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A Nice Dream

A new report from McKinsey has some interesting suggestions for reigniting growth, but comes across as somewhat naive. 

by Martin Ehl 17 December 2013

In Europe today, to put the word “dawn” into the name of anything that has something in common with politics or the economy can be downright dangerous (think Golden Dawn in Greece or Dawn of Direct Democracy, a new Czech party). But we can suspect a renowned consulting firm rather of ham-handedness than populism and extreme right views. That's why we can study the new report from the McKinsey Global Institute, “A new dawn: Reigniting growth in Central and Eastern Europe,” without preconceptions.

 

The global analysts have thrown eight countries into one pot. That in itself should be taken with raised eyebrows. Shouldn't Poland be in a category by itself owing to its size and the fact that it's the only country in the region to survive the economic crisis without a slump in growth into negative numbers? Is it possible to compare Romania with the Czech Republic, if the local average wage is half of the Czech one? Can Slovenia, whose GDP per capita is $29,000, be in the same category as Bulgaria with per-capita income around two-thirds less?

 

Aware of these differences, let's take a look at what new model for growth the McKinsey analysts have come up with. Under any scenario it would be tough to restore the flow of foreign investment from the times before the crisis and renew the average 4.6 percent growth of the years from 2000 to 2008. McKinsey estimates that if we in this region were to see the restoration of the pre-crisis situation, our growth prospects up to 2025 would only be around 2.8 percent annually. But if we start doing some things differently, we would have a chance to get back to pre-crisis growth levels.

 

The main advantage of this region is the combination of low labor cost and a relatively well-educated workforce.

 

McKinsey advises developing three pillars of Central and Eastern European economies:

 

  • To elevate complex and knowledge-intensive production to the next level. In other words, produce more complex cars and other machines;
  • To become the administrative-accounting backbone of Western companies, similar to, on a global level, India;
  • To become the farm, bakery, kitchen, and butcher shop of Europe through development of agriculture and food processing.

 

Nice inspiration. But given the economic nationalism popular in Europe one has to ask: Is this proposed model, based on foreign investment and cheap labor, sustainable or even welcome from the view of long term prosperity?

 

How long is it possible to be the cheap assembly line of Europe with the risk that if more favorable conditions appear elsewhere investors will take their capital away? What if, for example, Ukraine (miraculously) became a country with a stable government? Labor costs are even lower there than in the eastern EU members.

 

And isn't it dangerous, with Detroit's recent filing for bankruptcy in mind, for Central Europe in particular to be so dependent on the automotive industry? In Slovakia, the three automobile plants annually produce 171 cars per capita, which is easily the highest productivity in the world. The Czech Republic is in second place with 112 cars per capita and Slovenia is fourth with 64 cars. And in third place in the rankings, with 69 cars annually per capita, is the most important trading partner for all the above-named countries: Germany.

 

The McKinsey analysis highlights a still undervalued phenomenon: how this region has become a center for corporate outsourcing and offshoring, serving as an administrative and technological service base for many Western companies, again exploiting low labor costs and relatively high education levels. This sector is growing in our region at twice the speed of India, which is the office, accounting, and call center for many firms operating globally. Poland is the regional leader in this direction.

 

The decline in foreign investment after 2008 showed up the weakness of domestic demand and a shortage of domestic savings. Yet McKinsey’s recommendation to increase domestic savings through higher private pension contributions is now irrelevant – after the latest steps by the Hungarian, Polish, and Slovak governments to cancel or cripple mandatory private pension schemes only a few years into their existence. That suggestion, however, does make sense in terms of funding future development, not to mention the old age of many individual workers.

 

The proposed strategy requires exactly what the governments of these  countries have long struggled with: investment in education, research and development, and infrastructure. For the sources of this, we can look to the basics of post-communist governance: shaky rule of law, poor performance of state administrations, and the inability and unwillingness of politicians to offer voters a longer-term vision of development.

 

Viewed through this lens, the McKinsey analysis is a nice, interesting, and numerically padded intellectual exercise, which omits one basic variable: the human factor of reform-weary voters.

Martin Ehl
 is the foreign editor of the Czech daily Hospodarske noviny, where this column originally appeared. He tweets at @MartinCZV4EU.
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