Resilient growth in the EU acceding countries

Progress with convergence has continued, albeit at a slower pace. Growth has been maintained primarily by still strong domestic demand in the eight future EU members in Central Europe. High unemployment and widening budget deficits still pose problems.

The acceding countries have continued to make progress with convergence, albeit at a slower pace. According to our convergence indicator, the eight Central and Eastern European countries that will join the EU on May 1, 2004 (CEEC-8) are bunched close together (see table, p. 26). Poland has remained at the bottom of the group owing to its weak growth rate. Bulgaria and Romania have made up ground, but still lag quite a way behind. This shows once again that the decision to restrict the current EU enlargement round to the CEEC-8, Malta and Cyprus was right.

All in all, the economies developed satisfactorily in 2002. Happily, the CEEC-8 again displayed few signs of growth fatigue. The exceptions were Poland, which continues to suffer from its problematic policy mix (expansionary fiscal policy, tight monetary policy), and the Czech Republic, which was severely hit by the disastrous floods in August 2002. The catch-up process is thus still intact, despite the renewed weakening of growth in the industrial countries since mid-2002. Central and Eastern Europe is one of the fastest growing regions in the world. Even in the CEEC-8 group, however, average per capita GDP is still far below the level in the old EU member states.

Growth was maintained to some extent by still strong domestic demand in the CEEC-8. Even more positive, though, was the fact that exports continued to rise despite the weakness of growth in Western Europe, which takes between 60 and 70% of CEEC-8 exports. On average, the group’s exports increased by 5% in 2002 while total imports into the euro area fell by 2% to 3%. This means the acceding countries gained market share. Exports were evidently not hurt – at least not yet – by the strong rise in some countries’ domestic currencies, e.g. the Hungarian forint. The appreciation was compensated by sustained strong growth of productivity, which is estimated by the Vienna Institute for International Economic Studies (WIIW) at 10% p.a. since 1995. The increasingly close ties established with the EU countries through direct investment in past years are also having a positive effect through rising deliveries to firms in the respective corporate groups.

The rapid growth of productivity allows wages and salaries also to be raised accordingly. But caution is required here. From Hungary, the German-Hungarian Chamber of Industry and Commerce reports that the investment climate has already deteriorated owing to a pronounced rise in unit labour costs. It says the high non-wage labour costs are also a problem. Employer contributions to social insurance are equivalent to 33.5% of gross wages in Hungary, and the figure in other countries is similarly high.

The accelerating wage growth, especially in Slovakia and Hungary (wages up 8.8% yoy and 9.7% yoy, respectively, at end-2002), became increasingly difficult to pass on. At the last reading, industrial producer prices were up only 2.3% yoy in Slovakia, while in Hungary they had even fallen 1.8%. The strength of the forint in the forex markets also played a role here. In the Czech Republic and Poland both wages and prices have been rising less quickly and are already tending towards complete stability. Towards the end of the year, wages in the Czech Republic were rising by around 5% (November 2002) and those in Poland by only 1.7% (Q4 2002 vs Q4 2001). These figures were matched by very low rates of consumer price increase – less than 1% lately in both countries. In Slovakia and Hungary the rates were higher (3.3% and 4.8%) but are declining rapidly. This progress in stabilising prices was not due to particularly good harvests: even when the food and energy components are stripped out, the rates still document considerable disinflation in the acceding countries. Core inflation recently lay between 1.3% (Poland) and 5.3% (Hungary); in between were Slovakia (2.0%) and the Czech Republic (2.4%). Considering the very high inflation rates registered by so me of the countries at the beginning of the transition phase and the double-digit rates of the mid- 1990s, the policymakers must be congratulated on their remarkable success in stabilising prices.

Two very problematic areas are high unemployment (see chart) and the difficult budget situation in some of the countries. Despite the good economic growth, none of the acceding countries has managed to reduce unemployment significantly. But the levels vary greatly. Among the large countries in the group, Poland topped the black list in 2002 with unemployment at 18%, while Hungary did best with 5.8%, which put it – like the Czech Republic (7.3%) – below the EU average. Even if growth is sustained at the rates seen in past years, there is unlikely to be any major improvement in the labour markets of the countries where unemployment is high.

The budget deficits are the other problem area. Some have widened surprisingly strongly. That refers to Hungary in particular in 2002: it posted a deficit-to-GDP ratio of no less than 9.4%. Poland and the Czech Republic were also considerably over the Maastricht ceiling of 3% with ratios of 5.4% and 4.1%, respectively. If these countries want to qualify for EMU as quickly as possible they will have to alter their budget policy in 2003, for 2005 could already be the year on which the convergence examination is based. Whereas Hungary will probably reduce its deficit in 2003, Poland is unlikely to show much improvement, and the Czech Republic even faces a worse result.

Despite the homegrown strength displayed by the acceding countries in the past two years, further progress would naturally be much easier if the economy in Western Europe were soon to pick up speed. At present it does not look as if this will happen – especially with the additional strains of the war in Iraq. Nor is the political uncertainty helpful that is emerging in some countries (Poland, for example). On the other hand, EU accession has now been – almost – sewn up. The greater certainty for planners should result in a new inflow of direct investment. Currently, it is anyone’s guess whether the acceding countries’ support for the US position in the Iraq conflict will bring a” war dividend” or not. But the announcement by the US secretary of commerce, Donald Evans, in Slovakia, Bulgaria and Romania that US economic relations with the region would be strengthened was widely noted. It is unlikely to result in any stimulus in the short term, however. All in all, the acceding countries can, for the present, be expected to continue to register strong economic growth. That will provide favourable conditions for the referenda.

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