A long-term matter

22 November 2017

Most countries in CESEE will take decades to converge with average EU per capita income levels, but there is no obvious alternative to the current development model. By Leon Podkaminer

  • Countries in Central, East and Southeast Europe (CESEE) will continue to converge with Western per capita income levels in the coming decades.
  • However, our findings confirm the standard result in the convergence theory that as countries get wealthier, their rate of convergence will slow. No country in CESEE will reach EU average per capita income levels in the next decade.
  • There is no easy answer for how to break out of the so-called middle income trap and speed up the pace of convergence. Attempts by Hungary and Poland to move towards the development path pursued successfully in the past in parts of East Asia are unlikely to succeed.

After a period of rapid convergence before 2008, the pace of catch-up growth in the economies of Central, East and Southeast Europe (CESEE) has since moderated, especially in the wealthier parts of the region. Although the current strong upswing in Western Europe will continue to push up rates of economic activity in CESEE in the near term, this growth merely represents catch-up after what was effectively a decade of stagnation. It is therefore unlikely to last.

As countries get wealthier, the pace of convergence slows

Even without this projected slowdown in Western Europe, the pace of convergence would likely slow from here, especially for the wealthier countries in CESEE. The “beta-convergence hypothesis” argues that the higher the level of a country’s per capita GDP income, the more slowly it will grow. While poor countries converge quickly, as they get wealthier, their rate of convergence falls. We looked at the relationship between growth rates and income levels in a number of EU and OECD countries between 1995 and 2016, and found evidence that the beta-convergence hypothesis holds.

Wealthier countries in the region, such as the Czech Republic, may now be getting stuck in a so-called “middle income trap”. Breaking out of this trap is something that precious few countries have managed to do. Historical examples of rapid convergence are rare, and are primarily found in East Asia. However, these countries achieved convergence under a very different model to that being pursued in most of CESEE, particularly in the case of the region’s EU members. It is highly unlikely that policies in many countries in CESEE will follow those pursued in previous decades in Japan or South Korea.

A muted outlook for convergence

For higher incomes CESEE countries—the Czech Republic, Slovenia, Slovakia and the Baltic states—we expect the pace of convergence to slow even further over the next decade. By 2026, we calculate that the Czech Republic will have exceeded 90% of the EU average per capita GDP level. However, Poland and Hungary will not even have reached 80% by this point. Poorer countries in the region, such as Albania, Serbia, Macedonia and Turkey, are likely to converge more quickly, but from a much lower level. For CESEE as a whole, we expect the average (unweighted) per capita income level to reach around 71% of the EU average in 2026 (from 61% now), and 75% by 2031.

Frankly, nobody knows for sure how to break out of the middle-income trap. The East Asian experience might suggest that a system restricting democracy, the rule of law and free markets could be conducive to fast convergence. Recent political economy developments in Hungary and Poland can be seen as (desperate) attempts to emulate the East Asian models of development. However, these are very likely to fail (as they did in Latin America).

This is a summary of an article that first appeared in our Autumn Forecast Report. The full article includes convergence forecasts for CESEE countries out to 2031. For six months after publication, wiiw Forecast Reports are only available to members. To learn more about wiiw membership, click here.