High tech investment the answer to CEE’s labour crisis

High tech investment the answer to CEE’s labour crisis
Robots are increasingly replacing workers in the automotive industry.
By Clare Nuttall in Glasgow December 17, 2018

As labour markets tighten across Central Europe and employers struggle to fill vacancies, economists say the best outcome for the region is for companies to respond to worker shortages by investing into new technologies to make their businesses more efficient and move away from the old low cost model to a higher value added one. 

Since the fall of communism, the countries to the east of the former Iron Curtain were seen as attractive manufacturing destinations for West European companies thanks to their combinations of much lower costs, their proximity to Germany and other western markets, and their skilled workforces. 

This type of investment was initially focussed on the most developed countries in Central Europe, leading to Slovakia, for example, becoming the world’s top country in terms of car production per capita. The auto assembly and components industries in particular have focussed on Central Europe, although companies of all types — from clothing production to aviation — have targeted the region, gradually fanning out southwards and eastwards as business conditions improved in less developed markets and costs started to rise in the Visegrad region. 

A new McKinsey report refers to a “golden age of growth” in CEE during this period. The report, titled “The rise of Digital Challengers: How digitization can become the next growth engine for Central and Eastern Europe", looks at 10 countries across Central and Southeast Europe — Bulgaria, Croatia, the Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia — which, it says, recorded on average a 114% increase in GDP per capita between 1996 and 2017, compared with an increase of just 27% in the EU’s “Big Five” economies, France, Germany, Italy, Spain and the UK. As well as labour cost advantages, this growth has also been driven by factors from ranging from traditional industries, strong exports and EU funding. 

Overall, “[t]he CEE region has become one of the most attractive places to invest in globally,” says the report. 

 

Slowdown ahead 

 

Recently, however, this trend — combined with mass emigration from the region to Western Europe — has led to a sharp tightening of the labour markets especially in the Visegrad Four, with unemployment rates plummeting to post-communist lows in countries such as Czechia, where it dropped to a 21-year-low of 2.8% in October, and Poland where the rate of 5.7% recorded in September hasn’t been seen since the early 1990s. While this is mainly a phenomenon in the most advanced economies in the region, a tightening labours market has also been seen to some extent in Southeast Europe’s largest economy Romania, where a ManpowerGroup survey released in June found that more than four out of five employers in Romania are facing difficulties in finding employees with the skills they need, putting the country among the greatest sufferers from the global talent shortage identified by the international recruitment firm. 

McKinsey lists rising workforce costs and limited labour reserves among the reasons for an expected weakening of CEE’s growth trajectory. On top of this, its report says, “CEE economies are generally undercapitalised compared with their more advanced European peers. The capital stock, measured as total gross fixed assets per employee, is 60% lower than the average for the EU Big Five … 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."

Companies across CEE are already responding to the labour market squeeze by becoming more creative in how they attract and retain workers. In the IT sector, for example, companies offer flexible working hours and lifestyle benefits modelled on those provided by Silicon Valley firms. In an interview with bne IntelliNews last year, serial Romanian entrepreneur Cezar Nourescu, creator of silo monitoring technology Silometer, said the trick of getting the best people is to know how to attract them. He described his workspace as “Google-ish” with Wiis and Playstations, flexible hours and free food. 

Firms are also increasingly looking to cross border recruitment. The presence of Ukraine, with its 44mn strong population, immediately to the east of the Visegrad countries has been a pressure valve for Poland especially. Ukrainians started flooding into Poland and other EU countries in 2014, but numbers increased  sharply after Kyiv secured a visa-free travel deal with the EU in November 2016.

Poland became a favourite destination for Ukraine’s Gastarbeiters, with wages in CEE’s largest economy four times higher than at home. And Warsaw sought to take advantage, offering special work permit schemes that grant limited right to work permissions. As a result, millions of Ukrainians left their homeland, albeit many of them only for a few months to earn extra cash in EU countries. 

Recently, however, the flood of Ukrainians leaving the country to look for work in the EU countries has peaked, and will stabilise or start to decrease next year, said a report by the Centre for Eastern Studies (OSW) released in October. “The increased wave of migration from Ukraine to Poland, which began in 2014 is slowly beginning to decelerate. This migration is still mainly temporary in nature, and it is difficult to assess to what extent it may become fully residential. Probably over the passage of time, the current circular migration model will stop attracting new people,” wrote OSW analyst Marta Jaroszewicz in the report. 

Ukraine isn’t the only source country for migrant workers moving to CEE, however, reports from countries in the region document migration from countries as far away as India, Nepal and Southeast Asia. The arrival of new workers can help CEE economies continue to offer a low cost alternative to Western Europe, and wages in the region remain below those in most West European economies, despite years of convergence. Romania's hourly labour cost, for example, rose 15.6% y/y in the second quarter of the year, marking the highest annual increase in the EU, data from Eurostat showed, but wages in the Southeast European country remain among the lowest in the bloc. 

 

A different approach

However, economists say that to continue to be competitive internationally, what companies really need to do is start investing seriously into advanced new technologies and processes. 

“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,” says the McKinsey report. 

“By closing the digital gap with Northern and Western Europe, CEE could earn up to €200bn in additional GDP by 2025 — a gain almost the size of Portugal’s entire economy in 2017. In this aspirational scenario, the region’s digital economy would grow to represent 16% of GDP by 2025. That would mean up to 30% additional GDP growth, the equivalent of one extra percentage point on GDP growth each year over the period.” Specifically, digitisation would help by improving the region’s productivity by boosting e-commerce and offline consumer spending on digital equipment.

On the other hand, “[t]he alternative “business as usual” scenario is one in which the digital economy in CEE maintains its historical growth rate, expanding by just €60bn and representing 8.7% of GDP in 2025,” the report continues. “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.”

Economists from the Vienna Institute for International Economic Studies (wiiw) also stressed the importance of investment into productivity in a new report on the region. In a webinar to present the report on November 7, wiiw economist Richard Grieveson referred to the current “very significant” labour shortages as “the main positive risk for the region” — should they force a rethink of investment. 

“Vacancy rates are very high. There is really substantial unmet labour demand, which has never been seen before,” said Grieveson. “One possibility which we are seeing, and are cautiously optimistic will continue, is that firms are paying higher wages and investing in productivity upgrading. 

 

Well placed to invest 

McKinsey analysts consider countries in the CEE region “are uniquely positioned to capture the digital opportunity”. It describes the 10 countries covered in the report as “digital challengers” given their strong potential for growth in digital. This means they have the potential to follow “digital front-runners”, namely relatively small European countries with very high digitisation rates like Estonia, Ireland and the Scandinavian countries. 

For comparison, the digital economies across the digital challengers accounted for 6.5% of their combined GDP in 2016, which put them almost level with the EU Big Five (6.9%), but behind the digital front-runners. On the other hand, the growth rates of the digital economies in the digital challenger countries in much faster than those of the EU Big Five at 6.2% per year between 2012 and 2016. 

“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),” says the McKinsey report, which also lists positive factors such as good primary and secondary education with respect to maths and science literacy. Then there is the large talent pool in the science, technology, engineering, and mathematics (STEM) and ICT sectors, with no less than 230,000 graduates in these subjects in 2016, which is more than any of the EU Big Five markets and twice as many as the entire digital front-runner region. The CEE digital challengers have also invested into high-quality digital infrastructure, and are less hidebound by older technology infrastructure than the Northern and Western European countries. 

All this has helped the development of a vibrant emerging digital ecosystem, with a conducive environment for software development and game development, for example, and the emergence of a growing number of “unicorns” with valuations of more than $1bn, among them Czech antivirus software company Avast and Bucharest-born robotic process automation (RPA) company UiPath. 

But digitisation isn’t just a task for the private sector, McKinsey analysts believe, saying that the public sector also needs to get involved in using digital technology to improve the business environment and for governments to promote the adoption of new technologies and create positive conditions for startups and high tech businesses.

The report also stresses that rapid action is needed. “We believe that to benefit fully from digital transformation, the time for CEE to act is now,” says McKinsey. The consultancy identifies three reasons for this. The first is specific to the region, where the CEE economies are booming, yet there are already signs already that the fast growth is slowing. 

Then there are two global factors. McKinsey believes the world is “on the cusp of a fourth Industrial Revolution, in which new technology will fundamentally transform the economy and the labour 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.” 

The report points to the potential for automation in the region, saying that to “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.” Indeed, an earlier OECD report identified workers in Slovakia as the most likely among the 32 OECD members to lose their jobs as automation technologies are adopted. 

And finally, “the rules of the digital game are crystallising and new ecosystems emerging”, says McKinsey’s report, and many companies are now drawing up long-term digital strategies. “If the countries of CEE wish to compete and capture the €200bn digital opportunity, they urgently need to come together and devise a robust long-term digital strategy of their own,” the report concludes.

 

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