Ex-Soviet Republic Countries Evolving Into High-Tech, Competitive Economies by David Tobenkin Forget those Pieter Bruegel-esque images of peasants toiling with scythes and drab, inefficient state factories churning out inferior goods. The countries of the former Soviet bloc are rapidly evolving into high-tech showcases with some of the most competitive economies in Europe. Taken as a whole, the aggregate gross domestic product of the 10 new European Union members, which include eight former Soviet bloc nations that joined May 1, 2004, is expected to grow by some 4.5 percent in 2004 and 2005, according to a July 2004 U.N. Economic Commission for Europe report. That growth rate is some 2 percentage points above that predicted for the 15 EU countries that constitute most of Europeís largest and most mature economies. Although such growth admittedly comes from a low base, it is remarkable nonetheless, particularly considering its nature. Rather than serving as sources of inexpensive hands for assembly, many of these countries are becoming hubs for high-tech industries, manufacturing the most sophisticated goods. Poland is a magnet for foreign invest ment, with its economy expected to grow by nearly 6 percent this year. The Czech Republic and Slovakia are becoming the Detroit of Europe. Romania is benefiting from thriving aerospace and computer software industries. And the Baltic countries of Latvia, Lithuania and Estonia are hubs of transportation, construction and machinery production. That contrasts with the course taken by erstwhile Big Brother Russia, where, despite a formidable high-tech presence of its own, strong economic growth is being driven primarily by the energy sector. "Everything has to do with achievements on the ground and changes of perceptionóall of a sudden people know about Eastern Europe and its opportunities," Romanian Ambassador Sorin Ducaru said. "Itís a new frontier and thereís a multiplier effect. There is a more accurate perception of the opportunities, and then more interest, and then a better perception again of its potential as a market and its well-trained workforce, and then more interest." Ducaru noted that in 1989, when Romanian dictator Nicolae Ceausescu fell, only 1 percent of the Romanian GDP was derived from the private sector, whereas that figure is now 72 percent. Likewise, in 1989 only 10 percent to 15 percent of commerce was with the West, whereas now 75 percent of trade is with the European Union and United States. That has produced a torrid growth rate of 7.6 percent predicted for 2004, up from 4.9 percent in 2003. The country is in final negotiations to join the European Union, with accession itself expected to occur in 2007. The rapidity of improvement has been astonishing for some countries. In first-quarter 2004, the unemployment rate in Slovakia was nearly 19.3 percent. In October, it was 12.9 percent. "We have a good heritage of industry from the past, qualified labor, relatively low costs and good government," Slovakian Ambassador Rastislav Kacer said. "Then we had six years of courageous efforts to engage in reforms that were not always popular. But there is great motivation. We felt left behind [by] the rest of Europe, a victim of the cold war, and that there was a need to catch up." Although a variety of factors are fueling this type of growth, the hard-working and patient nature of the populace tops the list, one expert said. "The most significant factor explaining the sustained growth in the former Soviet bloc is the extraordinary patience and emerging entrepreneurial spirit of the people of the region," Johannes Linn, a visiting fellow at the Brookings Institution, said. "Despite years of economic and social decline and pain, caused by the breakup of the Soviet political and economic system, the overwhelming majority of people has not lost hope, nor a will for integration with the worldís market economy, and a readiness to forsake extremist and violent actions," Linn explained. "This has made it possible over time for reforms to work and now generate the sustained economic growth from the natural advantages of the regionóan educated labor force, low wages, relatively good infrastructure and access to Western markets, as well as abundant energy resources in some countries." Those factors have combined to produce large potential financial advantages for businesses evaluating competing sites for manufacturing and service facilities. A report by the Boston Consulting Group presented at the recent Polish Economic Forum in Krynica, Poland, found that labor costs are five to 12 times lower in Central Europe than in Germany, yet productivity is comparable, including capital investment and technology. Over the past several years, the prospect and actual accession of many of the countries into the European Union has been a tremendous positive force, said JirÌ Kulis, economic and commercial counselor at the Czech Embassy. "Today we have 143 Japanese companies in the Czech Republic. In the mid-1990s, there were almost none," Kulis said. "It wasnít business incentives that brought them. All the states offer business incentives. The number-one thing the Japanese looked at was the skill level of the labor. The number two was the affordability of labor. But the dominant factor has been European accession. They, and others, saw European accession as guaranteeing we would play by the same rules, have access to other markets, and still have lower costs." Discipline imposed by the European Union as a condition of joining has also made a great difference. In Romania, reform packages prompted by accession have tamed a 100 percent inflation rate in 1989 to a present rate of roughly 8 percent. An austere and painful monetary policy, tight budget control and high interest rates, as well as targeted lending by the Central Bank of Romania were all designed to support investment, particularly in information technology and new technology and services, all of which has helped to reduce the budget deficit to 1.6 percent. Slovakia offers a similar story. After the country split from the Czech Republic in 1993, it was, in the words of Ambassador Kacer, the underdog, with more foreign investment channeled into the already more developed Czech Republic. Bad went to worse with the emergence of the semi-authoritarian regime of Vladimir Meciar, which lasted until 1998. That year, the newly elected center-right Slovak Democratic Coalition party took power. Under the financial leadership of esteemed Finance Minister Ivan Miklos, the party secured passage of reform packagesówhich included a tax reform that reduced high taxes to a 19 percent flat rateóas well as social reform that streamlined pensions, the social net and other retirement benefits, and finally, health care reform. "The first stimulates economic growth, the other two are the biggest consumers of it," Kacer said. The country has also worked hard to increase transparency and reduce the paperwork and other governmental barriers to free-market competition. This year the World Bankís "Doing Business in 2005: Removing Obstacles to Growth" report termed the country the worldís leading business climate reformer. But the true prize was Slovakiaís admission to the European Union this year. "Despite being the underdog, we caught up and joined the EU with the other more advanced countries," Kacer said. In many of the former Soviet bloc countries, outside supervision by the International Monetary Fund, World Bank, the European Union and private consulting firms, as well as successive rounds of crackdowns by reforming governments, have helped to flush out the cronyism and sweetheart deals that are an ongoing scourge to Russiaís market economy. "Everything was done in a transparent manner and with the monitoring of European and international financial institutions," Romaniaís Ducaru said of his countryís privatization. "There were no negative stories." Romania also passed anti-corruption legislation that forced ministers with conflicts of interest to disclose their assets, and surrender either the assets or their positions. An anti-corruption prosecutor was established, but Ducaru conceded that bribery and the use of political influence for economic benefit remain significant problems. "Is what weíve done enough? I donít think so," he said. "Is it a huge step forward? Yes." In many ways, the growth in the region has been a triumph for the little guys, with many of the fastest growing economies concentrated in the smallest countries, some with a total population of only a few million people. One emerging trend is that international businesses are using these smaller countries as distribution centers for penetration into larger adjacent countries. In this respect, the smaller countries have an advantage: l anguage, or rather languages. The high prevalence of multilingual workers in countries where such fluency is a daily necessity has made them an obvious choice for communications facilities such as call centers. Yet continued efforts will be necessary to sustain such growth and challenges abound. "In many ways the easy gains of attracting investors have already been reaped, since the confidence created by the prospect of EU accession has already been a factor attracting investors for a number of years," Linn of the Brookings Institution said. There is also the issue of staying the course on difficult economic reforms, especially in countries where the milestone of accession has been achieved. Like economies everywhere, the new trends are harming segments of the population tied to obsolete products and located away from the centers of growth. "EU accession has a positive economic impact on the country, but the challenge is from the profound social change it engenders," Ducaru said. "How to spread growth as fairly as possible and how to compensate people in industries without any future." "The new EU members have very high unemployment rates, major fiscal problems [both in the short term, and in the long term given aging populations], and still quite weak institutions," Linn said. Some of the countries are also finding that success breeds envy, particularly from larger, more slowly growing European economies with higher taxes, stronger trade unions and more expensive social welfare commitments. Hungary has a flat 16 percent tax rate, just under half the French rate, while Poland and Slovakiaís 19 percent corporate tax rate is half the effective rate of Germany. France and Germany have both threatened to curb EU subsidies to the upstarts unless they raise their corporate tax rates. Slovakiaís Kacer rejects such criticism. He noted that increased GDP ups Slovakiaís contributions to the European Union and therefore benefits the more developed countries. More fundamentally, he said, the success of the smaller former Soviet bloc countries serves as a necessary prod to the more mature European market economies with growth rates that have consistently lagged behind those of the United States and the Far East. "If [the EU doesnít] want to be marginalized, we must increase growth," Kacer said. "The small countries can serve as the example, saying ëLook guys, we should be more competitive.í" The strong local growth has also helped ease fears among Europeís more mature economies that Central and Eastern European country accession to the European Union would result in a flood of workers from the poorer new members to higher wage countries. That largely has not happened, in part because of social policies implemented by the new entrants aimed at staunching the exodus of their most valuable workers. In Romania, Ducaru said legislators reacted to an exodus of software engineering talent after the fall of communism by passing tax laws designed to persuade them to stay. "All of a sudden, in the 1990s they could go away, so five years ago we realized we had to do something about it," Ducaru said. "We passed legislation that software engineers pay no income tax." Perhaps the biggest challenge to the growth among former Soviet bloc countries is the danger that the flood of investment will move east to less developed neighbors such as Belarus, Ukraine and Turkey, which have even lower business and labor costs. Some eyes were raised, and claims of economic poaching advanced, when Microsoft in October chose Hungary for a worldwide software services center that will eventually employ 200 to 300 software specialists, rather than expanding its strong software presence in Celtic tiger Ireland. The cost of a programmer in Hungary was estimated by one firm as $10,500, compared to $24,500 in Ireland. But what goes around comes around, some say. "There is a risk that these gains will erode and jobs will move on," Linn said. "The key challenge for the new EU members will therefore be to raise their labor productivity more than their labor costs, as, for example, Ireland and Finland have been able to do. This means continued restructuring and downsizing of old industries, improving the investment climate for new and, especially, small and medium enterprises who, among other things, act as suppliers for big foreign firms, and modernizing their education, technical training and IT environment." The upstart economies are already trying to adapt to the threat, Ducaru said. "What do you do? You have to have something left after such investment leaves. Weíre investing in IT," the ambassador explained. "We already have experience dealing with this problemótextiles, which we used to produce, are no longer a big business. Also, the social contract in Romania will be more relaxed than in Western Europe and there is a more flexible labor market, so we hope that we will remain attractive in relative terms." Kulis said the Czech Republic is now trying to promote the growth of biotechnology, a regional strength for nearby countries Switzerland and Austria. By the time such challenges materialize, the new tigers of Europe hope they will be competing with the continentís best on their own terms. As an example, Kulis said Panasonic established its television set factory right opposite a Pilsner Urquell brewing factory in 1997 and soon found it was the fastest and best quality operation of its 27 operations worldwide. In talks with U.S. manufacturers considering where to establish European operations, he said he eschews the hard sell: "I say to the U.S. companies, itís up to you. If youíre not [in the Czech Republic], youíll lose competitiveness. Look at where the Japanese are investing, where the Germans are investing. Itís there." David Tobenkin is a freelance writer in Washington, D.C.