Economic growth in the middle-income countries of Europe and Central Asia (ECA) has progressively slowed since the early 2000s due to an increasingly challenging global environment, especially weaker economic activity in the European Union, and more modest progress in advancing structural reforms since the 2007–09 Global Financial Crisis. The current global uncertainty and geo-economic fragmentation continue to make it more difficult for the countries in the region to achieve high-income status.
Despite this backdrop, or, in fact, because of it, these countries can take action to accelerate economic growth as we outline in our latest ECA Economic Update published last month.
There is a need to rethink policies toward businesses. Ten countries in the region have become high income since 1990, and they have demonstrated that a dynamic and innovative private sector is at the heart of this remarkable achievement.
What is needed? Middle-income countries in the region need to make it easier to attract global technology, expertise, and capital. They should undertake reforms to support young high-potential companies, deepen financial markets, and increase private research and development (R&D) investment.
Investing in young, innovative companies is what is needed rather than broad efforts to target the entire population small and medium enterprises (SMEs). Evidence is overwhelming that it is start-ups and young dynamic companies that are the main drivers of jobs growth. Policies should prioritize these firms by addressing their specific constraints and tackle the market failures that impede their access to capital, markets, skills, limiting their growth and innovation potential.
Vibrant firms can only emerge and reach their full potential in a competitive environment that fosters both technology adoption and innovation. In the ECA region, state-owned enterprises often dominate markets and stifle competition and entrepreneurship. Financial markets are thin, venture capital is scarce, and innovative companies struggle to access needed investments to grow. As a result, few private companies expand beyond small-medium size, and the large companies are not as productive as their size would suggest.
Through broad policies that deliver institutional backing to innovative companies and incentives to boost productive capabilities through innovation, firms can catch up and grow. By adopting technology and improving their management and organizational structure, enterprises can become more efficient and reach new profitable markets. Rather than operating mainly as production facilities for foreign firms, they can develop their own technologies to expand their reach into foreign markets.
This requires increased access to finance, especially long-term and risk capital. Firms typically rely on their own funds or short-term commercial bank credits, which tend to finance working capital rather than long-term investments and innovation. Start-ups founded on new technology and novel business models typically find it hard to obtain commercial bank loans and access venture capital.
Finally, investing in human capital is vital for attracting and retaining highly skilled workers and entrepreneurs. This means creating opportunities to upgrade skills through training and raise management quality. Vocational schools must be thoroughly revamped to equip graduates with skills and aptitudes that are needed rather than obsolete. Better management practices alone account for differences in productivity levels across countries of 30 percent, and 20 percent within countries.
Each country needs to define its own balance of policies to re-ignite growth. The key ingredients for enhanced economic expansion, however, apply to all. They include enabling competition, expanding integration with the global economy, leveraging technology and innovation, and promoting private sector innovation.
Ivailo Izvorski is Chief Economist, Europe and Central Asia Region, at the World Bank.
Leonadro Iacovone is Lead Economist, Finance, Competitiveness & Investment Global Practice, Europe and Central Asia Region, at the World Bank.
