Executive Summary

Over the last thirty years the rise in prosperity across Central and Eastern Europe has been truly remarkable. But as convergence with Western Europe has slowed over the last decade, less than 20% of the gap in prosperity has been closed, and serious questions now loom.  Even so, the Legatum Institute believes that whatever path is followed the common foundations of prosperity, including: rule of law; government integrity and performance and an engaged citizenry are going to be critical to success. If the region were a single country, the average score in the Legatum Prosperity Index would now rank it at 38th in the world. 

Long-term prosperity is ever more dependent on creating the conditions that develop, attract, retain, and welcome home, highly skilled citizens.

European demographic decline is as much a problem in Central and Eastern Europe as it is for Western Europe, but added to this is the challenge specific to Central and Eastern Europe: migration. The best and the brightest are all too often leaving, responding to slowing economic growth, or merely where foreign opportunities appear more tempting. Meeting expectations and creating the opportunities that the next generation expect is a key challenge. 

European Union membership has made prosperity more achievable for countries in transition, but also made the consequences of failure more apparent. 

Membership of the EU has opened up opportunities that were unimaginable a generation ago. Business investment has surged as the adoption of EU rules and standards gave a degree of confidence and trust that would have taken decades to build. But more mixed results are seen where domestic norms and rules still predominate from the effectiveness of business regulations, to judicial independence, to access to credit, to migration and non-tariff barriers. 

There are differing starting points on the path to prosperity, but there are also common foundations: effective governance; property rights; international and domestic competition.

We are seeing different zones of prosperity emerge: the Baltic ‘entrepreneurial sea’, the central “industrial hinterlands” adjacent to Germany and Austria, and a south east “food hub”. Each area has different advantages and challenges, and each will likely follow a distinctly different path in future. What underpins all successful paths is effective governance which stops corruption; property rights that facilitate investment and a competitive landscape that promotes the best ideas. 

Estonia exemplifies the characteristics of the entrepreneurial sea. It has a relatively high penetration of venture capital, scores well on affordability of credit, and is ranked 13th globally for ease of starting a business. Estonia’s people are pioneers in the digital society and have high levels of intellectual property protection. This is underpinned by a strong performance in Governance indicators. The country has the strongest rule of law and the most independent judiciary in Eastern Europe, together with a government that scores well for integrity and transparency.

The Czech Republic and Slovakia sit at the heart of the industrial hinterlands, and have become a key part of the integrated European supply chain. These countries have high levels of exports, and are logistically well connected. However, both countries score poorly on the perception and reality of starting a business, and have relatively restrictive labour markets. When compared with the Baltic countries, the quality of governance is also weaker, particularly regarding public sector corruption and transparency of decision-making.

Croatia’s (in common with much of South East of Europe) agriculture remains a key industry. Like many of its neighbours, it scores poorly for its business environment. The costs of starting a business and securing financial support are both high, and many business rigidities remain, from a high degree of occupational licensing, to relatively rigid labour markets. The result is less diverse and lower value exports than those of countries in the other sub-regions. 

To foster further prosperity, the countries of Central and Eastern Europe must look beyond existing partners and technologies to either integrate or invent, or best of all, do both.

The economic model built on comparatively low cost labour is coming under terminal pressure. This model was the right one in the immediate post-Communist world, but rising wages and wage expectations and the longer-term difficulty of having productivity match wage increases means the “middle income trap” becomes an ever more prevalent challenge. Looking to the next stages of economic growth requires businesses to be further integrated in the wider European and Global supply chains, but also to be far more entrepreneurial. This can be achieved through the creation of new ventures, or the facilitation of entrepreneurialism within existing businesses. 

Prosperity has to be home grown, depending on a range of competitive small and medium businesses 

Fostering growth beyond that generated by foreign direct investments is a key priority. But in practice, most people work for small and medium enterprises, and too many of these firms are not internationally competitive. A burden of bureaucracy makes growth difficult and working within the shadow economy too tempting. At the same time, larger firms are not greatly affected by the Governance issues because they have developed mechanisms to cope with bureaucracy and negotiate exemptions; such an approach is a serious hindrance to fostering widespread prosperity.

The digital and information age puts “creative adaptation” at the heart of business and government transformation.

The digital and information revolution means that the pace and scope of change seen over the past thirty years is likely to continue. The countries of the Baltic ‘Entrepreneurial Sea’ rank on average 29th in the world for broadband connections, whereas the ‘Industrial Hinterlands’ rank at 36th, with South Eastern Europe coming in at 49th. Finding the necessary investment for the digital challenge is primarily going to come from ‘creative adaptation’, existing companies using their cash flows to access capital and enable new business ventures to be built. Bringing about this adaptation is a challenge, and one that will be met much more effectively and readily embraced if the opportunities created are to be open to all.