Central and eastern European countries have been an economic success story for the past two decades. However, after years of being Europe’s fastest growing region, their economic engine appears to be running out of steam.
The leaders of four central European countries gathered in Warsaw two months ago to ask what might replace an outdated growth model. They were there to sell the region as a hub of technological innovation, not just old-fashioned manufacturing.
“We want the region to become the centre of innovation,” Beata Szydlo, Poland’s prime minister, told an audience of nearly 1,000 entrepreneurs and investors from local countries gathered in Warsaw. “It is our responsibility to create an ecosystem in which you will be able to develop your talent.”
Since overthrowing Soviet-imposed communism, with many central and eastern European countries joining the EU, the region has used low labour costs to lure investors to build new factories. However, it has done little to convince them to locate researchers there.
This strategy now appears to have reached its limit. Productivity growth has been far slower in the region than in western Europe since the financial crisis, according to the International Monetary Fund. It has not helped that 20m people — 6 per cent of the working-age population — have left the region in the pursuit of riches abroad over the past 25 years.
Looming on the horizon is the “middle-income trap,” says Vladimir Vano, chief economist of Sberbank Europe, the Austria-headquartered subsidiary of Russia’s Sberbank. This is when rising living standards make economies lose their competitive edge. “It is harder to move up the ladder to a high-income economy. It requires a more agile business environment and innovation.”
Shifting to an innovation-based economy will not be easy. Central and eastern European countries invest modestly in research and innovation, spending just 1.2 per cent of GDP compared to an average of 2.1 per cent across the EU, according to the European Commission. Only half of this investment is spent by businesses rather than the public sector or universities.
Nonetheless, important differences exist between the countries. Estonia has become a hotbed for digital entrepreneurs in recent years. The Czech Republic and Slovenia spend just as much on research and innovation as western European countries do, and Slovakia’s investment has grown at a rate four times higher than the average in the EU.
A few global success stories have come from the region. Skype, the video-calling app, and TransferWise, an online money transfer start-up, had a substantial part of their development work done in Estonia. A string of antivirus software companies, such as the Czech Republic’s Avast and AVG and Slovakia’s Eset, are well known in the global cyber security market. Hungary’s Prezi, an online presentation app, is also used by millions worldwide.
Others are following their lead. Two Slovaks have recently unveiled the world’s first market-ready flying car, Aeromobil, competing with Silicon Valley companies. In Romania, UiPath, which makes intelligent software that automates repetitive office tasks, has received a $30m venture capital investment help market the product internationally.
“The environment has radically changed,” says Andrej Kiska, partner at Credo Ventures, one of the largest venture capital funds in the region. “A few years ago, we would receive 300 business plans a year, it was about 1,200 last year. Not only has their quantity increased, but also their quality.”
Luciana Lixandru, partner at Accel Partners, a venture capital firm in London, agrees. “The ecosystem is maturing, but it is still very early on. As time goes by, I am confident more interesting companies will come out of the region, and more international investors will invest in the region.”
Investors betting on central and eastern Europe say that entrepreneurs have access to a strong pool of talented engineers who can produce ambitious projects at a lower cost. Furthermore, because of the limited scale of local economies, they are often adept at pushing products out to global markets faster than their western rivals.
Whether the local tech success stories can transfer central and eastern Europe into a leading innovation hub, however, still remains to be seen.
One problem is that central and eastern European countries have not been able to muster the same quantity or quality of venture capital as their western counterparts. Private equity and venture capital investment into the region was a modest €1.6bn in 2015, just 3 per cent of the amount spent across the whole of Europe, according to Invest Europe, an association of investment funds.
Most venture funding the region come from state-backed funds. The EU, in particular, has ploughed billions of euros into government-run funds and local venture capital funds.
Some entrepreneurs worry that government funding of start-ups might hold back entrepreneurs’ chances of attracting private sector backing and distract from fixing deep-rooted problems, such as improving education systems and making the business environment friendlier by removing cumbersome legislation.
“State-backed funds have distorted the environment for real entrepreneurs,” says Michal Stencl, founder and chief executive of Sygic, a Slovak navigation software company and one of the region’s technology success stories, with 200m customers globally. “If governments want to help, they should create an environment where talent can be nurtured.”
The region’s pool of skilled engineers is also becoming stretched as western IT companies poach talent from the region. Many continue to leave the region for Silicon Valley or western Europe, while local governments resist opening up borders to international talent.
“There have been many positive changes from the governments in supporting innovation,” says Peter Kolesar, head of Neulogy, an innovation consultancy in Slovakia. “But what we don’t see is a sense of urgency. The future of the region depends on how well we can produce excellent research and support tech firms with global potential.”
Despite all the talk of innovation, many leaders of the region’s start-ups still feel there is a long way to go before governments create the wider conditions needed for knowledge-based economies to flourish.
“Our success came in spite of, not because of, government policy,” said one entrepreneur who has successfully built a global technology firm from the region. “The determination and talent is there, but politicians have no idea how to leverage it.”