Working age population will continue to shrink…

Population aging is visible across all indicators. Share of working population has dropped over last decade from its peak at 69% to 65% and the downward trend will continue. The median age has increased. The share of the elderly in the population has been rising (it roughly doubled since transition), as life expectancy at birth has gone up visibly over thirty years. More importantly, the expected number of years in good health after 65 has been growing as well. While the growing elderly population is mostly seen as a burden to public expenditure (retirement, health care), compression of morbidity (the relative or absolute length of life spent in chronic ill health) may reduce at least some of the burden of aging.

…as fertility rates are below replacement ratio. 

Population growth in the region was hit particularly hard, with fertility rates diving shortly after transformation. They reached all-time lows (slightly above 1) in early 2000 in most CEE countries and began to converge toward the European average (1.56 as of 2017). With the variety of opportunities opening up after transition, the median age of women at first birth increased visibly, from 23 in the mid-1990s to 27-28 currently. Instead of having children, women rushed toward education. The share of women in reproductive age with tertiary education increased four or even five times since early nineties. While this initial drop in fertility was mostly temporary (fertility rates have been on the rise since 2000), the postponement effect may not have ended yet as evidenced by gradually but constantly increasing age at birth in western countries. Further, the fertility rate tends to drop together with economic development. All in all, fertility rates in CEE remain well below the replacement ratio of 2.1.

Increasing female workforce could help labor market 

Although making fertility rates increase is a marathon, CEE could buy time by increasing its female workforce. There is a gap between CEE and the EA (Euro Area) in female employment, that is even bigger compared to Sweden – a country with one of the highest female employment rate. Closing this gap would potentially bring millions of female workers to the job market. Further, both fertility and female labor participation could benefit from developing appropriate institutional childcare in CEE. Analysis of German reform from mid-2000 suggests that expansion of public child care has positive effect on fertility, in particular, increasing the incidence of second
and third birth. 

There is also evidence in CEE that government policies seem to play an important role in how women decide on employment. In Poland, particularly, the introduction of generous child benefits seems to have lowered employment among lower educated women. In the Czech Republic, there is evidence that the introduction of joint taxation in 2005 led to a decline of about 3pp in the employment rate of married women with children. Further, part-time employment, which could particularly encourage young mothers to return to the job market, remains a limited option in CEE. 

Another important aspect of labor force participation is employment by age group. Employment rates remain low, especially among women above 55, as many of them take advantage of early retirement, making the effective retirement age among the lowest in the OECD world.

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CEE Challenges for the new decade:

No.1 Demography

No.2 Going Green

No.3 Rule of Law

No.4 Healthcare

No.5 Euro Adoption

No.6 Labor Market

No.7 Education

No.8 Regional Development

No.9 Capital Markets

On path to meet Green House Gas emission targets…

Greenhouse gas emissions (particularly CO2 emissions) are global drivers of climate change. To avoid negative consequences, a reduction of GHG emissions is needed. CEE countries are on track to meet European targets, with one notable exception – Poland. While CO2 emissions per capita are in general lower in CEE compared to the EU average, CO2 intensity per unit of GDP is higher in all CEE countries. That means high CO2 emissions could be a bottleneck for countries with high growth aspirations (which demand more inputs) unless they change the energy mix or reduce energy intensity. On the other hand, the CO2 intensity suggests that Czechia and Poland in particular should have plenty of room to reduce the economy's carbon footprint.

… energy production mix has to change...

In most countries, the electricity, gas and steam supply sector is a major producer of emissions, followed by transportation. The share of coal-fired power plants in electricity generation remains pretty high in CEE, at 48%, compared with just around 20% for the EU average. The share of coal-fired power plants in electricity production ranges between 77% in Poland to a little less than 11% in Croatia. Excluding Serbia, there were 100 coal power plants in CEE countries, which produced a total amount of 173 Mt CO2 emissions.

Not surprisingly, the highest amount was recorded in Poland (107 Mt). With 44 facilities, it produced 61.8% of all CEE coal-related emissions The Czech Republic follows, at 23.7%. We can see that only two CEE countries produce 85.5% of the air pollution caused by coal plants. The other side of the coin is the much lower wind and solar capacity in CEE. These renewable sources provided little more than 12% of electricity in CEE, which compares with nearly 28% in the EU. CEE therefore has huge potential to catch up even with just the EU average.

… and move away from burning coal

While CO2 emissions cause global problems, there are a lot of locally present negative externalities related to coal-fired power plants. These plants were responsible for an estimated 6,841 premature deaths in 2016 in CEE (including Austria and Serbia). But the damage to health goes beyond the sheer death toll. Air pollution stemming from such plants increases the number of chronic illnesses (adult and childhood bronchitis), increases hospital admissions and translates into lost working days. Health costs stemming just from coal-fired power plants can be estimated in billions of euro per year. As a percentage of GDP, this ranged from 0.1-0.2% in Hungary to 1-2% in Romania, Poland, and Czechia.

Moreover, the running of coal-fired power plants is not economical, even though at first glance it can be considered a cheap source of energy that does not require new investment. The industry has been relying on heavy subsidies, not just direct (as state aid is regulated in the EU), but also many indirect, via loans, guarantees, long-term power purchase agreements, take or pay clauses, tax rebates, special pensions. On top of that, the producers and consumers of such energy have not been charged to compensate for the environmental and health damage the production of coal energy has been causing, which according to IMF estimates exceed the value added reported by the industry by a vast margin.

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Institutions and long-term growth

Capital, labor and technological progress are well-known factors behind economic growth. However, those factors usually do not fully explain the differences between the prosperity of countries. Scholars Douglas North and Daron Acemoglu were among the first to recognize the importance of institutions. Acemoglu sees them as a fundamental cause behind economic development. They can be inclusive, generating prosperity by supporting investments and innovation with secure property rights and balanced distribution of power, or exclusive, dampening growth prospects.

It is not only the type of institutions that influences growth prospects, but also the effectiveness of those institutions and the redistribution of power in society. The CEE region has been continuously lagging behind Western Europe in the quality of institutions for the obvious reasons. Although a Western-like legal system was adopted by CEE countries in the early ’90s, changes in culture, traditions, norms and codes of conduct seem to be a gradual and lengthy process. The Baltic countries, however, are an example of how dynamic changes are possible. Latvia and Lithuania have progressed the most in terms of improving their rule of law ranks (Worldwide Governance Indicators), while Estonia is ranked top among former communist countries. Estonia also scored the best among its peers in the Corruption Perception Index in 2019.

All in all, positive developments after transition cannot be questioned; however, recently observed increase in populism and weakening rule of law might take a toll on long-term growth prospects. We recognize, for example, that lack of structural reforms weighs on long-term potential growth in Romania. Digitalization of the fiscal authority, streamlining of the education system to bring it closer to labor market needs, better capacity of the public administration to absorb EU funds and constitutional reform require solid political support, however. The effects are not likely to be immediate, but should become apparent over time.

Deterioration in democracy level

A falling Democracy Index (Economist Intelligence Unit) is a global phenomenon, as in 2019 it reached its lowest point since its creation in 2006. In the region, Czechia, Hungary and Poland in particular fit the downward trend. Hungary experienced the biggest overall deterioration in the Democracy Index. In Poland, more visible deterioration began in 2015, as a result of which Poland slipped below Hungary for the first time, mostly reflecting concerns over changes in the judiciary system.

On the other hand, Slovakia and Romania seems to have experienced a small uptick in 2019 Democracy Index. Corruption is a hotly debated issue in both countries. In Slovakia several corruption allegations linked to high politics started to emerge following the murder of an investigative journalist and his fiancée in 2018. The new government won elections chiefly thanks to its heavily emphasized anti-corruption electoral campaign. It has announced wide-ranging plans it wants to enact in order to tackle corruption, improve institutional quality and the rule of law in the country. This includes better processes for appointing prosecutors as well as several other judiciary reforms.

In Romania, corruption related issues brought thousands of peoples into the streets in 2017 in response to Social Democratic Party overnment’s legislation proposal to decriminalize the offence of abuse of power. In the course of the following years, European institutions also expressed the concern over Romanian judicial and criminal laws that could even lead to EU sanctions. In 2019, National Liberal Party formed a government and is currently leading in the opinion polls.

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Reduction of risk factors is most crucial…

The relatively high preventable mortality in CEE is associated with the fact that people in the region are more exposed to risks factors such as smoking, alcohol , air pollution and an unhealthy diet (lack of high-fiber food). Risk factors increase the incidence of ischaemic heart diseases and cancer, the two largest contributors to premature deaths.

Smoking is the key risk factor in CEE countries which needs to be tackled. While the share of adults smoking daily has been on the decline in the last decade in the EU, there has been hardly any progress in CEE countries, with the sole exception of the Czech Republic. The situation is particularly worrying among teenagers, as about 29-33% of 15-16-year-old Croats, Slovaks, Czechs, Romanians and Hungarians smoke regularly or occasionally. CEE countries have not increased tobacco excise taxes as much as Scandinavian countries, Ireland or the Netherlands and keep them close to the minimum level required by the EU Directive. The affordability of cigarettes could be one of the reasons why CEE countries have been less successful in reducing smoking rates.

…together with intensified prevention

Early diagnosis of disease can substantially increase the effectiveness of treatment and chances for survival. Thus many countries have intensified
screenings for risk groups. This is the case for cervical cancer screening, where substantial expansion of screened groups in Poland and Romania led to a visible progress in the reduction of cervical cancer mortality. Romania would still need to at least double the number of cervical screenings to curb its cervical mortality rate, which is the highest in the EU.

Over the last decade, the five-year net survival rate of breast cancer has improved in the EU thanks to early diagnosis and effective treatment. Unfortunately, it remains rather low in Romania and Slovakia, which lag far behind other countries in mammography screening, or in Poland, where the number of screenings only recently increased. Some progress has been made in the reduction of colorectal cancer mortality (mainly in the Czech Republic), but potential for improvement remains very high in all CEE countries, especially in Slovakia, Croatia and Hungary.

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Institutions and long-term growth

Capital, labor and technological progress are well-known factors behind economic growth. However, those factors usually do not fully explain the differences between the prosperity of countries. Scholars Douglas North and Daron Acemoglu were among the first to recognize the importance of institutions. Acemoglu sees them as a fundamental cause behind economic development. They can be inclusive, generating prosperity by supporting investments and innovation with secure property rights and balanced distribution of power, or exclusive, dampening growth prospects.

It is not only the type of institutions that influences growth prospects, but also the effectiveness of those institutions and the redistribution of power in society. The CEE region has been continuously lagging behind Western Europe in the quality of institutions for the obvious reasons. Although a Western-like legal system was adopted by CEE countries in the early ’90s, changes in culture, traditions, norms and codes of conduct seem to be a gradual and lengthy process. The Baltic countries, however, are an example of how dynamic changes are possible. Latvia and Lithuania have progressed the most in terms of improving their rule of law ranks (Worldwide Governance Indicators), while Estonia is ranked top among former communist countries. Estonia also scored the best among its peers in the Corruption Perception Index in 2019.

All in all, positive developments after transition cannot be questioned; however, recently observed increase in populism and weakening rule of law might take a toll on long-term growth prospects. We recognize, for example, that lack of structural reforms weighs on long-term potential growth in Romania. Digitalization of the fiscal authority, streamlining of the education system to bring it closer to labor market needs, better capacity of the public administration to absorb EU funds and constitutional reform require solid political support, however. The effects are not likely to be immediate, but should become apparent over time.

Deterioration in democracy level

A falling Democracy Index (Economist Intelligence Unit) is a global phenomenon, as in 2019 it reached its lowest point since its creation in 2006. In the region, Czechia, Hungary and Poland in particular fit the downward trend. Hungary experienced the biggest overall deterioration in the Democracy Index. In Poland, more visible deterioration began in 2015, as a result of which Poland slipped below Hungary for the first time, mostly reflecting concerns over changes in the judiciary system.

On the other hand, Slovakia and Romania seems to have experienced a small uptick in 2019 Democracy Index. Corruption is a hotly debated issue in both countries. In Slovakia several corruption allegations linked to high politics started to emerge following the murder of an investigative journalist and his fiancée in 2018. The new government won elections chiefly thanks to its heavily emphasized anti-corruption electoral campaign. It has announced wide-ranging plans it wants to enact in order to tackle corruption, improve institutional quality and the rule of law in the country. This includes better processes for appointing prosecutors as well as several other judiciary reforms.

In Romania, corruption related issues brought thousands of peoples into the streets in 2017 in response to Social Democratic Party overnment’s legislation proposal to decriminalize the offence of abuse of power. In the course of the following years, European institutions also expressed the concern over Romanian judicial and criminal laws that could even lead to EU sanctions. In 2019, National Liberal Party formed a government and is currently leading in the opinion polls.

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CEE labor market trends

After a fast catching-up process, the CEE region continues to offer a relative labor cost advantage vs. Western Europe, with companies benefiting from a similar regulatory environment. At the same time, accelerated know-how and technologies transfer within the single market have resulted in much faster productivity convergence in CEE relative to income convergence.

The main trends that have been affecting labor market development over the last two decades are:

• Migration: Number of CEE-born population living abroad has increased fourfold since EU accession, i.e. almost 9mn people have emigrated from the region.
• Education: Currently, one third of the working age population has a tertiary education, compared to only 10% in 2000.
• Aging society: Low fertility rates and an increase in life expectancy result in a rising share of the population over 65.

Youth employment gap

While employment rates in CEE do not differ significantly from the EU average, we look at Sweden as a benchmark target, as it has one of the highest employment rates in the EU27. Firstly, the youth employment gap is quite visible. While in the case of men this gap closes at the age of 25 (CEE has an even higher employment rate than Sweden), in the case of female employment, the gap persists for another 10 years, due to particularly lengthy maternity and parental leave in CEE. Low female employment before the age of 35 is another distinctive feature of the region. The gap compared to Sweden closes between the age of 35 and 50 and opens up again for the 50-64 age group, due to the relatively low retirement age, among other factors.

Integration of the young generation into the labor market is a factor that could also ease pressure for employers, especially in Slovakia, Romania and Bulgaria. The high share of young people (aged 20-34) neither in employment nor education and training (NEET) in these countries could also be partially explained by the significant marginalization and segregation of Roma population.

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Education affects employment and wages

Educational attainment has been continuously improving in the EU and particularly in CEE. The convergence story of CEE has also been supported by the improving educational attainment level. Since 2005, the share of people with tertiary education increased from 20% to 28% in the EU, while in CEE8 it almost doubled (up from 13.8% to 26.5%). However, the share of people with tertiary education in the region remains below the European average of 30.2%, with Romania having the biggest gap.

Interestingly, the gender education gap also widened, with more females obtaining a higher level of education than males. Back in 2005, the gap was almost non-existent, while in 2019 it was 3pp in the Eurozone and as much as 7pp in the CEE region.

At the same time, higher educational attainment is associated with a lower risk of being unemployed. Last year in CEE, the average unemployment rate of those with tertiary education stood at 2.2%, compared to 3.5% of those with upper secondary education. The premium seems to be particularly high, however, if compared to those who have only primary education, for whom the unemployment rate was at 10.3% in 2019.

Within CEE, Slovakia clearly stands out, as one in four people with primary education remains unemployed, while in other CEE countries it is one in ten people, at most. In Slovakia, such a high unemployment rate in the group with primary education is most likely driven by the Roma minority. During times of crisis, those with primary education also seem to be more exposed to job loss. Over the following three years after the 2009 crisis, the unemployment rate of those with primary education went up by almost 4pp, while those with upper secondary and tertiary education saw a rise of roughly 2pp.

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CEE capital cities are catching up quickly

Increasing attention has recently been paid to regional development, with a focus on removing inequalities. Regional development - which in many cases involves the development of the rural areas in a country - has become a focus of policy-makers. Politicians are being forced to address the issue of providing equality, given the increasing discrepancies between the status of capital cities and the rest of a particular country.

According to an OECD study², together with faster growth in high per capita income countries since 2011, the regional disparities between the countries increased. On the other hand, the regional economic disparities within countries have been falling since their peak at the beginning of the global financial crisis. However, they remain significant in most OECD countries. In 2016, on average, GDP per capita was more than twice as high in the top 10% of a country’s regions as in the bottom 10%.

Regional income disparities within and across the countries arise from differences in labor productivity. Higher labor productivity is in general associated with regions with a large share for the services sector - those are usually the capital regions. The OECD points to the high and increasing importance of capital regions, which on average accounted for more than one quarter of national GDP in 2016. The capital cities and metropolitan areas (agglomerations of at least 500,000 inhabitants) are important for the overall convergence of the country, as they tend to have higher rates of innovation and firm creation.

In CEE, the division between more and less developed regions is seen around a west-east axis. The eastern parts of CEE countries usually have much lower GDP per capita compared to central regions. Despite the availability of Cohesion Funds that should mainly support the less developed regions, the pace of convergence differs visibly between capital cities and the rest of the country.

With the fast income convergence of CEE capital cities, the satisfaction of living in those cities has also been rising. According to the European Commission Quality of Life study³ from 2019, the overall satisfaction with living in the city among the CEE capitals is the highest in Warsaw, Prague, Bratislava, Ljubljana and Zagreb, where 90-92% of respondents strongly or somewhat agree with the statement. In Budapest and Bucharest, the overall satisfaction is slightly lower, standing at 86% and 81%, respectively, while in Belgrade the situation looks the least favorable, as the satisfaction rate stands at 63%.

Prevailing domestic disparities

In the CEE region, more than one third of the total population is living in rural areas that are characterized by lower living standards. The access to Cohesion Funds supported regional convergence, as the gap in disposable income between the richest 10% and poorest 10% of regions over the 2006-16 period narrowed in all CEE countries but Poland. In Poland, the regional divergence was due to the better performance of the richest region. Elsewhere, faster catching-up of the poorest regions resulted in regional income convergence. Although living standard have improved in rural areas across CEE, poorer access to education and equal chances in less developed areas remain the key obstacle in the catching-up process.

Enrolment in tertiary education shows strong regional disparities. While in the cities, the share of the population enrolled in tertiary education is above or close to the EU27 average in all CEE countries, in the rural areas this holds only for Slovenia and Poland. Other CEE countries are characterized by a lower share of the population with higher education in rural areas compared to the EU27 average.

Poorer access to education results in an outflow of the talented, skilled and young workforce to urban areas, which offer a broader range of opportunities. Poorer access to higher education and limited job opportunities result in increased migration from rural areas to urban areas, namely from poorer to more wealthy regions. Those who leave are usually young people seeking better employment opportunities in the cities. As a result, rural areas are depopulating and are characterized by increasing old age dependency ratios.

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What is the gap compared to the EU average?

CEE is behind the European average in the importance of securities markets in financing. As for non-financial corporates, CEE companies only have 0-6% of GDP in debt securities on their liability structure, as opposed to the nearly 12% on the EU level. The role of listed shares is between 2.4%-20.7% in CEE, whereas in the EU, this is nearly 47% of GDP. The gap is proportionately lower for loans, however, with CEE ranging between 37%-51% of GDP, while the EU standing at 65%.

Savings of households paint a similar picture. CEE countries are very heavy in cash and deposits (ranging between 27-63% of GDP), barely below the 69% of the EU average, while savings in listed shares is just 0.3%-3.9% in CEE compared to nearly 10% of GDP in the whole EU. CEE also remains well behind the EU in terms of insurance, pension and guarantees, and investment fund shares. As for debt securities, Hungary might look quite developed, but its high share is attributable to large holdings of 5-year retail government securities. These bonds offer a valuable put option after coupon payment and a yield to maturity nearing 5%, making this investment competitive to deposits.

With the low interest rate environment, households have started to seek higher returns. In recent years, investing in real estate has gained in popularity, as ownership of a tangible asset has been seen as a “safe long-term investment” and superior to investment in securities. It is only a matter of time before investors realize that real estate investments also have their cons – they are less liquid, require a high initial payment, lack diversification, and are more demanding in terms of property management and maintenance in the case of second-home ownership. 

Pension savings could enhance the role of capital markets in CEE

Pension savings is another area where improvements could potentially enhance the role of capital markets in the region. Besides the pay-as-you-go (PAYG) systems as the first pillar, several regional countries introduced second and third pillars. Second pillar reforms (which means that some part of social contributions was needed to be channeled from the PAYG system) were reversed in Hungary and in Poland in recent years, however. The second pillar was also liquidated in 2016 in Czechia, downsized in Slovakia and temporary open for opting out. In Romania, the second pillar was only established in 2008, but Croatia established it in 1998 already. The latter has over 20% of GDP in pension assets. Due to the second pillar, Croatia scores relatively well in pension system sustainability¹, despite its ageing population and negative migration balance. Tax benefits for third pillars exist everywhere in CEE, but these pillars are mostly completely voluntary.

Financial literacy: a key to a more prosperous population

Financial literacy, financial inclusion and robust financial consumer protection framework are all crucial to empowerment of individuals and can contribute to the overall stability of the financial system. The COVID-19 crisis again revealed gaps in people’s financial knowledge and highlighted the need for better financial education and higher financial inclusion. According to OECD 2020 International Survey of Adult Financial Literacy² conducted in 26 countries in Asia, Europe and Latin America on average around 70% of respondents reported that their savings would last them for up to 6 months with almost 30% having a financial cushion for one week or less. Therefore, as one of the elements of the COVID-19 recovery program, OECD announced that it will double efforts to promote financial literacy.

Furthermore, the OECD 2020 International Survey of Adult Financial Literacy³ found that the overall financial literacy score is low across sampled economies. Individuals scored just under 61% of the maximum financial literacy score, even in advanced economies with developed financial markets. Overall, the financial literacy score includes three sub-categories: financial knowledge, financial behavior and financial attitude. Financial knowledge score measures the ability of individuals to compare financial products and services and make appropriate, well-informed decisions. The financial behavior component looks at following behaviors of consumers: saving and long-term planning, making considered purchases and keeping track of cash flow. Finally, financial attitude looks at attitude to long-term financial planning. As far as the CEE region is concerned, Slovenia has the highest Financial Literacy Score followed by Poland, while Romania had the lowest score.

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