Hungarians, Czechs, Poles Race to Join EU

The political attention recently given to the entry of Poland, the Czech Republic and Hungary into NATO has obscured the important - but directly related - phenomenon of Central Europe's growing integration into the Western economy. Membership in major Western organizations such as the OECD, European Union (EU), or NATO is based not only on political criteria such as democracy or military compatibility, but also on economic compatibility based on market standards. In this respect, Central Europe's progress in the short span of seven years stands as a remarkable achievement.

Though its transition is far from complete and more adjustments are required, Central Europe's adaptation to the Western economic model is already far advanced, opening the door to trade and investment opportunities of a vastly different order from the heady but uncertain days of the early 1990s.

To see the real dynamic of Central Europe you have to look beneath the surface. Prague, the capital of the Czech Republic, presents a glittering face of European culture and a strikingly Western image. Renovation of the city's historic core occurred rapidly, and now draws nearly 100 million tourists to the country each year. Tourism has become a mainstay of the Czech economy. With growth last year of 4.4 percent, a private sector accounting for 70 percent of gross domestic product (GDP), a retail/consumer boom, and the only reform government in the region still in place after the transition from Communism in 1989, the Czech Republic is understandably a favorite of Western journalists, businesspeople, and visitors.

Czech banks' blank check

Underlying the sophisticated veneer, however, deep structural problems remain to be tackled. When Czech industry was privatized, ownership vouchers were aggregated in a number of large investment funds, many of which were dominated by banks. The banks, which have large loans outstanding to these former state enterprises, have been slow to force corporate restructuring. So, many industries continue to maintain bloated payrolls and fall short of international standards of efficiency and productivity. As a result, many Czech products are uncompetitive, which largely explains the country's sizable balance of trade/current account deficit (7 percent of GDP).

This lack of strong corporate governance also explains both the Czech Republic's remarkably low unemployment rate of 3.3 percent (almost 0 percent in Prague), and the economic retrenchment the country now faces. It is increasingly clear that the pain of economic transition, which at one time the Czech Republic appeared to have avoided, was only deferred.

Last spring Prime Minister Vaclav Klaus enacted economic measures designed to address these issues, including budget cuts, accelerated privatization, restraints on public sector pay increases, import curbs, and creation of a securities commission to regulate capital markets. As a result, Czech growth will likely slow to 2 to 3 percent, with uncertain social implications and reduced import levels.

Hungary takes the lead

Hungary represents the opposite end of the spectrum. Open to market forces and Western influence for decades, Hungary offers perhaps the most comfortable setting for Western business. Its banking, regulatory, and management infrastructure is the most sophisticated in the region. Hungary is Central and Eastern Europe's leader in attracting foreign capital, with almost double the level invested in any other Central Europe economy and over half of all foreign direct investment in the region.

More than 75 percent of Hungary's GDP is now generated by the private sector. Privatization occurred through market-based evaluation and direct sale of state enterprises to investors, many of them foreign (in contrast to Poland and the Czech Republic, where ownership coupons were distributed to citizens).

This strategy forced Hungarian industry, under pressure by new corporate managers, into extensive restructuring. That process, now largely complete, was followed by austerity measures in 1994 that produced flat economic growth. As a result, Hungary hasn't attracted media attention recently like the Czechs and Poles. Having paid the price of austerity and restructuring, though, Hungary is poised for resumed economic growth.

Poland is another story. Having suffered devastating destruction during World War II, Warsaw is a new city - unattractive but muscular. With a population of 40 million, located between Russia and Germany, Poland offers by far the largest market in the region. Privatization through National Investment Funds has been relatively successful (over 26 million people have bought in - 90 percent of the eligible population), though the process remains incomplete. The country's private sector is vibrant and accounts for over two-thirds of both the economy and employment.

Poland's booming growth

Over 1 million new enterprises have been created in the last five years and private-sector profits are surging. Despite a general lack of working capital and the slow emergence of a consumer class, Poland leads the region in economic growth with 7 percent in 1995, 6 percent last year, and 5.7 percent predicted for this year. Investment from the US, already the largest from any Western country, was up nearly 50 percent in 1996. After a period of difficult economic adjustment, real wages are rising. That, in turn, fuels rising consumer credit.

Collectively, the transition of these economies to the Western model has been achieved remarkably rapidly and successfully. To be sure, real problems remain. In all three countries, bureaucracies and old habits persist. For many, the benefits of strong growth have yet to trickle down, and beyond the young entrepreneurs, some still long for the relative security of the old system. With the possible exception of Hungary, the three face liquidity problems and capital markets are weak. Inflation is high, and health care - particularly in the Czech Republic - urgently needs reform.

But the positive economic prospects for the region clearly outweigh the negatives. All three countries have highly educated, low-cost work forces with strong technical skills. Wages in Poland, for example, are less than half those in Greece (which are the lowest in the EU). This explains why Spain and Portugal are resisting membership for the three, which now appears unlikely before 2005. Unlike their EU neighbors to the West, which find economic and regulatory reform excessively difficult, Central Europe's leadership recognizes the necessity of reform and has embraced it.

This flexibility, and the imminent modernization of the region's physical and telecommunications infrastructure, leave Central Europe poised to lead the European continent in economic growth. Because of these factors - plus growing domestic markets and access to a large potential market in neighboring Russia and the former Soviet states - much new European investment in manufacturing can be expected to migrate eastward, to the Central European trio. Poland is already attracting high levels of foreign investment in the automotive sector, targeted toward the West European market.

Next: Romania

Looking further down the road, recent political and economic developments in Romania, which has the second largest population in Central Europe after Poland, suggest that even more opportunities are about to open up for the West. Many foreign companies that established themselves in Poland, the Czech Republic, and Hungary in the early 1990s now look to Romania as the next frontier. As economies in Russia and its neighbors stabilize, Central Europe's economies also stand to benefit, as they slowly revive old ties and reclaim markets lost in the wake of communism's collapse.

For the present, Central Europe's focus is on consolidating its integration into Europe - NATO now, the EU later. The region's pattern of trade has shifted decisively toward the West, and all three countries are realigning their economic regulations to be EU-consistent.

Not surprisingly, European nations, and Germany in particular, are investing heavily in the region and pose strong competition for the US. Central Europe's eventual membership in the EU will strengthen that bond further. Paradoxically, US companies are welcome, not only as a key source of technology and capital but as a counterbalance to a potentially dominant Germany.

The United States, by precipitating the collapse of Soviet communism, can claim some credit for what is happening in Central Europe today. Far from resting on their laurels, however, US businesses and government should also be taking full economic advantage of Central Europe's economic integration into the West.

* R. Sean Randolph is director of trade for the State of California. His office assists California exporters overseas.