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CEE at risk of slowing wage convergence with EU - Moodyʼs

Ratings

According to a new report by Moodyʼs Investors Service, the European Union member countries of Central and Eastern Europe are at risk of slowing down in their convergence with EU income levels if they fail to execute a rapid restructuring of their economies and start realizing the related productivity gains.

Under the title "Sovereigns -Central & Eastern Europe, Productivity growth crucial for further income convergence with EU averages," the Moodyʼs report focuses on the eight CEE EU member states. The report investigates the Czech Republic (rated A1 positive by Moodyʼs), Poland (A2 stable), Slovakia (A2 positive), Bulgaria (Baa2 stable), Romania (Baa3 stable), Slovenia (Baa1 stable), Hungary (Baa3 stable), and Croatia (Ba2 stable). Moodyʼs notes that the research is a market update and does not constitute a rating action.

Since the late 1990s, productivity has been driven upwards by factors such as low wages, skilled labor, EU funding, integration into European value chains, and large foreign direct investments. Growth and incomes have risen in the process, strengthening the economies of the region, which in turn has contributed to ratings upgrades in several cases, says Moodyʼs.

"The traditional growth model of Central and Eastern European countries is starting to run out of steam," warns Heiko Peters, Moodyʼs assistant vice president, analyst and co-author of the report. "The speed at which the CEE-8 nations are catching up with the rest of the EUʼs productivity levels has slowed significantly over 2009-17, compared to the 2000-08 period."

The report highlights that the states that have the most significant catch-up potential are quite often the same countries that have to overcome the largest challenges to realize this potential, due to relatively weak institutional strength, innovation abilities, and quality of human capital.

In this respect, while possessing relatively weak profiles in terms of institutions and readiness for innovation, Bulgaria and Romania seem to exhibit the largest catch-up potential, despite a limited capability to leverage the potential itself, says the report.

Slovakia and Slovenia are two countries that have a good capability to realize productivity potential, but a relatively low potential for catching up, which is bound to hold back their convergence speed.

The Czech Republic, Poland, Croatia, and - to a somewhat lesser extent - Hungary, are the countries that have a promising combination of both catch-up potential and the ability to leverage it, Moodyʼs says.

The report also outlines the potential political consequences of slowing wage convergence. Arguing that productivity improvements are crucial for future cohesion of the EU, the Moodyʼs experts claim that a slowdown or even a reversal of convergence of CEE-8 living standards with the EU could lead to declining popular support for the bloc. In turn, dissatisfaction could increase the approval rating of populist parties and politicians even further.

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