Europe146;s flying geese

There are some striking similarities. For a long period of time in East Asia, the continent8217;s small to midsize economies fed off each other8217;s success, growing quickly. It was described as the 8216;wild geese flying8217; model of development 8212; a reference to the V-shaped pattern those birds fly in, providing a thrust to one another with the flapping of their wings.

That8217;s true of Central Europe today. Many of its economies are racing against each other towards the common goal of rapidly integrating with the European Union. Over the past few years, the CE4 countries of Poland, the Czech Republic, Hungary and Slovakia have averaged growth rates of 5 per cent, the Balkan nations of Romania and Bulgaria have grown at nearly 7 per cent, and the Baltic nations of Estonia, Latvia and Lithuania have expanded at 10 per cent.

The process of economic catch-up is playing itself out in the classic way: the poorer the country, the faster the growth rate. As a result, the region8217;s living standards are fast converging with those of the European Union. Per capita income in each of the CE4 nations is now above 10,000. The pace of expansion is particularly impressive as it is not fuelled by any commodity boom, and unlike other emerging markets, a negative population growth is helping per capita income increase faster than economic growth.

Foreign direct investment FDI inflows are one of the most influential forces behind this convergence story. Faced with huge unemployment following the breakdown of their old Communist systems, these countries were forced to institute Western European laws to pull in investors 8212; a stabilising trait that8217;s often missing in emerging markets. The total stock of FDI in the CE4 countries is nearly half the value of the overall economy; that is an unprecedented proportion.

Human capital is another key factor. Much of the labour force is well educated and this has helped contribute to a labour productivity growth of 10 per cent a year in countries such as Poland.

The Eastern European economies may therefore have more legs than their East Asian counterparts. Many of the old growth stars of East Asia 8212; such as Thailand and Malaysia 8212; have been struggling to regain their momentum this decade, unable to make the transition to producing higher value-added goods due to lower productivity growth. The CE4 countries are still achieving growth rates in excess of 5 per cent despite breaking past the 10,000 per capita income mark because they are operating in high-skill manufacturing areas like autos, electronics and information-technology services.

There is a downside in Eastern Europe, mainly to do with current accounts. The large current-account deficits and heavy foreign indebtedness of the Baltic nations in particular are sure signs of overheating and make them vulnerable to any reversal in foreign flows. Furthermore, the sharp slowdown in Hungary after the government was forced to pare back the large budget deficit serves as an example of how things can go wrong.

However, most other countries 8212; particularly the larger economies of Poland and the Czech Republic 8212; are running current account deficits that are still manageable at less than 5 per cent of the economy, and are simply the mirror image of large capital inflows. To keep the money flowing, the developing economies of Europe need to carry out further reforms, principally involving reduced state spending and less bureaucratic intervention.