According to the IMF Slovenia could overtake Italy’s economy on a per capita basis by the 2030s, and many countries could follow soon after – and its a flip that could reshape the politics of the European Union.
Since the fall of communism, economic integration with the rest of Europe, inflows of foreign capital and from the EU budget, as well as the hard work of Eastern and Central Europeans from Tallin to Sofia have paid off.
With those countries richer than ever before, this has fueled one of the EU’s core myths: convergence.
Its the idea that the EU’s new member states would catch up with the rest of the block – and to a large extent, its been true.
Economies have grown relative to the EU, people are richer compared to the EU average.
But convergence hasn’t only been about those country’s success – its also down to the rest of Europe’s, particularly the South’s, stagnation.
And it has fueled narratives of a coming political earthquake, with the rise of New Europe as opposed to the rest of the continent.
In fact the previous Polish government was so sure about its economic success that it announced its plans to turn itself into a net contributor– actually paying more into the EU budget than it receives.
So I wanted to find out if those countries could keep up their economic performance to catch up – and what they might do with their new found influence if they manage to overtake Western Europe.
Its a story both of economic potential and success – but also changing supply chains that will reshape Europe.
This is the story of Convergence.
Central European Economic Powerhouses – Will they Catch Up?
Much of Central and Eastern Europe’s economic success can be pinned down to its integration with the rest of the EU.
The Central and Eastern European Growth Model
Even before joining the European Union, Central and Eastern Europe became an extension of Germany Inc.
Many Western firms outsourced their supply chains to the East of the continent, looking for a cost advantage in the form of a cheaper labour force.
Investment flooded from the West leading to a skyrocketing of industrial output and productivity across the region.
EU investment over the past 2 decades into infrastructure helpt finance highways across the block, and modernized aging soviet infrastructure.
As the rest of Europe stagnated, and CEE grew rapidly, GDPs relative to the EU average grew dramatically in most countries, in Poland and even more impressively in Romania, whose GDP increased from 40% of the EU average to 80%.
This has lead many to call this the EU’s greatest success story and an economic miracle.
In fact the only thing that seems to have grown faster than their economies is the amount of YouTube videos on Europe’s new economic powerhouses.
So yes, this rise in GDP is impressive, but for everyday people the results have been mixed.
There have been impressive rises in wages and living standards across the countries – but many regions were left behind by this transition.
I mean take a look at this map of GDP across the EU: most of the growth has been concentrated in capital regions, with much of the rest of the countries still far poorer than the rest of the continent.
The Uncertainty of Convergence: Middle Income Trap?
And there are some signs that the Central and Eastern Europe’s economic success might be more fragile than you would think.
Middle Income Trap
Despite some of the best education systems as measured by Pisa scores, for decades the region has experienced a brain drain to the West and North of the continent.
In fact the country’s own court of accountants pointed to the fact that the country had fallen into the Middle Income Trap, with all the opportunities of export growth to Germany having been used up, the country would need to make strategic choices to keep growing its economy.
Germany’s woes
And that growth model may be coming to an end.
Lets take look at their place in the European pecking order and supply chains.
Its fair to say that so far they have remained suppliers to one of Europe’s largest economies rather than being advanced economies themselves.
And the exports to Germany that dominate those countries’ economy – particularly auto industry are now facing severe headwinds.
High energy and commodity prices as well as an onslaught from Chinese EV producers are undermining the trade that allowed those countries to get richer.
Labour shortages
And with aging populations, labour intensive manufacturing that has become the region’s economic backbone is becoming increasingly tricky in countries like Poland or Romania.
After all, it is dependent on keeping labour costs low through an abundance of workers.
While there are reports of EU citizens from other countries that are moving to search for opportunity as well as a growing number of returnees from Western Europe – I couldn’t find any evidence of this happening in statistical databases of the home countries so far.
Why Economic Convergence with Western Europe will likely happen
So with these difficulties on the horizon, does that mean that convergence is out of reach for Central and Eastern European countries?
Well no, not necessarily – **convergence within the EU is relative.
It can mean one of two things: growing faster than the rest, or the decline of everyone else -while you manage to keep things together.
Strong Fundamentals
And it seems that CEE is already outcompeting Southern Europe in the places where it really matters so far.
In the case of quality of education or debt, CEE countries are in far better shape than in the South- and even Germany in the case of Demographics.
According to the OECD, by 2050 Germany is projected to have a dependency ratio far higher than that of countries like Romania or the Czech Republic.
Still Room for growth
And there are still many ways that these countries could still grow.
R&D budgets across the countries are steadily rising and are now starting to catch-up with southern European countries in the case of the Czech Republic, Estonia or Slovenia.
CEE are developing tech industries of their own – Lithuania is highly specialized in laser technology, Poland has developed high tech weapons systems that even the Americans have bought, as well as a budding space industry
Industrial Robots are quickly being deployed. Poland for example more than doubled its industrial robots rate between 2016 and 2022, though it still has a way to go before it catches up with other EU countries.
Re-arrangement of supply chains
Central and Eastern European countries could also get an additional boost by attracting more Value-Added production from Western Europe.
While having your main export partner decline economically is bad news, Germany’s problems might be the key to move up their economies up in the value chain.
With an energy crisis at home many German firms are looking to cut costs by employing cheaper labour. and German outflows of capital saw the country’s FDI outflows balloon to [135.5 billion, while FDI inflows were just at 10.5 billion](https://altoo.io/high-direct-investment-outflows-from-the-german-economy-why/#:~:text=The direct investment outflows from,by foreign companies in Germany.) – with most of it going to other European countries like Poland or Romania.
Impact on the EU
So convergence is happening, its likely to keep going, due to better fundamentals, Western Europe’s relative decline and stagnation, and shifting global supply chains.
But what might that mean for the politics of the European Union?
Why Central and Eastern Europe are still EU lightweights
Well lets first have a look at economics.
For all their growth the CEE countries remain economic lightweights in the European Union.
Despite doubling since they joined, the EU’s newest members collectively accounted for a mere 13% of the blocks economy-a share similar to that of Italy’s. And still a ways off from Germany or France.
And that’s because while they have grown fast the countries remain demographic minnows compared to the rest of the block.
The Visegrad countries combined population – is smaller than that of France.
Spread that influence over 12 countries -and unaligned foreign policies and priorities- and you have an explanation of the regions small weight in EU politics.
But it is fair to say that this convergence has meant a more equal partnership- and an ability to influence the balance of power in EU politics.
In fact CEE countries are increasingly involved in coalition building with other European countries.
The bulk of the French led Alliance for Nuclear countries was made up of Central and Eastern European Countries.
Eventually there might come a point where the CEE might form and lead EU coalitions themselves – something that Poland openly states as its ambition.
The Changing supply Chains of the EU
So perhaps the biggest change will come not from convergence but the re-adjustment of the supply chains- and the move away from semi-dependency on the German economy.
The European Union has historically been first and foremost an economic project.
And the glue holding it together is the interwoven economies of the different countries that make it up.
New Supply Chains
Now lets get something straight no one wants to be at the bottom of a supply chain.
Revenue is lower and the jobs pay less -and CEE countries have every right to compete for their place in the sun.
But one can only imagine in a world where cross-country European supply chains are weakened – or disappear.
Russia is providing natural gas and building a nuclear power plant in the country while China has poured money into EV and battery factories -its something that I have covered in a previous video.
As a result, the country has drifted away from the rest of the European Union and aligned itself more on Russian and Chinese interests.
Convergence a tool for competitiveness
Now granted changing supply chains could also have some positive effects.
More competition between EU countries could encourage better policy making – which is in short supply across the continent- to make their economies work better.
That counts for energy and taxation policy – but also for attracting and keeping talent.
If governments want to keep industries and jobs, they will actually have to be competitive.
It could also mean better outcomes for young workers – who governments want to attract – as opposed to pensioners who are the main beneficiaries of Europe’s welfare states.
Conclusion
But when we look at convergence there remains an important question: what happens next?
Can Central and Eastern Europe keep catching up? And what will happen when it does?
In 2018 Donald Tusk warned that Poland’s then right wing government would seek to implement Polexit – once it had caught up with the rest of the EU.
Some of that was likely politics to scare the overwhelmingly pro-EU population of Poland.
But its easy to be pro-EU when money is coming into the country, what will happen when the money stops coming or goes another direction?
Will these countries become just any other EU members, will they drift away in a similar fashion to the UK ahead of Brexit?
Well if the IMF is right, we will know in the next 15 years.
Okok