (CEE) the path to further economic integration into the European Union lies through (1) market linkages (e.g. integration into regional value chains, development of high value-added economic agents, increased FDIs) and (2[ii]) institutional and policy instruments (e.g. adopting the Euro, EU-funded investment projects).
In terms of institutional performance and policy choices, political will and knowledge are essential in order to further economic integration and effectively reduce disparities. For example, in the upcoming Multiannual Financial Framework (MFF 2021-2027)2, the process of negotiation will be very important as the EU may lose a net-contributing member state through Brexit, which would cause a deficit in EU budget revenues estimated at over €10 billion.
Central and Eastern European (CEE) member states are generally net beneficiaries from the EU budget, and are heavily invested in programmes such as those funded through the Cohesion Policy and the Common Agricultural Policy (CAP) which specifically address the current disparities. As far as Romania is concerned, it draws approximately four times the amount of money from the EU budget as it contributes. Still, it is important to maintain the same level of absorption of EU funds, as these are the third largest source of financing for public investments apart from the national budget and capital loans.
At this stage, it looks likely that Romania will be allocated more resources than in the previous financial year (in current prices), but the conditions of eligibility and the context are considerably different, making it harder to draw the pre-allocated funding. Other CEE countries whose regions have moved from ‘less developed’ to ‘more developed’ are likely to see their funding diminished, but they have a great deal of experience in using the available funds optimally (e.g. Poland, Hungary).
Overall, the negotiations for the future MFF will be more difficult for CEE member states in the coming period. With the growing concerns regarding the future and sustainability of the European construction, we should rethink the Central and Eastern European region not as a peripheral area, but rather as a region in which further integration will yield higher rewards for the EU as a whole.
This shift towards the core of the EU is based on three elements. Firstly, there is a sociological component: in CEE member states there is still a predominantly pro-European attitude, in contrast to the increasing wave of Euroscepticism in Western Europe.
Secondly, there is an economic element, as CEE has also
presented a strong economic outlook over the past years, making it a key market
for larger European economies such as Germany. Finally, there is a geopolitical
argument, as many CEE countries have strong incentives to increase their
interconnectivity with Western Europe, so that they are sheltered from
instability, such as that in neighbouring Ukraine.
[i] Volintiru, Clara & Ștefan, George (2018). ‘Economic Development and Opportunities in Romania: Local Business Environment Index (LBEI)’. Aspen White Paper; cf. Volintiru, C. et al. (2018). ‘Economic Development and Innovation at Local Level-Local Business Environment Index’, Romanian Journal of European Affairs, 18, 5
[ii] 2. Dăianu, D., Fugaru, A., Mihailovici, G., and Volintiru, C. (2018). ‘Multiannual Financial Framework Post-2020: Risks and Opportunities’, European Institute from Romania (IER) Strategy and Policy Study, no. 1/2018 [in Romanian].