Central European economies pin growth hopes on technology

The region turns to innovation as it seeks to escape the looming middle-income trap

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For many, Tel Aviv may seem an unlikely destination for central European policymakers pitching for business.

Yet, yards from white sandy beaches and azure seas, entrepreneurs and officials from Poland, Hungary, Slovakia and the Czech Republic were crowded into a room at Israel’s most prominent conference for start-ups.

They were there to sell the region as a centre of modern technological innovation, not just old-fashioned manufacturing. “We believe that by co-operating together, we have 65m people in the region that can be Europe’s growth centre,” Andor Nagy, Hungary’s ambassador to Israel, told the gathering.

Israel is considered by many to be one of the world’s most innovative economies after the US and Mr Nagy’s refrain was echoed repeatedly at last month’s DLD innovation festival. Emulating this success is the long-term goal for central and eastern Europe as it looks to build on strong expansion over the past decade and keep its economies developing.

The prognosis is healthy. The IMF’s 2017 forecast for economic growth in the region, 3.1 per cent, is almost double the eurozone’s 1.6 per cent.

Added together, the region’s economies have a total nominal GDP of $1.4tn, according to the International Monetary Fund, which would make them the world’s 11th biggest economy, ahead of South Korea and just behind Canada.

That growth, which began in 1989 and was boosted when many in the region joined the EU in 2004, is set to continue.

Central and eastern Europe is set to grow on average by about 3 per cent in 2017, according to European Commission forecasts, faster than the 1.8 per cent predicted for the eurozone.

But the relative gap between east and west Europe has decreased markedly over the past few years. Between 2004 and 2014, economies in central and eastern Europe grew an average of around 2.2 per cent. Over the same period, the eurozone showed growth of just 0.7 per cent.

That slowing of the region’s lead has not gone unnoticed by its political leaders. They understand that projects in their countries are still perceived by investors as having a higher risk premium than those in older EU members.

Compounding this is a steady convergence in wages and costs relative to western Europe, eroding the competitive advantage before overall GDP has caught up with the west, a predicament known as the middle-income trap.

No wonder, then, that in recent years almost all governments have set up dedicated teams under their prime ministers or presidents to focus on innovation and start-ups.

“Poland is today in a situation which we can describe as having the conditions, at least, for the middle-income trap,” Jaroslaw Kaczynski, leader of Poland’s ruling Law and Justice party said last month.

But the 67-year-old, not known for his interest in technology, did say there are ways to avoid falling into an economic snare. “The first fundamental source is the inventiveness of Polish people or entrepreneurs. There are two sources of inventiveness: from those who already are entrepreneurs, and those who would like to be entrepreneurs but find themselves stopped by barriers.”

Mr Kaczynski is right to be worried. In the starkest example of a problem facing the whole region, Poland faces a demographic deficit in the coming decades. Its population will fall by 5.3m over the next 44 years and the share of working age people will fall by about 16 percentage points, almost doubling its dependency ratio (those under 14 and over 65), the European Commission predicts. But, as in many of its regional peers, there are signs of action. Poland has announced a scheme to support start-ups and young entrepreneurs, which includes a 3bn zloty (€700m) funding programme that combines state and private capital.

“That is an amazing opportunity,” says Jaroslaw Gowin, deputy prime minister. “We would like to build a network of connections between entrepreneurs and young people building start-ups.”

Some fundamentals, such as talent, are already in place. The region produces about 1.2m graduates every year in many subjects, about 20 per cent of the EU total, according to Eurostat, the EU’s statistical agency. And in Poland, the Czech Republic, Slovakia and Ukraine, a total of 285,000 engineers — in high demand for technical skills across Europe — graduate every year.

But other ingredients are still lacking. Private equity and venture capital investment into the region reached its highest level since 2009 last year, rising 25 per cent to €1.6bn. That flowed into 222 companies, including almost 130 start-ups, according to Invest Europe, an association of investment funds.

“There is a new wave of entrepreneurs, ideas and solutions from the central and eastern Europe region, spurred by the increasing flow of public and private investment,” says Don Grantham, central and eastern Europe president for technology company Microsoft, which works with 9,000 regional start-ups. However, as a proportion of the €47bn spent by private equity and venture capital investors across the whole of continental Europe last year, the region’s slice is still tiny.

A result of this can be seen in the widespread complaints from its entrepreneurs that they often have to leave for the US, UK or Germany to find funding.

Despite all the talk about innovation, many foreign companies still want to invest in the factories that made the region’s name during its first decade in the EU, and these still need local employees to staff them.

GE Aviation is building a €350m factory in the Czech Republic to produce turboprop engines. Carmaker Daimler is set to spend €1.5bn on factories in Poland and Hungary. British carmaker Jaguar Land Rover has started construction on a £1bn plant in Slovakia.

“There is a divergence between what governments want investors to do here, and what investors want,” says Iain Batty, regional partner at law firm CMS Cameron McKenna, who acts on behalf of foreign investors in the region.

“It is still the case that many investors see this region as a place for manufacturing with high quality but low costs. We are not seeing as much investment in innovation as the central and eastern Europe member states would like. But we get the impression that it is improving, especially in the tech sector.”

The long-term hope for governments is that talented engineers trained by the likes of JLR or local executives in the Bucharest offices of international banks will set up their own businesses.

“The young generation in Romania is probably the most connected generation, used to good internet speeds and mobile coverage,” says Elena Coman, programme director at TechSoup Romania, which provides instruction and technology to non-governmental groups and runs career programmes for young people.

“Not only do they see more opportunities for themselves than their parents, but they are more involved in building those opportunities for themselves.”

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