Central and Eastern Europe needs a new engine for growth

Central and Eastern Europe needs a new engine for growth

By Karol Ignatowicz, Tomasz Marciniak, Jurica Novak, and Marcin Purta

Creating a digital, tech-driven economy could be the growth engine that ten economies in the region need.

For the countries of Central and Eastern Europe (CEE), the potential economic benefits of digitization are great: up to €200 billion in additional GDP by 2025. Such an economic boost would lead to greater global competitiveness and prosperity for the region’s 100 million people. While the digital transition also harbors potential risks in the form of shifts in society, public- and private-sector leaders can take effective actions to mitigate them while pursuing the digital opportunity.

CEE’s current growth engine is losing momentum

Since the transition to a market economy almost three decades ago, CEE has enjoyed a golden age of growth. The ten CEE countries examined in this report—Bulgaria, Croatia, the Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia—recorded on average a 114 percent increase in GDP per capita between 1996 and 2017, compared with an increase of just 27 percent in the European Union’s “Big Five” economies: France, Germany, Italy, Spain, and the United Kingdom.1 The CEE region has become one of the most attractive places to invest in globally. This has enabled CEE countries to partially close the economic gap with Western Europe and their populations to enjoy a significant rise in living standards.2

Growth in CEE has been driven by a number of factors, including traditional industries, dynamic exports, investments from abroad, labor-cost advantages, and funding from the European Union. But these drivers are beginning to weaken. CEE economies are generally undercapitalized compared with their more advanced European peers. The capital stock, measured as total gross fixed assets per employee, is 60 percent lower than the average for the EU Big Five.3 Workforce costs are also rising, and there are limited labor reserves left to plug into the economy, with unemployment at record low levels—on average 6.5 percent in 2017, compared with 7.6 percent in the European Union.4 Labor productivity still lags behind Western Europe.5 Furthermore, the inflow of EU funds to CEE countries is likely to slow down after 2020.

What does that mean for the countries of CEE? If they hope to continue on their path to general prosperity, they urgently need to redefine their growth strategies.

For a deep dive on the opportunity for digital, tech-driven growth in Central and Eastern Europe, see our interactive digitalchallengers.mckinsey.com.

Digitization can be the next driver of sustained growth

Today, CEE has the chance to make a strategic choice that will determine its growth path for decades to come. Our analysis shows that developing the region’s digital economy across all sectors would bring significant economic benefits, given the resulting productivity gains. By closing the digital gap with Northern and Western Europe, CEE could earn up to €200 billion in additional GDP by 2025—a gain almost the size of Portugal’s entire economy in 2017.6 In this aspirational scenario, the region’s digital economy would grow to represent 16 percent of GDP by 2025. That would mean up to 30 percent additional GDP growth, the equivalent of one extra percentage point on GDP growth each year over the period.

How would digitization secure this ambitious goal for CEE? Primarily by improving the region’s productivity through a digital transformation of the public and private sectors and by boosting e-commerce and offline consumer spending on digital equipment.

The alternative “business as usual” scenario is one in which the digital economy in CEE maintains its historical growth rate, expanding by just €60 billion and representing 8.7 percent of GDP in 2025. In this scenario, CEE countries would miss out on the additional one percentage point of annual GDP growth and remain a long way from the “digital frontier” represented by the countries of Northern Europe, for example.

The countries of CEE are uniquely positioned to capture the digital opportunity

Looking at Europe from the perspective of digitization, we distinguish three broad groups of countries. First are the ten countries of CEE that form the core of this study. We call these countries “digital challengers,” as they demonstrate strong potential for growth in digital and can emulate the second group, consisting of relatively small countries with very high digitization rates, which we call “digital front-runners”: Belgium, Denmark, Estonia, Finland, Ireland, Luxembourg, the Netherlands, Norway, and Sweden. Third, there is the EU Big Five, which typically rely more on their large internal markets for economic growth. These five countries have digitization rates that are relatively high, but not as high as the digital front-runners.

In 2016, the digital economy7 of digital challengers accounted for 6.5 percent of their GDP. This is almost on a par with the EU Big Five, at 6.9 percent, but well behind digital front-runners, such as Sweden, at 9.0 percent.

Notably, digital challengers are enjoying great momentum in their digital economies. Between 2012 and 2016, the region’s combined digital economy grew by 6.2 percent a year, twice as fast as in the EU Big Five. The news for specific sectors of the economy in CEE is also good. Although most industries in digital-challenger countries lag behind their equivalents in digital-front-runner countries, some are almost level with EU Big Five benchmarks—for example, financial services and information and communication technology (ICT).

Digital challengers have the foundations for further digitization:

  • Good primary and secondary education with respect to math and science literacy scores, according to the Program for International Student Assessment, or PISA, ranking—almost on a par with digital front-runners.
  • A large talent pool with respect to science, technology, engineering, and mathematics (STEM) and ICT, with more than 230,000 graduates in these subjects in 2016—more than any of the EU Big Five markets and twice as many as the entire digital front-runner region.
  • High-quality digital infrastructure with excellent 4G coverage, some of the best coverage rates in the world for ultrafast broadband and good affordability for ordinary citizens.
  • A legacy “technology lock-in” that is milder than in Northern and Western European countries. Having joined the digitization race rather late, CEE economies are less tied up with older technology. For example, the CEE region almost entirely bypassed the use of payment by check, going straight to payment by card. Today, the region has one of the highest contactless-payment adoption rates in the world. So, while it may be more difficult for digital challengers to compete in the traditional economy, they enjoy a level playing field in the digital one.
  • A vibrant emerging digital ecosystem. We have already seen multiple digital success stories across the region, with digital-native companies achieving unicorn status (valuation of more than $1 billion). Because of a strong talent base, CEE is becoming a hub for gaming developers and software-development houses, many of which are among the fastest growing companies in the region. Moreover, incumbents in traditional industries are beginning to follow suit, successfully adapting digital solutions both internally and in their client offerings.

The business world, governments, and individuals need to act for the transition to be successful

To realize the aspirational digitization scenario, all stakeholders in digital-challenger countries need to be actively engaged in the digital transformation. Businesses could increase their adoption of digital tools, improving their productivity and ultimately their bottom line. They would also be well advised to take advantage of digital solutions for reaching new customers and expanding into regional and global markets. This export potential is especially relevant in CEE, where the size of the domestic markets limits growth opportunities.

The public sector can play a role in the transformation by using digital technology to achieve faster, smoother processes and services for both companies and ordinary citizens. Individuals must be active, too; investing in lifelong learning will enable them to take advantage of new opportunities in the labor market. Individuals also need to embrace increasing flexibility in their career paths.

Policy makers can support the process on a wide range of fronts. They can promote the adoption of technology by both public and private sectors. They can improve the ecosystem for start-ups and the opportunities for digital innovation—for example, by creating regulatory “sandboxes,” or testing environments. They can also support workers by setting in motion programs aimed at reskilling and upskilling workers.

Collaboration between CEE countries as digital challengers is important

The countries of CEE will only be able to capture the full potential of the digital transformation by cooperating closely with each other:

  • Similar starting points. The countries of CEE have high levels of market openness, similar levels of digitization, and cultural and historical commonalities.
  • Scale effects. Together, digital challengers represent €1.4 trillion in GDP, making them the equivalent of the 12th largest economy in the world.
  • Common challenges. The region’s countries face many similar challenges, such as the “brain drain,” or the emigration of skilled individuals, and need to reskill the workforce.
  • Best practices. Each CEE country has developed a different area of digital specialization, each with its own advantage. Sharing best practices can accelerate the process of transformation.

In the future, digital challengers could work together on digital policy solutions across the region. Efforts could include allowing access to standardized public data sets to fuel innovation and support the digitization of enterprises. Cross-border infrastructure projects would also be possible, such as the introduction of fiber optics or 5G technology infrastructure. The countries of CEE, together with other countries interested in furthering digitization, could form a coalition at a European level to ensure that their digital interests are heard.

The time to act is now

We believe that to benefit fully from digital transformation, the time for CEE to act is now. Our sense of urgency is based on three factors.

First, digital challengers are currently booming economically, with thriving private sectors. In 2017, digital challengers saw their highest levels of GDP growth in more than a decade. This positive environment gives new digital initiatives a head start. History shows, however, that booms do not last forever. Indeed, there are already signs that limitations on growth will emerge in the region, such as negative demographic trends limiting the positive effects from a growing labor force.

Second, we find ourselves on the cusp of a fourth Industrial Revolution, in which new technology will fundamentally transform the economy and the labor market. This seismic change will drive growth and create many new professions: big data scientists, machine-learning engineers, and new technology designers, to name just a few. But it will also create serious challenges. Our analysis shows that up to 51 percent of workplace activities in CEE today—the equivalent of around 21 million jobs—could potentially be automated by 2030 (depending on the economy, future regulation, and the situation in the labor market) using technology that already exists today. This creates both an opportunity for increased productivity and challenges for the labor market. To avoid potential spikes in unemployment, immediate action is needed, such as updating the education system to teach the skills that will be required in the future and creating a support system for lifelong learning.

Third, we are at a point in time where the rules of the digital game are crystallizing and new ecosystems emerging. This is the moment for drawing up digital strategies and developing tool kits for the digital transformation ahead. Many companies, countries, and regions have realized this and are busy developing their long-term digital agenda. If the countries of CEE wish to compete and capture the €200 billion digital opportunity, they urgently need to come together and devise a robust long-term digital strategy of their own.


Download The rise of Digital Challengers: How digitization can become the next growth engine for Central and Eastern Europe, the full report on which this article is based (PDF–10MB).

For a deep dive on the opportunity for digital, tech-driven growth in Central and Eastern Europe, see our interactive digitalchallengers.mckinsey.com.

About the author(s)

Karol Ignatowicz is an associate principal in McKinsey’s Warsaw office, where Tomasz Marciniak is a partner, Jurica Novak is a senior partner, and Marcin Purta is a partner.

The authors wish to thank Kacper Rozenbaum and Kasper Yearwood for their support of the research behind this article. They also wish to thank several McKinsey partners across CEE: Tomislav Brezinscak, Andras Havas, Levente Janoskuti, Tomas Karakolev, Michal Skalsky, Daniel Spiridon, and Dan Svoboda.

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