Studies Eastern European Markets
Eastern European Markets
June, 2006

Tauno Tiusanen
Northern Dimension Research Centre
Publication 31.

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The World Bank report on business environment in different national economies covers all post-communist countries in Europe, as well as all former Soviet republics in Asia. This comprehensive study on institutional circumstances comprising no less than 155 countries allows to evaluate the relative development in TE-region under review from the point of view of doing business in different societies.

In the first part of this short study, TEs involved are analysed in the light of World Bank’s report results. The three Baltic states, Lithuania, Estonia, and Latvia, have the highest ranking in IBRD’s business environment list within the 12 TEs covered here. The first two countries are among the best 20 in the world; Latvia is not far away from her Baltic neighbours. In these three small countries, there has been vigorous economic growth in the early years of the new century, even if the Baltic states have a modest endowment of resources.

Ukraine with rather large population is the worst scoring TE under review in the business environment assessment on the 124th rank of 155. Uzbekistan in Central Asia is the only TE ever below (138th) Ukraine. Thus, there is an urgent need to accelerate institutional reforms, which is not necessarily easy because of political uncertainties in Ukraine.

There is plenty of evidence that FDI inflow in the post-communist period has had a very positive impact on economic development in TEs. It can be maintained that TEs compete with each other, in order to receive FDI from the West. However, there is no “perfect competition” in this sphere. Russia has deliberately limited her FDI inflow by creating special rules for foreign companies willing to enter mining sector, including oil and gas extraction, as well as in financial services (in banking and insurance). Therefore, it can be maintained that Russia is not interested in maximizing her FDI inflow, which by definition contains foreign economic influence.

TE-region’s FDI stock is extremely unevenly distributed between individual countries. The smallest TE under review, Estonia has far the largest FDI stock per capita in the region, about USD 7.000. Hungary and Czech Republic are not far away, while Ukraine at the bottom of the list has a very modest figure of only USD 200.
It is rather generally assumed that EU membership is an important background factor in FDI movement. Before 2004, foreign companies were said to prefer TEs with anticipated early EU entry. Now, after Eastern enlargement of EU, it is visible that NMS-group has higher FDI figures (in relative terms) than other TEs. However, Bulgaria is scoring in FDI competition better than Poland. Romania, Russia, and Ukraine (non-members of EU) are below NMS-group in attracting FDI.

One of the most quoted business climate indicators is called corruption perception index published annually by Transparency International, a non-profit organisation. In this index (CPI), a high number of people are interviewed and asked how they perceive corruption in about 150 countries. No TEs are on the top of the list (they are not classified as entirely honest countries).

In those TEs, which are perceived as least corrupt in CPI-assessment, is the highest concentration of FDI (in relative terms). Poland, Romania, Ukraine, and Russia have a low ranking in CPI-table and a rather modest FDI stock.

It is a well-known fact that Western Europe is better off than post-communist part of the Old Continent. However, the gap in living standard between these two is not very deep when differentials in price levels are taken into consideration. Generally speaking, prices are lower in the East than in the West. Therefore, comparisons in wellbeing must take purchasing power parity corrections into consideration. GDP per capita figures PPP-adjusted show that living standard in Slovenia is higher than in Portugal. Slovenia is far the richest TE in our comparison.

All TE-currencies are undervalued, but not in the same manner. Slovenia’s undervaluation is very modest, while in Ukraine it is remarkably high. Differences can be measured via exchange rate deviation index (ERDI).
Nominal wages are still very advantageous in TE-region in average. Countrywide differences are remarkable. “Real” wages in TEs are much higher than “nominal” ones: “real” income figures are PPP-adjusted.

In cost level comparisons, it is important to note that less than half of FDI stock in TE-region is invested into industry (manufacturing). Actually, about two thirds of that stock is in assets linked with service sector.

There are capital intensive and labour intensive branches in manufacturing. Obviously, firms belonging to the latter, have special interest in starting activities in TE-region with relatively cheap labour costs. Thus, price and wage issues in TE-region are of importance.

Unit labour costs (ULC) were very advantageous in TE-region in 2000 compared with Austrian level, PPP-adjusted (Austria is taken as proxy for EU-15). However, ULC in TE-region shows increasing tendency in 2000-2005 (in comparison to Austria). The relative ULC figure, however, has in that period decreased somewhat in Latvia, Lithuania, and Poland.

In Slovenia, ULC figure in 2005 was about one fourth lower than in Austria. Thus, ULC gap between these two neighbouring countries is not remarkable. If Slovenia with her rather high income level was left out of the calculation, the average ULC level in TE-region (eleven countries) would be just about one third of the Austrian level. The cheapest ULC figure can be found in Bulgaria and Ukraine, which have both ULC levels of about one fifth of the Austrian equivalent. Thus, labour cost savings can be achieved by moving labour intensive activities in production from the West to the East in European framework.

Especially cheap labour in Bulgaria has not been able to guarantee equilibrium in current account. Far the most expensive ULC figure is in Slovenia (within TE-group), which has a well balanced CA. Thus, modest-level ULC cannot be linked with overall competitiveness which is supposed to be reflected in CA results. Furthermore, Slovenia has an essentially lower unemployment rate than Bulgaria.
In the second decade of post-communist development, a very diversified picture can be observed within the selected twelve TEs. Differences are very visible both in institutional frameworks, as well as in economic results between individual transitional economies.

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