Central Europe's productivity imperative

Written by Stephen Poloz

Increasing productivity is crucial for all companies, in all countries, in today’s competitive global economy. But the need is particularly compelling in the accession countries in central Europe — the Czech Republic, Slovakia, Hungary and Poland.

Convergence to the living standards of the euro-zone sounds easy: simply replicate the Maastricht criteria and sit back and wait, and convergence will be yours. But behind the scenes will be some pretty tough slogging, as companies struggle to climb the productivity ladder. Along the way, companies must transform what workers do to produce goods and services of higher value. This rising productivity process translates directly into rising income per person.

Take the Czech Republic, for instance. Productivity per hour worked is around half the average level of the current members of the euro-zone. A reasonable expectation is that over the next 15-20 years this gap can be closed, along with the associated income gap, provided the government keeps its policies on track and companies respond to the improving macroeconomic environment.

How will this happen at the company level? In part, inbound foreign investment will create new jobs, with the latest capital equipment, that will replace more traditional low-productivity jobs. Domestic investment in the latest technology, imported from abroad, will also make a contribution. But perhaps the biggest contribution will come from increased globalization of Czech companies. As those companies reach higher to produce increasingly complex products and services, they will find it appropriate to import the lower-productivity inputs from abroad instead of producing them domestically, thereby increasing average Czech productivity and living standards.

The U.S. economy has been the leader in using globalization as a tool to increase productivity. During the past 50 years, trade penetration into the U.S. economy (total trade as a share of GDP) has increased by a factor of four. In contrast, Germany has increased its use of trade only by a factor of two — one of the reasons why Germany’s productivity growth has lagged America’s.

The good news is that Germany’s trade penetration has been picking up, as German companies take advantage of the emerging central European economies as suppliers of lower-cost inputs. In part, this is in response to increasing competition from the accession countries. Fact is, the latter have become very aggressive traders, with trade penetration much higher than most major economies already, and rising quickly. This is partly because much of the foreign investment into those economies has been by globalizing companies, which makes the new investments automatically part of a global trading network. But it also reflects the beginning of a movement of central European investment out to even less expensive European markets further east.

The bottom line? Central European policymakers have grown accustomed to attracting foreign capital, and turning that attraction into an enhanced productivity performance. But the next phases of convergence will be more demanding — companies will increasingly find it necessary to invest in lower-cost markets to generate that productivity. This should be encouraged.

September 29, 2005

The views expressed here are those of the author, and not necessarily of Export Development Canada.

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