June 14, 2010 6:30 pm

Eastern Europe grapples with business challenges

The past 20 years have seen the re-emergence of entrepreneurship in eastern Europe. The establishment of market economies would not have been possible without countless enterprises, small and large, that drive development and growth. Today, many parts of the region boast a strong industrial base that has been built with the help of massive foreign investment as well as a skilled and flexible workforce.

These are lasting successes. They will not, however, be enough to secure continuing entrepreneurship and dynamic growth in the decades ahead. As the region begins to recover from the global financial crisis, its entrepreneurs are facing challenges from two directions. One has to do with the aftermath and the likely medium-term consequences of the crisis. Another, perhaps even bigger, hurdle relates to trends inherent in the region’s growth model before the crisis. They can be overcome, but doing so will require both imaginative entrepreneurs and good public policy.

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The crisis has made business in the region more difficult in many ways. Some have to deal with the obvious problems of surviving in an environment with subdued demand and no access to credit. With growth in Europe still weak, and credit constrained by pre-crisis debt and non-performing loans, these problems are expected to persist for some time.

More importantly, new investment will be challenging even beyond the recovery phase. With scarcer global capital, foreign direct investment will remain subdued, compared with pre-crisis levels, over the medium term. This is true also for external funding of bank credit. At the same time, local funding remains difficult, mainly as a result of underdeveloped local capital markets. Developing these markets – hence allowing domestic firms to benefit from local investment – is high on the policy agenda for the region.

Eastern Europe grapples with medium-term challenges that it would have faced sooner or later, crisis or no crisis. During the integration process with the wider European and global economy, the region was successful in attracting billions of dollars in foreign direct investment mainly for three reasons: competitive unit labour costs, favourable tax regimes and the promises of largely underdeveloped markets with huge pent-up demand. All these elements are temporary as these economies converge with those of advanced countries. Therefore it is indispensable for enterprises to improve their competitiveness and step up efforts to produce value-added goods and services.

Part of this effort is to make best use of existing skills and entrepreneurial talents. Eastern Europe is still losing valuable talent to the west, and a life story such as that of Sergey Brin is all too familiar: born in Moscow in 1973, Brin arrived in the US in 1976 with his parents and went on to co-found Google. Steve Wozniak, the inventor of the Apple computer and co-founder of the company, is the son of Polish immigrants. Retaining such talent will require both improving education and training and creating the kinds of opportunities for business growth that entrepreneurs can expect in the US and other advanced countries.

Eastern Europe today already has large and successful companies. Indeed, it boasts some truly global players in the natural resources sector, first and foremost in Russia. On a smaller scale, but in the same sector, Hungary’s oil company MOL became an important regional player in recent years and Poland’s PKN Orlen was strong enough to expand to Germany, where the company took over the petrol stations of BP, its bigger rival.

Outside the natural resources sector, however, such stories remain rare; an eastern European brand of the power and global recognition of, for instance, Google or Apple has not yet emerged.

What will it take for the region to produce such success stories? Lack of knowledge on the world market about the existence and quality of products “made in eastern Europe” still impedes efforts to win market share. In some cases, these impediments can be overcome by the creativity of individual companies.

An example of adroit positioning and solid delivery is the Czech carmaker Skoda, which, since a takeover by Germany’s Volkswagen Group in 1991, has become the country’s biggest exporter.

However, public policy needs to create a more supportive environment for the growth of good business. A characteristic of the business structure of many European countries is the missing middle range: strong, large firms at the top – often formerly state-owned or natural resources firms; plenty of talented small firms at the bottom; and not very much in between.

To be sure, there are exceptions: firms that have emerged and gone from domestic market leaders to regional champions and who are now successfully competing on the global market.

These exceptions have mainly occurred in countries with strong business environments, particularly in central Europe. To give other entrepreneurs similar opportunities, long-standing challenges such as red tape, transparency, law enforcement and corruption need to be tackled. In addition, competition rules must be better enforced to facilitate the emergence and growth of new players.

Eastern Europe is only at the outset of developing its new entrepreneurial class. But today there are hundreds of thousands of sound, innovative and well-run private businesses in the region. Among them there may well be future champions in a global league. Public policy needs to focus on taking obstacles out of their way.

The writer is president of the European Bank for Reconstruction and Development

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